This post first appeared on Minyanville.

It appears even the embattled homebuilding industry is getting rosy-eyed, finding enough “green shoots” of economic recovery to stick their shovels back into the ground.

In May, US builders broke ground on 17.2% more projects than in April, far exceeding analysts’ expectations. Work on new apartment buildings leaped, while single-family starts continued what’s now become a 3-month rally.

Although the aggregate figure is still well off last year’s rate, economists are breathing a sigh of relief that the worst of the housing market swoon could be behind us. Skeptics, however, are quick to point out that any recovery could be muted, as high levels of inventory, a weak labor market, and mortgage rates that just won’t seem to stay down, could forestall any recovery.

As Kenneth Simonson, chief economist for the Associated General Contractors of America, told the New York Times, “There’s a real possibility [housing starts] will just stall at a low level. If the recent jump in interest rates is sustained, that could choke off buyer enthusiasm for new homes.”

For nearly 4 years, the business of building and selling homes has been, in a word, lousy. As home prices tumbled, the likes of KB Home (KBH), Toll Brothers (TOL) and Lennar (LEN) slashed prices, offered generous incentives, and otherwise bent over backwards to unload inventory. Building all but stalled, jacking up unemployment — particularly in exurbs and sprawling communities whose economies were largely based on the construction trade. An industry that grew fat during the boom was forced to slim down, lay off workers, and hibernate, while the market’s violent correction ran its course.

And although a host of small builders have closed up shop, to date, no major US homebuilder has gone under. Consolidation, too, has been scant. The only merger of note was Pulte Home’s (PHM) purchase of Centex (CTX), a marriage that, once consummated, will create the country’s largest builder.

The outlook for those builders that remain — builders that are bleeding cash while pleading with creditors to extend loan terms and waive busted covenants — is bleak. Last week, the National Association of Homebuilders/Wells Fargo Builder Sentiment Survey ticked down after rising far more than expected the month before. Higher interest rates are mostly to blame, as the specter of bigger monthly payments is quelling optimism that the housing market is on the mend.

The reality — an unfortunate one for builders and their employees — is that for the foreseeable future, their services aren’t needed in this country; we have too many homes as it is. Demand for new ones remains weak as communities just a decade old slip into disrepair, and shoddy craftsmanship and half-finished developments scare off prospective buyers.

Builders are also fouling up the nascent housing “recovery” by turning recently completed condominium units into rentals. Even as demand wanes thanks to job losses and tighter budgets, rental inventory is rising. Rents, as a result, are falling. This is great news for tenants, eager to jump on affordable apartments, but bad news for landlords and even homeowners.

One of the most popular arguments posited by housing-market-bottom callers is that in some of the hardest hit areas, prices have gotten so low that investors can scoop up cheap homes and rent them for an attractive return. What they neglect to mention, however, is that this sort of market-clearing activity also increases the supply of rental units, further pressuring home prices. Even in the worst, most washed-out areas, a bottom remains elusive.

New Home Sales in March came in higher than expected, even as prices fell from this month last year. According to Bloomberg, the Commerce Department reported that builders tallied sales last month at an annual pace of 356,000, down just slightly from February.

Inventories dropped to the lowest level in 7 years, while prices dipped to levels not seen since December 2003.

Without a doubt, lower inventories and sales activity that is becoming somewhat less abysmal than before is a good sign for homebuilders, who saw their stock prices jump today. Lennar (LEN) popped 14.99%, Hovnanian (HOV) rose 10.75% and Pulte Home (PHM), who recently announced plans to buy Centex (CTX), finished higher by 7.34%.

At the risk of being labeled perma-bears, while the news was cheered by most industry experts, that doesn’t mean builders will begin breaking ground any time soon on new developments. And since homebuilders make money by, well, building homes, the group still isn’t out of the woods. As prices keep falling in line with broader measures of home prices, building houses will remain a non-economic enterprise for the foreseeable future.

When will that trend reverse? While it’s anyone’s guess, a good sign would be when builders start buying finished lots that currently can barely be given away for free.

