New-Home Slowdown Is Good News


Housing starts fell in 3.7% in November. That's a good thing, because reduced inventories is the only way to stir demand

You'd think the chief economist for the National Association of Home Builders would be alarmed that the pace of new-home construction in November dropped to the lowest level in more than 14 years, according to a Dec. 18 Commerce Dept. report.

But David Seiders, the NAHB's chief economist, says he's somewhat pleased. Builders cannot reduce their inventories of unsold homes unless they cut production, particularly in light of weak demand and rising competition from existing-home sellers, he said.

"The builders are behaving appropriately at this point," Seiders said. "I would have liked to see the production decline start earlier than it did. But since the beginning of 2007, production has been falling rapidly."

Builders Suspend Projects

The pace of housing starts fell 3.7% in November from a month earlier, to a seasonally adjusted annual rate of 1.187 million, and it dropped 24% from November, 2006. Building permits, an indicator of future home construction, fell 24.6% from November, 2006, to an annual rate of 1.152 million.

Single-family home starts fell 5.4% from October to an annual pace of 829,000, the lowest pace since 1991. Building stocks have been particularly hard hit. Once-robust companies like Toll Brothers (TOL) have dropped sharply in 2007. Its shares have lost 30% of their value. Many of its competitors, including Lennar (LEN), Hovnanian (HOV), KB Homes (KBH) and D.R. Horton (DHI) are faring worse.

Steve Cameron, president and founder of Foremost Communities, a land development company in Irvine, Calif., said many builders are "mothballing" projects, putting fences around residential complexes that could remain unfinished until inventories drop and buyer demand returns.

"They're freezing activity," Cameron said. "What they're trying to do is generate positive cash flow. There's no use in building a project that nobody is going to buy."

Keith Gumbinger, an analyst at HSH Associates, a New Jersey-based publisher of consumer loan information, said housing inventory is starting to decline.

"This is really part of an adjustment process," Gumbinger said. "Inventory levels for builders, which remain elevated, are set to decline further because [the builders] are not adding to their stocks."

In October, the supply of new homes dropped to 8.5 months, the time it would take to get rid of existing inventories at the current sales pace, compared with 9 months in September, according to the Commerce Dept.

Builders' confidence is at a record low and has remained that way for three months in a row, according to the National Association of Home Builders/Wells Fargo builder confidence index released Dec. 17.

Market Hasn't Bottomed Yet

But the builders likely haven't seen the bottom of the market yet, said James Hughes, dean of the Edward J. Bloustein School of Planning & Public Policy at Rutgers University. The subprime mortgage crisis and the credit crunch, which have made it harder for buyers to secure mortgages, has slowed housing demand throughout the country, not just in speculative pockets.

In related news, the Federal Reserve Board on Dec. 18 proposed an amendment to the Truth in Lending laws to better protect home buyers from unfair or deceptive mortgage lending and advertising practices, primarily in the subprime area. Under the proposal, not only would creditors be guaranteed full disclosure of fees and payment schedules but lenders would be prohibited from extending a loan without first verifying the borrower's ability to repay. (To see the full transcript of Fed Chairman Ben Bernanke's comments, click here.)

"We certainly haven't hit bottom yet," Hughes suggests. "We may well be in uncharted territory here. Since the Great Depression, we haven't had a sustained national downturn like this."

But some markets are doing worse than others. Competition with existing homes is growing—especially in Southern California, Florida, Arizona, Nevada and other speculative markets where foreclosures are on the rise and existing-home listings are lingering on the market. Builders are reacting by offering discounts and incentives such as free upgrades and mortgage interest-rate buydowns.

In the Northeast, housing starts in November dropped 16.3%, compared with the previous month. They fell 6.9% in the West and 1.5% in the Midwest.

They actually rose 0.3% in the South. The South includes Florida, one of the worst-performing markets, but it also has Charlotte, N.C., one of the nation's best.

Greg Wessling, chief executive officer of custom homebuilder HouseRaising (HRAI) in Charlotte, N.C., said production builders have slowed construction even in the relatively hot housing markets in the Carolinas—though new-home construction is beginning to pick up in New Orleans, more than two years after the devastation of Hurricane Katrina.

Still, "the slowdown is universal," Wessling said.

Gopal writes about real estate for BusinessWeek.com in New York .

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