Morningstar Advisor - August/September 2009 - 58

Sector Rap Signs of Stabilization in the Housing Industry By Haywood Kelly Deep problems remain in the market, but there are reasons to believe spring was a turning point. At the epicenter of the financial crisis is the U.S. housing market. We recently sat down with Eric Landry, an associate director on Morningstar’s equities team who oversees coverage of homebuilders. His team sees signs that the market is stabilizing, which, if true, would have positive implications for a number of other sectors of the economy. Haywood Kelly: Let’s start with where the housing market sits now. Bring us up to date. Eric Landry: Every person not living under a rock knows the U.S. housing market has been a disaster for the past three and a half years. Home starts peaked at a 2.1 million annual rate in January 2006 and have fallen straight down a very steep hill ever since. In fact, April’s seasonally adjusted annual rate was 458,000, the lowest amount of homes started since 1959, or as far back as the data extend. That said, some in the industry see evidence of a bottom. They have seized upon the fact that for four consecutive months through May the number of single-family starts has been steady-to-increasing. by 30% to 120% year over year in several markets across sections of California, Nevada, Arizona, and Florida. These states led the country off a cliff three years ago, so I think it’s good news that they’re finally reaching clearing prices. Believe it or not, California residential real estate is now in better shape than most markets in the country. San Diego, San Francisco, and several other cities are all markets that, we think, may have turned the corner earlier this year. HK: One factor that will determine when the housing markets stabilize is supply; much hinges on how much will be coming on line over the next few years. What do you forecast? EL: Unfortunately for the homebuilders, but fortunately for the rest of the housing market, this year looks to be another record low for housing starts. If we add up the backlogs of the 15 builders we cover, assuming market shares aren’t radically altered and cycle times stay relatively constant, we come up with an annual estimate of around 500,000 to 600,000 home starts for this year. To put this in context, last year’s 906,000 was the lowest on record. In the past, the housing market has generally bottomed at the 1 million mark. To have two consecutive years well below that level is unheard of, and it illustrates the severity of the current downturn. The reason that I say this condition is “fortunate” for the rest of the market is because it’s very obvious that the builders are now undershooting by a large margin what we would consider a normal level of demand. HK: Which brings us to demand. How do you see that shaping up over the next few years given rising unemployment? EL: The U.S. economy has the potential to create as many as 1.4 million net new households per year over the next several years. Echo boomers (the offspring of baby boomers) have just started to enter their prime household-formation years, creating a mild tail wind for housing production for the next several years. Also included in that 1.4 million number is demand from immigrants who came to the United States several years ago, as well as nontraditional households created through divorce and other means. We think these optimists are on to something. This spring, we started to see encouraging signs. After years of decline, prices finally seem to have found levels that are attracting buyers in several of the former bubble markets. We’re seeing existing home sale volumes up We also need to account for demand created by removals of homes that are destroyed, as well as second-home demand. All told, we estimate that the U.S. produces an overall demand of about 1.8 million homes in a normal economic year. Unfortunately, some level of employment is usually needed to support a new household, so 2009 and 2008 can hardly be termed normal. Adding up all the puts and takes, we come up with 58 Morningstar Advisor August /September 2009

Morningstar Advisor - August/September 2009

Table of Contents for the Digital Edition of Morningstar Advisor - August/September 2009