Building in a bear market

NEW YORK (CNNMoney.com) -- The pace of homebuilding stepped up in February, an unusual bit of good news in the devastated housing market. The number of housing permits issued and homes starting construction both rose at an annualized rate of 547,000 and 583,000, respectively. However, they were still off nearly 50% compared with February a year ago.

Meanwhile, the inventory of existing homes for sale is at a 10-month supply, and sales of both new and existing homes are at their lowest levels in years. So why are homes still being built at all?

"There's a minimum level of building activity that goes on even in recessions," said David Crowe, chief economist for the National Association of Homebuilders (NAHB). "People are building their own homes or acting as general contractors and hiring our members to build them. That's in the range of 200,000 to 300,000 homes a year."

The housing bust has hit hard in Tampa, Fla.

According to Zillow.com, the online real estate Web site, home prices in the city have fallen more than 34% from the peak they reached in early 2006. More than a quarter of all homes are underwater, with their owners owing more on their mortgages than their homes are worth. And foreclosures in the area more than doubled in 2008, climbing to one for every 25 households.

What little construction remains in Tampa is mostly of homes on single lots being built to order for their owners, according to John Barrios, manager of construction services for the city. "Construction of high-end, custom homes is still going well," he said. "But we're not seeing green-field, tract-home development."

In the last three months of 2008, the city had 932 housing starts - 33% fewer than the last quarter of 2007

Residential construction is split evenly between single family homes and commercial developments, according to Cynthia Miller, the City of Tampa's director of housing and building development. Many commercial developers have switched strategies over the past couple of years, though.

"We had a number of condo developments completed over the past 12 months that the builders have made into rentals instead," she said.

That's a viable strategy for condo developers in down markets; the units can easily be switched to rentals, providing some income for the builders while they bide their time until prices recover.

Don't put too much stock in the latest housing start numbers, advises Michael Larson, a real estate analyst with Weiss Research. They don't mean a place like Tampa is about to see a glut of new homes rising out of earth.

In fact, the building might have been spurred into action recently because the costs of building new homes have dropped - not necessarily because there is newfound demand. The price of building materials is down, mortgage rates remain very low and contractors are sharpening their pencils to win jobs. Bargains abound.

Framing lumber, for example - the kind that is used to build floors, walls and ceilings - is about half the price it was three years ago. Asphalt, concrete, metals and most other building materials are either down or flat. All told, falling construction prices have whittled more than 10% of the cost of building a new home since the beginning of 2007, according to the Census Bureau.

Meanwhile, interest rates for 30-year, fixed-rate loans are have been in the low-to-mid-5% range for the past few months. They stand at 5.11% this week, according to Bankrate.com, about a percentage point below a year ago. That lowers the monthly mortgage payment on a $200,000 loan by about $125, an encouragement for potential homeowners.

In addition, a good portion of February's national increase in building permits and housing starts was tied to multi-unit housing, which are very volatile. Just a few large projects getting launched can skew statistics upward.

Many of those multi-unit starts could have been long-planned projects that had been held up because of frozen credit markets. Those have eased a bit lately, according to Larson, enabling some developers to go forward. That's especially true for more expensive buildings. The high end has held up comparatively well in most places, and there's still demand for luxury housing.

Development of all varieties - especially big, single-family home projects - remains very slow, causing Larson to remain unenthusiastic about the near future. "Demand for new homes remains downright anemic," he said. "Sales dropped to an annual rate of just 309,000 in January, the lowest level in the 46 years the government has been keeping track."

At the same time, however, there were only 342,000 new homes on the market at the end of January. That is the lowest total since July 2003. In normal circumstances, so few homes would create a seller's market, but at the current sales rate there is enough supply to meet demand for 13.3 months.

Nonetheless, the NAHB's Crowe takes heart in the numbers. "There are some signs that we're bottoming," he said. "I'm not ready to say we're there. We're still at an awful level, but at least we didn't dip any further."