Housing Inventory Still High: Are There Enough Buyers and Savers?

In order to tackle the excess housing situation in America, the “incremental buyer” must be able to afford a home. Who is the incremental buyer? It is the person who currently does not own a house, as a current homeowner who simply sells his/her home to buy another does not remove inventory. He/she is not a net buyer, and neither adds nor decreases the housing inventory. Therefore, the important question to ask is, “Who is the likely incremental buyer (outside of second home buyers/investors since banks are currently averse to multiple mortgages)?”

In the US, 75.6 million (June 2009 U.S. Census) house owners out of the 113.6 million total households (U.S. Census 2009 estimate) own at least one home. According to the IRS, the 2008 median gross income is $61,500, and of the 113.6 million total households, the 56.8 millionth one possesses this median income. If we assume that most households above the median income own a home, then the majority of incremental buyers lie in the lower half of household income. Now that the potential incremental buyer has been identified, it must be determined whether this buyer/group can afford to buy a home.

Lower interest rates are not enough and only represent one factor in housing affordability. Mortgage applications have been dominated by refinancings. Where are the buyers? Does the U.S. have enough qualified buyers to meet current, supposedly strict lending requirements, such as 20 percent down? This leads us to the debate on whether a high savings rate, such as 10 percent, might be reached. And if it is reached, is it sustainable? Will the average American consumer quickly go back to its most recent spending pattern, or will a new savings culture emerge? However, for those wishing to make a large purchase (for many, that’s a house), these households may not have a choice.

Below is an exercise to figure this out. The analysis is not perfect, but does strongly suggest that absolute housing inventory should remain high for awhile. For a median income household planning to purchase a home, a sustained 10 percent savings rate is not too high.

Please bear with me, as it was difficult to get same-year data for all statistics.

Base Case Assumptions:

• Typical buyer is a median income household.
• Buyer will not dip into their retirement plans such as 401k, IRA and Roth IRA to provide funding.
• Buyer will not contribute to retirement plans while trying to save for a house.
• Buyer will not save for a rainy day.
• Buyer has no debt nor meaningful cash savings.
• Locations with higher home prices have higher incomes.
• 20 percent down payment remains the favored standard for lenders (this was actually very common before ARMs and exotics were introduced, so it’s not so hard to believe this can’t continue), plus you get a lower monthly payment; FHA loan addressed below.

Median Household After-Tax Income

• Real 2007 Medium Household Income (US Census): $50,233
• 2008 Median Gross Income (IRS): $61,500

Let’s use the 2008 number: $61,500

• Apply a 20% tax rate (federal + state - deductions)
• After tax income: $49,200

Median 20% Down Payment

• June 2009 Median Home Prices (Average of Existing from NAR and New from HUD): ~$194,000
• Median Down Payment: $38,800
• Some exceptions that may lower down payments:
  • “First Time Home Buyer” Assistance programs, such as $8,000 federal tax credit for down payment.
  • For FHA home loan qualifiers, this loan offered through standard lending institutions could result in down payments as low as 3.5%, but also higher monthly payments and PMI.

Using a 10% After-Tax Savings Rate and Federal Tax Credit, the Years Necessary to Afford 20% Down Payment

• 10% of $49,200 = $4,920
• ($38,800-$8,000 tax credit)/$4,920 = “A little over 6 years"

Conclusion:
Paying a 20 percent down payment is very onerous for the median income household. A 10 percent after-tax savings rate is not unreasonable, and one could argue that my base case assumptions are too lenient. Per the assumptions above, this analysis does not specify the actual amount the incremental buyer may wish to save for a rainy day, contribute into a retirement account, or pay down the household’s revolving debt, like credit cards. The average credit card debt per household (Nilson Report, April 2009) is $8,329, or almost 2 years of savings. All of these factors would lengthen the savings period necessary to make any kind of down payment, and thus further limit the number of incremental buyers.

However, if the majority of incremental buyers qualified for a FHA loan, certainly the savings years would drop. FHA loans are offered by your standard lending institutions, and lenders may also have their own requirements in addition to the HUD minimum. Here are some common qualification criteria:

• Stable income for 2 to 3 years, and preference for stable to increasing income, or employment advancement.
• Foreclosure at least 3 years old, with good credit since.
• Bankruptcies at least 2 years old, with good credit since.
• Minimum credit score, or demonstrated timeliness in paying bills
• Loan size based on income.
• Applicant may be required to have a security reserve (ex: 3 months of available funds).

