When Will Housing Prices Return to Previous Highs?

A few weeks ago, I was riding in a taxi from midtown Manhattan to Newark Airport. Having set forth for Newark at 4:00 PM, I (as most of you know who have ever dealt with traffic from Manhattan to New Jersey in the early afternoon) had a great deal of time to kill. Not one to shy away from meeting new people and seeking their opinions, I struck up a conversation with George, my driver. George, by the way, is one of those entrepreneurial personalities that do not need a medallion or a permit to whisk passengers from Newark to the City. After some pretty speedy small talk – George had driven me into the City earlier that morning where he learned that I was in New York meeting investors for my distressed asset acquisition fund – George got right to the point:

I have a house in New Jersey I paid $500,000 for four years ago. I pay $4,000 per month for my mortgage, and my brother-in-law just rented the house next door and he pays $2,000 per month for a much bigger house. Why should I keep paying $4,000 per month? Hey, and I ain’t making what I was making when I bought that house – not so many people like you heading into the City from Newark anymore. It just doesn’t seem fair that he only pays $2,000 month. I could afford $2,000 per month. I wish I never bought that house.

He then asked me a very pointed question,

How long do you think it will be before my house is worth $500,000 again?

Great question. And, believe it or not, there are several answers floating around from some very informed sources. Unfortunately, I think most of them are so optimistic that they are misleading. Let’s start with the National Association of Realtors (NAR). In the recently published Housing Market Trends & Outlook, NAR’s chief economist Lawrence Yun suggests that demand for new housing is currently far outpacing the supply. He estimates the demand for new housing at 1.5 million units per year and compares it with annual housing starts of about 900,000 in 2008, 500,000 projected for 2009 and 600,000 for 2010. NAR’s analysis suggests a cumulative housing shortfall of approximately 2.5 million units between 2008 and 2010 (i.e., the sum of the annual differences between housing starts and new units needed).

Roughly estimating the excess housing supply between 2000 to 2007 depicted in NAR’s chart at approximately 2.2 million units, the chart would suggest that this entire excess inventory should be absorbed sometime in 2010, assuming the 2.5 million shortfall from 2008-10. Wow, that’s easy: in under 2 years, we can expect George will be well on his way back to recovering his lost home value, grilling steaks and sipping beer in the backyard of his $500,000 house again.

Can it be that simple? Is it possible that NAR, by it’s very nature, is deeply invested in asserting that the housing inventory is relatively small and that the absorption of those houses will be relatively quick? Well, NAR is not the only organization that believes in this rosy, speedy recovery picture.

Take, for instance, the National Association of Homebuilders (NAHB), who recently reported two consecutive years of declining new-home inventory, quoting recently released government figures of 297,000 new housing units available for sale. The NAHB highlighted that this inventory represents a 10.1-month supply at the current sales pace. And, based on their recent Housing and Interest Forecasts report, the NAHB believes the inventory will continue to shrink.

You may be as skeptical of NAHB’s motives for these chipper prognostications as you are of NAR’s, the organization whose president testified to the Senate Banking Committee in 2006 that there is no housing bubble and that forecasted in their December 2006 Real Estate Insights newsletter existing home sales to remain steady in 2007 at about 6.4 million when, in fact, 2007 sales declined 13% from 2006 to 5.7 million. Again, just a couple of more years, George? I wouldn’t get the steaks out just yet.

NAR’s optimistic forecast came just six months before the folding of Bear Stearns’ mortgage-backed securities-based hedge funds, followed within a year by the collapse of the entire firm. This was a mere four months before the NAR allegedly fired their chief economist, who by the way has stated publicly that the organization all but forced him to make these reassuring predictions in order to prevent a panic among home buyers in what was already an apparent housing crisis in formation.

I can see why these answers from these two organizations might not be very reassuring to George, but what about all the private sector projections of a near-term recovery? In marketing materials for a new distressed land acquisition investment fund sponsored by a large U.S. homebuilder, the investment strategy is driven off of reported forecasts of housing demand of anywhere from 1.4 to 2.0 million new household formations per year and housing start shortages of as much as 1.5 million based on this year’s projected 510,000 new homes. From these figures, the sponsor expects market recovery in approximately 18 months and a significant increase in new home demand and associated decrease in excess inventory over the coming 24 months. This isn’t the only new real estate investment fund we have seen making erroneous conclusions on housing data. Several other startup funds project similar housing shortages and increasing demand over similar time periods.

