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US Housing Market: In Recovery Mode Or Not?

One of the key questions both economists and investors have to ask themselves is whether the U.S. housing market is finally in recovery mode or still just half way through a lost decade, with home prices already down a third from the 2006 peak?

The answer to this question is important to the future of the American economy, at least according to the International Monetary Fund (NYSE:IMF). It said recently that the housing market is vital to eventually boosting economic growth and reducing high levels of unemployment in the United States. The IMF forecast that there will be a need for about 1.5 million homes to be built annually over the next five years. One of its economists, Gian Maria Milesi-Ferretti, said "it [housing] is clearly going to be something that will help U.S. growth over the medium term."

And indeed there are signs of recovery from the bottom in the housing market. Home prices (Case-Schiller home price index up three months in a row) and new home sales (up about 20% from a year ago) are on the rise. Inventories of unsold homes are also declining thanks largely to record low mortgage interest rates. Additionally, the latest National Association of Home Builders' housing market index rose solidly in all regions of the country to an overall 35 reading in July, a five-year high and well ahead of expectations. The monthly gain from June's 29 reading was the largest in almost 10 years.

As usual, Wall Street momentum players have jumped well in front of what they perceives as a trend, pushing the prices of home building stocks up until they are on pace for a record year. Goldman Sachs recently upgraded the sector to 'attractive'. The Standard & Poor's Supercomposite Home Builders index is up about 50% so far this year, which is nearly five times the gain of the S&P 500 index. Among the leaders in the index are PulteGroup (NYSE:PHM), Lennar (NYSE:LEN), Toll Brothers (NYSE:TOL) and DR Horton (NYSE:DHI). Publicly-listed homebuilders make up about a quarter of total new home sales in the United States and that percentage is rising every year.

However, Wall Street may have jumped the gun. After all, this not your father's housing market; great shifts in the U.S. economy over the last 10 years have changed housing market dynamics for good. Among the factors affecting today's housing market is the fact that many homeowners are still "underwater" on their mortgages. Add to that 15 years of stagnant or declining income for many households and the record levels of student loan debts - more than $1 trillion - and you have a scenario which acts as a brake on household formations via younger people buying houses. First-time home buyers in 2011 made up only 37% of home purchases versus 51% in 2010. Stringent mortgage requirements by banks are also a major factor behind the drop in first-time home buyers.

Take a look at the obstacles that recent college graduates - the largest group of first-time home buyers - face. They are starting out as the most indebted generation of Americans ever, with an average of $25,000 in student loan debt. They are entering a labor market where the number of people with jobs is at a 30-year low, wages are falling in many sectors, and those with jobs face decreasing health and retirement benefits. None of these factors are conducive to making young people run out and buy a home.

The basic fact is that the housing market and income generally move in lockstep with each other, and real median household incomes of Americans are still stuck at the same level they were under the Clinton administration in 1996. This means that the housing market will remain troubled for "an extended period of time," according to senior economist at housing data company CoreLogic, Sam Khater, in an interview with Reuters.

Pulte's CEO Richard Dugas told Wall Street analysts home sales are still "preposterously low" when compared to historical trends. But at least things seemed to have bottomed, laying a new foundation for the future. Most economists expect home prices to be stable this year and project a modest rise of 2% in prices in each of the next few years. It's a good start, but conditions will likely improve at a more rapid pace in the housing market only if and when the U.S. sees an improvement in its employment situation.

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