By ANDREW JEFFERY

This post first appeared on Minyanville.

After nearly 3 years of bleeding cash, US homebuilders are on shaky ground.

The market for new homes is being decimated by rampant overbuilding during the boom, and by the flood of bank-owned properties now being sold on the cheap. Prices remain in free fall. Even as labor expenses and materials costs hover around recent lows, the business of building new homes is still broken.

But after 2 “positive” datapoints last week, and KB Home’s (KBH) narrower-than-expected loss, many are wondering if the worst is now behind the beleaguered industry. Government-backed efforts to keep mortgage rates low and encourage home buying could save the builders. Maybe.

New home construction, for all its complications and intricacies, is a rather simple business: Sell homes for more than it costs to build them.

New homes have traditionally carried a premium to “used” ones; the median sale price of a new home is currently about 20% higher than that of one that’s been previously owned. Builders relied on this premium to cover their construction and financing costs, not to mention to generate a healthy profit. But now that buyers can buy barely used houses at fire-sale prices, the allure of the brand-new is on the wane.

Here in the San Francisco Bay Area, banks are said to literally be giving land away for free: Builders will have nothing to do with it. The costs associated with owning improved lots (in other words, lots ready for the construction of a house) are too high for - even if they’re offered for free. Building just isn’t an economically viable option - and it won’t be until housing prices rebound.

And that could take years.

Meanwhile, homebuilders like KB Home and rivals Centex (CTX), Lennar (LEN) and DR Horton (DHI) are struggling to rid themselves of unsold homes. Builders large and small are slashing prices, trimming staff, hawking vacant land for pennies on the dollar, and doing anything else they can think of to stay alive.

Many face an additional headwind this year: Tax rebates from previous operating losses will be drying up. Debt remains high, and cash is barely trickling in.

Ultimately, some big builders won’t make it. The market, both for equities and default protection in the form of credit default swaps, is betting on Hovnanian (HOV), Beazer Home (BZH) and Standard Pacific (SPF) to be the first of the big dogs to fail.

Those hoping to survive are rapidly adjusting their strategies to adapt to the changing demands of the American homebuyer. As Minyanville’s Terry Woo noted on Friday, KB Home’s better-than-expected earings were partly a reflection of a switch to smaller, cheaper homes.

This is a positive trend: it’s yet another indicator that Americans have a newfound love affair with thrift. And while we may lose a few builders along the way, I doubt we’ll miss all those identical, pre-fabricated houses that had come to litter our landscape.

By ANDREW JEFFERY

This post first appeared on Minyanville.

This week, 2 data points led optimistic market-watchers to declare the bottom in the housing is nigh: Indeed, one widely read trader-writer proclaimed, “The oversupply of housing that so plagues the market at present will be a figment of our memory a few months hence.”

The first: On Monday, the National Association of Realtors said existing home sales jumped 5.1% in February compared to the previous month, largely due to the high number of foreclosures being dumped onto the market by big banks like JPMorgan Chase (JPM), Bank of America (BAC) and Wells Fargo (WFC).

While indicative of buyers gingerly dipping their toes back into the market, existing home sales are still down 13.4% from a year ago.

The second: On Wednesday, the Commerce Department released data on February new home sales which showed a similar trend: Transactions bounced 4.7% from January, but remain a whopping 41% below sales this time last year. Nevertheless, shares of beleaguered homebuilders like Centex (CTX) and Lennar (LEN) had stellar performances this week, capping a nearly 100% gain since the beginning of the month.

Prices, however, continue to slide for both existing and new homes. And while median (and average, for that matter) price data is skewed to the downside due to the mix of homes sold in a given period — in this case, more cheap houses than expensive ones — property values remain in a decidedly downward trend.

But since transactions typically find a bottom prior to prices, the number of people who believe prices should stabilize in the near future is growing.