Can it be true? While I would love more than anything to tell George that he has only a little longer to wait, I cannot imagine that – as we experience what almost every financial pundit agrees is the largest housing dislocation in U.S. history and quite possibly the largest recession in American economic history – it will take only two years for George to be grilling steaks and sipping on a beer in the manicured backyard of his newly re-claimed half-a-million dollar home.

Hey, I wish it were so, but the fact of the matter is that the various projections we have referenced are misleading at best and, in some cases, flat wrong. Let’s look at the facts using U.S. Census Bureau data. But before I get to that, here are the definitions of some of the data used in developing these conclusions:

Housing Units – A housing unit is a house, an apartment, a mobile home, a group of rooms, or a single room that is occupied (or if vacant, intended for occupancy) as separate living quarters. Each apartment unit in an apartment building is counted as one housing unit. Collectively, housing units represent the inventory of U.S. housing (U.S. Census Bureau).

Read this definition carefully. Housing units include rental units. All of the aforementioned optimistic housing projections make no mention of rental units. Yet rental units account for roughly 30% of all housing. How could they not be factored into these estimates, especially in light of the current mortgage and foreclosure environment, which is all but forcing millions of Americans into rental housing?

Household Formation (HHF) – HHFs represent the prime demand driver for residential property; they reflect the change in occupied housing inventory over a period of time (for our analysis, we consider HHFs over a 12-month period).

That’s simple enough, as long as you are also considering rental units. Again, until the mortgage industry loosens its current underwriting standards (God forbid) and foreclosure rates decline (God help us), the rental component of HHF may be the largest metric in HHF.

Permits – Permits reflect the number of housing units that have been authorized via permit from a local jurisdiction to begin construction of the housing units (U.S. Census Bureau).

Again, read this definition carefully. It excludes all those lot development and raw land acquisition positions currently held by developers and financed by banks across the U.S. Based on our analysis of the troubled loan portfolios of multiple banks in the Southeast, we believe the number of unfinished lots may exceed the total number of permits issued by 100%. The important thing to note is that we do not account for any of the land acquisition and development lot oversupply anywhere in our estimates.

For purposes of our analysis, we review the disparity between permits and HHFs from 1991 through the first quarter of 2009, because that is when the oversupply problem began. In other words, the current oversupply is not, as many assume, solely a creation of the real estate bubble of the 2000s. The Census data clearly indicate that the current bubble began forming at the end of the last large real estate bubble in 1993.

So, George, here is my answer to your question: if you compare the increase in occupied housing units (i.e., HHFs) over the trailing twelve months from 1991 to the first quarter of 2009 to the number of housing units that were permitted for construction during the same time period (including rental units), there are over 7 million excess housing units in the U.S. compared to the number of households formed during the same time period (see the following chart). Assuming no additional housing units are created, that’s about 5 years worth of inventory, based on what we feel is the aggressive assumption of 1.5 million HHFs per year posited by the projections reviewed earlier. (We will discuss why we think 1.5 million HHFs is wildly optimistic later in this article).

There are two elements of this chart that need particular attention. First: consider that on average, developers in the U.S. built 425,000 housing units in excess of the average number of households formed each year. Second, pay particular attention to the number of households formed during the last mini-recession in 2002. HHFs in 2002 dipped to about 500,000. Note further during that same time the number of additional housing units permitted was over 1.6 million.

What? Is that possible? Household formations declined 66% from the prior year, but the rate of residential construction increased 7%. Indeed it is, and you have Alan Greenspan to blame. In 2001, the Federal Reserve began its infamous credit giveaway. Beginning January 2001 through June 2004, the Fed lowered interest rates 5 ½ points. Not only did this splurge of free credit inspire massive builder production, but it also gave those builders the false sense that everyone in America was going to buy a home. In short, developers could not help but build more housing units than needed because credit was just too cheap to pass up on. Keep in mind, this false sense of security was heightened by wild speculation from investors who were also gorging on cheap credit.

