The outlook for projected growth in the second half was revised downward from Fannie Mae’s projections of 2.8 percent in July and 3.2 percent in June.  In the new August 2010 Economic Outlook released today, Fannie’s economists no longer foresee the modest recovery for housing in the fourth quarter and into next year that they predicted in their July forecast.

Low 30-year fixed mortgage rates, projected to average 4.5 percent for 2010, are expected to boost refinance activity but likely will not be low enough to trigger a refinance boom, said Fannie’s economists nor support a fourth quarter housing recovery as previously predicted.

“The inability of the financial sector, business, and households to determine the likelihood of events on the economic horizon is making planning for the future difficult,” said Fannie Mae Chief Economist Doug Duncan. “It is particularly difficult to know how the economy will evolve given recent and forthcoming policy changes. Because of this uncertainty, downside risks are trumping upside potential. Corporate profits are strong, but uncertainty around future labor costs is hindering near-term hiring. The Fed is reinvesting maturing MBS into Treasuries as a strategy to keep long-term interest rates low, but uncertainty about reform in the financial sector is constraining credit availability. Consumers are lowering their leverage and positioning themselves to resume consumption, but they face uncertainty about employment and the renewal or expiration of tax cuts,” said Duncan. “The upside possibilities are there, however the key sectors are reticent to contribute meaningfully to expansion.”

Duncan’s gloomy comments contrasted markedly with Fannie’s July forecast which said “the headwinds in housing are picking up” and his June comment that “Clearly, housing still faces headwinds but housing starts are expected to increase slightly by year end.”

Recent gains in home values are temporary and markets are poised for a 5 percent dip during the balance of 2010.

Even worse, prices will continue to bounce around for as long as three years to come.  That’s the latest scenario from Fiserv, Inc., a technology provider to the financial services industry that bases its forecast from an analysis of home price trends in more than 375 U.S. markets from the Fiserv Case-Shiller Indexes.

In the first quarter of 2010, U.S. single-family home prices rose an average of 2 percent over the year-ago quarter, the first year-over-year national gain since 2006. However, prices have fallen 28.7 percent since 2007.

“We expect to see prices bounce up and down around their lows for the next two to three years, especially in markets that experienced the largest home prices bubbles. This will result in alternating bouts of optimism and pessimism regarding the housing market recovery, similar to what we have seen for the economy as a whole. This will make it difficult to know exactly when the housing market has reached its bottom.,” said David Stiff, chief economist, Fiserv.

Despite the gain in the national average, prices were actually lower in 303 of the 384 metro areas compared to the 2009 first quarter. The overall increase was driven by strong price increases in markets such as the San Francisco Bay Area and Washington, D.C. However, prices in many markets continued to plummet, with double-digit drops in Detroit, Las Vegas and many small Florida markets, Fiserv said.

Ohio and Michigan, two states hit hard by the recession and loss of manufacturing jobs, are still seeing signs of price corrections, though not at the levels of the past couple of years, making housing very affordable across metro areas in these states.

Home prices in Utah, a market that has historically performed well, saw significant drops in home prices, with Provo, Salt Lake City and St. George seeing declines of 13.3 percent, 9.9 percent and 17.5 percent, respectively.

The largest home price increases were seen in the San Francisco Bay area, where San Jose home values increased 17.2 percent, and Washington, D.C., where home values increased 8.5 percent.

The largest year-over-year increases in home prices have occurred in the low-priced segments of metro area markets. There is indirect evidence that the recent rebound in home prices was driven primarily by the home buyer tax credits, which were most beneficial to households that purchased lower-priced homes.

Stiff warns there will be renewed downward pressure on home prices. “Although part of the rebound in the less expensive market segment is due to improving affordability, it is likely the rising sales volumes and prices of low-priced homes were mostly due to the tax credit. When the tax credit expires, sales activity for low-priced homes will drop causing a moderate decline in overall home prices.”

“We expect continuing improvement. Risk levels should be lower on newly originated mortgages next year barring a “double dip” recession,” said Dennis Capozza, the Dykema Professor of Business Administration in the Ross School of Business at the University of Michigan, and a founding principal of University Financial Associates, which created and publishes the UFA Default Index. 

Local economic conditions that have been building for a decade, not underwriting or moral hazard, are the primary driver or defaults.  ”Although declines usually happen faster than increases, it will still take many years to return to “normal” prices.  We are not there yet,” Capozza said.

