Housing: Not Cheap Enough?

Some economists believe that the hardest hit areas of the real estate market, such as Florida, California, Nevada and Arizona will be the first ones to recover. Homeowners may not want to move to Indianapolis, but Florida is still a ‘hot spot.’ KB Homes (KBH) has said it is pulling out of the Atlanta market, but it remains firmly entrenched in South Carolina. Parts of California’s real estate market are trending up lately, as well. Economist Karl Case said:

Some of the biggest potential overshooting in home prices on the way down is in states such as Arizona and Florida, areas where major overbuilding took place during the boom. "Where this glut is occurring is fortunately in places where people still want to go," Case said.

But markets that were safer until now are falling. San Antonio, Texas, a market previously buoyed by oil prices is now hitting the skids. Manhattan is diving and even the Hamptons, New York’s beachfront enclave of the rich and famous, is in decline.

Kiplinger notes cautiously that

A slight rise in sales of existing single-family homes last fall was driven largely by big increases in sales in California, Florida, Arizona and Nevada -- the states most afflicted by the housing bust. Sales have also risen in Minnesota, Rhode Island and northern Virginia. Plus, the number of homes on the market declined for the first time since March 2005.

Historically, home prices begin to rise within nine to 12 months of a sales uptick. But sales in September (the latest data available) reflect contracts negotiated in June and July, when the economic climate wasn't so dire. Numbers reflecting later fall sales could nip the trend in the bud.

Karl Case says those who think the bottom in housing is near are in “la-la land”. But he does point out two hopeful elements in recent housing data:

"People are showing up at the (foreclosure) auction sales and buying. The price declines are starting to gather in buyers," he said. "And a fair number of people are prepared to lower the price on their house until it's sold."

That capitulation effect, breaking through the phenomenon of "downward stickiness" on housing prices, started to show up more markedly in 2008.

Bloomberg throws cold water on the theory that the slump is over in California:

As the U.S. housing recession enters its fourth year, there’s no sign of a recovery because speculators account for most of the rise in sales.

Case thinks speculators will extend the slump after they unload speculative properties in to any potential uptick in the market. The economist does note the positive effects that coming government intervention may have:

Speculators may soon see some competition as state and local governments start receiving the $3.9 billion allocated by Congress in July to buy and renovate foreclosed properties and sell to families who intend to live in them.

Communities have 18 months to spend the federal money or lose it, according to the Housing and Economic Recovery Act of 2008 that authorized the program.

Florida will get $541.4 million from the federal government for the so-called Neighborhood Stabilization Program, which allows the states to direct the funds to local housing groups. California will receive $529.6 million, Michigan is getting $263.6 million, Ohio is slated for $258.1 million and Nevada for $143.9 million.

The WSJ points hopefully to

years of falling prices [that] have made houses intriguingly affordable, especially relative to rising rents.

But tempers that with a reminder that pending home sales are falling again after rising in the summer. Lower mortgage rates may also have little impact. In the end, it still comes down to affordability.

Mortgage rates have tumbled to their lowest levels in nearly 40 years… Slashing rates to 4.5% for new borrowers, as the government aims to do, won't be a panacea, [though]. Ivy Zelman, chief executive of housing-research firm Zelman & Associates, estimates that, even with such a low rate, only about 67% of U.S. households can afford a house. Homeownership was nearly 68% in the third quarter, according to the Census Bureau, implying there is virtually no untapped demand for homes.

Comments

[jswede:]

rates don't matter. they could go to 2% and it wouldn't stop the drop.

the issue is the fact that nobody has 20% to put down --- today's low rates are available to but a sliver of the home buying public -- maybe 10%.

many more *think* they have 20%, and it won't be til after an appraisal of their current property that they find out they don't... it will be a harsh reality.

the uptick in sales and prices in some places are due to mis-guided investors/speculators who wrongly think we're nearing a bottom.

and as far away as the bottom is, the idea that we'll see significant appreciation after it hits is laughable. after we hit bottom, home prices will go up about at the rate of general inflation, like they did for the 100 years previous to this bubble.

Jan 08 11:53 AM

[baldguy:]

I agree jswede. You must also factor in the afordibility issue.A lot of people have been forced out of the housing market by the huge jump in their cost of living. The cost of food, energy, healthcare, and taxes, which affect each and everyone of us, coupled with the stagnation of the income of the lower and middle class, have put the American Dream out of reach for millions.

Jan 08 12:06 PM

[fatcat:]

Employment,employment,... has replaced the realtors mantra...location,loca...

Jan 08 12:08 PM

[CautiousInv...:]

Home prices have fallen 24% from their peaks and are likely to fall another 12 percentage points. In parallel, unemployment is increasing and more homeowners are getting underwater....leading to foreclosures.

More foreclosures increases existing supply and the excess number of homes on the market which could easily exceed one million units. Existing supply and falling prices are crucial factors.

Prospective buyers see this ominous trend and are deferring purchase decisions under the belief home prices will continue falling. Those that would like to buy, face the task.......as others have noted......of coming up with 20% for a downpayment.

