Don't Believe Advocates of a Soft-Landing for Housing

by: Barry Ritholtz

"We do expect an adjustment in home prices to last several months, as we work through a buildup in the inventory of homes on the market. ...This is the price correction we've been expecting -- with sales stabilizing, we should go back to positive price growth early next year."
David Lereah, economist, National Association of Realtors
The New York Times, September 2006

I am out of pocket most of today, but I wanted to reference something of Doug Kass's from some time ago. Doug discusses the details of his debate with NAR's chief economist last year (CNBC's "The Real Estate Boom") and what it might mean going forward:

"Back in April 2005 (on the CNBC special), Lereah and the managements of Hovnavian (NYSE:HOV) , Prudential Realty and LendingTree were fully convinced (you might say glib) that the housing market was destined for a long boom. They saw a new paradigm of uninterrupted, noncyclical growth. One month later, Lereah was quoted as saying, "We simply don't have enough homes on the market to meet demand."

Forgive my preoccupation with the housing markets, but it has had a disproportionate role in economic growth since 2000 (and maybe before). This merits a continued discussion as to the possible slope of the decline, and the nature of the inevitable recovery. The housing cycle, among other variables, is a key influence on aggregate economic activity.

I expect a hard landing, and I have roughly quantified my expectations as to when the housing market will bottom (2009). It is folly to think that an unprecedented rise in home prices (in real and nominal terms) will be over in relatively short order. Yet this has been suggested by Lereah and others."

More from Doug:

"Housing cycles are long, and they play out over many years. We have learned that the peaks are surprisingly high and the up cycles unexpectedly long. Unfortunately, so too are the depth and duration of the down cycles.

Days/months inventory have only begun to rise as the glut of homes will be exacerbated by continued overbuilding, disposition of land, and the selloff of homes by flippers. And, as discussed previously, the consumer enters the current downturn in a weak position. Consumers are highly leveraged after the overconsumption binge of the last decade and after massive cashouts of home equity.

Consider the dramatic sale of D.R. Horton (NYSE:DHI) homes in the Daytona Beach market in Florida. Please note the message at the bottom of this advertisement: "Realtors Warmly Welcomed!" That's never a good sign.

These discounts include up to $90,000 a unit or as much as 30% (plus a free washer/dryer and refrigerator). This is not unusual: Most homebuilders have offered large price discounts and/or large incentives (vacations, car leases, reduced mortgage rates, etc.) for several months.

The ramifications of an extended housing downturn are broad -- far broader than many realize. For example, the apartment REITS, a sector I am short, argue that there has been no new construction, so supply/demand favors an escalation in rents. But just wait until speculators, unable to sell their condominiums and homes, resort to renting the units.

Or consider the implications for building materials companies like Eagle Materials (NYSE:EXP), which warned on Tuesday. What about the sale of pickup trucks, which are often used on the construction trade? What does an extended downturn portend for carpet, gypsum, lumber and appliance manufacturers? Or for subprime and some prime lenders? And what do you suppose happens to the plethora of real estate agents and mortgage brokers? (Do they become daytraders again?)

You get the point: The housing decline is just beginning to be felt. The fixed-income market recognizes this. But for now, equity market participants don't. Common sense has taken a sabbatical.

Don't believe the housing soft-landing advocates, and do recognize the broad economic impact that a protracted downturn will have on our economy.

The worst is yet to come."

Thanks for the realism, Doug,

Housing Headed to the Woodshed
Doug Kass
Street Insight, 9/29/2006 10:14 AM EDT