Yesterday UFA said the UFA Default Risk has dropped to 182 in the second quarter, half the peak level of 362 set in 2007. The Index illustrates the important role that local economic conditions have played in this credit cycle, since loan, borrower and collateral characteristics are held constant over time in the Index. If, as some observers expect, inflation spikes due to excessive monetary ease, nominal house prices will be higher and defaults will be lower.

Under current economic conditions, investors and lenders should expect defaults on loans currently being originated to be 82 percent higher than the average of loans originated in the 1990s, but much less than the worst vintages of this cycle (2006-2008).

Strategic defaults, which Capozza said have always been a risk for investors when house prices decline precipitously, are already factored into the UFA forecast, which predicts declining foreclosures started; so he  does not expect strategic defaults to increase default risks.

The UFA Default Risk Index measures the risk of default on newly originated prime and nonprime mortgages. UFA’s analysis is based on a “constant-quality” loan, that is, a loan with the same borrower, loan and collateral characteristics. The Index reflects only the changes in current and expected future economic conditions, which are much less favorable currently than in prior years.

Get ready, say several leading economists. 

Brian Wesbury, chief economist at First Trust Advisors, told Forbes this week that we’re building only one-third of the houses we need just to keep up with population growth.

Wesbury figures America needs to add 1.5 million housing units per year just to keep up with population growth plus another 100,000 for fires and tear-downs, et al, we need 1.6 million or more per year. Right now we’re down to about six and a half, seven months’ inventory, whether you look at new homes or existing homes. Housing starts are now between 500,000 and 600,000 a year.

“I think one of the secret investments, if you will, over the next decade is going to be housing. It is extremely cheap, inflation is on the way. But people are running away from it. You know, it’s that old adage, ‘When there’s blood in the streets, that’s when you invest.’ And this is the time, I think, for real estate,” Wesbury said.

Wesbury, dubbed “Mr. Sunshine” for his sunny forecasts, including his prediction that by the third quarter of this year there could be a seller’s market for new homes, is not alone in expectation of a housing shortage.

Last week, William Strauss, senior economist at the Federal Reserve Bank of Chicago, said that though he sees a growth in housing production, he foresees a potential shortage in housing units.

“Kids who have graduated are mostly still living at home, more people are sharing houses and divorce rates go down in a recession. It’s a lot cheaper to be together than to separate,” he said. “The housing market is looking better on affordability measures. After World War II we had a boom with 170 million people living in this county. Now we are over 300 million, and we have fewer houses for these people to live,” said Strauss.

Writing in the Vox economic site, MIT economist William C. Wheaton made a case similar to Wesbury’s in an article last July. 

“During the last decade, net new household formation averaged approximately 1.4 million per year. Last year, the Census reported that the US added only 544,000 new households - during severe contractions the young stay at home, singles “double up”, and household formation (normally) slows. Even with declining demographics, however, most analysts foresee new household growth resuming to a level of at least 1 million by 2010 and beyond. If we conservatively add 200,000 demolitions per year, the US economy will “need” at least 1.25 million new units yearly in the near future. With today’s currently depressed construction, this generates a yearly deficit of 750,000 units. At that rate, the current excess inventory of units for sale or rent will be back below normal by 2011. Prices historically have a strong relationship with sales “duration” - the ratio of inventory-to-sales. Hence under reasonable conditions, in two years we will have to increase construction considerably and prices will have to justify the cost of that construction,” wrote Wheaton.

Not surprisingly, home building industry leaders concur.  At the International Builders’ Show (IBS) in Las Vegas last month, they predicted that demand for multi-family housing units will outstrip current supply by mid-2011, with increasing shortages of rental housing through 2014. This is very likely to increase market-rate rents as much as 8 percent to 10 percent per year in 2011 and 2012, and by 4 percent to 7 percent per year thereafter through 2015.

“Lack of debt and equity is crippling the private companies’ ability to start new development,” said Jerry Durkin of Wood Partners in Atlanta. “Over the last 10 years, our company built about 3,500 apartment and condo units a year. In 2009, we closed on one development deal, in December.”

