Rates trend upward: quarterly building trends forecast: the honeymoon winds down as mortgage rates continue to climb

Prosales, Jan, 2006 by Jonathan Dienhart

The mortgage rate honeymoon seems to be drawing to a close, and since consumers have gotten used to sub-6 percent fixed mortgage rates over the past two and a half years, there are now plenty of questions about the immediate future of the housing market. With high energy costs, steady consumer spending, solid GDP growth, and constant short-term rate hikes by the Federal Reserve, mortgage rates have finally started to trend upward. And unlike the occasional jumps that have happened in recent years, this time they are not likely to come back down. The spread between one-year adjustable rates and the 30-year fixed rate has continued to narrow, and, like a compressing spring, it will eventually push apart again, sending 30-year rates upward.

So where exactly are mortgage rates headed? According to the office of the chief economist at Freddie Mac, the 30-year mortgage rate will average 6.4 percent in 2006 and 6.6 percent in 2007. That means for the next year we should see only very gradual increases in mortgage rates--important news for the housing market. While the pace of home sales and price appreciation will slow, gradually rising mortgage rates will mean a more forgiving marketplace, providing more time for home buyers to adjust to changing conditions. In terms of affordability, the rise in mortgage rates will be partially offset by continued economic growth and job growth, and overall should result in a "soft landing" for most housing markets across the country.

But wait, what about "the bubble"? Talk of a housing bubble has been a staple of housing market commentary for almost as long as we've enjoyed the sub--6 percent mortgage rates. The reality is that there still is no housing market bubble at the national level. Economists often try to apply the lessons learned during the tech boom/bust to today's real estate market, and the exercise has not proven to be particularly valid. Housing (or, more specifically, land) is not only real property but is an inherently scarce local commodity and has a much more stable marketplace than the speculative technology stocks of the late '90s. And because housing is a local commodity, any rises or declines are more often going to occur as a result of local trends and not as much on a national basis, especially with a solid national economy.

While some short-term fluctuations are to be expected, the long term remains bright. In the next few years, construction activity will find a new equilibrium that is below recent peak levels but still a high plateau compared to the preceding decades. And as time goes on, the task becomes even more monumental. According to the Brookings Institution, by the year 2030 almost half of the buildings in which Americans live, work, and shop will have been built after 2000. For builders and the companies that supply them, that means there's precious little time to worry about temporary market adjustments.--Jonathan Dienhart heads the published research group for Hanley Wood Market Intelligence, a division of PROSALES' parent company, Hanley Wood, LLC.

Hanley Wood Market Intelligence provides data and consulting services on residential real estate development and new-home construction, including analysis of key trends impacting the housing market through its proprietary software products and research reports. Contact: 800.639.3777. www.hanleywood.com/hwmi. == RELATED ARTICLE: Market spotlight: Florida.

The Sunshine State is home to the hottest housing markets in the country and, in recent years, is experiencing one heck of a hurricane cycle. Florida has seen a tremendous amount of construction activity over the past year, with an average of more than 16 permits issued per 1,000 residents over the last 12 months. That's more than twice the pace of the nation overall, and amounts to nearly 280,000 issuances. In general, demand has kept up with supply, making most Florida markets lucrative for investors. However, the downside to being attractive to investors is that at some point they tend to move their money somewhere else.

Unlike primary residences in which homeowners most often live for a number of years and are slow to pick up and move out, investment properties add volatility to the market and are the first housing units to be "dumped" when signs of a market shift emerge. As a result, the probable rise in inventories in Florida over the coming months will be due in part to investors trying to "cash in" their investment properties and move on to other opportunities. Some may even have to wait a month or two to sell their properties instead of having a line of bids before a property even makes it to MLS (as has been the case in some areas during the past couple years). Suddenly in a panic, the edgier investors will fear they've missed the boat and drop prices to ensure a sale.

Will this sort of behavior cause a market-wide decline of prices in Florida? It's very unlikely, but we probably will see a few months of volatility in pricing sometime during 2006, as the market finds a new equilibrium and deals with an outflow of some of the investment monies that the robust market has soaked up. In addition, home buyers still looking for a primary residence may be able to get a great value if they can find an investment property whose owner is anxious to get their money out.