Homebuilders: When Will Things Turn Around?

S&P Ratings answers key questions about the health of the sector—and its prospects for recovery

by James Fielding and Thomas Nadramia From Standard & Poor's RatingsDirect

In light of the ongoing difficult operating environment for U.S.-based homebuilders, investors have raised several questions about S&P Ratings' views on the sector's credit quality over the next several quarters— and the probability of more rating actions. Here, we present our responses to key questions:

We're nearly three years into a housing downturn that is already longer and more severe than many anticipated. When do you expect the cycle to bottom?

Calling a bottom to this severe, and in many ways, unprecedented housing cycle is certainly challenging. Single-family starts have already fallen as sharply and as broadly as any time since World War II. The road to this point in the cycle has been difficult. First, many investors abruptly exited the housing markets, which contributed to pockets of oversupply. Then, prices began a downward trend as each successive round of price cuts by builders further softened consumer sentiment and demand. Deflating home prices pushed mortgages underwater, which contributed to rising delinquencies and foreclosures. And, finally, mortgage financing abruptly tightened for many willing buyers.

Now with the economy likely in a recession and lenders under pressure, the road ahead appears rough. The one encouraging sign we can point to is the fact that new single-family construction has already slowed considerably, to roughly one-third the 1.7 million unit cyclical peak in 2005. Our base-case scenario now assumes that starts will finally bottom out in the third quarter of this year, and we expect to end the year at a little over 600,000 single-family starts.

Prices, however, will continue their downward trend in our view. Our chief economist expects that home prices will continue to fall, perhaps by another 10% through the middle of 2009. Since the S&P/Case-Shiller price index is already down 18%, we're looking at a 25% to 30% peak-to-trough correction. Furthermore, home prices in the "bubble states" of Florida, California, Arizona, and Nevada will likely continue to fare worse relative to the nation as a whole.