Real estate forecast calls for soft landing -- with turbulence

Anderson Forecast predicts prolonged correction in home prices

Thursday, September 28, 2006

By Glenn Roberts Jr.
Inman News

The housing market will not crash unless the job market weakens significantly, though home prices are expected to stagnate for at least five years during this down cycle, according to the latest Anderson Forecast.

Produced by a University of California, Los Angeles, center, the forecast calls for the market prices of homes to hold steady over the next five years, which equates to a drop of about 15 percent to 20 percent in real terms because of projected inflation. Also, the forecast calls for a lowering of the Federal Funds Rate from its current level of 5.25 percent to 4.5 percent by mid-2007.

Washington, D.C., could face price depreciation of about 7.5 percent in real terms through 2010, according to projections in the forecast report, while prices in real terms could drop 7.1 percent in California, 6 percent in Hawaii, 5.9 percent in Rhode Island, 5.8 percent in Maryland and Nevada, and 5.2 percent in New Jersey during that period.

These price corrections could take a very long time in some states, according to one of the forecast reports, titled "2005: The Year the Tortoise Won the Race, Whither California Home Prices?" and prepared by Edward Leamer, forecast director. It could take 6.3 years to 16.5 years to work off excess home-price appreciation in California, the report suggests.

"In other words, these problems are likely to be with us for a long time," Leamer states in the report.

Already, home prices have dipped in some markets. "There are some cities and some states that have experienced slight price declines so far this year, but we are very far from a Great Comeuppance in which the extraordinary appreciation of the last five years is taken away," the report states.

Home sales in California have dropped about 30 percent this year compared to peak levels in 2005, and the report notes that price corrections tend to be slow affairs that lag behind a drop in sales. Homeowners "hold their homes on their personal balance sheets at the old price levels that applied back when their neighbors sold at the peak of the market. With those excessive personal valuations, owners cannot find any buyers and sales do not occur.

"Owners therefore have what seems to them the very attractive option of waiting until they get the price they want. So they wait and they wait. It is only after a couple of years of weak sales, and maybe some job losses, too, that the resolve weakens and home prices begin their very slow march south," Leamer states.

Home builders, meanwhile, are motivated to sell whether the market is strong or weak, and the forecast states that regions with substantial new-home construction activity face a greater risk of price declines.

Leamer notes that some states that experienced sharp home-price appreciation during a past boom-bust cycle in 1985-89 later "racked up big real price declines in the aftermath of the 1990 recession," though in that case those same states also were hit by a weak job market. "Historically, there has been a close association between the job market and the housing market," he states in the report.

But unlike the recession of 1990, "manufacturing is not positioned to add to the loss of jobs that will occur in construction and real estate finance, and absent the loss of jobs in manufacturing the housing downturn will be considerably softened. Softer but longer lasting, too. Instead of a rapid and painful adjustment, expect a slow and aggravating one," the report states.

A separate Anderson Forecast report, "The California Report," also does not expect a recession for the state. "We are still firmly convinced that the national economy is the primary driver at the state level: statewide home prices (in California) are unlikely to decline significantly unless there is a recession," according to that report. "Real estate sectors will continue to decline, but without significant declines in another sector the net result will be a slowdown, not a recession."

In 2005 the construction sector created 61,000 jobs in California, though year-over-year growth in construction employment has slowed this year, and "construction employment is about 10,000 jobs lower than we would expect given the usual seasonal patterns." The construction sector may lose about 100,000 jobs through 2008, and building permits are expected to bottom out in 2008 "as activity returns to levels seen in 2000."

Mortgage companies and other financial companies have already been hit by the real estate slowdown, the report notes, with layoffs at Ameriquest and Countrywide, among other mortgage companies, hitting particularly hard in Orange County and Southern California in general.

"The high share of independent contractors in this industry means that the payroll employment data may very well understate the scope of these job losses," according to the report.

Another Anderson Forecast report, titled "Soft Landing with Turbulence Ahead," states that the "free fall in housing construction" will end within the next few years and will aid in the economy's recovery.

This report projects a decline in housing starts of about 30 percent to 35 percent by the end of 2007, with housing starts hitting bottom at an annual rate of about 1.5 million to 1.6 million units. But if housing starts actually drop more than 50 percent by the end of 2007, that "could very well cause an actual recession," the report states.

"In summary, we forecast the economy is about to enter a period of several quarters of sluggish growth with inflation above the comfort level. The Fed will respond by gradually cutting the funds rate to 4.5 percent. Although not a recession, the unemployment rate will modestly increase and those sectors of the economy tied to residential construction will be in a cyclical decline," the report states.

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