No bubble bursting here: the housing market is projected to deflate a bit this year, but economists agree the market will remain strong.

The supposed housing bubble is not going to burst--not in 2006 anyway. If anything, it will deflate slowly to past "healthy levels."

That is the sentiment among several economists tracking the housing market.

David Seiders, chief economist for the National Association of Home Builders, said the housing sector will undergo a "simmering down" in 2006. This years totals are predicted to return to 2004's, "which are still excellent," he added.

In 2004, total housing starts reached 1.95 million units; the NAHB's 2006 forecast calls for 1.94 million units, a slight decrease from the estimated 2 million units in 2005. Seiders said the dip is not unusual, adding that 2005's record pace was poised to level out sometime.

"We'll basically be retracing the increases we saw in 2005, heading back to 2004's very healthy levels," Seiders said during a December teleconference with James Glassman, senior economist for JP Morgan Chase.

One of the factors that will allow 2006 housing starts to remain at near-record levels are interest rates.

Interest rates, at their current average of 6.3 percent, will prove beneficial to the housing sector. Glassman and Seiders predicted that the Federal Reserve is about done driving the interest rates higher. Seiders said he sees 2006's average U.S. interest rate at about 6.6 percent.

"If you think about it, with 10-year treasury yields at 4.5 percent, why would the Fed need to drive short-term interest rates above long-term interest rates, unless they saw a glaring inflation problem?" Glassman asked during the teleconference. "That way, we dose the year with fixed income markets for the third year in a row with relatively stable, low long-term interest rates."

These low interest rates can be attributed in part to the low inflation rate. While it seemed in 2005 that the economy could experience an uptick in inflation, as a result of the hurricanes, Glassman said that was "quite the opposite." He said the inflation rate of about 1.75 percent is "at the low end of the Fed's comfort zone." And the Fed forecasts it will only rise to about 2 percent.

This bodes well not only for homebuilders, but also for manufacturers of cabinets, millwork, flooring, etc., especially considering that eight of the last 10 economic recessions started with declines in the housing market, according to Anderson Forecast, UCLA's quarterly economic study. Though a recession is possible, the economists agree the economy is strong enough to elude such an occurrence.

"Historically, [an impending recession has] been true, but I don't expect any weakening in the economy in 2006," said Ken Simonson, chief economist for the Associated General Contractors of America.

Simonson said a big problem facing the housing market is the increased price of construction materials; he even issued an alert regarding construction costs outpacing consumer prices. The alert cited "widespread materials inflation" on products across the board, but especially fuel, plastics and cement. Much of the price inflation can be attributed to the 2005 hurricane season, which caused energy costs to skyrocket and destroyed a significant portion of the forestry in the Gulf region.

"For 2006, I expect the cost of fuel asphalt and plastics, such as PVC pipe, to average 10 to 20 percent higher than in 2005, because of high petroleum and natural gas costs," Simonson said in a release.

But while the costs associated with energy spikes (namely oil-based products and service, such as shipping and the resins for PVC) can be expected to remain more expensive, the timber and lumber markets escaped relatively unscathed. Simonson said he expects wood, as well as steel and gypsum, products costs to be "no higher on average than in 2005, despite a lot of month-to-month volatility."

In addition, of the 5 million acres--an estimated 19 billion board feet--the USDA Forest Service predicted to be downed, much can be salvaged. That is a potential of an extra 800,000 single-family homes, the Forest Service estimates.

However, compounding the added costs, most of which are expected to be covered by consumers, home price appreciation is predicted to fall this year and into next. In 2007, the pace of appreciation may be down to 4.4 percent as a whole, compared to 2005's 10.7 percent, according to the OFHEO house price index cited by Seiders during the teleconference.

"It's pretty obvious at this point that the real estate market is gradually shifting to more of a buyers market," Glassman added. "It's clear to me that the rapid gains we've seen in the real estate market over the past years is more a story about the real estate catching up to the good fundamentals in the economy--not a bubble. The next several years should present a good backdrop for growth with low inflation.

U.S. Housing Forecast
(thousand units)

                         2002    2003    2004   2005 *   2006 **

TOTAL STARTS            1,710   1,853   1,950    2,060    1,940
SINGLE-FAMILY           1,363   1,505   1,604    1,710    1,590
MULTI-FAMILY              347     348     345      354      350
EXISTING HOME SALES     5,593   6,098   5,913    6,151    5,796

* = Estimated value

** = Forecast value