Sep 29 2006 8:05AM | Permalink | Email this | Comments (0) |
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If we knew how many extra homes were on the market we could easily sketch out the path of housing starts for the next year and sales for all suppliers from developers through mortgage brokers. But we do not know with sufficient certainty. Major inventory corrections are forecasting nightmares.

Here is what we do know about how inventory corrections work from previous correction period in housing and other markets. First, inventory estimates are much less reliable than production or sales estimates. Permits and sales leave a trail of legal documents in known places which can be readily counted. Inventories do not. Second, the initial estimate of an inventory surplus is always too low because some previously sold product comes back on the market. Some recent homebuyers always intended to resell the home. Other recent buyers will decide to resell when they can not find a tenant at a high enough rent or can not afford the payments when their variable mortgage rate resets. This flow of added inventory stretches over a long period, sometimes over a year.

The August housing data suggests that the sum of surplus new and existing homes is equivalent to six or seven months of housing starts at the current depressed level of starts. This could quickly surge to ten months or more if sour economic conditions cut home demand further and weaken consumer income growth forcing additional panic or foreclosure sales. This would keep starts depressed below current demand all the way through 2007.

However, it is more likely that improved economic conditions will stabilize home sales and limit unplanned sales of existing homes so that the inventory excess, measured in months’ supply, will not rise past eight months this fall and will be ebbing slowly by the end of the year. Our 2007 starts forecast of 1.759 million comes from this assumption.

How are economic conditions improving? Credit costs have dropped 40 basis points, although not all of this decline will persist through yearend. Consumer confidence is rising again and already back to early 2006 levels. Falling commodity prices have reversed the decline in real consumer income which is now rising again. These changes will produce a significant boost in housing affordability this fall. In turn, this will speed the absorption of the surplus housing inventory.