Housing Bubbles and Bottoms - Light at the End of the Tunnel?

In relation to PC personal income the residential real estate bubble reached its peak in 2005 and, as shown on the following chart (click to enlarge), prices continue to decline after an extraordinary run-up in the Northeast and West Regions. For the rest of the Country, except Florida, current home prices appear sustainable at least by historical standards.

Bubbles in all markets come and go, but the recent one in housing was by far the most excessive in modern history in relation to the fundamental long term driver of residential real estate i.e., personal income, just as exorbitant PE’s, the income equivalent for corporations, signaled the Tech equity bubble and the 1929 crash.

Looking at the chart, one might ask why the 2000-05 run-up in prices relative to income was a multiple of the prior late 1980’s residential bubble. It appears that, by far, the single most important factor was the collapse of credit standards, not interest rates, securitization or rating agencies.

While there were aiders and abettors in the most recent run up, notably the rating agencies, had credit standards held firm, the damage today would be a fraction of what has happened so far.

During the late eighties run up, mortgage interest rates were in the double digits, variable rate mortgages were common as were mortgage securitizations (Fannie (FNM), Freddie (FRE), and in the municipal market), but mortgage underwriting standards held firm.

Essentially, the rapid near elimination of mortgage underwriting standards in the early 2000’s, redefining “affordability”, dramatically increased the number of “Qualified Borrowers”, pushing prices far beyond historical norms and past peaks.

Prognosis

As can be seen in the chart, further price declines in the West and to a lesser extent in the Northeast appear inevitable. The West with substantial concentrations of sub-prime lending in California, Nevada and Arizona has the worst prospects.

Given current economic trends and reinstated mortgage credit standards, the question is how much prices will fall below the historical price to income ratio norms (medians) before stabilizing. On the chart, the early Eighties clearly show the effect of near double digit unemployment rates, a time when the ratio declined to 5.75x across the board and loan to value ratios were 80% and lower.

Holding PC personal income constant for the Northeast and West, and targeting a price to income ratio of 5.75x, the indicated decline from today’s median price levels would be -10.7% in the Northeast and -18.7% in the West. Very little nominal growth or some decline in National and Regional PC personal income is expected in 2009. Nationally, median prices are already below 5.75x current national personal income.

For readers wishing to create alternate scenarios, fourth quarter 2008 median new home sales price and PC personal income for the Nation was $211,800 for price and $39,825 for income. The Northeast was $313,800 price, $45,222 for income and for the West, $298,100 price and $38,083 in income.

For policy makers, implementing mortgage credit standard regulations is necessary as is closing a barn door albeit far too late. Capital requirements for mortgage lenders and collateralization levels in securitizations proved woefully inadequate only because lending standards became un-hinged.

The market has already restored lending standards, apparently with a vengeance. Increasing capital requirements for new mortgage lending is not necessary and would make matters worse.

Positive things that can be said are that 1) price to income ratio analysis provides a basis for expecting light at the end of the tunnel in the not too distant future and 2) the magnitude of price declines to date, while historic, should not be surprising or taken with extraordinary meaning because they are proportional to the preceding unprecedented size and rate of price increases.

Notes: Ratios are based on large area regional median values and PC income which mean that prices, income and price/income ratios in the hundreds of local markets within a region will be above and below the median for the region. Longer term, in local markets where personal income remains strong, results have and will continue to outperform medians just as other local markets have and will under-perform large area medians.

Ratios are based on new single family home sold price data going back to 1963, available from the Census Bureau. Historical existing single family home price data back to the 1980’s is available from the National Association of Realtors at no cost for the last three years only. Besides the obvious correlation in price movement between existing and new homes, new home sale prices provide a better measure of actual clearing prices. The distribution of new homes sold by price category has not materially changed.

Comments

[scotty1560:]

The market we are currently in may not have charts to reflect a trend.
Thanks to 0% financing in boom areas, we are left with massive over building
and unheard of defaults and negative equity.

IMO..real estate is dead in the water at minimum until foreclosures run the
full course...2 or 3 years. Second, with traditional lending standards back in
place, we can expect moderate appreciation for years. We witnessed a
once in a lifetime boom, and doubt I will live to see another such event.

Could easily take 15-20 years to touch 2005 levels. Wealth is now distributed
in smaller and smaller circles...so count the middle classes out...that is
the road this country has decided to pursue for better or worse...imo worse.

Feb 02 01:01 PM

[baldguy:]

I do not think that the charts are applicable in our situation today unless you make some big adjustments for the cost of owning a home today versus in the past. As a home owner since the early 70s, I can assure you that the cost of ownership, taxes, insurance, utilities, and maintenance have increased greatly %wise over the years. The cost of the real estate tax in our area, the midwest has gone from about 1.2 % of home value in the early 90's to about 2.7 % today. Thats a huge increase of just one item which has to figured in.

Feb 03 10:02 AM

[notsosmart:]

as said so often the light at the end of the tunnel is the train rushing towards you. with 14.7 mos of housing supply & ever increasing unemployment its tough to be optimistic.

Feb 03 12:30 PM