Don't Expect a Housing Bottom Until Late 2009

Readers, I am going to spare you from posting about housing every month when these reports come out. For those who have been reading the blog a while you know my views. But, for new readers, here is a summary: Month after month it will be bad news. Every so often a report will look "ok" since it was "up" from the previous month (but still massively down year over year). The CNBC talking heads will tell you *this* is the bottom. The home building stocks will rally for a few days, probably 20-30% off of very low levels. Seals will clap on TV, and you will just ignore it. Just realize that until late 2009 or early 2010, it's all a sham.

Until prices come down to a level where people with 5-20% down, 6% fixed rated, making normal American incomes can afford, we are nowhere near a bottom. The only good thing that I have seen lately is that new home starts are finally slowing, and home builders in desperate attempts to see a cash flow, have slashed new home prices. We now are going to face an almost comical dichotomy in some markets - new homes selling for 30% below existing homes. It's already happening in some spots in southern California. This just means that existing home sellers are still in the denial stage and think they can get 2005/2006 prices. This is why your 'median' prices are not falling.

Remember, unlike stock prices, home prices are very illiquid. Stocks are priced instantly, by the second, while homes can takes quarters/years to adjust. Eventually people who cannot afford homes that they 'received' (and I mean received since many put NOTHING DOWN), will see they cannot afford these homes, and will be forced to sell. Also keep in mind that with each passing month, more and more people who bought with 0% down, 1% down, 2% down will be going upside down on their homes. So they need to make a decision - do I continue to make payments on something I put almost none of my own money into, for an asset that is depreciating by the month. When they come to their "aha" moment, that's when the real price adjustments will happen. Until then, you will hear hopeful talk about how we will have a bounce next spring when people are out and about in prime house hunting season, and about how prices are "holding up." That is bullish, and a bunch of lies.

The reality is it would be better for all of us if housing prices fell. Why? So it would not be such a strain on our budgets. While it would not feel good to lose asset wealth, for anyone who is looking to buy a new home would you rather have a $1400 monthly mortgage payment or a $2700 mortgage payment? Well you would get the former if the median price was where it should be. If you are new to the blog, please read this analysis: What Should Median Housing Price Be Today?

Again, I am not going to post these monthly figures every month because it's already getting very old, very fast. We are in about the second inning of this correction. A 7-year bubble of epic proportions does not get fixed in 11 months, no matter what the pundits claim. A correction does not end when everyone is looking to "buy a bargain," which is the stage we are now in. It ends when no one wants to buy real estate because "all it does is lose value." We are nowhere near that stage (despair), as we are still in the early stage - denial. Just as we are when we talk about coming recession (er, slowdown). Until people see "facts and figures" (which will come to fruition next spring/summer), they will continue to live in denial. These are people who live in NYC and don't see what is happening in the real world. Just think about the coming few years where every major city, county, and state needs to make budget with plunging real estate tax dollars. Except for areas in secular bull markets (for example, Houston, with its energy market), it is going to be an interesting time trying to make budgets with overspending politicos drunk on excess from 2002-2006. [California in State of Fiscal Emergency]. I'd argue that five of our largest ten states, California, Florida, Michigan, Ohio, and Pennsylvania, are already in a recession. I do expect the sunbelt states who are benefiting from migration trends to do the best on the back end of this, but many of those states were also the most inflated so there is major cross currents, even for them, in the near term (1-2 years).

New Home Sales Plunge by 9%

Sales of new homes plunged last month to their lowest level in more than 12 years, which is a grim testament to the problems plaguing the housing sector. On December 21, the Commerce Department reported that new-home sales tumbled by 9 percent in November from October, to a seasonally adjusted annual rate of 647,000. That was the worst showing since April 1995, when the pace of sales was 621,000.

The sales pace for November was much weaker than economists were expecting. They were predicting sales in the weakest sector of the economy to drop by around 1.8 percent, to a pace of 715,000.

The median sales price of a new home dipped to $239,100 in November. That is 0.4 percent lower than a year ago. The median price is where half sell for more, and half for less. (And, this remains the problem.)

New-home sales dropped by 19.3 percent in the Northeast. They plunged by 27.6 percent in the Midwest, and fell by 6.4 percent in the South. However, in the West, sales increased by 4 percent.

Over the last 12 months, new-home sales nationwide have tumbled by 34.4 percent, the biggest annual slide since early 1991, and stark evidence of the painful collapse in the once high-flying housing market.

A drop in home prices left some people stuck with balances on their home mortgages that eclipsed the worth of their home. Other home buyers were clobbered as low introductory rates on their mortgages jumped to much higher rates, which they couldn't afford.

