US Housing Market may have overheated

U.S. housing market overheating
ROMA LUCIW

Globe and Mail Update

Most of the U.S. housing market is now showing signs of overheating, with more than two-thirds of the country's biggest cities experiencing steamy, if not outright frothy conditions, according to Merrill Lynch & Co.

In a June, 2005, report titled Mega Metro Bubbles, Merrill said half of the 52 major urban centres in the U.S. were showing signs of overheating. More than a year later, conditions have deteriorated further and that number has jumped to 70 per cent.

Evidence of a slowdown is piling up. Sales of existing homes dropped 11 per cent from a year ago in July, while new home sales have tumbled 20 per cent. At the same time, inventory levels of new and existing unsold homes have grown by almost 40 per cent.

''This suggests that several regional markets could experience material price corrections,” said the updated report.

The team of economists said Monday it expects home price increases will slow to 5 per cent in 2006, and then prices will actually decrease by 5 per cent in 2007. The bearish stance on the housing market led Merrill to cut its outlook for U.S. economic growth to a ”sub-par” 1.8 per cent in 2007 from close to 3.5 per cent this year.

”The findings suggest that many real estate markets face downside risk, which could put more pressure on home builders as well as have negative implications on consumer discretionary equities,” the Merrill report said.

As has been the case for four years, Miami took the top spot as the most overvalued city, with prices rising 25 per cent from a year ago.

Housing prices south of the border have been rocketing higher since the U.S. central bank started to cut rates in 2001. In addition to record-low interest rates, the housing boom has been fuelled by a proliferation of accessible ”buy now, pay later” mortgage products.

However, rising interest rates, higher house prices and surging costs for heating homes have triggered a severe drop in the U.S. housing market.

Craig Alexander, a Toronto-Dominion Bank economist who has been tracking Canada's residential real estate market, said Monday the U.S. housing-led slowdown has become a reality.

”Real estate activity has come down quickly and the economic fallout will be felt over the next several quarters,” he said. The housing correction has become the dominant topic of conversation, fuelling talk about a possible U.S. recession.

Mr. Alexander says he does not foresee an outright recession but rather a mid-business cycle slowdown, with economic growth slumping to 2 per cent before recovering.

”For Canada, the timing of the U.S. slowdown is rather unfortunate,” he said. ”Exporters are still struggling to adjust to the higher value of the loonie, and now they will have to cope with weaker demand in their largest market.”

Canadian demand will remain strong, although it will be hurt by the indirect effects of a slowing U.S. economy, including modest job growth, Mr. Alexander said. Canada's housing market will also cool, although ”nothing like” the experience south of the border.

There is clear evidence that the rise in Canadian housing prices is being supported by economic fundamentals, not speculation, TD said. "Real estate markets have responded to strong demand growth, which has reflected the lowest unemployment rate in 30 years, strong personal income gains in the last three years, and attractive borrowing costs."

The gradual cooling in the Canadian housing market will not threaten the domestic economy, which will continue to grow at a solid pace. TD forecasts Canadian economic growth of between 2 and 2.5 per cent in the fourth-quarter.

Mr. Alexander said the U.S. Federal Reserve is likely to cut rates by 100 basis points in the first half of 2007, while the Bank of Canada is expected to be less aggressive and slower to ease, with quarter point rate cuts in March and April of next year.

TD forecast that the weaker U.S. housing picture will lead to a 25 per cent drop in base metals in the next four quarters, while crude oil will fall to $50 (U.S.) next year before rebounding. Meanwhile, the Canadian dollar will likely trade a range between 87 and 90 cents in 2007. This Article from the Globe and Mail

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