Put another way, investors poured into the market using cheap credit to speculate on houses that were never going to be occupied. How could they? The cumulative inventory of excess housing built up from 1991 to 2004 was 4.7 million, several times the median of 900,000 households formed. Not only were there 1.6 million housing units more than households needed before the severe dip in household formation in 2002, but U.S. developers doubled that oversupply in the following 12 months to 3.2 million. From there, they never looked back.

A final look at the above analysis shows the most disconcerting fact of all: the disparity between housing permits and household formations has not yet reached equilibrium. In the first quarter of 2009, housing permits exceeded household formation by over 600,000 units. Not only are the estimates that annual demand exceeds household formation from NAR, NAHB and private equity funds flatly wrong, the data indicates that the oversupply of housing units is increasing to this day, further exacerbating, not mitigating, the problem.

I am quite sure that even George knew that housing oversupply was blowing the market out by at least the beginning of 2007. It was all over the news. So, how could developers possibly be continuing to exacerbate the problem? Remember 2002. Simply put, we are repeating the mistakes of the last housing recession in 2002. Cheap credit is again fuelling unnecessary development of additional housing units in a dramatically oversupplied market.

What does this mean for George? Well, using the consensus figures of the projections we reviewed earlier, currently about 1 million units of supply are absorbed per year (1.5 million household formations and 600,000 housing units). Based on our estimate of supply and their estimates of absorption, we have over seven years to go to exhaust the excess inventory. Bad news for George. No steaks and beer for quite some time.

As much as I hate to say it, the real answer is very likely worse. The household formation estimate of 1.5 million is probably highly overstated. Between 1991 and the first quarter of 2009, the median of HHFs was 950,000 units. Assuming that median but the same housing unit adds – thus an annual absorption of the excess of 350,000 units – it will take over 21 years to deplete the existing housing inventory! It gets worse. Remember the mini-recession of 2002, household formations declined substantially in what was a very mild recession. How will it not be worse during the greatest recession since the Depression? I wonder if George knows anyone who has moved in with a family member – consolidated housing? Assuming we have a similar 2-year decline in HHFs in this recession, and assuming we continue to add 600,000 units of housing, we are actually not going to absorb any of the excess supply of available housing units for two more years. Again, using their numbers, George is not grilling steaks and sipping beer until 2032.

How can that possibly be? Forget about the biggest housing bubble ever and forget about the biggest recession ever, look at NAR’s own numbers. Today, there are about 4.0 million existing homes listed for sale in the U.S. There are about 300,000 new homes listed in the U.S. That’s a total of 4.3 million homes for sale according to NAR and the U.S. Census. Add to that the 4.1 million rental units for rent, giving a total housing inventory currently available on the market of 8.4 million, a number much closer to our estimate based on Census data.

If you do not believe those numbers, look at the U.S. Census Bureau’s estimate of vacant houses. If you take our estimate (remember we used the same methodology as the rosy forecaster, but adjusted for those elements they left out and time) and compare it to the actual existing home and new home for sale listings, including rental units listed, and the Census estimate of vacant houses (excluding vacation homes) the numbers are remarkably close. One thing is for certain; they are much higher than all the optimistic forecasts we have reviewed.

We understand there is some variability in the time estimates. First, there are demographic influences not easily predictable that could drive up HHFs sooner than expected possibly related to, for example, the Echo Boomers and increased immigration. And, as is often said, real estate is local, meaning a variety of unique factors for a given neighborhood could generate increased demand for the local housing stock. Perhaps the proximity of George’s neighborhood to Newark Airport and the lack of any moderately priced houses in the area will cause a recovery in the neighborhood sooner than the national average. On the other hand, maybe there are too many Americans on limo driver salaries who bought $500,000 homes…

So, George, I hate to tell you, but I believe it’s going be at least 10 years. It is bad news for all of us. The good news is that you do not have to wait to grill that steak and sip that beer, you are just going to have to wait at least 10 years until you are doing it in the manicured lawn of a $500,000 house. I’ll tell you what, I am right there with you. I’ll bring the steaks; you bring the beers.

