As it turned out, the fear of a national meltdown wasn’t a potential red flag, but became the lead story of the housing market in 2008. Once again, the fact that the Western PA market is dominated by small builders rather than high production builders heavily influenced the slowdown, with builders in Pittsburgh pulling back from any spec construction as early as late spring. By the time the stock market cratered in the first two weeks of October, most of Pittsburgh’s builders were hunkered down already, and activity was at its lowest in two decades.

Before covering the regional market, it’s worthwhile to look at the problems facing the national market for residential sales and new construction.

The two most significant factors dragging the national market down have persisted for two years: declining values and excess inventory. The well chronicled sub-prime mortgage debacle was a catalyst which sparked the collapse of a bubble built on too much artificial demand. Regardless of whether you believe easy credit was the chicken or the egg, the result was that more houses were built than there were buyers who could afford them, and the decline in value that followed created an avalanche. Caught in that snowball effect were mortgage companies like Countrywide and American Home Lenders, and banks like IndyMac and National City. The common denominator for all the financial failures was non-performing mortgages.

Because the U. S. mortgage market had been re-sold and packaged into derivative securities, the ripples of the first failures in late spring became the tidal wave that consumed the biggest banks in the world by the fall.

As expected, the last 60 days of 2008 revealed one dismal economic report after another in reflection of the stunning crash of the stock markets in early October and the breakdown in the credit markets. If there’s a positive to derive from all the bad news (and this is definitely a reach), it is that the negative reaction by consumers and businesses was swift and decisive, which may hasten the beginning of a recovery. Until a recovery begins, the national economy and construction markets will continue to experience contraction.

From among the litany of gloomy data several reports underline how the national residential market is floundering.

In December, the Mortgage Bankers Association (MBA) issued its expectations for the coming year:
• Total existing home sales for 2008 declined about 12 percent from 2007 to 4.96 million units. Sales will pick up about three percent in 2009. 
• New home sales declined about 36 percent from 2007 to 500,000 units. Sales should decline another 12 percent in 2009.
• Median home prices for new and existing homes, which fell more than 7% in 2008, are expected to decline more modestly in 2009.
• Total mortgage production was down 22 percent to $1.81 trillion in 2008. 

One positive note at year’s end was that the actions of the Federal Reserve to purchase mortgage-backed securities from Fannie Mae and Freddie Mac drove mortgage rates down below five percent temporarily, and between five
and six percent for the indefinite future. This action triggered another tsunami of re-financing, and offers the opportunity for a less expensive solution to the foreclosure problem, at least for those who can afford to keep homes at lower rates.

On December 23, the National Association of Realtors (NAR) reported that November’s existing home sales fell below a rate of 4.5 million units. That chilly report followed a report earlier in the month showing that October’s sales fell only seven-tenths of a percent compared to September, and only 1% compared to October 2007, not as steeply as economists had feared, and a much smaller decline than most other indicators in October. The October data also showed declines across all regions, an indication that the financial crisis was keeping prospective buyers on the sidelines, and NAR economist Lawrence Yun estimated that 45% of the existing home sales were foreclosures.

Yun called on the incoming administration to consider mortgage assistance as part of any stimulus package, suggesting that $50 billion should be used to buy down interest rates to allow buyers to qualify and troubled mortgage holders to refinance at affordable levels.

The Commerce Department report on November’s new construction was also grim. Privately-owned housing starts in November were at a seasonally adjusted annual rate of 625,000. This is 18.9 percent below the revised October estimate of 771,000 and is 47.0 percent below the revised November 2007 rate of 1,179,000. Single-family housing starts in November were at a rate of 441,000; this is 16.9 percent below the October figure of 531,000. The November rate for units in buildings with five units or more was 166,000.

While virtually all residential market indicators are somewhat negative, the last six months of 2008 saw several upticks in home sales, a much smaller decline in sales after the stock market crash, another double-digit decline in new home construction, and falling mortgage interest rates. Together these factors all seem to indicate a bottom to the housing decline has been reached. Economists expect that values will decline only slightly in 2009, and most expect to see buyers coming back to the market by mid-year. Of course, most felt that the housing recovery would begin in 2008 as well. Whether 2009 marks an increase in home buying or simply a prolonged bottom, there is no evidence that demand and supply will align so that new home construction will start recovering anew until 2010.

At the National Association of Homebuilders’ (NAHB) Construction Forecast Conference on October 22, housing economists laid out expectations that the coming year should mark the end of the decline of the market, but warned that risks existed that new housing construction could remain dead beyond 2009.

“Things are a lot worse than any of us had anticipated six months ago,” said NAHB chief economist David Seiders. “Who would have anticipated the turmoil in the financial markets that we’ve seen since September? I would say that the keyword for the day is risk. The uncertainties out there are probably unprecedented and the degree of risk forecasted has probably never been higher.”

Bernard Markstein, NAHB staff vice president, offered the opinion that some of the measures taken by the government were a step in the right direction. “We’ve seen that the policymakers, particularly the fed, have gotten together and done a lot of the right things, which will take time,” he said. PNC Financial Services CEO James Rohr echoed Markstein’s point in a recent speech at the Duquesne Club. Rohr noted that the key to a recovery was the return of appreciation in housing prices, and thought the actions taken by the Federal Reserve and the Treasury, plus the anticipated economic stimulus of the Obama administration, will make the difference in beginning a recovery. During his presentation, Rohr showed a comparison of the estimated cost of the government’s intervention to stimulate a recovery, a staggering $4.6 trillion, to the costs of the Marshall Plan, NASA’s budget, all of our wars since Korea, and the New Deal, combined.

