Home construction reaches 25-year high

Construction on single-family homes soared to the highest level in 25 years last month as buyers and sellers rushed to take advantage of low mortgage rates before they rose sharply higher.

The Commerce Department reported that house construction jumped 1.9 percent to an annual rate of 1.52 million. This stoked optimism among housing officials that the historical boom in housing that buoyed the economy throughout the recession is continuing despite climbing mortgage rates. Starts on all housing units, including apartment buildings, surged to a 17-year high of 1.87 million.

Many economists, however, believe the surprisingly stellar performance of housing last month is the industry's last hurrah before it settles into a more modest growth path as a result of a surge in 30-year mortgage rates from 45-year lows in June.

"The push to complete homes before mortgage rates slow the market is on, and builders are going wild," said Joel Naroff, president of Naroff Economic Advisers. "But while construction is booming right now, it might not last. ... We are experiencing the typical reaction to higher rates."

Mr. Naroff sees a less-frenzied pace of home sales and construction by the end of the year. In a sign that some builders also anticipate slower sales, the agency reported that applications for housing construction permits dropped 2.4 percent to 1.78 million.

Home sales skyrocketed to unprecedented levels in recent years, fed by extraordinary low interest rates that made homes affordable for many renters and escalating home prices that made housing the preferred investment of Americans burned by their investments in stocks.

The average mortgage rate dropped steadily from 8.5 percent in the middle of 2000 to a low of 5.25 percent in June before shooting back up in recent weeks to around 6.4 percent on signs that economic growth is picking up even as budget deficits are burgeoning to record levels.

The sudden rise in interest rates forced home builders and mortgage bankers to scale back their rosy forecasts for growth, although most continue to believe the housing market will remain sturdy in the face of higher rates. They note that home buyers should be supported by steadier growth in jobs and incomes as the economy gains strength, even if they have to pay higher rates.

"We're still at a historical low on interest rates, defining a very affordable housing market," Stuart Miller, chief executive officer of Lennar Corp., the largest home builder, told Bloomberg News yesterday. "We've got a lot of room before we start to see interest rates threatening the affordability of the home."

Mr. Miller said mortgage rates would have to rise to 8 percent or more to hurt the housing market. His optimism was reflected in a measure of home-builder expectations this month that rose to the highest level since January 2000.

The Mortgage Bankers Association is less bullish, projecting that mortgage loan originations for purchasing houses will level off next year at this year's projected rate of about $1.1 trillion. It sees a plunge of 80 percent in mortgage refinancings next year as higher rates kill off the refinancing boom.

Douglas Duncan, MBA's chief economist, said he expected the refinance market to "dry up" as rates rose, but the unexpectedly sharp jump since June made that happen with lightning speed.

"Rates have risen dramatically for several reasons, the most important being the expectations of rapid growth beginning in the third quarter and changes in investment strategies," he said, with many investors now flocking into stocks as rising rates make bonds and mortgage-backed securities less attractive.

The blow to housing will be visible by the end of this year, economists say.

Peter Kretzmer, economist with Banc of America Securities, said the jump in mortgage rates is forcing would-be home buyers off the fence and into the market before rates climb higher. That should keep home sales at robust levels into the fall, as home purchases typically take several months to complete.

But by the end of the year, housing sales will slack off under the weight of rising rates, he said. One important factor going against the market is that the hectic pace of sales in the last five years may have left buyers exhausted and with little "pent-up demand" to buy new homes, he said.

Just as housing stayed unusually strong during the recession, it may be unusually weak as the recovery gathers speed, some economists say. A few Wall Street gurus even fear the housing market will experience a "bust," with home prices losing some of their gains during the boom.

The raging debate about the future of the housing market was sparked by the unusual role it played propping up the U.S. economy during the recession. Housing typically played the opposite role in previous recessions, which were precipitated by rising inflation and interest rates. Then, the pattern was that interest-sensitive home and auto sales led the rest of the economy into the downturn.

The 2001 recession was precipitated by a bust in technology and stocks, rather than high interest rates, so housing and auto sales thrived throughout the downturn.