* For our analysis, to focus on available permitted housing units, we adjusted the recorded number of permits to reflect cancelled construction and other factors using parameters suggested by the U.S. Census

Comments

[OptimizedPrime:]

If the anti-immigrant sentiment in our country continues, we'll simply have nobody to live in all of these houses (US population growth is neutral without immigrants). The baby boomers are already trading in their large 4-bedrooms where they work for small 2-bedrooms in a distant state near a golf course. After the bubble pops we're going to discover plain old-fashioned deteriorating conditions for house prices.

Looks like the NAR (the new NRA) is going to start lobbying to talk the walls down!


OP

Jun 12 02:21 PM

[OptimizedPrime:]

TAKE the walls down. Yeesh.

Jun 12 02:34 PM

[crewman:]

It's hard for me not to dismiss your article out of hand because it deals with the macro U.S. housing market as a whole and doesn't focus on the micro market. As such, it has little relevance as to when "my local housing market" will recover. To be sure, we are way over supplied in the aggregate. But, most of the oversupply is in outlying areas where there was lots of land for builders to build on - those areas will take decades to recover their value. However, in core job centers, the over supply (and there is oversupply) is quite a bit less. In these core locations, excess inventory coupled with a lack of buildable land and higher incomes will allow these areas to recover much more quickly. If you're trying to forecast when markets will recover - you have base your analysis on the local picture and not use macro U.S. statistics.

Jun 12 02:44 PM

[mlonz:]

How about this. You want to immigrate to the USA legally? You buy a house, and it comes with a passport. Problem solved.

Jun 12 05:54 PM

[OptimizedPrime:]

@mlonz -- Great idea (most immigrants would spend $50k or more to come here and not even want a house in return), but most anti-immigrant sentiment is not economically motivated. Most of it is plain old-fashioned racism. The US seems go through anti-immigrant waves about once every 30 years or so. It started with those DAMN IRISH about 100+ years ago...


OP

Jun 12 11:07 PM

[Sean in CA:]

bla, bla, bla......

numbersusa.com


On Jun 12 11:07 PM OptimizedPrime wrote:

> @mlonz -- Great idea (most immigrants would spend $50k or more to
> come here and not even want a house in return), but most anti-immigrant
> sentiment is not economically motivated. Most of it is plain old-fashioned
> racism. The US seems go through anti-immigrant waves about once every
> 30 years or so. It started with those DAMN IRISH about 100+ years
> ago...
>
>
> OP

Jun 13 08:31 AM

[Sonia:]

The housing crisis can only get worse. A friend in Ohio hoped to get a first and second mortgage with "blended" interest up to 11% modified, but was told that Bank of America/Countrywide and National Mortgage are not modifying mortgages or interest and will not refinance. Her income from commission as a real estate agent has collapsed, both from declining sales prices and lack of sales, and she cannot make the payments. The 2 bedroom condo she put 20% down on 14 years ago would not sell for 90K on the courthouse steps - but she owes $140K on it. When she and hundreds of thousands of people in the same situation across the country give up and walk away, the avalanche of foreclosures will bury the banks.

A PA in Dallas recently took a pay cut and her husband, a computer tech, was laid off. Her income is sufficient to pay the mortgage and his unemployment to buy groceries. But if she is laid off there will be another house for sale on the courthouse steps.

Why can't the government use TARP to refinance mortgages at present appraised value?

Jun 13 09:23 AM

[CLH:]

Great article. I just saw an article where the govt. wants to bulldoze millions of houses and turn the land into parks. Sounds good to me.

War was the best way at one time but hopefully those days are gone.

Jun 13 09:25 AM

[No1:]

Great analysis, thought provoking and helps establish/solidify/dis... various theories out there.

Jun 13 12:42 PM

[t-bird:]

Very good information. Your research was extremely thorough. One point you made early sums up this entire discussion

George and the other George's in this world are not making the $ they were accumulating several years ago. With lending regulations much more strict, no more non-recourse loans etc. I agree with the author that it will be many years, possibly more than ten b-4 housing comes back.

Jun 13 01:19 PM

[TinyTim:]

Nice article. good fundamental analysis.

Of course, the housing market is not homogeneous at the national level. Local results may vary.