Examining the data, unfortunately, tells a different story. Below is a chart produced by my firm, Cirios Real Estate, showing home prices and sales transactions in for the eastern part of the San Francisco Bay Area. The East Bay is a fairly representative sample of California housing markets: A little high-end, a little middle-class and a little low-rent all mixed in.

Click to enlarge

The red line shows average home prices, while the blue line shows sales transactions, as measured by their change from a year ago. Notice how, even as sales have spiked from the previous year, prices continue to plunge.

Two things jump out at me on this graph (aside from the massive increase in transactions and precipitous decline in prices):

First, transactions began to ramp up as prices moved down toward levels where borrowers could get government-backed loans to buy homes. That means Fannie Mae (FNM), Freddie Mac (FRE) and the FHA have financed a whole swath of homes in the past 18 months that are now severely underwater.

Second, transactions bottomed in September 2007, not long after the market peaked. 18 months have passed and prices have dropped more than 50% since that time.

With that in mind, the current “euphoria” over housing data — after a single month-over-month increase in sales, when year-over-year measures remain well behind even last year’s weak totals — seems a bit premature.

This is not to say prices will never stabilize, or that increased sales are a bad thing. In fact, the more sales we have, the quicker price discovery happens and the faster a true bottom can be found. Nor is this some proclamation that this part of California is a perfect proxy for home prices nationwide.

But given the backlog of foreclosed homes sitting on the books of the major American banks, continued price declines across the country and tight mortgage market conditions, calls for the devouring of supply by voracious home buyers causing an imminent housing bottom is downright premature.

To be sure, we may be one step closer to a housing bottom, but that’s one step on a very, very long path.

By ANDREW JEFFERY

This post first appeared on Minyanville.

Our elected officials appear convinced that Americans should buy stuff they don’t need with money they don’t have.

The Senate, in passing its version of the over $800 billion economic stimulus package yesterday, threw a great deal of cash at 2 industries whose products we have far too much of already. Despite the fact that we have too many cars on the road and far more homes than we do people to buy them, lawmakers are determined to prop up both the auto-making and home-building industries.

According to Bloomberg, Ford (F), General Motors (GM) and Chrysler, the latter 2 already suckling the government teat just to stay alive, will benefit from a provision that allows consumers to deduct car-loan interest payments and local sales taxes from their income tax.

Meanwhile, Centex (CTX), DR Horton (DHI) and other homebuilders are salivating at the prospect of a $15,000 tax credit for those brave enough to buy a new home. The new, more generous tax break replaces a $7,500 credit granted last year.

In what shouldn’t come as a surprise, Brian Catalde, the president of the National Association of Homebuilders (or NAHB) is pleased that his group’s intense lobbying efforts paid off.

“We’re pretty happy with the way the Senate bill is shaping up,” Catalde said. “We think it will entice a lot of those people sitting on the sidelines into the marketplace.

”NAHB members nervously await the disposition of the final bill as their balance sheets remain bloated with unsold homes priced well above prevailing market prices.

Lawmakers seem determined to dig our way out our debt problem with yet more debt. By encouraging Americans to borrow more to buy the cars and homes irresponsibly manufactured by these industries in the first place, Congress and the President alike reward the very poor financial decisions that brought our economy to its knees in the first place.

To borrow the analogy from Professor Succo’s piece yesterday, Economy: Code Blue, this is akin to handing an obese person a donut, telling them to munch away as long as they stay away from pizza. It just doesn’t make any sense.

Among the Senate bill’s numerous differences from the House’s version passed last week — most notably the handouts earmarked for homebuilders and automakers — it also excises more than $20 billion in funding for new public-school construction.

Once again, lawmakers display their unparalleled financial acumen: Only more McMansions will counteract the vast oversupply of schools this country is struggling to get out from under.

This post first appeared on Minyanville.

Finally, housing is starting to act like a market searching for a bottom.

Well, sort of.

In former boom states like California, Arizona and Florida, distressed sales are driving the local real-estate markets. After a near-complete evaporation of buying activity last year, buyers have been brought off the sidelines by continued price declines, a glut of homes for sale, and low interest rates. Comparisons with last year are easy: Some areas are seeing activity up more than 300% year-over-year.

