John McIlwain, ULI Senior Resident Fellow for Housing, describes the U.S. housing market, and how it will be affected by demographic trends. John’s talk was recorded at a gathering of ULI trustees on Jan. 26, 2010.

For the 12-month period ending in March, Atlanta saw 8,972 housing starts — ranking No. 5 out of the metro areas tracked by Metrostudy. Houston topped the list with 22,502 housing starts during the same period.

According to the study, Atlanta also had the fourth-largest supply of vacant, finished new homes with 8.8 months-worth.

Home Prices

Home prices continue their downward trend. Prices in Atlanta have declined 15.7% from May 2008 to now. They have also lost 1.7% since February. Atlanta continues to “perform” better than most of the other major markets except a select few.

The Case Shiller index shows Atlanta stands at about 105. That means that homes have only appreciated 5% since January 2000. This puts Altanta near the bottom of housing appreciation of the 20 major markets that Case Shiller tracks. Only Cleveland (96) and Detroit (71) have performed worse over the past nine years. That’s fairly poor – other southeast cities that the index tracks are Charlotte (119) and Miami (149) have fared significantly better.

Despite the pessimism of the Case Shiller numbers for Atlanta, Steve Palm of SmartNumbers told the AJC that home prices hit a bottom in February.

“Case-Shiller is a great survey, but you just can’t read too much into that,” said Steve Palm, president of SmartNumbers, a real estate research firm in Marietta. “February was still the bottom, and I say that because we have every [home loan] closing tracked, so I know February was the bottom.”

Palm said the average April sale price was up $10,000 over March, which is “a very good sign.”

Finally, the National Association of Realtors says that homes are now undervalued. Be careful, though, how much stock you put into NAR’s information. I’ve included a link to their information just to be complete – I’m very skeptical of anything that NAR puts out.

There is also concern that the home price trend is now pushing into “formerly stable markets”. (Stable markets is the WSJ’s term – not mine. Sounds like an oxymoron to me.) This was inevitable, though. Overall, economist Phil Dales expects housing prices to drop another 5-10% yet.

Home Sales

Despite Georgia having the lowest mortgage rates in the country, and rates overall are practically the lowest they have ever been, economist John Lonski says they aren’t low enough to bring equilbrium in the market.

However, home sales in April were up 2.9% over March.

“Most of the sales are taking place in lower price ranges and activity is beginning to pick up in the midprice ranges, but high-end home sales remain sluggish,” said NAR chief economist Lawrence Yun. “The Federal Reserve needs to help restore liquidity for the jumbo mortgage market by buying these loans under the TALF program.”

The number of first time buyers declined to 40 percent in April, a sign that NAR says indicates more repeat buyers are getting back into the market. And the number of people actively looking for a home to buy is up 14 percent from a year ago.

This article in the Wall Street Journal has reactions from a number of economists on the housing market, including a lot of very good data – too numerous to reprint here. There is a concern that we may have hit a false bottom in housing however, as foreclosures were up 40% from March in April in California. The always optimistic NAR says that home sales will bottom in the second quarter of this year.

Home Construction

Looking at bad news optimistically, home builder confidence rose in April from March from 12 to 14. While it did rise, anything under 50 indicates that market conditions are poor. Builder expectations over the next six months rose from 24 to 27.

Home construction in general has gone down significantly from even last year. Generally, permits and starts are down for April 2009 about 50%. The number of “Zombie Subdivisions” is a major concern too – with lot inventory so high that even in the usually stable coastal markets along the east coast, they’re at least a couple of years away from seeing shovels and hammers.

Again, this article in the WSJ has a ton of data on home construction and is very much worth the read. Real estate investor Sam Zell sees the recovery happening this summer because of demand returning. In support of that, at least one firm expects a big recovery in housing because new construction is off so much that demand is going to out pace supply very soon.

Bottom Line

I would strongly reccomend reading the linked articles and drawing your own conclusions on housing market. There is an incredible amount of information there – too much to even summarize here.

In my early January blog regarding this year’s residential real estate market, I commented that I didn’t think we’d likely see a bottom until next year. I still believe that, but there has been some encouraging news develop in the metro Atlanta area over the past two weeks.

The metro area’s biggest builders have started buying lots and are preparing to build again, according to an article in the Atlanta Business Chronicle.