I'll say it again folks, the economy will be issue #1, #2, and #3 in the coming general election. Expect proposal after proposal by these politicians to stop the business cycle from happening, and numerous attempts to keep home prices above where they should be. This should not be allowed to happen since in the long run it will be better for all of us with mortgage payments to have cheaper homes that we can actually afford, instead of having to stretch with 40-45-50% in some cases of our income going to try to put a roof over our head. This is what the people trying to come up with bailout plans do not get.

Comments

[Rocktex]

I agree with you.
People's need is there. But need has to be converted into a demand. The only way is to make housing affordable and reasonable.

After asking some agents in California who I don't know before to present my all cash offers, it seems to me that they don't know how to help and advise lenders to dispose those huge REO inventory in this downhill. They just sit and wait for housing price to "naturally" fall.

In this situation with potential buyer's sentiment, I believe we can't see the bottom until 2009 as you said. No need to read all the distort interpretation from those media gurus if you know the basics of economy.

[billb]

I pretty much agree with everything you say, although I think it's foolish to speculate the date that everything will be "fixed". It'll get fixed when it gets fixed. However, I've continued to watch the homebuilder ETF and may pick up very small positions on big down days. The bottom line is that homes are not going away. I wouldn't dare buy any individual builder, but the next couple of quarters, I'll be watching the XHB very carefully.

[DuffBeer]

I saw this coming way back when. I am a realtor for the past 22yrs so I have seen a lot
of different markets-- good,bad and now the ugly.
I usually represent sellers and for well over a year I have seen the eroding
of the selling prices. You are correct sellers are in denial,they say not over here it is only over there. The market time marches on gets longer and longer and thier asking prices gets farther away. Now I am not in the mega pricing areas I am talking 80 to 400.
Yes there will be plenty of foreclosures to come on the market. Guess what the banks are doing the same with those asking prices !!!!!!
Cheers, DuffBeer

[climb1212]

Thanks for the plain vanilla truth

[TraderMark]

billb, the homebuilders will bounce before the housing market does. With that said, many are on life support and only in business because the banks have changed their terms of credit. Meaning under original assumptions of the loans they have defaulted. I do expect a Toll Brothers, Pulte, etc a few of those to pull through, but I do expect to see a few go bankrupt when the long awaited "spring 2008 real estate bottom" does not happen. Or, I guess the banks can keep lending money to companies who are not going to make it. Not sure how much longer the game goes. I do expect at points over the next 2 years for the home builders to make some great tradeable bounces, but overall mostly sideways. Then probably in 2009/2010 they are buyable again for the 'recovery' in 2011 :) But people expecting the housing market to bounce back up 25% in 2 years are thinking 2003-2006, not 1950-2002. Home prices in general are not like tech stocks, but the past half decade have changed people's perception of homes... that perception will get fixed over coming half decade.

[Malkiel]

Based on the traffic through the house I'm selling in a northeast market I would say that there's some pentup demand and that bargain hunters will jump on properties in the Spring after scoping the market through Jan. and Feb. This will give the appearance of a bottom as sales may have a spike in the Spring and all the talking heads will declare us at bottom. It won't be the bottom, however, since the foreclosures and inventory buildup will continue despite the Spring sales spike. You can sit back and watch the show unfold like clockwork...

[WAKEUP]

I've been telling my associates these same things (although without as much data as you have) for more than a year. I've been told I was a cynical, negative person, for simply pointing out the obvious to the denial crowd. I'm sending your article to all of them. One final thought: There is no telling where this house-thing will end. My prediction is a 50% drop in CURRENT home prices in three years, or less.

[cfish]

I have long determined, since early 2007, that I'll start to look around to buy a house by winter 2009. Here's what I figure:

1. The worse year for reckless lending happened at around spring 2006. But prices already went soft the begining of 2006.

2. Let's say a speculator buys a house in 1Q 2006. A common teaser term is 2 years. Hence the mortgage payment resets 1Q 2008. The borrower misses payment.

3. Legally, the bank will give the borrower 3 months to catchup on the payments. Then the loan goes into default.

4. The bank has to setup auction with a third party trust and advertise it. That takes another 2-3 months. Here we are at 3Q 2008.

5. The property becomes REO, and the bank hires an agent, board up the house and sell it as-is. Currently, housing inventory is 11 months. which brings us to 3Q 2009.

So basically, my estimate is that holders of the worst loans(the Motivated Sellers) will finally buck by winter 2009 and drop prices. By then, there will be plenty to choose from.

