Is the Normalization of Housing Prices a Realistic Expectation?

Something that’s often “tossed around” is the idea that housing prices will normalize within a couple of quarters, a year or two, etc. I find this concept of “normalization” funny, to say the least, as it’s basically stating that the housing prices we saw over the last couple of years were normal, sustainable, and supported by sound fundamentals. In other words, people are predicting a return to the heady real estate days of years past.

However, the reality of the situation is far different; housing prices weren’t driven up by sound fundamentals, they were driven up by a combination of speculation, overheated expectations, overspending and bad lending practices. While I won’t rule out the possibility of another Real Estate Bubble, I think it’s a stretch to say that we’re going to see another one anytime soon. Just consider the following factors which provided upwards pressure on prices, that are either ending or will end very soon:

1) Market Psychology: The belief (or the desire) that real estate prices would go up forever, led a lot of people to take on risks they shouldn’t have, whether they were buyers, investors or lenders. Now that people understand that RE isn’t a “sure thing”, it’s unlikely we’ll see this kind of “irrational exuberance” for some time.

2) Rampant Speculation: While I won’t say that we won’t see a time when ¼ homes are bought for speculation purposes, I’d say it’s unlikely that we’ll see it on a national scale any time soon.

3) A return to common sense lending practices: this isn’t just about tightening of credit standards limiting buyers in general; it’s about lenders originating loans that the buyer has a chance of servicing over the long-term. During the boom, many lenders positioned ARMs, interest only and flexible payment (negative amortization) loans as tools that would enable the borrower to purchase “more house”. The borrowers would take on an “exotic loan” where they could only afford the “teaser” payment, once the loan recast/reset, the borrower was left with a loan they couldn’t afford. As lenders wake-up and change their standards, these types of loans will no longer be driving up housing prices.

4) Alt-A lending is practically dead. Whilst it’s often positioned as a tool for the self-employed, I know from personal experience that many loan officers will tell a borrower with full documentation: “If we go with the low documentation loan, we can get you more money”.

5) Subprime lending will be greatly constrained, resulting in fewer home buyers, creating less competition for homes and resulting in greater supply. Again, there are some who are trying to position this is a “travesty” of some kind, but enabling people to buy homes they can’t afford, if only for a few years isn’t a good thing by any means.

6) Foreclosures doubled during the month of July and we already have an inventory problem due to overbuilding, and this excess inventory will create additional downward pressure on housing prices. It’s also quite possible that the over-supply situation is greater than we imagine as more and more people cancel contracts or walk away condos and townhomes they were only planning to buy for speculation purposes. It was not uncommon for speculators to buy up all of the available units within a housing/condo/townhome development, with the expectation of flipping them before they’re complete. As the market slows, expect to see supply increase and more and more of these speculators walk away from their “investments”.

7) Zero money down and piggyback mortgage lending will be greatly constrained as well, taking potential buyers out of the game that have the income to afford a house note, but lack a down payment.

As a result of the above, you’re going to have fewer buyers with less money chasing after a greater supply of homes, none of which points to “housing price normalization” as in a return to the prices and appreciation of the “pre-mortgage crisis” days. People should expect appreciation rates at 1990s levels with pricing that's higher than the late 90s, but not at housing boom levels

Comments

[Malkiel:]

Actually, housing prices must, by mathematical constraints, bear some relationship the the range of incomes in a given market. People can only afford so much mortgage at a given income level, even if they're willing to adopt unsafe levels of debt to sacrifice for a better home/investment. Someone needs to do the studies showing whether the creation of a richer upper-middle class is a statistical reality, what percentage of the population in a given market that is, and hence what to expect the range of housing prices in a given market to do. It's kind of surprising to me that so much expensive housing is built on speculation without any market studies of whether an area can actually support the expected asking prices--maybe there's a new profitable line of consulting work out there for anyone who can do this kind of number-crunching and provide it to builders, banks, realtors, and mortgage originators...

2007 Aug 23 10:15 AM

[Markham Lee:]

Understood, my point is that without the things I mentioned artificially inflating housing prices, things will have to return to a point where the fundamentals drive the price I.e. things like income.

2007 Aug 23 01:30 PM

[Paul Meisel:]

It is difficult to be very precise in calculation of what payments people can afford, given shifts in wage collectors vs. self-employed, increases in the number of the folks well-to-do-enough to afford two homes, and other changes in the economy over the last 30 year. But...

Is there any reason we should expect housing to increase over the long term by substantial margins above the GDP increase? The tax benefit of own-vs.-rent is old news and should be baked into behaviors.... the baby boomers have been in home-ownership brackets for years..... why should we expect more of society's resources, on a percentage basis, to go into housing year after year?

2007 Aug 23 08:45 PM

[brynaw:]

Markham Lee,

Why do you hate America and our Freedom™ so? Your post makes no sense and was clearly influenced by Freedom™-hating Gloom-n-Doomer terrorists who want to undermine our cheap-credit and hyperconsumption fueled Potemkin Prosperity.

The historic relationship between rents, incomes and carrying costs has been forever severed. The permament land shortage and endless supply of wealthy retiring Boomers and rich foreigners means that first-time American buyers will be priced out forever.

Renters, and those born in future generations, will be will be unable to afford a $10 million starter home in 5 years. They will live in tent cities, and used Hondas. This asset bubble is unlike any before it in history, because it will never slow down, or pop. The gains are permanent. It’s a new paradigm, and anyone who doesn’t buy now will forever miss out on perpetual 20%/year appreciation.

Homeownership and perpetual gains from asset speculation are inalienable *rights* guaranteed by our Constitution. If those gains are ever wiped out, the government is obligated to confiscate surplus wealth from responsible savers and renters and transfer it to Wall Street, reckless subprime lenders and people who cannot afford the mortgages on their 10 "investment" properties.

These are the "facts", the truthiness of which is beyond dispute.

2007 Aug 23 08:22 PM

[Markham Lee:]

Your sarcasm is appreciated :)

2007 Aug 29 08:58 AM

[joeofclew:]

brynaw,
"The permament land shortage .......... "
in America?

anyway, Markham Lee is not flamboyant speaking. He does not say people will not speculate. He is saying the system won't support it as much. And, I like his argument.

Makiel (first poster), i.e. "Actually, housing prices must, by mathematical constraints, bear some relationship the the range of incomes in a given market". I think what happens are people are outpriced. However, most Americans were buying on extreme leverage which he is saying is not available if credit is tightened. I.E. unless the Fed releases credit again with another decrease in the overnight interest rate.

2007 Aug 28 07:23 AM