Many contend this is a healthy development, as prices return to more affordable levels and latent demand sops up overhanging supply. The bottom, they argue, is nigh.

However, even in areas seeing strong buying activity, median home prices continue to tumble. Banks and private sellers alike are finding the only way to guarantee a sale is to list the house below the market. This constant undercutting is pushing prices down, sometimes well below affordability levels derived from median income data.

This trend is not indicative of the capitulation most market watchers believe must happen before prices can truly bottom.

Capitulation is a concept more often reserved for equity-market analysis than for housing. Since real estate is vastly more fragmented and localized than stocks, housing trends take months, even years to develop, while equities can reverse course in a manner of days, if not hours.

Still, drilling down into individual transactions, evidence of capitulation in certain markets is becoming evident. Sellers, after 4 years of price declines, are finally throwing in the towel.

Homebuilders are becoming desperate: Toll Brothers (TOL) is trying to lure in buyers with 3.99% interest rates through a partnership with Wells Fargo (WFC). Centex (CTX) did them one better by offering rates as low as 3.25% (that rise to 4.50% after 2 years) and Pulte Homes (PHM) also offers a 3.99% fixed rate option for qualified buyers.

Banks like JPMorgan (JPM), Bank of America (BAC) and Citigroup (C), desperate to shed their growing inventory of foreclosed homes, are beginning to accept bids 10, 15 or even 20% below their asking prices.

And its not just banks. Just in the past few weeks, private sellers have started to jump at low-ball offers. Better to take less cash now than be constantly priced out of the market, chasing it all the way down.

Although this type of sale is still very much the exception rather than the rule, it’s an indication that sellers are becoming despondent, willing to accept any reasonable price to rid themselves of what could be months of headaches, upkeep expenses and deteriorating market conditions.

To be clear: This analysis is by no means a call that housing has bottomed, or is even remotely close to a bottom. It’s merely evidence that certain areas are closer to stabilization that others, and these signs — which may look like capitulation — should be viewed as a positive development in a market deeply in need of hope.

By ANDREW JEFFERY

This post first appeared on Minyanville.

The private sector is actively engaging the mortgage crisis with the first broad-based, systemic attempt to prevent foreclosure. Both Bank of America (BAC) and JPMorgan (JPM) are attempting to help hundreds of thousands of troubled homeowners with massive loan modification efforts.

Regulators and bank executives are operating under the assumption that reducing foreclosures will slow record drops in home prices. In turn, this will help stabilize the financial system - and, by extension, the economy as a whole.

This logic isn’t necessarily flawed - but it’s reactive, rather than proactive, which is what’s most needed now.

Most foreclosures are concentrated in regions where homebuilders like Centex (CTX), KB Homes (KBH) and Lennar (LEN) built huge developments, using cheap financing to help fuel speculation and massive over-valuation. These areas, especially those where homes were purchased by lower income buyers, are being decimated by delinquencies and repossessions.

This, however, is widely known. What’s less well-understood is the storm that’s brewing on the horizon: Trouble in the prime mortgage market – where borrowers with good credit are starting to miss payments with alarming frequency — is looming on the horizon.

Recent delinquency data indicates that while defaults on subprime loans are occurring at a less frenetic pace than in recent months, prime borrowers are starting to feel the pinch. In early September – before the financial crisis accelerated in October — the Mortgage Bankers Association released its quarterly delinquency data, concluding,

“The increase in prime ARMs foreclosure starts was greater than the combined increase in fixed-rate and ARM subprime loans. Thus the foreclosure start numbers will likely be increasingly dominated by prime ARM loans.”

There is still a vast misconception that only “subprime” people maxed out credit cards, took out loans they couldn’t afford, and were generally reckless with their personal finances.

This couldn’t be further from the truth.

