How Much More Will Housing Prices Decline?

by Dirk van Dijk

On Thursday, the National Association of Realtors announced that the median price of an existing home declined 12.4% in 2008 and now stands at $180,100 -- its lowest level since the second quarter of 2003. Median home prices are not the best measure of housing prices, since they can be skewed by changes in the mix of houses being sold. That appears to be happening with this data.

Low-end houses are selling better than high-end houses. This is because an increasing proportion of sales are of "distressed" houses, that is, either homes that have been foreclosed on or short sales where the owner is trying to sell for less than the value of the mortgage, with the bank forgiving the difference. These sales increased to 45% of all sales in the 4th quarter from 38% in the 3rd quarter.

A better measure of housing prices are repeat sales indexed, like the Case Shiller index. The 4th quarter data on that index will be out later in the month. Any way you measure it though, housing prices are down significantly from the peaks, including all the economic consequences of that fact.

It raises the question of how much lower will housing prices go? The nominal price of houses is not a very good gauge. A house is an asset, and as such its value is determined by the value of future cash flows. What are the cash flows you get from a house you own? It is not like you get a stream of checks in the mail each month just because you are a homeowner. The point is that you don’t have to write out checks each month to rent an equivalent house.

With this in mind, it is a good idea to look at previous housing bubbles and what happened. Since we don’t have that much recent experience with housing bubbles in the US (other than the current one), let's take a look at Sweden, which had a big bubble in the late 1980’s that burst in 1991, causing a financial meltdown. The graph below (bigger version available here) shows that home prices did not return to pre-bubble levels after they popped. However, the ratio of home-prices-to-rents did.

This is just what one would expect if one looks at housing as an asset, just the way if a stock gets pushed up to irrationally exuberant levels, it is best to look for it to return to its historic P/E levels, not to its original price level.

So what does this indicate for the US today? The second graph, also from Calculated Risk, shows the price-to-rent ratio here based on the Case Schiller index, and the owners equivalent rent component of the Consumer Price index. This is only through the 3rd quarter, and clearly the ratio came down further in the 4th quarter -- possibly to about the 1.2 level on the graph.

This would indicate that we are most of the way, but not completely done with the fall in housing prices. On a nationwide, Case Schiller basis, there is perhaps another 8-10% left to go. However, even this will continue to put a huge strain on the very weak balance sheets of the major banks like Citigroup (C), Wells Fargo (WFC) and Bank of America (BAC). Regional banks like Wilmington Trust (WL) and Key Corp (KEY) will also face severe stresses and might not pass the new government stress test without the need for new and very dilutive capital.

In case you had not noticed, Sweden today bears little resemblance to Somalia or the Sudan; they managed to survive their housing crisis. However, it took bold and dramatic action to solve the problem. They nationalized the banks -- cleaned them up. And then resold them after a few years. Eventually the US may have to go down that road, rather than trying to pussyfoot around with partial solutions like "bad banks" and "public-private partnerships." It is a much cleaner solution, and one that has been shown to work in the past, albeit on a much smaller scale.

Comments

[kruser53:]

Thanks for the housing update. Your estimate of 8-10% more to drop is similar to the estimates I have seen from many other sources, although a few have predicted larger drops to the bottom. The few estimates I have read that we are nearly to the bottom I have not considered credible.

On another note, I prefer to wait for the Case-Shiller report on housing. NAR has not been as reliable, in my opinion.

Feb 15 08:55 AM

[EMS:]

Let's just assume for a moment that the further 8-10 % near-term drop is correct. Let's further assume that the value stay at those realistic levels for 5-7 years. Where will that leave the value of MBS as compared to where they are being carried on their (banks) books ? These factors can be priced into investibles and we can all model/ move/ choose to invest etc. forward...

Feb 15 09:25 AM

[sickofthehype:]

Sweden also began the early 80's with their one and only smash hit group and hasn't sent another band to the charts since. You might as well put that into the equation as well, because comparing the US now to Sweden then, is apples to oranges.

We're about to undergo SERIOUS inflation, and that includes asset inflation. Like it or not.

Feb 15 10:44 AM

[Aristophanes:]

At this point the regional and local situations will be determinants more than the overall credit glut which caused universal froth. Some markets are likely hitting bottom already (less froth, economically stable), other have a ways to go (lots of froth, unemployment concerns). Some markets could drop another 40%. Once the credit glut is averaged out, talk of a national decline are problematic. Look local.

Feb 15 12:27 PM

[Mr. Ed, Jr.:]

I doubt if an 8-10 % additonal drop is realistic. It will likely be much worse.

Homeowners who are delinquent are now just gaming the system, staying in the home as long as possible, with no intention of paying. They are walking away, not even responding to calls and letters from the bank offerring to "adjust". They know the adjustment will be small, and interest payments are just tacked onto the end of the loan. That still leaves them very upside down in a still-depreciating asset. The stigma of foreclosure is no longer what it was. They will rent for now, They have no skin in the game now, if they ever did.

