By Janet Morrissey
From The Wall Street Journal Online

There are signs a housing slowdown that has gripped certain high-growth markets during the past few quarters, is now spreading nationwide.

Preliminary reports from builders Hovnanian Enterprises Inc. and Toll Brothers Inc., whose quarters ended April 30, indicate demand is falling faster and more sharply than previously thought, and that the pullback is no longer confined to hot markets that had seen sharp home price run-ups in the past few years.

Hovnanian's orders fell 20% in its fiscal second quarter -- an about-face from the 5.5% order growth reported in its fiscal first quarter. Toll's orders declined 32%, which is steeper than the 29% dropoff posted in its fiscal first quarter.

For Toll, the order decline was across the board as all of its geographical regions reported year-over-year decreases in demand. Chairman Robert Toll attributed the declining demand to higher cancellations and to speculative buyers who are dropping out of the market and putting the homes they recently acquired up for sale. Although Toll said his company doesn't sell to speculators, "we have certainly been impacted by the overall increase in supply."

On top of this, some builders, such as Centex Corp. and Hovnanian, have started taking writedowns in connection with land options. In general, when builders take writedowns to walk away from land options, it is a sign that either land values are falling or demand in that market has dried up. In past cycles, declining land values often were a sign that a market was falling fast.

Until now, home-building executives said the pullback in demand was largely confined to markets where sales had been overheated and home prices had skyrocketed during the past few years, such as Washington, D.C., parts of California (especially Sacramento), Phoenix and parts of Florida. They blamed speculative buyers for much of the pullback, saying investors had exited the market, causing less overall demand and more inventory.

These hotspots continue to see the sharpest pullbacks, but other markets also are slowing.

Majestic Research analyst John Tomlinson, in his monthly report that tracks new-home sales in 40 major markets, found sales fell year over year in every market during February and March, with the average decline being 25%.

Washington, D.C., Los Angeles/Long Beach, Tucson, Ariz., Sacramento, San Francisco, and Phoenix saw the biggest declines with sales falling 22%, 50%, 50%, 46%, 30%, and 37%, respectively. However, even markets that hadn't been weak previously -- such as Philadelphia, Dallas, and Las Vegas -- softened in the quarter, with sales falling 30%, 15%, and 13%, respectively, he said.

"Almost every single major market that we track is showing pretty significant year-over-year declines in sales," Mr. Tomlinson said. "It's much more broad-based" than it was prior to February.

Rising inventory, slowing sales and bigger incentive packages all signal a correction in the housing industry, Mr. Tomlinson added. But time will tell if this will lead to big dropoffs in home prices, "which I think most people are most afraid of," he said.

So far, builders' efforts to offer more incentives and discounts have "failed to move the needle" in driving sales, Mr. Tomlinson said. As a result, he said some may need to resort to bigger price discounts. "That's the million-dollar question," he said.

Bernard Markstein, director of forecasting at the National Association of Home Builders, said there is no question housing demand is slowing nationwide. He said rising mortgage rates have given people reason to "pause" in their decision to buy.

"We've been getting reports of a slowdown in housing across the board," Mr. Markstein said. But so far, he said, it's just a "moderating of activity -- not a falling off of the cliff." He describes it as a "return to normalcy."

Mr. Markstein is predicting that overall housing starts will fall 7% to 1.95 million from 2.1 million in 2005. He sees demand returning to 2004 levels.

If companies continue to build at the pace they had in 2005, there could be more serious inventory problems.

"We were building at a pace that we did not expect to be sustained and we're seeing a slowdown," Mr. Markstein said. He expects builders to slow their pace of construction to meet the softer demand.

However, many builders aren't cutting back, and are instead talking about opening many new communities in order to drive order growth. Toll Brothers, for example, plans to open 80 communities during the next six months, and expects to wrap up fiscal 2006 with 295 subdivisions, up from 230 in fiscal 2005.

Chairman Toll sees the glut of inventory on the market as a "short-term phenomena" and believes the supply imbalance will correct "relatively soon."

Despite the softening trends nationwide, Fitch Ratings analyst Bob Curran said he still believes the housing sector is heading for a soft landing -- not a crash -- and that the current housing slowdown is temporary and will likely rebound by late 2006 or early 2007. He said economic data for job growth and consumer confidence has been positive.

"It would be highly unusual for housing to go into a multiyear tailspin when the general economy is holding up," he said.

Mr. Curran noted that most of the publicly traded home builders are heavily weighted in big-growth markets, such as California, Phoenix, South Florida, and Washington, D.C., which experienced overheated demand and a spike in home prices during the past few years -- and are now seeing the biggest weakness.

As a result, the sharp slowdown in the hot markets makes the major builders "a little more vulnerable in the short term," he said. A slight slowdown in smaller markets won't make a huge difference for them, Curran said.

"If you've got 25% of your assets in California, quibbling about what's happening in Salt Lake City isn't going to make a difference," he said.

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