As the economic slowdown swirls outward into the broader economy, cracks are starting to form in established neighborhoods that have thus far experienced minimal home price depreciation. Many of these areas experienced stratospheric appreciation – just as their subprime neighbors did – but the strong job and stock markets insulated middle- and upper-middle income homeowners from rising interest payments and the slowing economy.

As mortgage underwriting requirements have tightened in recent months, home buying has slowed in these more well-to-do areas. This trend is being masked by spikes in the distressed sales driving broad housing market indicators.

As layoffs continue, homeowners in these areas will be forced to sell for the first time in years. The illiquidity in these markets means it will take just a few such sales to readjust prices dramatically downward. Homeowners that don’t sell by choice, particularly if they’ve accumulated equity in their homes, are apt to be less picky about their price.

Furthermore, it’s likely the recent onslaught of modification programs, tomorrow’s election, and pundits’ continued obsession to call a bottom in housing will encourage buyers to step back into the market. Increased sales transactions – even if they continue to be concentrated in distressed areas – will fuel the perception that the housing market is stabilizing.

This is likely to encourage a fresh round of selling, as anxious homeowners leap to take advantage of “improving” market conditions. This new supply won’t necessarily offset inventory that’s kept off the market by preventing foreclosures on a unit-to-unit basis; instead, the supply will simply crop up in different neighborhoods.

The subprime mortgage crisis may indeed be waning; its final battles are now being aggressively fought in Washington and bank boardrooms across the country. The prime wave, however, is just beginning to crest.

This post first appeared on Minyanville.

Some say the definition of insanity is trying the same thing over and over again, expecting a different result. By that measure, voters should load up on straitjackets this November and drag everyone in Washington off to the nuthouse.

Despite overwhelming evidence that we’re in the middle of a debt crisis, regulators insist they’re wrestling a liquidity crunch. And all the while, a cancer continues to eat away at the guts of the economy: The housing market. Only when it stabilizes will the financial system and, by extension, the economy - recover.

And yet, despite this widely recognized fact, the recent $700 bailout package contains little support for struggling homeowners. Even the $250 billion being dumped into banks will have only a minor effect on property values.

Smothered under the weight of falling home prices and tight credit conditions, consumers are reining in spending, as evidenced by yesterday’s bleak retail sales data. The economy is following the housing market into the abyss.

Since last summer, Washington’s tactic has been to encourage loan modifications through HOPE NOW and Project Lifeline and to widen the scope of government-backed loan programs via the Federal Housing Administration, Fannie Mae (FNM) and Freddie Mac (FRE).

As noted in the Wall Street Journal and discussed ad nauseum here at Cirios, these measures are woefully inadequate to stem the continued decline in housing prices.

As property values fall, over-leveraged borrowers find themselves underwater, or owing more on a house than it’s worth. In order to sell, the homeowner must come up with the difference between the sales price and the balance of their mortgage. For most, this is cash that simply doesn’t exist.

As a result, homes sit on the market for months, further pressuring home values. Despite the insistence by some real-estate agents that this is a buyer’s market, it most certainly is not. Until bloated inventories fall, home prices will continue to slide, making buying a home a dangerous proposition in the vast majority of the country.

Meanwhile, politicians continue to bang their heads against the proverbial wall, backing programs simply that do not work with the scope and efficiency that’s needed. Loan modifications, opening up mortgage guidelines and providing tax breaks so homebuilders like Centex (CTX), Pulte Homes (PHM) and KB Homes (KBH) can sell more overpriced houses may help a select few, but they do little to address the root of the problem.

Until taxpayer funds are appropriated to absorb negative equity, price discovery in the housing market will be a long, agonizing process.

This post first appeared on Minyanville.

That glitzy McMansion you’ve always wanted may finally be within reach.

Or not.

If nearly 3 years of home price declines, historically low interest rates and a relentless media barrage of half-truths from the National Association of Realtors haven’t been able to stabilize home prices, it’s doubtful a gimmicky used-car-style sales event will do the trick.

