Home prices recently marked seven consecutive months of decline. It is fair to ask some questions:
- How much further will prices fall?
- What should be the "normal" median price for homes today?
There are a number of different ways to look at these questions and we will try to cover some of those is the following.
On an inflation adjusted basis, home prices have returned to the range experienced during the 1980s and 1990s. This is seen in the following graph from Chart of the Day:
Is this the correct reference for home prices? Notice that before 1977 home prices were below the range for the years that followed.
Another reference for home prices is in relation to income levels (click to enlarge images):
Based on median income it appears that home prices may be above the levels of the 1980s and 1990s. With current income, home prices may need to fall approximately 15% to reach the former levels.
David Rosenberg has a graph showing much deeper history of home prices based on data from Robert Shiller.
When the housing depression which lasted 40 years from 1907 to 1946 is included, the 1980s and 1990s appear as a period when home prices were consistently above average.
One could make three arguments here:
- The 40 year home price depression should not be included in an average of "normal" times. Omitting this time period would mean that the long term average would be similar to the 1980s and 1990s prices.
- The data for the housing bubble of the 2000s should be omitted. This would produce the average for the time period 1890-2000 between $5,000 and $10,000 lower than Rosenberg shows in his graph.
- Both of the "abnormal" price periods could be omitted. The resulting average woulf be close to the average for all data shown by Rosenberg.
If any of the three alternative data treatments were used, the conclusion using deep history or selected deep history shown by Rosenberg remains the same and is changed only in degree: Home prices are still above historical norms, but by not as much if the 40 year housing depression data is omitted.
The Sentiment Factor
Home prices can also be driven by sentiment. There is not much support in that area at present (see Doug Short) as the University of Michigan Consumer Sentiment Index can not escape levels associated with the bottoms of previous recessions. The consumer durable discretionary expenditures tracked by the Consumer Metrics Institute have recently dipped lower than during the Great Recession. High unemployment and stagnant income levels are undoubtedly primary factors involved here. The income problem is seen in the following graph from the St. Louis Fed:
The declines in home prices after both the 1981-82 and the 1990-91 recessions corresponded to declines in disposable personal income per capita. The duration of the current decline/stagnation in income is greater than either of the other two recessions cited. This simply adds to the forces pressing down on home prices.
Distressed Sales
Michael David White is one of the best at following the foreclosure and distressed sales data at Housing Story.net. Here is one of his graphs:
When the 6.7M delinquencies are added to the 3.5M existing for sale inventory the total is more than 10M. This is 34 months of inventory at recent levels near 300,000 units per month; 25 months of inventory at the post bubble high in the spring of 2010; and 17 months of inventory at a sales rate of the peak of the housing bubble in 2005.
To put this in perspective, normal inventory in a healthy market is in the range of 6 +/- 2 months. So we are facing an inventory burden 4-6 times what would be normal for post-bubble housing demand. Even though prospects for returning to bubble demand soon are slim, we note that potential inventory is 3X peak annual demand seen in 2005.
Non-Distressed Sales
While there appears to be a huge inventory of distressed property sales yet to come, there are signs that non-distressd property sales are seeing prices start to stabilize. Even though distressed sales are near 30% of all sales nationally (50% in some markets), stabilization of the remaining 70% of prices nationally will reduce the downside for average or median prices in the coming months.
New Home Sales
With new home sales near historic lows there are signs that home building volumes may increase in 2011. Several months ago, William Wheaton and Gleb Nechayev posted an analysis which found that 2011 would see new housing construction start to return to its historical norm of about 1.4 million units per year. This would compare to the 2010 total which was just above 500,000 units and the first quarter of 2011 which was well under an annual rate of 500,000 units. Only a modest start on return to normal demand for new housing would be a significant improvement in new home sales. For example, a 50% increase in new home sales would only get half way back to historically normal demand.
Why is it important if new home construction and sales increase? It is another offset to the downward pressure on overall average or median sales prices. Homes are not built at a loss and construction costs are well above current median home sales prices in many areas of the country. Some people who can afford it will pay the premium for a new home rather than take on the rehab challenges of a distressed property.
Seasonal Factors
Scott Sambucci of Altos Research has discussed how the spring selling season is working its annual magic on home sales. These tend to be smoothed out when 3-month moving averages are used, as in the following graph by Steve Hansen, but they are still clearly visible:
Although the seasonal pattern is obvious, the graph also shows that two of the three housing indexes have dropped below the seasonal lows for 2008 and 2009. The third, Case-Shiller, has not yet reported data to the same most recent date of the other two. So, when you see headlines about housing market improvements in March and April, try to factor out the seasonal bounce affects.
Conclusion
We are starting to see some significant compensating factors in the residential real estate market. In spite of the high affordability of current housing (see graph below from Housing Story.net), there are offsetting factors including low consumer sentiment, high unemployment, poor employment security, and several years of stagnating personal income.
Of course, as White points out, high affordability compared to the build-up to the housing bubble is not high affordaility when a deeper history is included - see the second graph in this article.
There are factors discussed in this article that will support housing prices in the face of continuing high foreclosure volumes in several major markets. These may not be sufficient to produce a meaningful rebound in median or average home prices, but they should mitigate the further decline in national averages. This author feels that home prices, on average, may be within 5% - 10% or so of the ultimate low for the post bubble period.
Another economic downturn would change this outlook, as the factors offsetting the depressing impact of distressed property sales would be diminished. And, bad as they are already, another recession would simply multiply the number of distressed properties. But, if we can continue John Mauldin's "muddle through" progression from The Great Recession, there could well be a long rounded bottom in home prices. We could be very near that bottom.
Finally here is some interesting reading for those in the U.S. who are looking at the fourth year of a collapsing housing bubble. I think you will appreciate the work of Steve Keen who has analyzed what appears to be a top forming in an Australian housing bubble. Keen refers to housing bubbles as "Ponzi schemes."
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
