Home Builders Take a Holiday

The holiday we refer to is from optimism. Over the past 18 months, builder optimism has moved meaningfully higher to a recent high of 47 from a low of 9, according to the NAHB's sentiment index. This month, though, sentiment dropped to 44.

Demand for new homes remains robust, but supply issues – in labor and building-material – are hampering construction. Home builders are equally frustrated by restrictive appraisals and tight lending standards. As for lending standards, we concur. Underwriting standards remain too restrictive.

For this, we can blame uncertainty and tighter regulations. We were encouraged to hear Federal Reserve Chairman Ben Bernanke agree with our assessment. In a press conference earlier this week, Bernanke told reporters the Fed is seeing "much higher credit-quality requirements" from potential borrowers. Bernanke cited the rule where mortgages could be put back to banks as being particularly detrimental to risk taking.

There are no free lunches. When the uncertainty and cost of doing business rise, businesses – including mortgage lenders – take action to mitigate uncertainty and to recover costs. Yes, the Fed gives on the one hand by continuing to buy mortgage-backed securities at the rate of $40 billion a month. On the other hand, the pool of potential borrowers is reduced by higher lender costs and the increased risk of doing business.

So we can understand why home builders might feel down from time to time. But we did say the builders were taking a “holiday” from optimism. Given strong demand for new homes and rising construction, we don't expect them to remain down for long.

The good news is that home builders continue to break new ground at an expanding rate. Housing starts increased 0.8% in February, pushing starts up to an annualized rate of 917,000 units. The trend in permits portend increased activity heading into spring. Permits rose 4.6% to an annual pace of 946,000 units in February.

When viewed from a longer-term perspective, you can see home builders have made significant progress and have room to accommodate more progress this year.

Rising prices will continue to move the housing recovery along. Zillow reports that home values rose for a 16th-consecutive month in February. Zillow's home price index shows the average home value at $158,100. Of course, within the context of an entire country that doesn't mean much. What's meaningful is that monthly and annual price appreciation was recorded in 30 of the largest markets Zillow follows.

Rising prices, in turn, reduce negative equity. CoreLogic's research shows that 200,000 homes were lifted into positive equity during the fourth quarter of 2012. This brings the total number of homes that moved to positive from negative to 1.7 million in 2012.

Time plays a role as well: amortization and rising prices are working together to hurry the process along. In other words, time really does heal all wounds, though it hardly feels that way at the beginning of the process.

Courtesy of Jessica Regan.

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