New Home Sales As Bad As Existing Homes

New home sales tumbled 26.4% last year, the largest yearly drop on record. Sales were down 4.7% in December, with median home prices dropping 10.4% year-over-year, the biggest 12-month decline in 37 years. These numbers don’t account for cancellations, so actual sales were probably even lower. Furthermore, I guess most sales featured additional incentives, so the prices are inflated, too. The median price of a new home increased a mere 0.2% to $246,900 in 2007 – if incentives were taken into consideration, new home prices would drop as well. The inventory of unsold homes is at 9.7 months’ worth, which is close to a record high, so there’s no light at the end of the tunnel for home builders. An economic stimulus package? Financial innovation, anyone?

Merrill: Housing Prices To Drop 15% This Year

Analysts at Merrill Lynch predict that Real Estate prices will fall 15% in 2008, and continue to slide in 2009. The NAR disagrees: in their rosy outlook, prices will be flat this year, with a 5.3% drop in the first quarter and a rebound in the second half of the year. According to Merrill Lynch, housing starts will drop 30% by the end of the year – a likely scenario that doesn’t bode well for home builders. “The reduction in housing starts is not stabilizing the economy, but it will stabilize the market”, said the NAR’s Lawrence Yun – at least he got this one right. The Fed’s rate cut will probably help sales, but it is unlikely to change the situation dramatically. Rather, 2008 will be just as bad for homebuilders as 2007. There’s little hope for a successful spring buying season, although lower interest rates and dropping prices could lure buyers to the market. Much will depend on consumer confidence and commodity prices in coming months. If the slowdown is more severe than expected and unemployment keeps growing at the same pace, many potential buyers may choose to delay a home purchase.

The Perfect Storm

Housing starts dropped 14% in December to an annual rate of 1.006 million, the lowest pace since 1991. Construction fell 25% in 2007, its biggest drop since 1980. Permits dropped to 8.1% in December, and 25% for the entire 2007, the biggest decline since 1974. Construction of single-family homes dropped 2.9%, and multifamily homes dropped 40%. Homebuilders are scaling down construction while they wait for the surplus inventory on the market to sell. Well at least there’s some hope that that will happen. Mortgage rates continued to drop this week, 30-year fixed-rate mortgages averaging 5.69%, the lowest in more than 2 years. 15-year fixed-rate mortgages averaged 5.21%, down from 5.43% last week. 5-year hybrid ARMs carried an interest of 5.40%, compared to 5.63% last week. 1-year adjustable home loans fell from 5.37% to 5.26%. Unfortunately, banks are reluctant to lend money to borrowers. Weak retail sales in December, which dropped 0.4% from the previous month, would suggest that consumers are feeling strapped and unlikely to start house-hunting just yet. This looks like a perfect storm for the economy, and we’ve run out of ideas – and financial innovation.

Banks Tighten Credit

The Fed’s efforts to add liquidity to the markets are being offset by banks such as Citi, which announced that it will be raising interest rates and reducing consumer lending. Mortgage lending and credit cards will also be trimmed. Lending, to anyone, in any form, is too risky right now, and while the market is trying to deal with the mortgage and mortgage-derivatives mess, there’s fear that other areas of the financial system may fail as well: credit card lending, commercial Real Estate loans, and the list goes on. To help revive the economy, the Fed will probably cut rates again at the end of January (or, as some like to believe, perhaps sooner), but maybe a serious crunch is what the economy really needs after all. Short term, tighter credit will only extend the crisis in housing, because home buyers won’t be able to secure financing. No wonder the immense inventory of unsold homes (currently above 10 months’ worth) is not moving and home builders are struggling. With or without the Fed’s help, housing will take years to get back to normal, as consumers learn to save, budget and prioritize expenses.

And now, KB Home

Big Wall Street banks will report 4^th quarter results in the coming weeks, and those are expected to be very, very bleak. But until then, home builders’ financial troubles will be in the spotlight. Shares of KB home lost 9% after the company reported a $773 million loss in Q4, 7 times the expected number. And they didn’t sweeten the pill either: Chief Executive Jeffrey Mezger said he expects the market to remain bad for a while, due to oversupply, low affordability and declining consumer confidence. Although revenue fell, the company increased its cash reserve, which, according to analysts, should help it survive the downturn. The surprising part was that KB Home placed a special emphasis on its “strategic partnership” with Countrywide. Amid fears that the lender might go under, it’s hard to see why this partnership is so important, but I guess they can always find another lender to work with if they have to. As for Countrywide, delinquency and foreclosure rates on its loans hit record highs in December, and loan origination dropped almost 50% year-over-year. It will report its financial results for Q4 later this month, too.