Price/Rent ratios are all over the map and must be examined market by market.

Jan 08 12:32 PM

[xomalley:]

There is a customer for all products based on price/quality/need.

1. how much of a home does a first time buyer need to be better off than living in an apartment ?
2. quality goods without saying--it must be good enough to last a life time.
3. price, monthly payments must not exceed 33% of a workers take home pay.

That is a simplistic model but---
If you can meet all of the above you've got a 5 million/ year market--just like Levitt did in 1946.

Jan 08 01:06 PM

[REITBull:]

Hi Judy,

I enjoy the articles on SA, but why is IYR consistently linked to residential real estate and homebuilders?

Jan 08 01:19 PM

[billddrummer:]

Hi Judy,

Again, consistently excellent reporting, thanks!

I was under the impression that IYR is an ETF of real estate related Dow stocks, which would explain why it's linked to residential real estate articles.

All good comments above. I too believe that houses have farther to fall in the boom areas, and now regions that were safe have experienced unanticipated declines.

It's instructive to me that those of us 'on the ground' saw both the rise and fall much sooner than the top brass of the government, the homebuilders, and the developers.

We also predicted that the fall would occur until affordability becomes the rule, rather than the exception.

As jswede noted, the qualification process is more rigorous now (which is a good thing). The downside is that the cash down that people now need isn't there. So FHA or other low-down purchase options are all that most families can qualify for now. And in high cost markets, that shuts out all but starter homes (despite the adjustments in FHA loan limits for high-cost areas). Even with a higher FHA limit, many families have trouble qualifying for the expanded limits because their income doesn't support the bigger mortgage payment and PMI. (For example, a mortgage payment on the $417,000 maximum loan at 5% is $2241/month. At a 28% debt ratio, household income has to be $8003/month to qualify for the mortgage, and that doesn't include PMI or property taxes and insurance.)

Housing must continue to fall until the median family can afford the median mortgage payment.

ATB,

Bill

Jan 08 01:38 PM

[Crocodilian:]

What once worked in favor of residential real estate, now works against it: leverage. Outside of a thin sliver of the very wealthy, few people buy houses for cash. They typically buy with %10 -20 down payment, borrowing the rest. Nearly every residential real estate buyer is a "margin buyer" in stock market terms.

That means that interest rates, and expectations of future home price appreciation are critical. Real interest rates are very high. Inflation is not zero, deflation is present in all sorts of asset categories, durables, non-durables.

But bringing mortgage rates down doesn't solve the problem: There is no interest rate that makes it a good deal to purchase a home with %20 down if prices fall (as they are likely to do) by another %10. A %10 fall in home price wipes out %50 of your equity.

Until there is an expectation of home price appreciation, why would anyone buy? People aren't buying houses for the same reason that their not going long SPX on margin: leverage magnifies losses. Unfortunately, the real estate sector has no cash market.

Jan 08 04:24 PM

[REITBull:]

billddrummer,

Here is why I ask the question about IYR:

Top Holdings in IYR as of 1/7/09
6.71% SIMON PROPERTY GROUP INC
5.23% PUBLIC STORAGE
4.98% ANNALY CAPITAL MANAGEMENT IN
4.96% VORNADO REALTY TRUST
4.33% EQUITY RESIDENTIAL
3.73% BOSTON PROPERTIES INC
3.69% HCP INC
3.21% PLUM CREEK TIMBER CO
2.72% KIMCO REALTY CORP
2.67% AVALONBAY COMMUNITIES INC

Top Sectors as of 1/07/09:
22.89% Specialty REITs
19.69% Industrial & Office REITs
19.58% Retail REITs
14.40% Residential REITs
6.96% Diversified REITs
6.85% Mortgage REITs
3.95% Hotel & Lodging REITs
2.75% Real Estate Holding & Development
1.26% Real Estate Services
0.03% S-T Securities
(source iShares website)

There certainly is some exposure to residential real estate, however, the majority of the residential real estate is apartment REITs such as Avalonbay and Equity Residential. I only point this out because the dynamics in the commercial real estate market are very different than those in residential. Not a big deal, just thought I'd point it out.

Jan 08 08:11 PM

[sr9web:]

REITs have done well in the last 10 days. One of mine, the bottom fishing gem CYRV, went up 25% today!

Jan 08 08:39 PM

[Scott Sambucci:]

Judy - Nice work on this synopsis of where we are. I attended Karl Case's presentation at the American Economic Association meeting last week - was a very revealing presentation of the data. Here's a link to the complete paper that he presented, with the presentation slides he used in the appendix of the paper:

www.aeaweb.org/annual_...

Jan 09 08:26 AM

[SA Editor J...:]

To REIT Bull,

Many of those companies listed, SPG, Boston Properties, Vornado, Equity Residential and more, are all involved in residential real estate as well. The state of those markets will have some impact upon their bottom line as well.
At least, that's the rationale for the tickers anyway...