In fact, in high growth communities across the nation, local housing shortages are already here or on the way.  Dallas, Austin, coastal California, Pendleton, Ore., Greater New York City, certain Washington, DC suburbs and dozens of college towns report low inventories and rising demand that is not being met by new construction.  Yet in California last year, a bank demolished 18 completed new homes whose builder had defaulted rather than try to sell them.

Home building across the country is almost non-existent compared to a few years ago. In 2005, 2 million housing units were built in this country. Last year, that number dropped to nearly a quarter of that.  Home builders have lost half their share of the U.S. housing market in the past two years, largely because of competition from cheap foreclosed houses. In 2009 only 7.6 percent of the homes sold were newly constructed, down from the average of about 16 percent over the previous two decades, according to the Wall Street Journal. From June 2007 to June 2008, residential construction lost nearly 115,000 jobs, according to the Bureau of Labor Statistics.

The mortgage giant predicts that home sales and new residential construction will boast double digit gains in 2010 compared to a disappointing performance in 2009. According to the forecast, existing home sales are expected to rise by 10 percent next year, compared to an estimated 3.1 percent gain this year, while new home sales are projected to rise by 26 percent in 2010 compared to an estimated 19 percent drop in sales this year. Similarly, new residential construction is expected to increase 35 percent in the New Year compared with a 38 percent drop in starts in 2009.

Fannie Mae’s upbeat forecast for the nation’s housing sector is consistent with the positive way housing activity ended this past year. The housing sector scored a trifecta in October-home sales were up; home inventories were down; and home values were stabilizing. Existing home sales surged10.1 percent to 6.1 million annualized units in October compared to a month earlier, while new home sales gained 6.2 percent to 433,000 in October, representing the strongest pace since the fall of last year. More encouraging was that the months’ supply for existing homes posted a cyclical low of 7 months in October, while the months’ supply for new homes registered a cyclical low of 6.7 months.

The median price for existing homes fell 7.1 percent in October compared to October 2008, but it was the second consecutive month where the decline was in single digits. More heartening was the meager 1 percent decline in the median home price in October compared to September. The median price for new homes fell only 0.5 percent in October from a year earlier.

According to its 2010 forecast, Fannie Mae expects home values to remain relatively weak next year, predicting a 0.2 percent drop based on the Federal Housing Finance Association (FHFA) home price index, compared to a meager 0.5 percent drop in the FHFA home price index this past year.

Although the housing sector is expected to rebound sharply in sales and housing starts in 2010, the mortgage giant predicted bad news for mortgage lenders, estimating that mortgage originations would decrease 33 percent by the end of next year. The company notes that the primary reason for a large drop off in the origination business is attributed to a projected 52 percent plunge in refinancing transactions compared to this past year, due to rising mortgage rates. Mortgage rates are expected to average 5.14 percent in 2010, compared to an estimated average of 5.03 percent this past year.

There remain serious risks in predicting a successful housing market recovery. Foreclosures are expected to mount over the next year or two because of rate resets on option ARM and interest only mortgage loans. Foreclosures add to housing inventories, which could slow the recovery. In addition, the homebuyer tax credit which is due to expire at the end of April, has been effective in enticing households to purchase homes during the past several months. If Congress does not extend the credit (again), the momentum in home sales could stall sometime next year.

A four-year downturn has evidently come to an end for U.S. homebuilders, according to Fitch Ratings in its outlook report for the sector.

While Fitch maintains a negative outlook for U.S. homebuilding in 2010, the homebuyer tax credit has positively influenced housing over the last few months. Pending home sales, existing home sales, single family housing starts and single family new home sales have all been generally showing improvement after bottoming out earlier this year. The same holds true for new home inventories, home pricing and consumer and builder sentiment. Moreover, the U.S. economy apparently moved from recession to expansion in third quarter-2009.

However, challenges remain, especially the expected upcoming surge in delinquencies and foreclosures for both Alt-A and option adjustable-rate mortgages (ARMs).

Fitch raised its forecasts for starts and new home sales earlier this year, the first positive adjustments in these metrics in over three years. Nevertheless, the rating service anticipates that the early stages of the expansion may be more muted than the average.

During the first 12 to 15 months, the recovery may appear jaw-toothed as substantial foreclosures now in the pipeline become distressed sales, and as meaningful new foreclosures arise from Alt-A and option ARM resets. High unemployment rates and the probable tightening of certain FHA loan standards (higher minimum credit scores for new borrowers and greater upfront cash requirements) will slow recovery.

