Homebuilders Rebound? April Fools!

Housing starts edged up in April, but permits, a better indicator of housing market health, plunged to the lowest pace in nearly a decade

by Maya Roney

The news from the U.S. Census Bureau that housing starts actually increased in April was surprising, to say the least. After all, just one day earlier the National Association of Home Builders/Wells Fargo Index, which measures builder confidence, fell three points to 30, matching the 15-year low set last September. And just last week luxury-home builder Toll Brothers (TOL) said its quarterly earnings would come in lower than expected due in part to tighter lending standards (see BusinessWeek.com, 5/9/07, "Housing's Woes Hit Toll Brothers").

Homebuilders were clearly suffering, but the headlines on the morning of May 16 seemed to tell a different story. U.S. housing starts rose in April for the third month in a row, climbing 2.5% to an annual pace of 1.528 million units, above the 1.49 million rate analysts were expecting (in March, starts rose 0.3% to rate of 1.518 million that was later revised down to 1.491 million). In the Northeast, starts were up 31.3%.

But don't let April's report fool you—there is nothing encouraging in these new figures. As in the past, the percent increase still fell well within the census' margin of error of plus or minus 9.3%, so we can't say for certain whether they even rose at all. Comparisons to last year were not pretty either: starts were down 16% from a year ago. "My overall take is that the downward adjustment in the housing sector is still ongoing," says NAHB chief economist Dave Seiders. "I don't view this little bounce as a sign the fundamentals have improved."

Permits: The Real Story

The biggest indication of a still struggling housing market came in the form of poor building permit numbers. In the month of April, permits fell 8.9%, the sharpest drop since February, 1990, to 1.429 million units, the lowest level in nearly 10 years. Compared to last year, permits were off 28.1%.

How do we explain the counter-intuitive movement of starts and permits? The bump-up in starts was probably achieved by builders using up some of their backlog in permits and accelerating starts as the weather grew nicer. But permits, economists say, are a much better barometer of housing market health. The margin of error on these measures is much smaller (about plus or minus 1.5%) and permits are not affected by the weather to the same degree as housing starts.

"They're the best measure of housing activity out there," says Patrick Newport, an economist at Global Insight. Newport calls April's residential construction report "discouraging" and "unexpected," attributing most of the permit decrease to the shakeout in the subprime market.

Uncertain Future

Global Insight's latest forecast calls for housing starts to drop by more than 10% before activity turns around. "We're not going to see as big a drop in residential construction in the second quarter because the housing start numbers were not that bad, but [falling permits] are going to catch up with us later on," Newport says. In about two or three months, starts will worsen, he predicts, which will feed into the gross domestic product and result in a slower growth reading.

Back in January many economists were sure the housing market was evening out. In the second half of the year, real estate would rebound—or so went the common prediction. Now, it's obvious that a turnaround may not take place until the fourth quarter of the year.

"The downtrends are still in place—probably not looking for a fundamental bottom until late in the year," Seiders says. "The signals coming out of '06 were that the demand side had stabilized, but everything was changed by the subprime mortgage market meltdown and subsequent tightening in lending standards. The uncertainties right now are tremendous."

Roney is Real Estate writer for BusinessWeek.com.