Single-Family Home Building Declines

Spending on private residential construction dropped 2.5% in November, its biggest decline in 5 years. This was the 21^st consecutive drop in home construction, which illustrates a slowing trend for private home building. Non-residential building, however, showed an increase of 2.1%, which offset the drop in residential construction. Total construction spending increased by 0.1% in November. Meanwhile, the Institute of Supply Management’s manufacturing index dropped from 50.8 to 47.7. Any number below 50 indicates contraction in manufacturing. Stalling home building and manufacturing will most likely lead to slower economic growth and affect the overall GDP. These results are closely related to the higher cost of credit and the problems in the housing sector, both of which result in lower consumer spending. What we get next is either (or maybe even both) of the following: another rate cut or recession.

Another Fed Rate Cut

The Fed cut its benchmark interest rate again, by 0.25% to 4.25%. The discount rate was lowered accordingly to 4.75%. Economists who had expected a half-point cut in the Fed Funds Rate were disappointed, as recent bad news was expected to prompt more aggressive action by the Federal Open Market Committee (FOMC). The Dow Industrials dropped nearly 300 points after the cut. Stocks of mortgage lenders and large banks suffered, including those of Countrywide Financial, Wells Fargo, Fannie Mae, Freddie Mac, Morgan Stanley, Merrill Lynch, Goldman Sachs and others. Shares of home builders Pulte Homes, Toll Brothers, Lennar and Beazer took a hit as well. The Fed’s statement suggested that they’re worried about the economic slowdown and lower consumer spending, while “some inflation risks remain” too. Meanwhile, holiday shopping has slowed down, and the holiday season’s start wasn’t that impressive after all. Analysts believe the Fed may cut again in January if holiday shopping data is weak and the financial markets remain in freeze mode.

Analyst Downgrades Lennar

Deutsche Bank Securities Inc. analyst Nishu Sood cut his rating on Lennar Corp. from “Buy” to “Hold”, citing concern over the home builder’s joint-venture agreements. Tighter credit and a glut of homes on the market have resulted in declining demand and a high rate of cancellations, which eat into home builders’ bottom lines. Sood cut his target price for Lennar stock from $36 to $17. The stock traded at $18.72 on Thursday.

Home builders and sellers, desperate to sell homes, are offering ever bigger incentives, ranging from trips and car leases to exotic pets. Sellers are willing to make deep discounts because they fear that home prices may fall further as forecast. However, the market is so bad right now that the chances to sell a home at all are really slim. And while most owners can afford to sit and wait for better times to sell their houses, home builders are suffering losses every day a new home sits empty.

Lennar Waiting For Better Times

According to an article in the RealEstateJournal, Lennar Corp. has decided not to sell new homes that are currently under construction. They realize that, should they decide to sell, they will be selling at a loss, and are unwilling “to go below a certain floor”, said Chief Executive Stuart Miller. Hovnanian Enterprises Inc. and Standard Pacific Corp. are still trying to sell, offering discounts and other incentives.

While it is easy to understand the builders’ anxiety over price cuts, I keep wondering whether this will work. Perhaps if they keep cutting prices on homes that are still for sale they could get the inventories moving, but having completed homes sitting vacant means constant expenses. True, they can’t just leave the homes unfinished, but completing them and then waiting for the market to improve doesn’t sound like the best idea ever to me. Luxury builder Toll Brothers is doing something quite different: it refuses to cut prices, even though this may mean few, if any, sales. Something like the “best of both worlds”, - fine, if they can afford it.

Countrywide and KB Home: the worst not over yet

During a panel discussion hosted by the Milken Institute, Countrywide’s CEO Angelo Mozilo and KB Home’s President Jeffrey Mezger talked about the housing market, the Fed’s policy and surplus inventories. The worst is not over yet, according to Mozilo, and Mezger believes “things are going to stay tough for quite some time” for KB Home. Both agreed that lifting loan limits for “conforming” mortgages would help the industry, because the current limit is below median prices in many areas. Non-conforming loans that cannot be purchased by Fannie Mae and Freddie Mac come at a higher price, which further diminishes affordability and exacerbates problems in the housing sector.

So if they see more trouble ahead, how come Countrywide promised to post profit in Q4?

D.R. Horton reports losses in fiscal fourth quarter

The second-largest homebuilder said orders dropped 39% year-over-year to the lowest level in nearly 6 years in its fiscal fourth quarter. Order cancellations were at 48%, up from 38% in the previous quarter. Chairman Donald Horton attributed the poor results to low mortgage loan availability, which hurts sales. Shares dropped 5.3%.

