The U.S. housing market includes the construction, sale, and resale, of all residential properties across the country. Even though it's only focused on housing, conditions in the housing market are indicative of the state of the economy as a whole. Homes are durable goods, meaning that new home construction and sales are often highly correlated with economic cycles; people tend to buy new homes only when they are confident that they'll have enough income to pay for it, so economic downturns can depress the housing market considerably. In addition to the buildings themselves, homes require appliances, furniture, utility services, and any number of other secondary goods and services. When a new home is built and purchased, the financial impact of that sale continues on indefinitely, every time the owner buys a lightbulb or pays the electricity bill. As such, conditions in the housing market are monitored closely, given their widespread implications.
As of the second quarter of 2008, the U.S. housing market is unstable, due largely to the collapse of the subprime lending industry. The Office of Federal Housing Enterprise Oversight, which tracks mortgages loans bought or backed by Fannie Mae and Freddie Mac, said that home prices in the first quarter of 2008 fell 3.1% from the same period in 2007 and 1.7% from the fourth quarter of 2007, which is the steepest decline on record.[1] A separate report from S&P showed a 14.1% drop in existing home prices in the first quarter of 2008, due largely to a 10.7-month supply of single-family homes on the market as of April 2008.[2][3] Additionally, a report from the National Association of Realtors stated that home sales fell 2.6% in June 2008, reaching a ten-year low.[4] July brought further bad news. The number of new home construction projects started in July 2008 fell 11%, reaching its lowest level in 17 years,[5] while the number of new foreclosure notices shot up 55% from 2007 and banks repossessed 184% more homes than in July 2007.[6]
[edit] Companies involved in the housing market
Construction and home improvement
- D.R. Horton (DHI), Toll Brothers (TOL), Pulte Homes (PHM), Lennar (LEN), and other residential construction companies are highly leveraged to conditions in the housing market.
- Home Depot (HD) and Lowe's Companies (LOW), both home improvement retailers, are dependent on the housing industry for business. Housing slumps have a significant impact on these companies' bottom lines.
- Plum Creek Timber Company (PCL), Weyerhaeuser Company (WY), and Louisiana-Pacific (LPX), as well as other producers of lumber and other wood-based building materials, benefit from housing booms and are harmed by housing slumps.
Appliances, furniture, and accessories
Mortgage companies and other financial institutions
Deteriorating conditions in the housing market can substantially impact mortgage companies such as lenders. If demand for residential real estate falls, prices are likely to fall as well. As such, any homes that a lender repossesses to cover mortgage defaults is worth less, possibly even less than the company lent in the first place. Also, extremely poor conditions in the housing market might lead to a decrease in interest rates, which would make each new loan less profitable.
- Federal National Mortgage Association (FNM), Freddie Mac (FRE), Wells Fargo (WFC), Washington Mutual (WM), and other large figures in the residential mortgage market could be negatively impacted by a housing slump as the value of their mortgage portfolios decreases.
- Goldman Sachs Group (GS), Bear Stearns Companies (BSC), Merrill Lynch (MER), Morgan Stanley (MS), Lehman Brothers Fin SA (LEH), and other investment banks could be harmed by a housing slump in some way. Many of these firms invest in the housing market either through purchasing secondary mortgages or investing in mortgage-backed securities. Regardless, a severe housing slump resulting in the lowering of interest rates would impact financial services firms of all types.
Other companies with exposure to the residential real estate market
[edit] What causes housing booms and slumps?
