July Housing Starts Raise New Concerns About the Real Estate Market

by: James Picerno

A number of dismal scientists, and market strategists have been advising for some time that the real estate market was set to stabilize. It wasn't poised to grow necessarily, but that was just fine as far as the broader economy was concerned. The prediction fit nicely with the idea that if real estate simply stopped being a drag on the GDP calculation, the second half of 2007 into early 2008 would look pretty good in terms of growth.

That may yet prove accurate. But after reading this morning's news on housing starts for July, new doubts arise about the momentum of real estate's correction and, by extension, GDP's prospects in the second half.

Today, the Census Bureau reported (pdf) that housing starts dropped again last month, falling 6% from June, on a seasonally adjusted annualized basis. More dramatically, July's 1.381 million annualized starts are down 21% from a year ago, as our chart below shows. Permits issued for new private housing construction is also off sharply on a monthly, and annual basis through July.

Housing Starts Chart

The housing starts and permits trends suggest that the pain continues. Until, and if the numbers show some stability, there's reason to expect more of the same, namely, declines. That may or may not be the right thing to do, but short of knowing the future, what else can a prudent investor to do these days?

Combined with the mortgage ills of late, it's all starting to look like a perfect storm for real estate. Consider how the chain of events may be playing out. A builder sets out to construct a new house. In recent years, there was no trouble finding willing buyers who would sign a contract to pay, say, $500,000 nine months from now, when the home was finished. Between today and nine months from now, there was a halfway decent chance that the $500,000 house would be worth more. That was combined with easy credit made banks, and other financial institutions eager to back the home buyer with a loan, regardless of the buyer's credit history. The deal was beneficial for all involved.

But the game has changed. The builder isn't so sure that he'll have a buyer who can find the necessary credit. One reason: it's not clear that the $500,000 house will be worth $500,000 nine months from now. And with mortgages tougher to come by, it's a lot easier to delay purchases, which only inspires builders to become defensive, and cut back on construction plans.

It's too early to say if the real estate troubles will derail the former optimism about economic growth in the second half of 2007, but it's not too early to worry. Or, to hedge the risk of slower growth than recently predicted.

Alas, all mere mortals can do is watch the trends and make a decision based on incomplete information, which is a perennial state of affairs in managing money, and discerning tomorrow's economic trend today.

On that note, we take no encouragement from today's update on initial jobless claims, which the Labor Department advised jumped to 322,000 for the week through August 11 - the highest since mid-June. Granted, this series is volatile, and it's also true that 322,000 is still quite middling in terms of recent history. But in these anxious times, any excuse will do.

Raising cash has been a focus of ours for some time now. For the moment, there's no compelling reason to change that bias. In fact, it seems that more investors are coming to a similar conclusion. That by itself is a significant change in sentiment, and a sign of the times.