She Predicted the 2007 Real Estate Crisis — and Sees More Trouble Ahead

In our Zelman Homebuilding Survey, we are seeing very negative trends. Net new orders started the year strong, up double-digit percentages year on year but then decelerated to mid-single digit growth this summer, then to slightly down year over year in September. It’s likely that net sales have continued to decline at an accelerated rate in October. It could result in a pretty ugly fourth quarter if these trends continue.

Also, builders’ sales incentives are picking up. The housing-start numbers are continuing to have slower growth than the market would expect.

Zelman Picks and Pans

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* “Zelman’s firm has received compensation from FBHS for non-investment banking services.”

Source: Zelman & Associates

Why is that?

As interest rates have moved up, they’ve had an impact on demand, with more difficulty for consumers, in some cases, to afford to buy a home. Compared with a year ago, the monthly payment on a $300,000 home using a Federal Housing Administration insured would be 13% higher. And home prices have also been increasing at 5% or 6%. It’s much more expensive for that entry level, medium-priced home.

There’s a hesitancy to adjust to the new rate environment, but assuming no further upside in rates that reluctance starts to diminish in roughly four quarters, which would bode well for the spring selling season.

Starts are going to be actually stronger than the market believes, not because housing is strong but due to roughly 40% of new housing starts being built on spec. That is, they don’t have a buyer. Starts are outpacing orders. Year over year we’re up about 20% in absolute new home spec building nationwide, though still near an absolute low level.

The September new homes Census Bureau data show a seven-month supply as a result of the increase in inventory and the decrease in overall new home trends. If you’re a home builder and you’ve got a lot of capital in the ground, you’re going to monetize it. You are not going to sit on a finished lot.

What does your crystal ball say about the next 12 months?

Given the strength of the economy and consumer confidence and employment growth, housing should resume growth. That said, prices will likely be under pressure and will have to adjust, even if we do see a rebound in the spring, because it’s more expensive with rates moving higher.

If mortgage rates keep rising, affordability will no longer be favorable from a historical perspective. The monthly payment as a percent of consumer gross income is still actually lower than it’s been for 40 years. But if you start to see mortgage rates go up, say above 5¾% roughly, that monthly payment as a percent of gross income would start to be higher than it’s been historically.

The other risk is the consumer’s balance sheet. That is, how much debt they have. For the single income household that can make the 3½% down payment that FHA financing allows, the trend line now is 39% for the percent of gross income being spent on the monthly payment, including mortgage insurance.

If we go above 40%, it will be more challenging for home buyers to get approval.

How are inventories looking around the U.S., and are there any regional differences?

Inventories on an absolute basis are close to about a 30-year low, although it has risen off that low base this year. It varies not only regionally but even more so by price point.

In a lot of markets that have been exceptionally strong, such as California, Washington, and Oregon, inventories are rising. New York continues to trend higher. The increase regionally is more pronounced in what had been the tightest, fastest-growing markets, because we’re starting to see slower demand there. The West Coast has been really the most negative.

Inventory is much tighter at the affordable price points than at the luxury level. The top 5% of the U.S. market inventory is very much a buyer’s market, with well above normal levels of inventory.

Ivy Zelman likes to do puzzles, big ones with 2,000 pieces. That helps explain how’s she’s able to assess thousands of disparate U.S. housing data points to assemble her closely followed market views. This ability—plus hard work and prescient calls on housing at both the top and bottom of the market—is why she’s among the best known and highest-ranked analysts in the industry. Her negative view on housing in 2006 also earned her the Wall Street sobriquet “Poison Ivy.”

What does she think about housing now? The CEO of Zelman & Associates, an ex-New Yorker with 27 years of experience, notes that home-building growth has slowed sharply of late and that inventory is rising in some regions and markets, like the West Coast and among luxury homes. Still, she sees this slowdown as a pause—but only if mortgage rates don’t go much higher. If they begin to approach 5 3/4%, affordability will become an issue, and all bets are off.

The mother of three teens, who founded her Cleveland-based firm in 2007 after a long career on Wall Street, likes Lennar (ticker: LEN), among other stocks, and doesn’t like some real-estate investment trusts.

Barron’s: How would you characterize the U.S. housing market?

Zelman: It’s at an inflection point and has definitely slowed from where we were last year.

Existing-home sales are down year-to-date about 2%. Most of that has been attributed to inventories too tight at affordable price points. It’s debatable if that negative trend is really due to an overall slowing or sellers’ unwillingness to capitulate to what buyers want in terms of price.

In our Zelman Homebuilding Survey, we are seeing very negative trends. Net new orders started the year strong, up double-digit percentages year on year but then decelerated to mid-single digit growth this summer, then to slightly down year over year in September. It’s likely that net sales have continued to decline at an accelerated rate in October. It could result in a pretty ugly fourth quarter if these trends continue.

Also, builders’ sales incentives are picking up. The housing-start numbers are continuing to have slower growth than the market would expect.

Zelman Picks and Pans

Picks

Pans

* “Zelman’s firm has received compensation from FBHS for non-investment banking services.”

Source: Zelman & Associates

Why is that?

As interest rates have moved up, they’ve had an impact on demand, with more difficulty for consumers, in some cases, to afford to buy a home. Compared with a year ago, the monthly payment on a $300,000 home using a Federal Housing Administration insured would be 13% higher. And home prices have also been increasing at 5% or 6%. It’s much more expensive for that entry level, medium-priced home.

There’s a hesitancy to adjust to the new rate environment, but assuming no further upside in rates that reluctance starts to diminish in roughly four quarters, which would bode well for the spring selling season.

Starts are going to be actually stronger than the market believes, not because housing is strong but due to roughly 40% of new housing starts being built on spec. That is, they don’t have a buyer. Starts are outpacing orders. Year over year we’re up about 20% in absolute new home spec building nationwide, though still near an absolute low level.

The September new homes Census Bureau data show a seven-month supply as a result of the increase in inventory and the decrease in overall new home trends. If you’re a home builder and you’ve got a lot of capital in the ground, you’re going to monetize it. You are not going to sit on a finished lot.

What does your crystal ball say about the next 12 months?

Given the strength of the economy and consumer confidence and employment growth, housing should resume growth. That said, prices will likely be under pressure and will have to adjust, even if we do see a rebound in the spring, because it’s more expensive with rates moving higher.

If mortgage rates keep rising, affordability will no longer be favorable from a historical perspective. The monthly payment as a percent of consumer gross income is still actually lower than it’s been for 40 years. But if you start to see mortgage rates go up, say above 5¾% roughly, that monthly payment as a percent of gross income would start to be higher than it’s been historically.

The other risk is the consumer’s balance sheet. That is, how much debt they have. For the single income household that can make the 3½% down payment that FHA financing allows, the trend line now is 39% for the percent of gross income being spent on the monthly payment, including mortgage insurance.

If we go above 40%, it will be more challenging for home buyers to get approval.

How are inventories looking around the U.S., and are there any regional differences?

Inventories on an absolute basis are close to about a 30-year low, although it has risen off that low base this year. It varies not only regionally but even more so by price point.

In a lot of markets that have been exceptionally strong, such as California, Washington, and Oregon, inventories are rising. New York continues to trend higher. The increase regionally is more pronounced in what had been the tightest, fastest-growing markets, because we’re starting to see slower demand there. The West Coast has been really the most negative.

Inventory is much tighter at the affordable price points than at the luxury level. The top 5% of the U.S. market inventory is very much a buyer’s market, with well above normal levels of inventory.

[“source=TimeOFIndia”]