Since the beginning of the banking and financial problems bubbled to the surface in mid-summer, the conventional local wisdom has been that Western PA will be resistant to the potential recession, which is now a reality. Much of the economic evidence has supported that thesis throughout the fall, even after the market panic in October. Metropolitan Pittsburgh has job growth rather than decline, and housing prices have continued to appreciate,
albeit slightly.

As the holidays began to approach, however, it became clear that the local real estate and construction market was being cooled off by the same negative influences that were hurting the national market.

“Western PA did not participate in the bubble in 2005 and 2006, so there has been stability in pricing that doesn’t exist in other regions,” explained PNC economist Robert Dye. “I do expect some decline in values in 2009, but the region is better positioned to recover in late 2009 because there isn’t the inventory overhang like in other cities.” Dye also noted that unemployment had begun to rise in late 2008 here in Western PA, and expected to see a net loss of jobs, even if only mildly, in 2009.

In Metropolitan Pittsburgh, housing is at its lowest point since the recession years of 1981-1983. There were 397 new single-family permits in the fourth quarter of 2008, the lowest number in any quarter since the Pittsburgh Homebuilding Report began gathering information on the region’s housing in 1994.

Single-family housing fell to 2,006 units for the full year of 2008. Permits for all housing units only reached 3,348 units, or about 65% of the number started in 2005. The outlook for our market is for recovery to start in 2009, but that’s more a reflection of how lean it is now than of conditions improving significantly.

What is puzzling about the housing slump here is that the fundamentals that drive housing, jobs and credit, aren’t dramatically different than the conditions three or four years ago. Job creation has been positive in the region, and credit conditions, while tighter, have not reached a point where mortgages are impossible to get. It’s more likely that the extended slowdown is a reflection of the buyer sentiment, and the nature of the homebuilder in the region. Pittsburgh’s biggest builders, Ryan Homes and Heartland Homes, are not large-scale speculators, and the majority of the builders produce between five and fifteen homes a year. If their collective perception is that demand is slow it’s more likely that most of the regional builders will cut back or eliminate any speculative building, reducing supply to contract-only levels.

This is a gloomy period for homebuilders in our region, but the strong response to lower demand here has also kept home pricing stable. The evidence of job creation continues, particularly of higher-paying jobs in engineering and healthcare. Lenders in Western PA have tightened standards like the national financial firms, but it’s important to remember that many regional banks have always been conservative lenders (and some, like PNC left the residential mortgage market but have returned), and institutions like Dollar Bank or S & T Bank have continued to provide financing throughout the crisis.

“Housing demand depends on available credit and consumer confidence,” said Robert Dye. “Credit appears to be improving of late, but of the two factors consumer confidence is what is lagging.”

Given the mind-set of the consumer as 2009 begins, housing starts should remain at these low levels until there is certainty that the national economy has hit bottom. For a region with strong economic fundamentals, like Western PA, it’s possible that the slowdown will only last until there is a perception that the last of the bad news has been heard. Clearly, a relaxation of lending standards back to normal conditions in the first part of 2009 could open development back up in Western PA, especially with borrowing rates falling towards five percent. And a couple of factors could stimulate demand sooner than the rest of the nation’s housing market.

Beginning in April, the first of the Westinghouse employees moving to Cranberry Woods will begin work there. By year’s end, approximately 4,000 workers will be permanently located there, including about 25% new hires. While some impact from the Westinghouse project has already been felt, most workers who will relocate (especially the new hires) have deferred moving until 2009. Moreover, Westinghouse is already beginning to make preliminary plans for further expansion, easily topping 5,000 employees at the beginning of the next decade. In the wake of the relocation, hundreds of thousands of square feet of office and warehouse space has been rented to companies doing business with Westinghouse, and plans are in the works for much more. A surge in demand for new construction in Cranberry and Adams Townships, Franklin Park and Pine Township, should follow.

When demand does pick up there will be lenders in Western PA ready to service the need for loans. In fact, the active lenders have already seen an up tick since the drop in mortgage rates. “Our mortgage application volume since early December has increased dramatically with most applicants seeking to refinance,” says Mike Henry, V.P. Residential Lending for Dollar Bank. “Given the large supply of affordable houses in the Pittsburgh region, and if rates continue to remain relatively low, we expect application volume for purchase and refinance to stay strong throughout the spring.”

The second positive factor will be the region’s share of the Obama administration’s stimulus package. Even if a disproportionate share of Pennsylvania’s stimulus goes to the eastern half of the state, hundreds of millions will be spent on infrastructure in Western PA, which will result in thousands of jobs. The wages associated with those jobs will create demand for housing, especially if the stimulus creates more jobs than the current labor force can support (a likely scenario). Such a scenario will spur additional relocation into the area, creating demand for more housing as well.

With the job creation trend staying positive, lower interest rates, and an inventory that is much closer to demand, market conditions in Metropolitan Pittsburgh should support the beginning of a growth cycle in new housing in 2009. Even if the direst of national circumstances prevails, there should be enough regional strength to see several hundred more new homes in 2009 than in 2008. NH