Cooling Housing Market Will Hamper U.S. Economic Growth - But By How Much?

The five-year housing boom is showing signs of cooling, which likely means slower growth for the entire U.S. economy, writes Martin Crutsinger in Forbes.

The big question? If home prices will come crashing to earth with severe consequences. The National Association of Realtors reports that sales of existing homes climbed to an all-time high of 7.072 million units in 2005, up 4.2 percent from 2004 and marking a fifth consecutive annual record. Sales fell by 5.7 percent in December, however, marking a third straight monthly decline for the first time since early 2002.

“The bloom is definitely off the housing rose. Housing peaked last summer and has been weakening ever since,” said Mark Zandi, chief economist at Moody’s Economy.com.

Analysts are forecasting that both existing and new home sales will fall this year, perhaps by as much as 10 percent, reflecting the adverse effects of rising mortgage rates and buyer resistance to current prices. The Realtors said the median price for an existing home sold in 2005 rose to $208,700, up 12.7 percent from 2004. That’s the biggest annual increase since a 14.4 percent jump in 1979.

Yet the group believes double-digit price gains will soon be a thing of the past. Price increases are expected to slow to more normal gains of around 5 percent to 6 percent this year, and some analysts are warning that some of the hottest markets — metro New York and South Florida real estate, among others — could see actual price declines.

The meteoric housing market has boosted overall economic activity over the past five years, with about 1 percent of last year’s estimated economic growth (of 3.5 percent) occurring because of the effects of housing growth. Increased employment in construction industries boosted consumer spending, which accounts for two-thirds of total economic activity — a rise in home values allows legions of Americans to refinance their homes or take out home equity loans to support higher spending on consumer goods.

But analysts say the economy could be in trouble unless other forces pick up the slack from a slowdown in housing. Goldman Sachs estimates that the housing slowdown will begin to be a drag on economic growth by mid-2006, and that by early 2007 it will be impeding growth by around 1.5 percent. Other sectors like business investment spending and an improving trade performance are expected to take up the slack.

“We think that housing will go from being a source of strength for the economy over the past several years to a drag on the economy over the next couple of years,” said Andrew Tilton, a senior economist at Goldman Sachs.

The danger is if home sales fall off by more than analysts are forecasting.

Such a scenario could mean that investors, who have boosted sales with their purchases of rental properties and second/vacation homes (especially in places like Florida), will start dumping homes onto the market, creating a glut of inventory and further depressing prices. Most analysts do not believe that is the likely outcome, however. They expect sales to decline slightly, reflecting only moderate increases in mortgage rates as the Federal Reserve wraps up its credit tightening campaign.

The Fed may be nearing the end of its rate hikes, with possibly two more quarter-point bumps coming up at its meetings next Tuesday and on March 28. If the Fed’s rate increases do stop at that point, industry analysts said 30-year mortgage rates — currently at 6.10 percent – will only jump to 6.5 percent or 6.75 percent by the end of this year. While higher than a year ago, these levels are still considered historically low and should support healthy home sales.

Locally, a demand for income and vacation properties should contribute further to keeping the market chugging along. The days of 20-30 percent annual appreciation may be over, but with Florida home loans still affordable, and the weather nice all year, the experts agree that there is a lot to be confident about.