With the above as a background, in June 2009, according to HUD 88,975 FHA loans were endorsed for purchase, compared to June actual new and existing home sales of 36,000 and 523,000 units, respectively. Thus FHA loans represented only 16 percent of total (new and existing combined) June monthly sales. Even if it is assumed that all the FHA loans are for an incremental buyer, given the greater than 9 months of total inventory (calculated from an annual run rate 30 percent below the August 2005 high of 7.2 million units), plus potential shadow and foreclosure inventory, many more incremental buyers are needed than what June 2009 has shown.

Now that the seasonally strong April-June period is over, it will be interesting to see how the second half of 2009 plays out.

Disclosure: No positions.

Comments

[Mad Hedge F...:]

No. Since I have been pelted daily with predictions that residential real estate has bottomed for the last 18 months, like hail in a Midwestern summer thunderstorm, I feel a public duty to tell you that is just not the case. Now that the state and federal moratoriums are off, foreclosures are accelerating. There are over a million Option ARM and Alt-A loan resets about to hit the fan. Since many owners will not see positive equity in their homes in their lifetimes, banks are seeing more walk always. The run up in mortgage rates from 4.5% to 5.5% has yet to hit the market. Some 18 million homeowners divert 50% of their incomes to pay for housing, double the 25% that is considered healthy, and many of them are losing jobs. While the volume of units sold has rebounded, the action is dominated by speculators, flippers, and bottom feeders bidding for properties at 10-40 cents on the dollar, not exactly a sign of health. Call me when Ozzie & Harriet Nelson come back to the market. I listen to industry insiders call the bottom of the Japanese real estate market for 15 years, until they finally died, and the market is still a fraction of its 1990 high. I thing we are closer to the bottom than the top in terms of price, but closer to the top than the bottom in terms of time. You can take that to the bank.

Aug 04 12:36 PM

[Accuriz:]

Your comments are interesting, but quite frankly fall short of the critical issue. In the past five years, 4 million renters became home buyers. These renters did not have the ability to own a home for several reasons. Notably real estate taxes, property insurance, home maintenance issues, utility bills to name just the big ones. Your mathematical approach to home ownership is flawed and quite frankly to state that 20% down is too onerous is ridiculous.

Your analysis should focus on bank underwriting standards which have existed for decades and worked fine until the “Geniuses” on Wall Street needed to figure a way to make even more money. 28% of total gross income to pay mortgage and property takes and 38% to cover mortgage and credit card debt. Great rule if not manipulated with no income verification or asset verification mortgages. Let’s not talk about ARM’s and Interest Only because this was based on the premise that in two, three or five years values would be 20% to 30% higher than when the mortgages were made.

This mess got started because we lowered the standards. Just like any investor will tell you: When you have flesh in the game you have more to lose; therefore you will do whatever it takes to work it out. Mad Hedge has it right; too many people have little or no skin in the game.

It is easy to walk away given these conditions.

Also, if you are going to state numbers, carry the analysis through to the end. Census data is not 100% correct and knowing the real numbers count. Of the 111 million residential housing units, 75 million are owner occupied and out of this group 72% of the properties are mortgaged (54 million). You do not discuss the number of vacant housing units which stands at 13.8% versus the historical level of 10%. You do not discuss median income and median house prices by region. Perhaps you should read our 12 pages report called Housing in Crisis which was published in March. This report discusses your comments in greater detail and analysis.

Aug 04 03:28 PM

[Raymond Chung:]

Agreed...if it wasn't clear, the point of my article is to basically say look all these homes...do we really have enough legitimate buyers? No we don't because legitimate buyers have savings, and we don't have a large pool of potential buyers with savings...and that might not happen for awhile, because saving at 8% for one month is far from enough. The reason why buyers can walk away is because they never had enough to put down the appropriate amount of equity. Getting back to putting the appropriate equity in a home will be tough, hence the housing market problems should continue to linger for some time.

On Aug 04 12:36 PM Mad Hedge Fund Trader wrote:

Since I have been pelted daily with predictions that residential
> real estate has bottomed for the last 18 months, like hail in a Midwestern
> summer thunderstorm, I feel a public duty to tell you that is just
> not the case. While the volume of units
> sold has rebounded, the action is dominated by speculators, flippers,
> and bottom feeders bidding for properties at 10-40 cents on the dollar,
> not exactly a sign of health.

Aug 04 03:52 PM

[nym:]

Accuriz's report is www.accuriz.com/docs/R...

Aug 05 10:49 AM