‘The continuation and expansion of the national housing credit should partially help offset expected seasonal declines during the winter months through the spring of 2010,’ said Managing Director and lead U.S. homebuilding analyst Robert Curran. ‘The federal government’s continuing efforts to moderate foreclosures may also show some success in 2010.’

Despite having fewer competitors, publicly held builders will continue to be challenged and need to maintain tight controls over costs and expenses during 2010.

Housing continues to be weak. Fitch expects that the public builders by and large to typically stabilize their aggregate land positions over the next 6-to-12 months or selectively add to owned, developed lot holdings. The still irregular flow of appropriately priced land from banks and others tends to support this conclusion.

‘With operational and financial pressures moderating to some extent, most public homebuilders have to operate successfully within this still challenging environment or wither away,’ said Curran. Companies have to at least maintain current cost profiles or continue to downsize to the point where they can remain/be profitable (excluding nonrecurring real estate charges). That means possible further moderate cuts in staffing and other overhead, as well as other cost reductions.

Despite the negative outlook for the sector, continued progress in industry and company metrics could prompt a reassessment and possible revision of some of the U.S. homebuilder rating outlooks.

Fitch expects the economy to return to positive growth next year, primarily reflecting the impact of the fiscal stimulus package, but also some likely stabilization in housing investment and a weakening inventory overhang. The CBO predicts federal government spending grew by 34 percent in nominal terms in fiscal 2009 (ending September), which should have an important subsequent multiplier effect on wider spending. Lower household tax rates should also help ease the pace at which consumers deleverage through cutting expenditures, while lower commodity prices will also support consumers’ real income.

Rates on 30-year fixed mortgages averaged 6.03 percent in 2008, off 31 basis points (bps) from the 6.41 percent in 2006 (and 6.34 percent in 2007). Fitch expects rates to decline as much as 90-100 bps for all of 2009 as the Fed continues to execute its plan to buy mortgage securities and the economy struggles.

Fitch’s initial outlook for the housing sector in 2009 started quite bearish due to the influence of a softening economy, even tighter credit standards for homebuyers and the effect of late 2008 disruptions in the credit markets. However, by mid-year the outlook brightened, prompting lesser forecast declines for a number of housing metrics. Fitch most recently forecast a contracting economy during first half-2009, with a mild recovery beginning in 3Q’09 and continuing through 2010. Real GDP is forecast to decrease 2.5 percent for all of 2009. Investment is expected to plunge 17.6 percent, with consumer spending to fall 1percent, exports to drop 11.6 percent and imports to see a 16.6 percent decline.

Given Fitch’s macroeconomic forecast for 2010, public builders are likely to experience a mild recovery next year. On average, revenues should expand low double digit despite lower home prices due to a mix shift to smaller, often entry level homes. Gross margins should improve 150-200 basis points reflecting earlier real estate charges and lesser selling incentives. With higher volume the typical SG&A expense/sales ratio may diminish.

*Existing home sales excludes condos;** Existing plus new home sales

Sources: Fannie Mae, Freddie Mac, Mortgage Bankers Association, National Association of Homebuilders, National Association of Realtors

Highlights

• The consensus forecast among the major real estate organizations is for the housing downturn to come to a close in 2009.
• The consensus forecast projects a 0.3 percent drop in existing home sales in 2009 and a 9.6 percent increase in existing home sales in 2010.
• According to the housing group, 30-year mortgage rates are expected to average 5.2 percent in 2009 and 5.7 percent in 2010.
• Both new home sales and housing starts are expected to experience wild swings, falling by 17.1 percent and 36.2 percent in 2009, respectively; and increasing by 25.4 percent and 34.3 percent in 2010, respectively.
• The Mortgage Bankers Association, Freddie Mac and Fannie Mae were the only organizations to forecast mortgage originations. The projected average of the three organizations is 37.0 percent increase in originations in 2009 to $2.219 trillion from $1.620 trillion in 2008. For 2010, the three organizations projected a 22.0 percent decrease in originations to$1.731 trillion in 2010. 

Celia Chen, senior director of the Moody’s Economy.com research staff, said, “For many reasons, the rebound will be disproportionately small compared to the decline,” Moody’s said this week in its latest outlook on the residential market. “It will take more than a decade to completely recover from the 40 percent peak-to-trough decline in national home prices” in Moody’s latest outlook on the residential market.

