Housing to Stay Healthy as It Recedes from Its Peak

Economists at the Construction Forecast Conference held by the National Association of Home Builders (NAHB) recently said housing should remain healthy through next year even as it recedes from peak levels. This was said despite some softening in U.S. economic growth, the Federal Reserve's ongoing interest rate hikes and rapid price gains in the nation's hottest housing markets.

Driven by ongoing population growth and household formations, an expanding market for second homes and the need to replace aging units, demand for housing should hold up well in the foreseeable future, said panelists. Also, further growth in the nation's job force and rising incomes should help offset the negative impact of higher mortgage rates, which are still expected to be at affordable levels by historic standards.

Some experts voiced concerns regarding speculative investment activity in a few of the nation's frothiest housing markets-including California, Las Vegas, South Florida, Washington, D.C. and the New York-Boston corridor. However, they expect to see a slowdown in the rate of price appreciation in most parts of the country rather than an actual decline in house prices.

How aggressively the Fed pushes up interest rates will depend on the inflation picture, and although inflation has now moved to the upward range of what the Fed finds acceptable, prices remain well under control, economists said. Barring unexpected run-ups in energy prices, the overall outlook appears quite favorable.

One unanswered question at the forecast conference pertained to the state of the nation's job market.

"There are deep uncertainties about the issue of slack in the labor market," noted NAHB chief economist David Seiders, and that's a big reason the Fed has been moving so cautiously as it tightens monetary policy.

Unemployment fell to 5.3 percent in the first quarter, and Seiders predicts it will continue downward to about 5.1 percent in 2006. That may be as low as it can go without generating some inflation, he said.

"We're only in the second inning of economic recovery," said Jim Glassman, managing director and senior policy strategist with J.P. Morgan Chase and a panelist at NAHB's forecasting conference. While payrolls have returned to where they stood at their peak in February of 2001, "the number of people who have come of working age has increased by 9 million" in that same time frame. Confronted with the bad job market that stubbornly persisted long after the end of the 2001 recession, many young potential workers decided to head back to college.

"There are about three million of them out there, and there is a good chance they will be coming into the job market soon," Glassman said.

Estimating annual housing demand at 2 million units over the next decade, Glassman also said that recent productivity gains bode well for housing in the period ahead because they have bolstered corporate profits, which in turn should lead to increasing wages. With current annual productivity gains in the 2.5 to 3 percent range, he said, America's standard of living will double in a single generation. This compares to the 1 percent productivity gain of the 1970s and 1980s, a rate at which it took three generations for the living standard to double.

On the other hand, Macroeconomics Advisers president Chris Varvares estimates that today's expansion is "in the bottom of the seventh inning," and doesn't expect too much more improvement on the employment front. He sees the economy settling in for a soft landing and 3.4 percent GDP growth for the year as a whole.

Varvares also expects to see some measurable decline in housing activity next year, but sees no recession on the horizon and pegs sustainable GDP growth at 3.5 percent. Agreeing with Varvares's assessment of the first-quarter economic slowdown that has continued into the current quarter, NAHB's Seiders predicted that "we do come out of it, we do better and we glide out in 2006" with "pretty good" GDP growth in the 3.2 percent to 3.5 percent range.

Seiders also projected a 4-percent federal funds rate at the end of this year, with another one-quarter percentage point increase in 2006. This would move up the prime rate from its current 6 percent to about 7 percent at the end of 2005 and 7.25 percent at the end of next year.

Although it now looks possible that 30-year fixed mortgage rates won't quite reach the 6.4 percent average that NAHB economists were forecasting for this year's fourth quarter, the pressures on those rates "have to be up going ahead," Seiders said.

J.P. Morgan's Glassman discounted fears of reduced house-price appreciation taking a toll on the economy. With the exception of a few boom markets, he said, higher prices largely reflect the real estate market catching up with the lagging prices of the 1990s.

"Worry if you want to," he told audience members. "But I think I would take most of the worries with a grain of salt and just get back to business."


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