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Should You Worry About More Bad Housing Numbers?

Richard Satran

Since interest rates began rising in May, the real estate market has been preparing for a major storm. A downpour arrived Wednesday as the Commerce Department reported the worst drop in housing starts in almost a year- confirming fears of investors and homeowners that a pullback in demand might dent the recovery.

But there was no panic in equity markets over the housing flop, and little fear that the sector will slip back into the hole it fell into in 2008. Housing as a whole appears to be holding its own, even with mortgage rates going up. (The Mortgage Bankers Association last week showed the average 30-year mortgage at 4.68 percent. That's nearly a full percentage point above last year.)

To be sure, the housing starts drop is the latest sign that interest rate increases are having an impact. Starts declined 9.9 percent in June and permits fell 7.5 percent. Meanwhile, homebuilding stocks over the past two months have been slammed by one of the biggest selloffs since the sector began its long recovery from the depression-type conditions of 2007-2009. The market overall shrugged off the weak one-month data, and even housing-related stocks edged higher.

[Read: 12 Reasons Not to Fear a Market Bubble.]

Over the past two months, real estate investment trusts were hit hard, declining to losses of 15 percent and more in a matter of weeks. Some gloomy forecasters warn that the rise in rates could injure not just the housing sector, but the economy as a whole. Homebuilders were also toppled by big losses.

But the data tell a less distressing story for homeowners, if not for builders. A closer look at the housing starts shows that nearly all of the slowdown was from multifamily projects, where there have been signs of overbuilding. Single-family homes were little changed despite the rising mortgage rates.

Professional builders are quick to pull back from starting some ventures like apartment complexes because those ventures are highly interest-rate sensitive, even more so than single-family homes. Also, rising rates means building costs go up quickly, and potential buyers are held back by rising rates. It's a double-whammy for the professional builders.

Some may worry that the builders, often the first to spot trouble, are the canaries in the mineshaft. But analysts who follow the market say signs remain positive for the housing market overall. In fact, there may be a silver lining for homeowners looking to sell if commercial builders chill for a bit rather than flood the market with too many units. Those mega-condos in "ex-urbia" with low-rate financing offers are for the single-family home market what Wal-Mart is for local retailers: an unwelcome, lower-priced option.

"It's not bad to see some moderation in the housing market," says Brad Sorensen, director of market and sector research at Charles Schwab. "We were actually ironically seeing a couple of months ago some different localities with signs of a real estate bubble. This might alleviate some of that concern [about local market bubbles or overbuilding.]"

He adds that the Fed has been watching those pockets of overheated housing closely. No one wants a repeat of the real estate "hypermarket" seen before the crash, he says.

[Read: How Investors Can Avoid the Market Bullwhip.]

"The Fed really wants to see things get back to normal," says Mark Germain, chief executive officer of Beacon Wealth Management. "What we have been hearing from [Fed Chairman Ben] Bernanke is that the Fed is considering taking away the medicine because the patient is no longer sick."

But he adds that the economy is not performing Olympian feats either, and the recovery has been slow. Housing has played a starring role through the initial stages of the rebound, but Germain says it is "recovering from a very low level, and it is still nowhere near where it was."

Still, the housing recovery is critical since it accounts directly for about one-sixth of the gross domestic product. It also has far wider implications, since new homebuyers purchase appliances, furnishings and other big-ticket items. Even more important, it's a key component of people's sense of well-being and the majority of net worth for middle-income Americans.

"Improved home value helps by raising people's net worth and consumer confidence," Sorensen says. "Even if it slows a bit, the recovery to the higher home values we have already seen will sustain that confidence."

[See: A Step-by-Step Guide to Homebuying in this Market.]

The Fed's mandate is to watch inflation and employment. Housing is a key component of both. The Fed will be ready to apply more stimulus to get it back on track, Sorensen says. But it will also be ready to pull back if things get frothy.

That's not a prescription for a new boom in housing stocks and REITs, Sorensen says. After the big declines of the past month, they are now fairly valued, not bargain-basement buys, he says. Germain agrees that the housing sector, which has been leading the market higher during the economic recovery, is likely to take a more quiet role.

"People had a false impression on how strong the housing market was. It's still recovering. But it still hadn't reached what it was 10 years ago," Germain says. "A slow, steady recovery is what we really need. It's good to go through a summer chilling down."

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