Will Home Sales Stall without a Tax Credit?

The homebuyer tax credit, introduced in last year’s economic stimulus package and expanded in November, has been a big success. From December through April, sales of existing homes rose 6 percent, while purchases of new homes jumped 42 percent, helping to lift new home construction by 17 percent, as home prices continued to stabilize. The program, which offered a maximum benefit of $8,000 to first-time buyers and $6,500 to repeat buyers, also has been costly. The Treasury reported some $16 billion in credits taken through Mar. 27.

Now the big question: With the tax credit having expired on April 30, can the housing market stand on its own without the crutch from the subsidy? The recession began with a downturn in housing, and an economic recovery will not be complete without that key sector. No other area of the economy has such a broad reach, especially since most people’s largest asset is their home.

Analysts generally believe that underlying trends in demand, construction, and prices, while hardly strong, are at least gradually improving. But the true picture won’t be clear until much later in the year. That’s because buyers using the provision have until June 30 to close their deals, and since the tax incentive pulled some home buying forward from future months, sales are sure to fall this summer.

Some signs of weakness are already cropping up. Mortgage applications dropped 39 percent during the four weeks after Apr. 30, according to the Mortgage Bankers Association.

Applications for government-guaranteed loans, which are skewed toward first-time buyers, a major target of the tax credit, plunged 50 percent. Plus, while housing starts through April have been strong, builders filed sharply fewer permits in April to begin to begin new construction.

Still, analysts say any backsliding is likely to be temporary, for several reasons including an improving jobs picture. Private-sector payrolls increased by a less-than-expected 41,000 in May, rattling the financial markets, but it was the fifth monthly advance in a row, bringing total gains this year to nearly 500,000. The report showed that overall hours worked are growing faster in the second quarter than they did in the first quarter, and so are wages and salaries. “Because of an apparently good pickup in private payrolls, we still believe home sales will be strong enough the support our forecast for a 34 percent rise in 2010 housing starts, to 750,000 units,” says UBS chief U.S. economist Maury Harris.

Other factors, such as near-record lows for mortgage rates, attractive prices, and improving consumer confidence are adding support. Of the estimated 4.4 million who will eventually claim the tax credit, some 3.4 million would have bought anyway, according to the National Association of Realtors. That means the credit brought in about one million buyers who would not have purchased homes without the incentive. The trade group is currently lobbying Congress for more flexibility on the June 30 closing deadline, given the extra time required for appraisal and approval of sales of distressed properties.

The tax credit also helped to stabilize home prices, as shown by the Case Shiller 20-city composite.

 In March, the index was 2.3 percent ahead of its level in March 2009, and other pricing measures are also leveling out after falling sharply since 2006. “Price stabilization has completely removed the consumer fear factor from the market place,” says NAR chief economist Lawrence Yun, allowing buyers to focus increasingly on improving economic conditions in their home-buying decisions.

The subsidy’s expiration could mean some renewed softness in prices in coming months. Most analysts say any new price weakness will be neither deep nor lasting, although any real recovery is still a long way off. For first-time home buyers, an $8,000 credit allowed them to afford a house costing about 5 percent more than they could pay otherwise, based on the $160,000 average price paid by first-timers. In a new monthly survey of housing experts compiled by the consulting firm MacroMarkets, the Case Shiller index is expected to stabilize this year and then rise 1.6 percent in 2011.

The real key to the pricing outlook will be the inventory of unsold homes. Despite the credit’s boost to sales, the stock of existing homes for sale jumped 11.5 percent in April, a rise that was a bit greater than the typical seasonal increase. Economists are especially edgy about a so-called shadow inventory of properties waiting in the wings, as more owners put their homes up for sale in an improving market and as newly foreclosed properties push up the total. The share of distressed sales—via foreclosures and other transactions at less than the mortgage value—has stopped rising and has been holding steady in recent months at about one third of total sales. Plus, Washington’s cash incentives to lenders who are willing to negotiate with delinquent borrowers are helping to limit new foreclosures.

In the new-home market, builders have made great strides in cutting their inventories. New-home buyers responded strongly to the recent incentives, with sales soaring 29.9 percent in March and 14.8 percent in April. “It indicates that underlying demand may be stronger than expected,” says JPMorgan economist Robert Mellman in a research note, although his expectations have been low. Still, stronger demand has cut builders’ inventories nearly 55 percent below their year-ago level to their lowest point since 1970, a big plus for future construction.

Although housing still faces some big hurdles, the outlook depends much more on the strength of broader economic conditions than on the absence of the tax credit. Housing led the economy into recession, but it will be an improving economy that will set housing back on its feet.