On the other side, buyers are heading straight to the banks REO departments, because that is where the bargains are. There are so many foreclosures that, in reality, the foreclosure price is becoming the market price. There is an incredible glut of homes, and another wave of ARM resets is just coming up, this one bigger than the last.

A glut of homes, tighter credit, rising unemployment-- nothing in that group that will be a catalyst for the housing market. And walking away from a bad investment is becoming more acceptable, which only aggravates the problem. In a "normal" economy, we would more quickly reach a price that would attract buyers. Not this time.

Feb 16 12:12 AM

[sr9web:]

Succinct, accurate, true.
Good Post!


On Feb 16 12:12 AM Mr. Ed, Jr. wrote:

> I doubt if an 8-10 % additonal drop is realistic. It will likely
> be much worse.
>
> Homeowners who are delinquent are now just gaming the system, staying
> in the home as long as possible, with no intention of paying. They
> are walking away, not even responding to calls and letters from the
> bank offerring to "adjust". They know the adjustment will be small,
> and interest payments are just tacked onto the end of the loan. That
> still leaves them very upside down in a still-depreciating asset.
> The stigma of foreclosure is no longer what it was. They will rent
> for now, They have no skin in the game now, if they ever did. <br/>
>
> On the other side, buyers are heading straight to the banks REO departments,
> because that is where the bargains are. There are so many foreclosures
> that, in reality, the foreclosure price is becoming the market price.
> There is an incredible glut of homes, and another wave of ARM resets
> is just coming up, this one bigger than the last.
>
> A glut of homes, tighter credit, rising unemployment-- nothing in
> that group that will be a catalyst for the housing market. And walking
> away from a bad investment is becoming more acceptable, which only
> aggravates the problem. In a "normal" economy, we would more quickly
> reach a price that would attract buyers. Not this time.

Feb 16 01:19 AM

[Rhett:]

He fallacy in DIrk's aticle is that rents will remain static, which they won't.

Feb 16 09:47 AM

[IAS360 Hous...:]

LATEST REPORT SHOWS U.S. HOUSE PRICES FELL 13.8% IN 2008

ntegrated Asset Services, LLC (IAS) (iasreo.com), a leader in default management and residential collateral valuation, released its IAS360™ House Price Index for December on Tuesday, Feb.10. The IAS360 is released a full three weeks before Case Shiller's. Based on the timeliest and most granular data available in the industry, the index showed a 13.8% decline in house prices for the full year 2008 and an overall decline of 19.1% since the market’s peak at the end of 2006. This after December 2008 posted continued declines of 1.1%.

The IAS report also identified 10 of the counties hit hardest during the national decline. Not surprisingly, most were in states that experienced the largest gains during the housing bubble, California and Florida in particular. California fared the worst with three of the nation’s hardest hit counties: San Joaquin County, down 51% from its high, Monterey County, down 49%, and Kern County, down 45%.

“We’re seeing house prices returning to pre-bubble levels and there are no signs of leveling off just yet,” said Dave McCarthy, President and CEO of Integrated Asset Services. “But location is still everything, and in this turbulent market the ability of the IAS360 House Price Index to gauge movement at the neighborhood level will make it the most vital house price index to watch for signs of a recovery.”

Visit www.iasreo.com/ias360_... to find the most recent housing data in the industry.

Feb 16 11:52 AM

[abal auctio...:]

My god who writes this stuff Dorothy from Kansas. Homes have a great deal more of a drop than 10%. NAR needs to open a window and smell the air of unemployment. We are still losing jobs.There are hugh industrial downturns in a variety of sectors each day. These trancend to foreclosures. How do you pay your mortgage if you don't have a job.

Still, i take intakes for auction real estate deals everyday with people that expect me to auction their home for the 2005 price they paid for it. It's almost funny except for the dire condition they find themselves in.

I have bank presidents tell me they will hold an REO for 2/3 years when the market comes back. Who are they kidding? The continue to hire blonds with boobs to plant for sale signs on the property for months on end. What a joke.

