Home Builder Confidence Took a Slight Drop in February

The Update:

Home builder confidence in the market for newly built, single-family homes was virtually unchanged in February with a one-point decline to 46 on the National Association of Home Builders/Wells Fargo Housing Market Index (HMI), released today.  “Following solid gains over the past year, builder confidence has essentially leveled out and held in the same three-point range over the last four months,” noted NAHB Chairman Rick Judson.

What is the NAHB HMI?

Derived from a monthly survey that NAHB has been conducting for 25 years, the NAHB/Wells Fargo Housing Market Index gauges builder perceptions of current single-family home sales and sales expectations for the next six months as “good,” “fair” or “poor.” The survey also asks builders to rate traffic of prospective buyers as “high to very high,” “average” or “low to very low.” Scores from each component are then used to calculate a seasonally adjusted index where any number over 50 indicates that more builders view conditions as good than poor.

Holding above the critical mid-point of 50 for a third consecutive month, the HMI component gauging current sales conditions fell by a single point to 51 in February. Meanwhile, the component gauging sales expectations in the next six months rose by one point, to 50, and the component gauging traffic of prospective buyers slipped four points, to 32.

What It Means?

Overall it is a good sign for investors in the housing market.  Why?  Because right now there seems to be a bit of a cap on new supply in many markets because financing remains tight and investors can still buy at such a discount to replacement cost.  Keeping a lid on supply when there has been virtually no new supply over the past several years (because of overbuilding in the first part of the 2000’s) should provide additional price support overall.

Historically there has been a reasonably strong correlation between builder confidence and housing starts; from 1985-2001, they had an R-squared value of .74 (for you statistics junkies) and a multiple R of .86.  So positively correlated, not perfectly, but strongly enough to be visibly evident.  However, this relationship began to break down post 9/11 when the Federal Reserve took interest rates to near 0% , enhancing the growth of the subprime and Alt-A mortgage lending industries.  From 2002-2005, this breakdown in the relationship implied an excess of nearly 840,000 new starts; however, this understates the magnitude of overbuilding, given that so many purchases were made by investors as well as unqualified buyers.

Looking at the historical HMI relationship compared to housing starts would imply that starts would be 40%-50% higher than they currently are, going from a current 600,000 to nearly 900,000; however, the excess supply of middle part of the 2000’s continues to be absorbed in a tight credit environment.

However, real estate is a local business and the absorption of new supply (as measured by new job growth relative to new building permits) needs to be carefully evaluated on a market-by-market basis to see the strength of a local market.