Is the Roof Falling on Housing?

It was not particularly surprising to most housing market observers that January starts fell from their December levels. But what did have the market abuzz was the magnitude of the drop. With a 14.3% decline to a seasonally adjusted rate of just 1.408 million units -- versus December's revision to 1.643 million units -- the housing activity level for the first month of 2007 was the lowest in nearly a decade.

Not since August 1997 has construction been begun on fewer haciendas in the United States. Indeed, the magnitude of the drop-off has more than a few observers questioning whether the nation's current housing slump actually will last longer than recently has been anticipated.

And the January numbers were released into a climate of gradually increasing concern about a higher mortgage foreclosure rate, especially among subprime borrowers, who have taken out adjustable-rate mortgages -- ARMs -- about 80% of the time, and almost as frequently have piggybacked a first and second mortgage to obviate the need for a down payment. Perhaps as a result, in 2006 the foreclosure rate among mortgaged U.S. households rose more than 40% over the prior year. And, in something of a spillover effect, last week ResMae Mortgage Corp. became the 20th subprime lender to file for bankruptcy.

The obvious concern is that something of a reverse wealth effect will take hold in the nation, as people feel less sanguine about the values of their homes, and therefore become more cautious spenders. With consumer spending constituting by far the largest sector of the economy, such a situation could constitute a real drag on economic growth.

So does all this seeming doom and gloom signal a soft housing market for all of 2007? And should investing Fools avoid the homebuilders as a result?

I have a couple of admittedly cautionary responses to these questions. First, I urge you to hearken back to the latter months of 2006, when the weather across much of the U.S. was unseasonably temperate. At that time, the higher-than-normal thermometer readings resulted in a few more starts in most regions than would have occurred had more normal temperatures prevailed. In January, the combination of colder temperatures and a sizable number of homes still in their early stages likely put the brakes on starts. Further, I would not read too much into the concern about subprime mortgage defaults. At this time, subprime loans constitute only about 6% of total U.S. mortgages, and so foreclosures in that area would need to escalate significantly to materially affect overall economic activity.

Finally, as I have said to Fools in the past, homebuilders' stock prices and housing start numbers are seldom in sync with one another. Since July, most of the U.S. builders have seen their share prices climb significantly. And Friday's release of the January start numbers did not materially affect the prices of the major builders. As such, I continue to urge Fools, particularly those able to invoke a somewhat longer-than-normal investment time horizon, to continue to keep an eye on such builders as Centex (NYSE: CTX  ) , Toll Brothers (NYSE: TOL  ) , and Ryland (NYSE: RYL  ) .

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Fool contributor David Lee Smith does own shares of Centex, but not of any of the other companies mentioned. He welcomes your comments or questions. The Fool's disclosure policy lives in a van down by the river.


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