For Centex, the purchase of the remaining 15 developed lots in Laurel Pond off Kimble Bridge Road in Alpharetta marks the first time in nearly a year the builder has purchased lots in metro Atlanta.

Centex (NYSE: CTX), which is down to single-digit new home inventory, bought the lots out of foreclosure from Colonial Bank in December, said Brent Landry, director of sales and marketing at Centex Homes in Atlanta, the 14th-largest home builder according to Atlanta Business Chronicle’s 2008-2009 Book of Lists.

Databank Inc., a real estate research firm, reports Centex paid about $1.3 million for the lots.

Centex is building homes on two of the Laurel Pond lots, Landry said, and will build more as those homes are sold.

D.R. Horton (NYSE: DHI), Atlanta’s third-largest home builder, bought lots in three new subdivisions in the past quarter, said Andy Oxley, chief operating manager for D.R. Horton’s Southeast region. Some of the lots were purchased out of foreclosure, others from developers at current market rates, he said.

Ryland Homes (NYSE: RYL) is scouting the market for deals, said Chuck Fuhr, Ryland’s Atlanta division president.

That’s a fairly significant move, although not huge, it signals that the builders are beginning to see something change in the market. It was a signal in the fourth quarter of 2006 from a builder who I worked with that things in the residential market were making a significant change for the worse. They were obviously on top of their game. Now, it appears that perhaps those builders who were seeing something wrong in 2006 are beginning to see something right in 2009. We certainly have a long way to go – single family building permit were down in the last quarter of 2008 by 75% over 2007 and 90% from 2005.

Now, closely related to this, because these builders are “large” builders, is a bill that is winding its way through congress. The builders would be able to take advantage of a huge tax break.

According to Zelman & Associates, a housing research firm, the nation’s 13 largest builders will reap $2.4 billion in tax refunds this year under the current law, which is more cash than Zelman expects them to generate from selling homes and land. Under the current tax law, many big builders won’t qualify for sizable refunds in the coming years, and they have been lobbying for the proposed change.

But some small builders say the measure would encourage big builders to continue to dump land and houses for artificially low prices to generate a loss for tax purposes. That, in turn, would drag values down even further, they argue.

Here is a good example of government influence in the market that makes it difficult to actually understand if market forces are at work or manipulative forces are at work. With the passage of the stimulus bill, this kind of conundrum will continue to rise – it’s going to be difficult to tell what is a real, sustained recovery and what is a recovery that may only be temporary because of either short term government spending or tax breaks.

Meanwhile, builders face another problem – foreclosed homes. Although this article focuses on builders, the guy trying to sell his home so he can move to a new job faces an even bigger hurdle. Much like the small builder who can’t take advantage of the tax break discussed above, the homeowner who is trying to sell his home also has a liquidity problem trying to sell his home against banks and builders.

As the normally hot spring selling season begins, two houses in the Inland Empire region of Southern California sum up the big problem facing many of the nation’s largest home builders.

One of the houses, a four bedroom built in 2006 that was seized by a lender in a foreclosure action, is listed for sale at $229,900. Meanwhile, in the same housing development, D.R. Horton Inc. is trying to sell a new house that looks nearly identical for $299,000, or 23% more.

Or consider Pulte Homes Inc.’s predicament in Henderson, Nev., near Las Vegas. The builder is trying to sell a new, four-bedroom house for $214,990, while a home owner is trying to dump a similar house, which Pulte built two years ago, for $149,999. That price is less than the owner’s mortgage under a “short sale” approved by the lender.

In many markets, “we are no longer competing with other builders. We are competing with foreclosures,” said Steve Ruffner, president of the Southern California division of KB Home.

All-in-all, the good news is that supply continues to diminish, and with so few new homes coming on to the market, we’re beginning to see the signs of a “bottom” in terms of home sales. It is likely that we will continue to see prices fall and that we’ll stay close to where we are now for at least the next year.

First, the theory behind the ever increasing need for housing is, of course, population growth. Estimates indicate that the U.S. population grew by 1 percent last year to 305,529,237 people. One percent would equate to adding a little over 3 million people to the U.S. last year. And, as is so often said, they have to live somewhere. The big questions? Where and in what?