Despite the ongoing challenges facing the U.S. housing market such as rising foreclosures and a supply glut, the rally in home-builder stocks shows investors are hopeful the worst is over. The sector has doubled from the March lows, the report said.

Moody’s said the home-building industry will rebound, “but a lingering overhang of inventories, combined with consolidation in the industry and caution on the part of both home builders and lenders to builders, will keep the pace of construction from reaching the peak it achieved at the end of 2006.”

On home values, the report said price volatility has been “particularly wild” during this housing cycle, with a giddy run-up followed by the dramatic crash. However, prices “will behave in a much more moderate manner during the recovery.” Moody’s predicts home prices “will remain at a persistently lower level than we anticipated prior to the crisis, and it will take a full decade from the 2010 bottom just for the  national index to climb back to its 2006 peak.”

The forecast signals a dramatic shift from her views a year ago.  In an interview on NPR in August 2008, Ms. Chen predicted home prices would hit “absolute bottom” in the spring of 2009. “If you’re buying to live in a house, it’s probably OK to purchase a house now,” says Chen. “It’s probably better if you wait a little longer,” she said at that time.

At a conference hosted by Fitch Ratings a week ago, Dennis Capozza of University Financial Associates said that home prices will continue to fall over the next five years, though the greatest declines have already occurred this year and property value reductions will gradually decrease until 2014.

 Comparing the current crisis to the recession of the early 90s, Capozza said housing prices will again trail the overall economic recovery, he said.  However, the severity of today’s situation will drive prices lower and lengthen the time it will take housing prices to begin to appreciate, compared to the recession eighteen years ago.

 Local economic conditions, especially excess supply, rather than underwriting or moral hazard, are the primary causes of falling prices.  Unemployment today is greater than the recession in the early 90s, driving borrowers who are already underwater into default and impacting on the economy negatively.  Though foreclosures are peaking now, a four and a half month excess supply is creating a huge overhang, Capozza said.

However, the lingering recession and the unremitting crisis in the housing markets may wipe away some of those smiles.

It’s clear the “echoes” will spawn a record number of households and boost housing demand but it’s not such a given that they will become homeowners, at least right away. In fact, in the near term, demographic forces favor the rental over the for-sale market. Echoes will make less in real income than earlier generations and tight credit could make it hard for them to get financing. The recession, if it continues, also will reduce immigration, the second major demand driver for housing.

That’s the conclusion of a conservative reading of the latest annual snapshot of America’s housing condition, the State of the Nation’s Housing by the Harvard Joint Center for Housing Studies.

Even a conservative projection puts household growth averaging more than 1.25 million annually over the next decade, thanks to the aging of the echo boomers. The number of echo boomers is expected to eclipse the number of baby boomers when they were 25-44 by more than 5.9 million.

“A severe and prolonged recession may reduce immigration…and the depth of the downturn may, for the first time in at least 40 years, reduce the real median household incomes of each 10-year cohort relative to its predecessor by 2010.  Rapid growth in the population under age 45 and over age 65,as well as the rising minority share, will shift the composition of housing demand over the next 20 years. These changes in the age distribution will mean greater demand for both starter homes and rentals, and for seniors housing. In addition, as the baby boomers…The first wave of change will occur in the inner suburbs of large metropolitan areas where people now in their 70s and 80s are concentrated, then fan out,” the report concluded.

Demographics alone won’t be enough to bring about a recovery, and the financing picture is not a pretty one for young buyers. “The home buying market will continue to struggle until the foreclosure crisis comes to an end. Although new federal efforts may prevent millions of families from losing their homes, mounting job losses will likely keep foreclosures at elevated levels. At the same time, falling prices are keeping potential buyers on hold while locking millions of potential sellers in their current homes. Tighter underwriting standards also present higher credit, income, and wealth hurdles to homeownership. While down payment requirements may ease when lenders sense that home prices have reached bottom, stricter caps on mortgage payment-to income ratios and thorough verification of income will likely remain in place for some time. Credit standards will probably be the last to loosen, given the abysmal performance of subprime loans,” the study found.

Whether “echoes” can afford to become homeowners largely hangs on the success of government efforts to revive the economy and the housing markets.