Market conditions are expected to remain challenging for months to come, according to industry officials. Federal Reserve Chairman Ben Bernanke said that housing will have a negative impact on the economy for the remaining part of the year and at least for some time in 2008. Builder sentiment is at its lowest level since the index was established in 1985. The index fell to 18 from a reading of 20 in September, which means that only 18% of respondents in the survey view market conditions as beneficial.

Beazer Homes In Trouble

Here we go again. Beazer Homes Inc., one of the top U.S. homebuilders, announced that cancellations nearly doubled in its fiscal fourth quarter to 68% from the previous quarter. Whoa, this is what I call troubled business. With prices dropping absolutely everywhere and record high inventory of unsold homes on the market, it’s only natural that buyers will cancel their orders, even if it means losing a deposit of tens of thousands of dollars. Brace yourself, this company is headed for more turmoil, if not insolvency. This is sad, and Beazer is not the only homebuilder in trouble. In fact, they’re all in trouble, and the situation is unlikely to improve in the near future.

Furthermore, an internal investigation at Beazer found violations of federal housing regulations and accounting errors, which means that the homebuilder will be restating financial results dating back to 2004, no good for its reputation and stock price. Fines and penalties from the government are highly likely as well. Fitch Ratings downgraded Beazer to BB-minus from BB, which is junk-bond area and essentially means the company’s creditworthiness is, well, somewhat shaky. Fitch also said further downgrades are possible.

And by the way, Lone Star completed the acquisition of Accredited Home Lenders Holding Co. Happy end to the soap opera.

Home Sales Dropped In August

Home sales fell for the sixth month in a row in August, with a remarkable 12.8% year-over year drop. The seasonally adjusted annual sales rate was 5.5 million, the lowest figure since August 2002. Economists believe that August sales data does not fully reflect the consequences of the credit crunch experienced by financial markets, so September figures could be even worse. In this context, NAR’s Lawrence Yun did his best to lighten up the mood: “Once we get through these disruptions, we’ll get a better sense of where the actual market is in late fall as conditions begin to normalize”. Thanks, that was funny, you’ll find more on realtor.org. There’s a record 10-month supply of unsold homes on the market, and that is not going away before the end of the year. Analysts are saying that sales will not stabilize until mid-2008, and some believe even that is optimistic.

Amid the turmoil, home builders are feeling the pain, too. Home builder Lennar Corp. reported the biggest quarterly loss in its history, $513.9 million, or $3.25 a share. This was unexpected, because the lowest estimation predicted a loss of $1.21 a share.

Housing starts lowest in 10 years in July

When the housing starts report came out yesterday, no one was surprised that housing starts dropped last month. It is only natural that in a market like the one we’re seeing today builders are unwilling to begin work on new projects. What was surprising is how much they actually declined. Starts dropped 6.1% to an annual rate of 1.381 million, from 1.47 million in June. That is 20.9% below July 2006 levels and lower than the 1.4 million forecast. Permits dropped 2.8% to an annual rate of 1.373, the lowest since late 1996. Builder sentiment is at the lowest level in years, and for good reason: inventories aren’t moving, despite significant price cuts. Although many would like to buy a house, it’s getting harder to find financing and there’s fear that further price declines may drain all equity out of a home.

Mortgage interest rates increased somewhat this week, but they’re still below the highest readings for this year. 30-year mortgages carried an interest of 6.62%, up from 6.59% a week ago. 15-year fixed-rate mortgages were at 6.30, compared to last week’s 6.25. 5-year adjustable mortgages averaged 6.35%, up from 6.33%, and interest on 1-year ARMs was at 5.67%, a little higher than a week ago, when it averaged 5.65%

Toll Brothers Inc. reports 21% drop in revenue

Luxury home builder Toll Brothers reported a 21% drop in revenue for Q3 2007, which was, nevertheless, better than analysts had expected. JP Morgan Securities had forecast a drop of 28%. Shares gained 6% on the news, the biggest increase in a year. Toll reported sales of $1.21 billion, a drop from $1.53 billion a year ago, but still better than the projected $1.09 billion. Toll did not make an earnings forecast for this year, which may mean that they are concerned about their financial stability.

Toll Brothers CEO Robert Toll said the worst markets were in Florida, Nevada and Southern California, but Philadelphia, Massachusetts and Washington are stabilizing. He also noted that ‘no one knows’ how long the slump in housing will last. The cancellation rate reached 24% in Q3, up from 19% in the previous quarter. The current housing slump is hurting all homebuilders, and Toll Brothers has not escaped unaffected, but they seem to be doing better than most for now.

More troubled hedge funds

The two troubled Bear Stearns hedge funds, the High-Grade Structured Credit Strategies Master Fund and High-Grade Structured Credit Strategies Enhanced Leverage Master Fund, that suffered devastating losses from bad bets on subprime loans filed for bankruptcy protection earlier this week. Investors are taking legal action against Bear Stearns Cos., accusing the company of providing misleading information regarding exposure to mortgage-backed securities.