2008 saw record decreases in home values, and they are expected to fall even further in 2009. Unfortunately, this is a near certainty that the prices will fall by as much or more than 2008 because further job losses are expected throughout the year. A report in the Wall Street Journal indicates that the value of homes dropped 18% nationwide from October 2007 to October 2008. For those of us in the Atlanta market, it showed a record decrease in monthly home value from September to October 2008.

Home prices will continue to fall until they get their historically correct price relative to income. This is highly dependent on the market being served, but in general outside the coastal regions, homes are still over priced by anywhere from 15-50%. Still. The coastal regions see an even bigger disparity – 50-100% or more and California is the proving ground of how home prices cannot possibly outpace income to the level that they did there.

Most of us are sick of hearing it, because it keeps being predicted to have happened (or soon to happen) and they keep getting it wrong – when are we going to hit bottom? Forecasters are now saying it will be the second half of 2009 or later. Personally, they should stop trying to predict “the bottom” because we’re not going to get there until employment turns around. And it’s a fool’s errand to attempt to predict when employment is going to stop seeing losses. This means that it likely will actually be at least 2010 before a bottom even has a chance of occurring. A recent study indicates that housing slumps like we’re in now last an average of 6 years – which means we’re only about half way through the current challenge.

Here’s an interesting quote regarding new home inventory.

“Home-building activity has declined so much that the backlog of unsold units is starting to be absorbed at a fairly rapid clip even in the face of such a slow sales environment,” said Morgan Stanley economist David Greenlaw, who added that inventories won’t drop to “manageable levels” for six to nine months.

In support of Mr. Greenlaw’s statement – and that is the stunning decline in new home building – is this chart from Dr. Housing Bubble.

Unfortunately, the month’s supply of new homes continues to climb – as a nation we are at a 12-month supply of homes. A normal supply of homes is usually in the 6 to 7 month range. Even as the number of new homes coming to market faces steep decline, the supply continues to increase because of the number of distressed homes coming on to the market. Distressed homes now make up about 50% of the homes on the market.

This article is particularly good at explaining where we’re at and where we’re going. The best part is the very last section, titled “The Daily Changes we will Face”.

Consider this blog an “executive summary” of the linked articles. If you have a keen interest in the residential real estate market, I would encourage you to read all of the linked stories in their entirety as they will give you a lot of helpful information on the 2009 residential real estate market.

My reaction – no kidding.

In fact, that’s the same words used by a client earlier this year. It was quite obvious that the problems were huge. In fact, they’re bigger than huge – they may be insurmountable for a long, long time. Take a look at this statistic from Metrostudy, a group that tracks Atlanta’s housing industry.

James said sales closings were down 44 percent for the third quarter, compared to the same period last year, and housing starts had plunged 67 percent. The metro area also has about 148,000 lots with infrastructure but no homes — a 117-month supply, he said.

A 117-month supply – or nearly 10 years. 148,000 lots without a home. Even in the best of times, that supply is at least 4 years. A healthy supply would be 18-24 months.

The rest of the article is a bit unnerving for the simple reason that the reactions to this problem are not realistic. Down payment assistance, as proposed by the Lt. Governor, won’t solve the problem of buyers not being able to get loans. The banks foreclosing and suing small builders is pointless. The idea of using the state employee’s retirement fund to buy residential projects only makes sense if they pay the right price, but using California as the example is bit silly given that economy is in worse shape that Georgia’s.

The answer is for the market to work through the supply. The prices will come down to the point where they will be bought – but it’s going to take time. Almost certainly years. But that’s the market. Speculation is the very definition of risk and a lot of people speculated on the metro Atlanta housing market. Some won and a lot lost. It’s unfortunate, but that’s the risk of chasing a speculative market.

The comments that follow the article are, for the most part, hilarious. People don’t realize the broad reach of the residential building market. It employees hundreds of thousands of people. It’s not just the developers and builders who are hurt in this market. It’s government employees, teachers, engineers, retailers, doctors – nearly every business gets an not insignificant percentage of their work as either a direct result of the housing industry or indirect result. It’s the furniture stores who sell new furniture to the new homeowner. It’s the road improvement projects that result of the sales tax from those furniture sales. It’s the new business that starts because the road as been improved and now people travel that road.

Metro-Atlanta is certainly facing some very tough times, but the market will eventually correct itself. We’ll be smarter, at least for a time, and we’ll make better decisions. That’s the lessons that successful businesses learn in times like these. The ones who don’t learn go out of business – and that’s the way it should be in a free market.

