The housing market headwinds

From a report in U.S.News and World Report by Luke Mullins, here's a look at the factors that will be blowing against the housing market in 2009:

1. Recession. After months of speculation, the National Bureau of Economic Research made it official in early December 2008, announcing that the U.S. economy entered into a recession in December 2007. The only question now is: How painful a recession will we have? In a Nov. 21 report, economists at Goldman Sachs revised their previous forecast to reflect a more significant economic contraction and higher unemployment. "We now estimate that real GDP is falling at a 5% annual rate in the current quarter, and we expect this to be followed by declines of 3% and 1% in the next two quarters," the economists said. "This deepens and extends the expected recession, bringing the drop in GDP close to the decline seen in 1982 (2.3% in our forecast versus 2.7% then)." The recession will exert downward pressure on the housing market in a number of ways.

2. Higher unemployment. The shrinking economy will result in additional layoffs, which will work to smother housing demand. The unemployment rate has already been climbing -- in early December it was at 6.5% -- but many expect it to increase significantly in the coming year. Goldman Sachs projects the unemployment rate will hit 9% by the end of 2009. "This forecast, if correct, makes the current recession unequivocally the worst single downturn on record since World War II insofar as increases in joblessness are concerned," the economists said. Fewer jobs mean fewer home buyers, since an income stream is essential to obtaining a mortgage. "A job is necessary for a home," says Mark Zandi, chief economist at Moody's Economy.com. "Without [a job] you can't get [a home]." In Michigan we are already running at over 9% unemployment.


3. Consumer confidence. If consumers are worried about the state of the economy and their jobs, they are much less likely to make the biggest financial investment of their lives: buying a house. With a leading survey showing that consumer confidence in the United States dropped to 28-year lows in November, downward pressure on this front will be working against the housing market as well. "You generally don't buy a home unless you feel pretty good about your economic situation," Zandi says. "No one feels good [today]." Obviously until we get some resolution on our automotive industry mess, Michiganders are going to stay in their fox holes.

4. The underwater effect. A recent Zillow report found that one in seven American homeowners has negative equity, meaning they owe more on a home than it is worth. (For those who bought a home in the past five years, it's nearly one in three.) Many homeowners in this situation will choose to simply walk away from their homes rather than continue to pay off a devaluing investment. And with home prices expected to fall further next year, the number of "underwater" mortgages will most likely increase. "The underwater phenomenon is going to be very bad in 2009," says Christopher Thornberg of Beacon Economics. We are alread down in value in Michigan anywhere from 25 to 40% from the 2005-6 high point.

5. Tighter credit. As banks face higher loan delinquencies, they've responded by jacking up their lending standards for even well-qualified borrowers. The Federal Reserve's most recent Senior Loan Officer Survey found that 70% of domestic banks had boosted their lending standards for prime mortgages. More stringent terms will prevent certain borrowers from obtaining mortgages, thereby limiting demand for housing. So even though rates are at historic lows, too many people just can't qualify to take advantage of the rates.

6. Slowing household formation. At the same time, the pace of new household formation is slowing, which further chips away at housing demand. Richard Moody, chief economist at Mission Residential, says the development is linked to three factors: More singles are moving in with each other; young adults are returning to live with their parents; and fewer immigrants are entering the country. "For those three reasons, you are seeing a slowdown in the rate of household formation," Moody says. "And to the extent that the economy and the labor market remain weak this year, which I think they will, then that's going to continue."



7. Radioactive effect. Despite lower real-estate prices and cheaper mortgage rates, the pain inflicted by the housing bust will frighten many would-be buyers away from the market next year, Larson says. "Enough of your 'average Joes' have been burned very badly and will be burned by the time this is all over that investment money is not going to flood back into the market," Larson says. "Any recovery, in my opinion, will be gradual and is going to take time."

8. Foreclosure sales. A huge problem for the housing market in 2008, foreclosure sales will continue weighing down the market next year. "There was a surge this year," Zandi says. "But next year [there] will be even more." While that will give buyers an opportunity to go bargain hunting, it's bad news for sellers. "It puts more homes out there for sale at a very deep discount," Zandi adds.

9. Subprime mortgages. While resetting subprime mortgages may not be a leading factor behind the decline in home prices, as they were this year, such products will again be working against the housing market in 2009, Thornberg says. "There are still lots of subprime mortgages out there that are going to reset not just in 2009, but 2010 and 2011," he says. "And so that's going to be a consistent problem for a while, although it is probably reduced in magnitude [from 2008]." In Michigan we have been running at about 50% of all home sales being foreclosure sales and that doesn't look to improve anytime soon. We are now seeing increasing default rates in Alt-prime mortgages, those just below prime, but not considered to be sub-prime.

It's always hard to find the bright spots in reports like this. I suppose the fact that sales are still being made, that rates are better than ever and that there's more to choose from on the market than ever are all good news for those who are out shopping for a house.