To Scott Sambucci,

Excellent link! Thanks,

All the best,

Judy

Jan 09 09:23 AM

[nobull:]

CA, FL, AZ - arent these also hotspots of immigrant labor. And ofcourse they were mostly drawn in by the building boom in the first place. Vicious cycle! Now the building frenzy is gone. theyre gone, speculators are gone. Their economies are dead. It will be a long time before balance is restored and prices can move up. So sit back and relax folks...even if it really has hit the bottom, its not going anywhere up anytime soon.

Jan 09 10:45 AM

[nym:]

The Bloomberg article is largely unsupported opinions. The only evidence that "Speculators Dominate Sales" is a handful of annecdotes. With 3,000 foreclosures/day, that isn't good enough.

Jan 09 11:09 AM

[billddrummer:]

To REITbull,

Thanks for the breakout on IYR. Judy's take that commercial REITs also have residential exposure is also accurate.

Jan 09 11:13 AM

[nym:]

If the house deleveraging is a "$20 trillion beast" seekingalpha.com/artic..., that $3.9 billion in the housing recovery act isn't going to make much difference.

Jan 09 11:26 AM

[REITBull:]

Hi Judy and Bill,

I agree that residential real estate does have some influence on IYR. And in all fairness, Annaly Capital, one of the top holdings rely heavily on residential mortgages. Thank you for the feedback!

Jan 09 12:31 PM

[billddrummer:]

To Reitbull,

Thank you for corresponding!

And to Judy,

Another statistic that suggests housing prices are too high relative to income is the price/household income ratio. As reported in the Gartman Report (proprietary), the ratio remained around 2.7:1 for nearly 35 years, until the spike in home prices in 2000. When home prices peaked in 2006, that ratio moved to 4.7:1.

Now, even with the long slide in prices, the ratio is still 3.6:1--far higher than is sustainable, in my opinion.

What I think we're witnessing is a trend back toward the 2.7:1 ratio. And nothing the government can do will stop this relentless movement.

But with hours worked falling and unemployment rising, the denominator for that ratio may start to slip. And if that happens, housing prices will have to fall even further to maintain the ratio.

This year will be an interesting one. The popping of a bubble is at least as compelling as the blowing up of one.

ATB,

Bill

Jan 09 05:41 PM

[xom-only:]

don't know where they found you but you ought to go get your doctorate in econ. you put togeather great articles

Jan 14 02:22 PM

[xom-only:]

i decided to read the comments to see what the ratio of emotion to insight and i am amazed at the high quality of the responses. much better than any other authors i have read as i watch my options. i think i have found a quality source . thanks

Jan 14 02:33 PM

[SA Editor J...:]

To REITBull, thanks for the gracious response.
To Bill, thanks, as always for your interesting commentary.
To Xom-only, thanks for the compliment!

ATB,
Judy

Jan 14 02:34 PM

[GEN X:]

Excellent insight and comments!

As someone in their mid 20's who is struggling with paying back ridiculous student loans - I think it is worth mentioning that younger demographics are still extremely priced out of homeownership.

It really all comes down to one thing on most individual basis' - and that is Debt to Income (unless you have a nice trust fund sitting around somewhere)!

Younger generations don't have close to the adequate income level to support their huge debts and to burden themselves with a $200 K mortgage on top of it. So it is no surprise that prices are in decline across the board - especially when a good portion of the working class is living paycheck to paycheck to pay rent. How is anyone supposed to save $40,000 for a down payment??

One thing is for sure, if Grandma and Grandpa want to sell their big family home to a younger family so they can downsize to a smaller retirement home, they are going to have to price it according to what the buyer's market can bear. Unfortunately, it seems like that still hasn't happened - at least from the perspective of a poor 26 yr old...

Jan 21 04:14 PM

[SA Editor J...:]

Dear Gen-X,

I couldn't agree with you more. After all, what stopped the music for the housing bubble (sorry to mix metaphors) was the lack of affordability.

At some point, people just couldn't afford the crazy prices and they stopped buying. Then everyone stopped buying. None of the measures used to stop housing's slide will help, IMHO, until houses become affordable for the people who want to live in them.

They say the whole housing chain will start to move when the first-time buyers (like yourself) start to buy. So until it's affordable to you, nothing is going to change.

Thanks for the comment,
Judy

Jan 21 04:32 PM

[billddrummer:]

Hi Judy,

I agree with GenX. Too often those of us on the back side of 50 forget that many new college grads come out of school with huge debt loads. And no savings.

Without an affordable entry-level home price, new workers without investment resources are forced to rent unless they've got the trust fund (or are beneficiaries of big insurance policies).

The FHA program can help to a degree, but it's also limited because even if you can scrape together a 3% down payment, your income still has to be sufficient to support the mortgage, PMI, taxes and insurance, and your other debts. Not only that, but many areas are still priced out of FHA maximum loan limits. And entry-level workers won't, in large part, be earning the $6,000-$7,000/month it takes to qualify for the higher loan balances.

GenX is right--until entry level housing is truly affordable for entry level buyers, prices will continue to drop.

ATB,

Bill

Jan 21 06:24 PM