No Rebound in 2011 as the Housing Market Continues to Rot

[Editor's Note:This special report on investment prospects for the housing market is the second story for Money Morning's annual "Outlook" series, which will forecast the prospects for gold, oil, the U.S. economy and other top profit opportunities in the New Year. Make sure to watch for upcoming installments in the days to come.]

The year of 2010 saw very little improvement in the housing sector, and that's not likely to change in 2011.

The industry's weaknesses - high unemployment, tight credit, ineffectual government programs, soaring inventories, plunging prices, and so on - are simply too gaping to be resolved by next year.

Even the normally ultra-optimistic National Association of Realtors (NAR) came out of its annual conference in New Orleans in early November with a frown on its face, predicting that, "nationwide, homeowners can expect little, if any, increase in home values in 2011." 

The real estate research and online brokerage firm Zillow agreed, issuing a report on Nov. 10 noting that U.S. home values fell by 4.3% in the third quarter and chances for improvement over the winter are slim.

"The unceasing declines in home values signal that we're in for a long, bleak winter of continued troubles for the housing market," said Zillow Chief Economist Stan Humphries. "The length and depth of the current housing recession is rivaling the Great Depression's real estate downturn and, with encouraging signs fading, will easily eclipse it in the coming months."  

Undermined by Unemployment

Chief among the obstacles to a housing market recovery is high unemployment. Unemployment has driven foreclosure statistics to dizzying heights, and in conjunction with tight credit, kept new buyers out of the market.

Currently at 9.5% the national unemployment rate likely will remain near double-digits in 2011. In the meantime, credit markets remain tight, making it even more difficult for Americans to buy new homes or refinance their existing mortgages.

Money Morning - Only the News You Can Profit from Outlook 2011

Although mortgage rates remain near their all-time lows - a recent average of 4.17% for 30-year fixed-rate loans and 3.57% for 15-year mortgages - actually getting one of those loans is another story. Banks are still trying to absorb losses from the earlier collapse of the mortgage market and dealing with record foreclosure levels, so they're demanding demonstrated job security and impeccable credit before granting loans to new homebuyers.

Lower interest rates have dramatically increased refinancing applications, which have doubled since the start of 2010 according to the Mortgage Bankers Association (MBA). However, less than half of those applications are being approved. And government programs have done little, if anything, to help.

Pitiful Programs

The government's Home Affordable Modification Program (HAMP), which was set up in March 2009 to help homeowners in trouble restructure their mortgages and avoid foreclosure, has been an abject failure.

Roughly 3 million of the 7 million homeowners facing foreclosure at the start of 2009 applied for relief under HAMP, but only 1.4 million were approved for temporary or trial modifications - and more than half of those have been canceled. By late October, only 466,708 homeowners had been granted permanent modifications.

Almost a quarter of the homes on which modification requests were cancelled are now in foreclosure - and, even worse, many homeowners who got modifications still wound up in foreclosure because of fees, late charges, and interest accrued while homeowners were waiting for approvals.

Meanwhile, the one government incentive that effectively cheered up the dour housing market - the federal homebuyers' tax credit - has fully expired. This program, which provided up to $8,000 in credits to first-time homebuyers and $6,500 for repeat purchasers, pushed many people to accelerate their buying decisions. However, the tax credit expired at the end of June and the market has cooled considerably as a result.

Absent the credit, the NAR says existing home sales for 2010 will total just 4.8 million, a 7% drop from 2009's 5.16 million. Pending home sales also fell in September and October, virtually guaranteeing a slow start in 2011.

For the year as a whole, the NAR sees existing-home sales climbing back to 5.1 million - but only if new jobs continue to be created. (Note: Several states, including California, also had smaller homebuyer incentives that have now expired.)

Still, sales and home prices will continue to languish next year, as foreclosures and housing inventory remain considerably high.

Foreclosures, Inventory, and Prices

Zillow said in its third-quarter report that 23% of U.S. residential mortgage holders are now "under water" on their loans - the highest level this year - and many will likely be forced into foreclosure in the year ahead.

"The high percentage of homeowners in negative equity ... represents a huge number of people who are not only more vulnerable to foreclosure, but who are essentially trapped in their current homes and are prevented from selling and buying a new home," said Zillow's Humphries. "This has profound implications for future demand and will be a millstone around the neck of the housing market."

NAR Chief Economist Lawrence Yun agreed, saying it will take at least another two years to clear the foreclosures and short sales currently on the market.

With tight credit keeping many qualified buyers at bay and foreclosures hitting an all-time high in the third quarter of 2010, the inventory of homes available for sale stood at 4.04 million units in September. That was a slight drop (1.9%) from August - but still represents a 10.7-month supply at current sales rates.

The average sales price for a home fell to $171,700 from $178,600 in September, and actual number of existing home sales was down 19.1% from year-ago levels.

The number of new-home sales actually rose 6.6% to an adjusted annual rate of 307,000 units, and the median price for those homes climbed from $220,500 to $223,800. However, the overall impact of the increase was minimal, since August sales were the third-lowest since the government began to track new-home numbers in 1963.

"Sales did rise, which is good," Celia Chen, a senior director at Moody's Analytics told CNN, "but the pace is still very weak ... still close to a record low. It just doesn't seem that demand is really firming."

That weak pace has also prompted the National Association of Home Builders (NAHB) to reassess its earlier estimate that 906,000 new homes would be built in 2011, saying in early October that their forecast "is less certain today."

A Sinking Feeling

It doesn't seem to matter which area of the country you consider, the outlook is dim from coast to coast. Zillow's Home Value Index of housing pricings in the 25 largest metropolitan areas found just six positive numbers in the third quarter - in Boston, Pittsburgh and four California cities - but even those numbers are misleading since the Zillow Index factors out foreclosure sales.

Local realtor surveys by The Boston Globe, The New York Times, The San Diego Union-Tribune and The Miami Heraldall had trouble finding anyone with optimistic forecasts for their areas.

Johnathan J. Miller, president of the real estate appraisal firm Miller Samuel, told The Times that despite small bursts of "happy housing news" in 2010, he expects "the 2011 New York market will be weaker."

Rick Loughlin, president of Coldwell Banker Residential Brokerage New England, echoed that sentiment to The Globe.

"We're in the choppy bottom, improving, but at a very slow pace," he said. "The real key issues are jobs and consumer confidence; when jobs come back, you'll see more of a recovery in housing."

So, given the state of the housing market, are there any stocks in that sector worth buying?

For most segments of the market - homebuilders, real estate developers, realty brokerages and mortgage companies - the answer right now is probably no. 

In fact, the only remotely positive recommendation we've seen recently was given to Barron's by Deutsche Bank AG (NYSE: DB) analyst Nishu Sood, who said the time has come to "start nibbling" at the housing stocks.

"Five years into the housing market's fall, we believe it is finally near the point from which it can sustainably recover," said Sood.

Action to Take: The best approach to begin 2011 is probably to heed the words of Coldwell Banker's Loughlin and wait until you see some steady improvement in new-job creation. When it's clear that more people are going back to work - and keeping their jobs - start checking out the major housing stocks because lots of folks will want new homes to go along with their new positions.

If you want to get an early jump on the rest of the crowd, look first at the stocks of firms that supply the homebuilders - Weyerhaeuser Co. (NYSE: WY), recent price $17.20, being a good example. It's trading at less than a third of its April 2010 high of $53.69, even though it has managed to remain profitable throughout this mess (reporting trailing 12-month earnings of $1.04 a share) and has had increased year-over-year revenue and earnings for three of the last four quarters.

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