Obama needs to take the banks over and start the recovery in the industry that caused the problems. Our economical salvation is dependent on economies like China. They got 2 trillion in cash to burn. We need their consumers to buoy our recovery.
Joe Abal
blog.abalauction.com

Feb 16 11:54 AM

[xom-only:]

no one believes we've seen the bottom. i personal consult with three familys that have decided to ride the free place to sleep as long as possible. they have asked me how to extend it. i tell them simple things like make application, when it is rejected find someone to make a cash offer around 40% of the tax value unless they are afraid it will be accepted, then negotiate by waiting till the last day or the required answer and counter with asking the owner of the mortgage to finance a higher but still below something that might be accepted and the next phase would be to offer to rent for a rate based on the original offer and then if all that comes to naught make them file eviction and carry your paper trail to the court to ask for a delay of 60 days because you were acting in good faith. the court won't let you stay without paying but they can put the responsibility on the sheriff who is now 60 days behind their normal 14 day eviction serving. all that said , does not include the moritorium of one of the mortgage owners till after obama 's plan to help home owners. all three have their jobs but have decided life isn't fair to them and it isn't their fault so they are getting all they can in free rent. oh yea none of them put money down and used seconds to get more than the house was worth in 2007. one has lived in the house since sep08 and the mort rep has offered to let them rent, one contact is only three months behind and has set up the first meeting with b o amer and the third has lived free for 4 months and has just been contacted by a rep.
whats my point, i don't see a bottom to houseing prices here in atlanta for some time and i believe the economic bottom won't occur untill everyone has had an opportunity to remortgage their house low enough to make them feel okay about their financial future probably < 3%. we'll see.

Feb 16 01:26 PM

[User 62119:]

I believe that homeowners in many areas continue "in denial". The market has further down to go because of the unemployment threat and the credit crunch reality. I don't believe we are near the bottom in home prices. Furthermore, another trick being played around is to rent in the name of a single renter and 2,3, or more family units move in to share the cost of renting. This type of situation help distort the rent market.

Feb 16 02:50 PM

[David in D:]

I think we have much further to fall than 8-10% based on many factors not accounted for in the post. Even if I do limit my analysis to the data presented in the post, your calculations are incorrect.

Price to Rent ratios bottomed at approximately 0.97 on the graph (let's just call it 1.0) the graph reflects 1.3 at the end of the 3Q 2008 off from 1.75 at the high. (1.75-1.3=0.45, 0.45/1.75-1.0=0.60). Therefore, based on you own data, to the end of Q3 6/10s of the drop has occured. Total drop = 19.1% 1/.6 = 32%. Therefore, based on your own data, total drop is roughly 13% from the bottom.

I for one, think we have even further to go... probably in the range of 18% -- definitely not 8-10% and probably not 13%.

Feb 16 02:52 PM

[theobannion:]

Denmark, Sweden, Finland, Norway & much of northern Europe have much more socially-oriented cultures than we have in Southern Europe, the US, & Latin America.

Nationalization of anything in this latter group would be anathema.

SOB.

Feb 16 04:16 PM

[Gerryt:]

The bottom is so far down it still cannot be seen. While politicians keep trying to prop up a banking system full of people that no one trusts housing prices keep on falling. And its the same here in Australia - our politicians said that we would be insulated from the "bad" credit practices in the USA. But we are tracking down the same road - only we are a few months behind you guys.
How far will prices fall - I don't know but I do know that they will not stop until they reach a sustainable level. That means not until a normal family can live normally on normal incomes and pay a normal amount of mortgage and that will be sustainable into the future. If the average house price is too high for the average income earner - then this is not sustainable and prices will fall until they are.

I've done this exercise here in Australia and I calculate that our houses prices will lose 45 to 60% of their 2006 high values before this is over. If wages drop due to the unemployment add a few more percentage points to that. Unfortunately I believe that the US is going to go the same way.

And you are right about prices going down and staying down for a long time. The point of this correction is not for prices to fall and then climb right back up to an unsustainable level - come on, everyone knows that didn't work.

Those "smart" property owners who are going to hang on for a little while until the market comes back up - well they are just going to be tomorrow's losers.

In a market where credit was the problem - throwing real cash at it is a total waste of money - the only solution for a sick credit market is the forgiveness of debt - because neither are real and anybody can do it. It just takes real people to do this. We all hope your new president is going to be the one.

Gerryt
Australia

Feb 16 07:22 PM

[T.Stamps:]

Obama won't help. He'll make things worse.

Feb 16 11:36 PM

[mallarde:]

Consider: where did the Nasdaq stablilize compared to its 2000 highs?

Admittedly, not a perfect analogy, but the housing market still must absorb the blow of not being a popular investment vehicle, like tech stocks. We have all these For Rent signs littering my neighborhood because "investors" bought extra condos -- not to live in, but to flip after holding for awhile. Since they can't sell them at break even, they rent them. Once all these "investors" leave the scene, the market will lose this source of capital.

Feb 17 01:26 AM

[David Nash:]

The housing bubble expanded in the first few years of the 2000s and it took 6 year to Peak, driven by historically low interest rates and poor lending standards.

The housing boom ended in of 2005 /06. Unlike Sock Markets, Real Estate can not be expected to crash and reach bottom quickly. There has been steady re-valuation. But are we anywhere near the bottom?

The global economy will struggle to cope up with falling industrial and consumer demand for several quarters more. We can not expect Real Estate Market to improve until potential buyers get a feeling of financial security and economic well being which is absent today. David N. exclusivereal.com

Mar 02 09:16 AM