The housing market is very closely related with prevailing economic conditions. There isn't a perfectly clear cause-and-effect relationship between the two; conditions in one can impact the other, and vice versa. In general, the housing market reflects the state of the economy as a whole. There are times when the economy seems to be humming right along, but the demand for residential real estate falls nonetheless. In cases such as these, the slump is often a sign of economic weakness that just hasn't manifested itself in other areas of the economy. While the relationship between the housing market and the entire economy is somewhat complicated, there are some observable factors that can impact the demand for residential real estate. Some of this housing cycle is caused by overbuilding. Developers saw excessively low rates for quite a while and used that to theorize that everyone can now get into a home. Together with lenders the thought was that if potential buyers can afford a $100K home at 6% then they can afford the same home for $200K at 3%. When this market dried up and it came time for rates to go back to normal levels, enter the bursting bubble. Homebuilders got caught with inventory, mortgage lenders have customers who can't afford the new rates, and homeowners who are in over their head are looking for a place to stay. The effect is far reaching and long term.
[edit] U.S. Economic Cycles
Business cycles have a number of significant repercussions for the economy. The most notable of these is the fact that household disposable income rises during booms and falls during recessions. The average American's purchasing power, therefore, rises and falls in tune with these economic cycles. When disposable incomes decrease, spending decreases overall, but some goods and services are more sensitive to these changes than others. Food and gasoline are two goods that are relatively less affected by these cycles; people still need to eat and get around, even during hard times. Durable goods, or larger purchases that are generally meant to last a while, are very hard hit by recessions, however. For example, if a person's income is halved, their food consumption will probably not change that much; they will be more likely, however, to put off buying a new washing machine, car, or house. Since these goods are "durable", the ones they already have will probably last until their finances improve.
Because the demand for durable goods decreases during recessions, and a house is about as durable as a good gets, the residential real estate market is extremely sensitive to economic cycles. A recession can lead to lower demand for new home construction, appliances, furniture, and even cars.
[edit] Interest Rates
Interest rates are another factor that can dramatically impact the housing market and new home construction. Many interest rates, particularly those for mortgages, are tied to the benchmark LIBOR, meaning that changes in this key index impacts the housing market significantly.
[edit] Cost of Borrowing
As interest rates increase, it becomes more expensive to obtain a mortgage on a home. Given mortgages' generally long terms (usually 15 or 30 years), even small changes in interest rates can significantly impact monthly payments and the total cost of buying a new home. Higher interest rates are likely to cause a decrease in demand for housing due to these rising costs. Conversely, lower interest rates can make borrowing money cheaper and stimulate demand in the housing market.
[edit] Subprime mortgages
Increasing interest rates can also harm preexisting mortgages and result in higher foreclosure rates, increasing the supply of homes on the market just as it becomes more expensive to buy them. The reason for this is the adjustable-rate mortgage, or ARM. ARMs are different from fixed-rate mortgages in that the interest rate is variable, changing throughout the term of the mortgage; ARM rates are usually linked to some outside index such as the LIBOR, the Cost of Funds Index, or a treasury index. These ARMs became very popular in the early- to mid-2000s, when low introductory, or "teaser", rates caused many people to take out ARMs and buy houses. After the introductory period, however, the rates on these ARMs were reset to reflect current interest rates, resulting in much higher monthly payments. As a large percentage of these ARMs were made to subprime borrowers, many of whom could not afford the higher monthly payments, increasing numbers of homes began being repossessed. As many ARMs are still in their introductory periods, future waves of rate resets could further increase foreclosure rates. Interest rate increases could further exacerbate the problem, causing even more consumers to default on their mortgages. This increased number of foreclosures could lead to rising inventories of homes for sale, which would, in turn, depress real estate prices and decrease demand for construction.
Outstanding mortgages and foreclosure starts in 1Q08, by loan type
[8][edit] See Also
[edit] References
- ↑ Home Prices Post Record Declines In First Quarter - CNBC.com
- ↑ Drop in Home Prices Accelerates to 14.1% - WSJ.com
- ↑ Housing Supply Declined in May - WSJ.com
- ↑ Home sales at ten-year low, jobless claims jump | Reuters
- ↑ Inflation pressures mount as home building slows | Reuters
- ↑ U.S. Foreclosures Rise 55%, Bank Seizures Reach High - Bloomberg
- ↑ U.S. Census data
- ↑ Delinquencies and Foreclosures Increase in Latest MBA National Delinquency Survey
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