Homebuilding recovery seen for 2011

With houses financing already cheap and prices low relative to income, the Michigan housing sector is poised for a recovery next year, believes Dana Johnson, Comerica Bank's top economist.

Johnson's latest Michigan Economic Brief, released yesterday, notes that homebuilding is a volatile and cyclically sensitive sector. Usually, it reflects overall trends in employment and income as well as financing conditions. Typically, it expands more rapidly than the overall economy in the early stages of expansions, and falls more sharply during recessions. During the first half of this past decade, however, housing went on a tear in many parts of the country, unrelated to the overall economy. Michigan, however, had a relatively mild housing upturn: over that 5-year span, house prices in Michigan 17%, compared to a national increase of 48%.

"Even so, Michigan had a severe housing downturn over the second half of the decade, reflecting the extended and sharp contraction in the state economy," the report observes. "From 2004 through 2007, Michigan suffered a relatively mild one-state recession, due largely to the loss of competitiveness of its auto manufacturing sector. Starting in 2008, however, real GDP in Michigan plunged, as the national recession devastated demand for cars and other manufactured goods produced in the state. The result is that Michigan suffered the largest cumulative decline in real GDP and the highest unemployment rate among the states."

Analysts say the Michigan housing sector has shown some signs of stabilizing this year, but it is not contributing meaningfully to an upturn thus far. Among the positives, total issuance of residential building permits from January through July were 36% above the first seven months of 2009, while permits for the nation are up only 7%.

Another encouraging development, according to Comerica, is the modest decline in the number of foreclosures started in the state. In the second quarter, the percent of foreclosures started fell to 1.4% of mortgages outstanding, the third consecutive quarterly decline. The inventory of mortgages anywhere in the foreclosure process also dropped in both the first and second quarters. Thus, with the number of new homes coming on the market exceedingly low and the number of foreclosures possibly beginning to trend lower, the downward pressure on house prices may be beginning to wane.

"In my view, nothing would do more to promote a durable recovery in homebuilding than convincing evidence that house prices have stopped falling," Johnson states. "It is the real cost of borrowing that should matter to a potential home buyer. For any asset, the real cost of borrowing can be calculated by subtracting from the nominal cost of borrowing the expected change in the price of the asset being purchased. At present, mortgage rates are incredibly low. But the real cost of financing a home purchase is not similarly low, if potential buyers expect
house prices could decline significantly in the period ahead. No matter how low mortgage rates get, it is not a good time to buy if house prices are likely to fall five or 10 percent in the next year or so."

Consumer psychology will play a big role in the direction of the housing sector, however, as Johnson believes meaningful change will occur when people begin to believe that Michigan house prices have stopped falling.

"The missing ingredient," Johnson says, "is confidence. Once people in Michigan become more convinced that their jobs are secure and that house prices have stabilized, demand will begin to build and homebuilding will start contributing to a more broadly based recovery."