The first bit of positive news comes in the form of the residential market not doing as bad as expected in October. Yes, we have gotten to the point where good news is things aren’t as bad as predicted, but at least that’s better than being worse than predicted which has happened all too often this year.

James Fleming, Cousins Properties’ executive vice president and chief financial officer, made some interesting comments in a recent AJC article. He gives some insights on where they see the current market and the future in Atlanta.

Fleming said, “We’re starting to see some broken retail deals. We think we may see some office deals that are broken, too. Those could be pretty interesting. We’re going to take a hard look at those things.

“We’ve got two of our people doing nothing but looking at acquisitions.”

Only “compelling” residential projects would interest Cousins, and so far they haven’t presented themselves, he said.

But Cousins could end up doing a joint venture with a home builder, Fleming said.

“If you believe the demographics, at some point that’s going to turn around,” Fleming said of the depressed residential market.
…
Emory Point, a mixed-use joint venture with Gables Residential, is on hold, but Fleming said “that still looks to be a very favorable project. That’s an infill location with a lot of demand and really no competition.”

Overall, however, “I don’t think we’re going to see large-scale development opportunities in the next 12 to 18 months,” he said.

An interesting story from Boston outlines how the Mayor intends to extend $40 million in loans to restart projects like office towers and retail developments. Like President-elect Obama’s desire, Boston’s Mayor wants to extend these federally backed loans to projects that can begin immediately.

In a similar vein, Georgia Governor Sonny Perdue intends to use the state’s high bond rating to attempt to stimulate growth.

Private residential construction dropped 3.5 percent while private nonresidential construction spending fell 0.7 percent — the third decline in the last four months. A large drop in utility construction spending was largely responsible for an overall decline in nonresidential construction spending. Commercial construction spending, office construction spending, and manufacturing construction spending all increased during the month.

From a year ago, private residential construction spending has declined 24.2 percent. By contrast, private nonresidential construction spending was up 9.1 percent over the past year. Residential investment will continue to be a drag to economic growth again in the fourth quarter. During the third quarter, residential investment subtracted 0.7 percentage points from economic growth.

And for those in service industries…

Activity in the service industries also showed a massive deterioration in November, according to the ISM Nonmanufacturing Survey, which plummeted to a new record low in the relatively short 11-year history of the survey. Service activity trends in the ISM survey are largely consistent with the employment report. About two-thirds of the recent job declines have occurred in the service-providing sector. During the first eight months of this year, job losses were largely confined to construction and manufacturing.

It’s hard to find good news these days, as much as many of us feel this is a self feeding fire – the more bad news comes out, the more likely we are to respond in kind, making things worse. The MBA also reported that 2.2 million homes are expected to enter foreclosure in 2008 – and they expect even more to go into foreclosure in 2009. This is particularly bad news for folks whose work is centered around residential development, as a depressed economy and huge numbers of foreclosures means that private residential development will likely be worse next year than it was this year.

To make things worse, the job numbers in service industries are really taking a beating.

During the past three months, the employment base shrank by 1.256 million. Losses were broad-based. Job losses more than doubled in service-producing industries, to 370,000 in November from 153,000 in October… Average hourly earnings increased 0.4 percent, while the average workweek declined to 33.5 hours, its lowest on record.

Some folks are trying to find innovate ways to get people back into buying residential property. It’s likely that these innovative tactics will be necessary to spur any sort of spending from consumers given the glut of residential property on the market – and more to come. In New York, one developer is offering an interesting incentive.

Now, with the building just about finished, an amendment approved by the state attorney general last month offers a five-year “buyback guarantee” to buyers who sign contracts before the sponsors declare the condominium plan effective (after at least 15 percent of apartments go into contract to residential buyers).

Under the guarantee, on the fifth anniversary of the closing, buyers will have 90 days to return their apartments to Rockrose for 110 percent of the purchase price. However, the buyers will have to pay all closing costs, including transfer taxes and the sponsor’s legal fees.

These are the types of incentives that builders and developers are likely going to have to come up with in order to get people off the sidelines. Unfortunately, those coming off the sidelines will still have to qualify for the mortgage. If the government buyback of $600 billion in debt from Freddie Mac, Fannie Mae and Ginnie Mae is successful, it could mean that we could see banks begin to once again start providing loans. It is likely our best hope for the start of a recovery in 2009.