Another hedge fund firm, Sowood Capital Management LP, announced that it’s liquidating its Alpha funds after they lost more than 50% of their market value in July. Sowood lost more than $1 billion in a month, as its asset value plunged from $3 billion to approx. $1.5 billion. Fearing that it will not be able to meet its margin calls, Sowood sold most of its portfolio to Citadel Investment Group LLC.

In other signs of spreading contagion from the housing market, car manufacturers are posting double-digit declines in sales in July, and companies from chemical maker DuPont to insurers and transportation companies are blaming low revenue on the weak housing market. Speculation is mounting that homebuilder Beazer Homes USA may file for bankruptcy after its quarterly report showed loss of $123 million, sending shares down 18%.

Home builder confidence drops again

The National Association of Home Builders’ July survey of builder confidence showed that less than a fourth of home builders see market prospects as “favorable”. The index dropped to 24 this month, the lowest reading in more than 16 years and the third lowest in the history of the survey. The decline was more dramatic than expected, compared to predictions for a reading of 27.

Patrick McPherron, economist at Moody’s Economy.com, commented that “the bottom of the housing market appears nowhere in sight”. Indeed, we see no reduction in inventories, slumping prices and low buyer activity. With mortgage lenders tightening their credit standards, affordability is becoming even more of an issue. After last week’s downgrades of securities backed by subprime loans, Moody’s is now placing under review deals issued by Bear Stearns and IndyMac, backed primarily by first-lien Alt-A mortgages.

Builders: focusing on affordability

As the housing slump keeps getting more severe, builders are looking for new ways to attract clients. Price discounts and free upgrades didn’t do much to reduce inventories, so now builders are concentrating on more affordable, smaller housing units.

During the housing boom, the average size of a home increased – along with its price – as many buyers attempted to purchase as much house as possible. In recent years many have come to realize that the house they live in doesn’t have to be a huge and expensive one to provide comfort and a sense of homeliness. While demand for housing grew, builders would construct larger houses and sell them at higher prices, but now that affordability has really become an issue, 1,000 – 1,600 sq. feet homes are back in fashion.

KB Home, one of the largest home builders which suffered a second-quarter loss of $148.7 million, is trying to revive the market by offering a line of smaller homes. D.R. Horton is also downsizing, providing more affordable options for buyers. Builders are generally better motivated to unload homes than other sellers on the market, because unsold homes incur significant losses as they stay unoccupied.

Well, apparently it takes a housing slump as severe as the current one to make buyers, builders, agents, lenders and investors apply some common sense when making financial decisions. Better late than never, after all.

Existing home sales steady in May

According to the NAR, existing home sales slipped a mere 0.3% in May, compared to April figures. Year-over-year, however, this is a 10.3% drop. Inventory moved up to the highest level in 15 years, but Quicken Loans’ Bob Walters believes that “we’re still in the early stages of a slow developing market stabilization”. What I heard is that the situation will at the very least remain as bad for several months. I wonder what David Lereah would say at this point if he still worked at the NAR.

And if low sales sound “surprising” to Bob Walters, it doesn’t take a scientist to realize that waiting on the sidelines is quite a wise thing for buyers to do. No one wants to spend their last savings on a house and watch its price drop as the “housing slump” gets worse. Why not wait for a month or two and spend less on the very same purchase, knowing that you won’t lose the equity in your home to market fluctuations?

New homes might sell better than the existing ones because builders are generally more desperate to unload houses and willing to cut prices or offer free additions to buyers. We’ll find out how those are doing soon enough.

The week ahead: a Fed meeting, and so much more

The Fed will be discussing financial matters on Wednesday and Thursday, and, although a change in interest rates is unlikely, economists will be paying much attention to the Federal Reserve’s statement, to be issued at the end of the meeting. With inflation at an annual rate of 2.2, chances for a rate cut seem to be non-existent, as the Fed aims to contain inflation in the 1 to 2% range. The official statement, however, will have a considerable impact on the market’s performance.

Other statistics to be reported this week include existing home sales, new home sales, a survey of consumer sentiment, and a revision of the Gross Domestic Product. All this should provide a clearer picture of the current economic situation, and some insight into the housing market’s near future. Most publications indicate serious pessimism in regard to Real Estate and predict that more bad news is on the way.

Home builders Lennar Corp. and KB Home will be reporting quarterly results this week. Home builders are generally suffering losses in the current market, as both sales and prices decline and homes stay on the market for months, so their reports will provide valuable information on housing as well.