Jun 13 01:55 PM

[notsosmart:]

maybe george should have been in a $250,000 house to begin with.did someone hold a gun to his head to buy this house.he can grind his granite counter & eat it.(but sip some beer with it)

Jun 13 04:44 PM

[Badgolfer:]

RVG,
I'm afraid that you have found an inconvenient truth, but unlike Mr.Gore's,your is not fake.
As a 55 year Realtor Emeritus, I've had a growing embarassment at my research fellows in Chicago.

Jun 13 04:44 PM

[cameroni:]

When Will Housing Prices Return to Previous Highs?

Never.

We have seen the good old days and now they are gone. Only a severe and hurtful inflation that destroys your buying power will also see house prices go up. But that will not be any solace. The numbers (measured in worthless dollars) will just be digits on your statement.

If you are young and thinking of buying a home now, I implore you not to make the biggest mistake of your life. Wait and save. The prices are about to get a lot better. All the moreso if we do experience a retracement of market lows in the next short while. That outcome will just further harm an already damaged economy and will put a final bullet into any green shoot still standing.

Jun 13 08:44 PM

[MikeOz:]

I don't live in the USA so don't see anecdotal or other evidence, but on one level the article does not make sense.
If the current oversupply is so great (up to 10 years inventory on hand, which as I understand the article, has built up over the past 6 years - see graph) this must have been apparent during that time to the people on the ground who were causing it - ie the building companies - as in most cases these are the same people who are tasked with selling that inventory.
Even if they got their finance for 1% pa, it would not be rational for any business to continue to buy in/build inventory if they know they already hold several years supply in stock.
I'm not saying they all act rationally all the time, but this would be wildly irrational over a extended period wouldn't it ?

Jun 13 09:40 PM

[58robbo:]

housing prices in general will return when oil goes back up to $150 and stays there. how long that will take is anyone's guess. imo, the reason that the governments inflation target of probably around 6-10% hasn't taken hold yet is because they've made all this printed cash available through the banks. most people having just experienced the ill effects of excess debt are too scared to borrow again. while i don't agree with money printing as a rule, it would've been far more effective if the government decided to give us all a few more rounds of $600 rebate checks. that would've brought about the desired level of inflation the govt is gagging for.

Jun 14 05:01 AM

[58robbo:]

yup, that's a great economic policy. sounds like chairman mao's smelting of doorknobs to make............. doorknobs! it wouldn't surprise me though. roosevelt did the same thing during the depression with agricultural products. he ORDERED acres upon acres of crops to be plowed over and livestock to be destroyed to prop up prices. what a humane policy when you consider all the starving people during the depression! there are many homeless people in this country who would be housed if the govt allowed the debt to be liquidated and real estate to find itself on the "no reserve" auction block!


On Jun 13 09:25 AM CLH wrote:

> Great article. I just saw an article where the govt. wants to bulldoze
> millions of houses and turn the land into parks. Sounds good to me.
>
>
> War was the best way at one time but hopefully those days are gone.

Jun 14 05:16 AM

[Blair Kuhnen:]

Super article. It's been a tough couple of years and the recovery will take time. I work with hundreds of new home builders nationwide. The bottom line for new housing is that until credit is provided to builders and developers, the current shrinkage will continue. Growth consumes cash and without adaquate investement and working capital, inventory levels will shrink. So, prices should stabalize and begin to recover with the decreased inventory. Consumer confidence is the key.

Jun 14 11:22 AM

[Cold Reality:]

Loose credit for over-builders and over-developers is one of the prime factors that got us into this mess in the first place. Lenders didn't stop lending to the fools until well past the point when it became obvious that they were continuing the building frenzy into a major bust.


On Jun 14 11:22 AM Blair Kuhnen wrote:

> Super article. It's been a tough couple of years and the recovery
> will take time. I work with hundreds of new home builders nationwide.
> The bottom line for new housing is that until credit is provided
> to builders and developers, the current shrinkage will continue.
> Growth consumes cash and without adaquate investement and working
> capital, inventory levels will shrink. So, prices should stabalize
> and begin to recover with the decreased inventory. Consumer confidence
> is the key.

Jun 14 02:06 PM

[Dirty Oil B...:]

Blair. you are at the root of the problem.

Jun 15 01:13 AM