Are Happy Days Here Again?

For homebuilders that appears the case.

The NAHB/Wells Fargo Homebuilder Sentiment Index surged eight points to post a 52 reading for June. This is the largest gain since 2002 and pushed the index above 50, where it hasn't been since 2006. (Fifty is the demarcation between general optimism and general pessimism, which means overall homebuilder sentiment now lists toward optimism.)

One hardly need be a genius to understand why homebuilders are eagerly anticipating the future: New-home inventory remains at multi-decade lows, while prices for this inventory are rising at a brisk pace. According to homebuilder feedback, average selling prices have risen 11% this year.

Few situations will boost a seller's spirits more than to see strong pricing combined with limited inventory. That's the definition of a sellers' market.

What's more, homebuilders still have room to expand supply at a robust pace. Over the past 50 years, homebuilders have averaged 1.5 million starts (single and multifamily). This year, they are expected to start one million units; next year, they are expected to start 1.3 million units.

New-home demand has also spurred pricing gains in many markets. Prices nationally have clawed back to 2003 levels, but they still remain 28% below the July 2006 peak.

Strong price gains have conjured thoughts of another housing bubble. Double-digit price increases can't go on indefinitely. What's more, the higher an asset price rises, the harder it tends to fall.

That said, affordability is a mitigating factor, at least according to Standard & Poor's, which estimates that housing is still 8% undervalued based on the price-to-income ratio. Historically, the typical median home costs four times as much as the median annual income. It's now at a 3.7 multiple.

At the same time, the household debt service ratio remains near a 30-year low, while the homeowner mortgage obligation is at a 15-year low at 8.25% of disposable income. During the bubble years, the mortgage obligation averaged 11% of disposable income.

It's worth remembering that rising prices stimulate more supply to come to market. More supply, in turn, will slow price appreciation. That's a good thing, because double-digit price gains are unsustainable. Next year, we wouldn't be surprised to see price growth moderate to mid- to low-single digit rates, which are sustainable rates.

But what about the elephant in the room – mortgage rates?

To be sure, lending rates are up significantly over the past six weeks, but are still cheap from a historic perspective. As we noted last week, rising rates have spurred more buying and refinances. If you believe the best rates are behind us (and we do), you don't want to wait in a rising-rate environment.

 Courtesy of Jessica Regan.

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