Coldwell Banker, one of the nation’s largest real-estate brokerages, launched a nationwide campaign last Friday to boost the flagging housing market. The 10-day sales event aims to close the gap between buyers and sellers by offering up to a 10% discount on listed homes for, you guessed it, 10 days.

This selling bonanza was hatched in response to a recent survey of over 3000 of the firm’s real estate agents, which found that a majority feel listing prices are too high to attract buyers. The survey also showed almost 80% of the agents believe more appropriately priced homes are garnering more attention; apparently, you need a license to know people like to pay less for a house, not more.

Coldwell Banker’s president and CEO, Jim Gillespie, is confident the housing market may finally be nearing a bottom. He told our friends at Marketwatch: “Despite the difficult headlines regarding our overall economy, the residential real estate market has been showing several positive signs over recent months that could be signaling a tipping point.”

It’s unclear whether continuing price declines, historically high levels of inventory, tightening lending requirements or frozen credit markets are the “positive signs” he’s referring to.

Gillespie also believes the unprecedented sales event will encourage buyers to jump back into the market: “Because of higher inventory, buyers have more homes to choose from and they can take advantage of near historically low interest rates and affordability levels that are the best they have been in years.”

Yes, affordability levels are the best they have been in years: Much better than when the only way to get into a house was to lie about your income and take out an Option ARM with a 1% teaser rate.

About this time last year, homebuilder Hovnanian (HOV) tried a nationwide fire sale to flush out its bloated inventory. More recently, Lennar (LEN), Centex (CTX), and DR Horton (DHI) tried a similar approach with both land and homes - to no avail. The fundamental forces pushing housing prices down will persist, regardless of futile ploys aimed at tricking buyers into paying more than they should for homes.

To be clear: Being negative on the housing market isn’t exactly a contrarian position. Therefore, anyone claiming it’s a great time to buy – like Coldwell Banker and tens of thousands of real estate professionals around the country — clearly have their own reasons for doing so.

Real estate agents get paid to close transactions; whether their client receives (or pays) a fair price is a non-issue.

Commission expenses are borne by sellers, typically to the tune of 6% of the sale price. In California, where the median home price is still over $350,000, that’s $20,000 out of the pocket of someone who’s already seen his home’s value evaporate before his eyes.

The selling agent usually splits the commission with the buyer’s agent, a pay structure that gives both sides an incentive to not only focus exclusively on closing deals, but also to sell homes for as much as possible.

Coldwell Banker correctly asserts that many sellers have unrealistic expectations about their homes’ final selling price, and as a result keep asking for prices too high for too long. Their cute little sales event, however, is aimed more at earning commissions for their struggling agents than advancing true price discovery in the troubled housing market. If the firm truly had the best interests of homeowners in mind, agents would volunteer to take a pay cut to ease their troubled clients’ burden.

Gillespie, Coldwell’s CEO, claims the event will “help move the US real estate market in the right direction.” He’s right - home prices must continue to fall. Simple economics, the interplay between supply and demand, is driving most markets, as tens of homes sit on the market for every one qualified buyer. Until this overhead supply is worked through, prices will remain under pressure.

In some of the most depressed areas – Las Vegas, the California Central Valley, Florida and Phoenix – homes have reached or surpassed traditional levels of affordability. Unfortunately, there’s more to buying a home than just being able to make the monthly payments. With down payment requirements returning to pre-bubble levels, low interest rates are almost a moot point.

There just isn’t any economic rationale for buying if home values keep sliding.

Even if a borrower can afford the monthly payments, home price declines wipe out the tax benefits of writing off mortgage payments and risk putting the new homeowner in the paralyzing position of owing more than his home is worth. Buying a home today is almost like buying a new car: You’re upside-down as soon as you’re handed the keys.

Until there’s real, verifiable evidence that home prices have stabilized, buying a home remains a dangerous financial proposition. This is true in every market, not just the ones that make the headlines for mind-boggling foreclosure rates.

Renting is still the far more fiscally responsible option. Staring into the teeth of a recession, families should be making choices in the best interest of their financial security, not for bragging rights at cocktail parties.