Investors unknown factor in 'cooling' 2006 economy

This article sheds some light on the impact investors have on the eonomy and the housing market in particlular.

While housing and finance industry economists say they don't expect the real estate boom to turn to doom and gloom this year, they do say that the record run-up in housing prices and sales has run out of steam, and 2006 should be an above-normal year but probably won't make the record books.

There is an asterisk for these predictions: How real estate investors react to this downturn could foil the forecast and potentially be devastating for the housing market and overall economy, economists said during an economic outlook presented Thursday by the Homeownership Alliance, a national coalition of housing and finance organizations.
While housing has been an economic boost over the past several years, this year the housing market could be a slight drag on the national economy, the Homeownership Alliance economists generally agreed.

"It's difficult to follow the strongest year ever," said David Lereah, chief economist for the National Association of Realtors trade group, which has about 1.2 million members. "The boom is obviously winding down. That's what we're all saying and observing." Existing-home sales should drop about 4 percent to 5 percent this year, compared to the 2005 levels, Lereah said, and new-home sales should drop about 5 percent to 6 percent year-over-year.

Price drops are possible in some "very, very hot metro markets," he added, though "it's very difficult to know which markets they will be right now." Nationwide, though, Lereah expects home-price appreciation to be up about 6.1 percent this year, compared to a rise of 13 percent in 2005.

As for investors, Lereah said, "Investor activity is by far ... the biggest risk that the housing sector is going to face this year, because investor activity had gotten to levels that we had never seen before. And we are in uncharted territory." Speculators who bought properties to flip quickly may be left at a loss, as interest rates are rising and the market is in transition from a seller's market to a buyer's market.

David Seiders, chief economist for the National Association of Home Builders trade group, said, "I think the biggest risk would be for investors not only to stop investing, but to move those units back onto the market in large volume, and that could create a bigger problem. This is kind of new to us," he said, adding that it's a "major uncertainty" where investors would put their money if they pulled it out of the real estate market.

"All of us will be observing keenly," Lereah said. In March 2005, the Realtor trade group released a study that showed a high level of investor activity in the housing market: 23 percent of all homes purchased in 2004 were for investment, and another 13 percent were vacation homes.

Frank E. Nothaft, chief economist for Freddie Mac, said rising energy prices also have the potential to disrupt the overall economy and could potentially lead to higher-than-expected increases in the mortgage rate.

The panel of economists said they expect the Fed will soon stop its trend in raising the federal funds rate, which they expect will level off at about 4.5 percent to 5 percent this year.
There will likely be no quick solution to affordability problems in markets where home-price appreciation has outpaced income growth, though 2006 may see income growth more in-line with price gains, economists said.

Nothaft said that areas that have experienced 20 percent or more appreciation for the past several years and have also had high levels of investor activity may be at particular risk as the housing market cools. Investment activity in Las Vegas, for example, has accounted for close to 40 percent of purchase activity, he said. "What will happen in Las Vegas in the coming year? It's very hard to say."

Refinancing activity should be down about 14 percent to 15 percent this year compared to 2005, and that should lead to lower consumer spending relative to refinancing cash-outs, he said.

Nothaft also said he expects the share of adjustable-rate mortgages to tail off in 2006, from about 30 percent of the overall share in 2005 to 25 percent of the overall share, and he also expects declining activity in interest-only and other unconventional mortgage products as there is "more regulatory scrutiny and pressure on lenders."

Seiders estimated that new-home sales, which increased about 6.7 percent in 2005, should drop about 6.6 percent this year, while existing-home sales should drop about 4.8 percent this year.
David Berson, Fannie Mae

David Berson, chief economist for Fannie Mae, said he predicts an 8 percent drop in new- and existing-home sales this year, with home-price appreciation of about 3 percent. Berson said his forecast is down largely because of a high level of investment activity in the real estate sector.

"Our data ... suggests that the investor share of the market has been at record levels and rising ... and the investor share has effectively doubled over the past three or four years. Investor demand is always more volatile than other housing demand," he said. Investors appeared to pull out of some markets toward the end of 2005, he said, and that trend could continue this year.

Overall, though, the housing market still looks good, he said. "It's still not a bad year for housing -- just not the record year we've had for the past couple years," he said.

Economists forecast cooling trend
Friday, January 06, 2006

David Seiders, NAHB