And it might be like TraderMark describes here: No body wants a piece of real estate because "all it does it lose money." and young professionals like me will finally be able to get a home of our own.

[TraderMark]

Malkiel, I agree. Just because there is some purchases won't mark a bottom. The "bargain hunters" will be buying property 5-8% below bubble levels and think they got a bargain. Just like people buying CSCO 15% off bubble levels and thinking they got a bargain. About 2010 or so they will see they were 2-3 years too early. Everyone is now counting on spring 2008 to mark a bottom. The great dichotomy will be the difference in home prices between new homes and existing, I think that will mark the 2008 market. New homes will be a much better bargain and existing home sellers will wonder why the heck new homes are coming on the market 20-30% below their rates? They will first think its just a short term issue, and hold on another 6 months, 9 months, 12 months. Then they will eventually come around to the new reality of market prices. but it could take 2+ years.

[TraderMark]

cfish, in the long run this will be a good thing. I (young professional) literally have wanted to move to some places but with home prices where they were in 05-06 have been locked out (i.e. was debating San Diego). I was thinking like an investor not a "hey you will let me borrow $500K for 0% down and 1% rate for 2 years?" cool!) This fallout will let young people get back into the housing market and for new home buyers country wide their cost of living will decrease as they won't be forced to spend 40-50% on housing. The other misnomer is some huge spike will happen if you don't get the exact bottom in the housing market. Again it's an illiquid market, and people need to view housing in the lens of 1950-2001, not 2002-2006. Just like they view tech stocks from 1950-1997 and 2002-2006, not 1998-2001 which was also a bubble. This is essentially the same Fed induced bubble - just in a part of the market that affects us all, as opposed to just the investor class. The ironic thing is the solution by the Fed to get us out of this mess, is to reinflate things again. So free money will be handed out, and a new bubble will be created. Its just a matter of what is next. Probably commodities. We keep repeating the same situation because the business cycle is not allowed to happen anymore...

[AppraiserGuy]

I am a commercial appraiser in Southern California. Several of my fellow appraisers & I have been "shouting into the wind" about the former "impending" and now certain crisis for over two years now. Unfortunately, we have been proven correct. We believe that you are "right on" as to how much longer this crisis will last

Here is an analysis that was created by one of my mentors, Steve Snith, MAI in San Bernardino, CA. He published a paper entitled "Measuring Supportable Demand for Housing and Projecting Future Value Trends" on 12/23/2007. Briefly, his hypothesis is that future value declines will follow along the lines of the Median Household Income to determine how far prices will decline. Only when the "average" income can afford a home will declines cease.

Below are the calcualtions we are using in our Market Analysis sections of appraisal reports we are completing to predict supportable price levels. Steve is teaching these methods in a Finance Class he is teaching at Cal State San Bernardino.

The figures we use are easily obtained from Sites like REaltor.com and are based upon Zip Codes:

Median Household Income in Zip 92264 = $42,431

$42,431 x 32% average allowed PITI in loan apps = $13,578
Divide by Loan Constant for 6.5% Fixed Rate: 0.0638

Yields the maximum Supportable Loan: $212,820
Add a liberal down payment: $100,000

Maximum supportable value in this Zip: $312,820

Average price for 1800 SF SFR in 92264 = $498,078
Median price supported by HHI = $312,820

Possible Percent decline to reach
supportable income:.................. 37%

I realize that there are many more sceanarios possible with respect to ratios of income to debt allowed in mortage loans, down payments but with ANY analysis along these lines, the results show that there is a significant amount of value left to be "shed" until values meet the Household Incomes and therefore meets the ability of the "average" person to afford to buy a home.

Please feel free to comment on these methods we use as appraisers to analyze demand:

John C. Carlson
Certified General Real Estate Appraiser
Diamond Bar, CA

[TraderMark]

John that seems very accurate - I put a post out a month ago about what the MEdian Home Price should be - it is not perfect but its a good back of envelope equation. The reality is without the exotic mortgages people in most urban areas cannot buy a house over $400K. Not the average folks and by average I mean the bottom 95%. Unless people in CA are paid a wage 2-3x the rest of America their housing bubble in particular seems the most troubling. I do understand San Fran just from the fact of limitations on building but the Inner "Valley" areas of LA etc make no sense. I keep coming back to this is no different than tech stocks in late 90s except this affects everyone since even neighbors who just have been living in homes for 20 years get hit with higher tax bills etc. Collateral damage. Every govt plan so far just seems intent on keeping prices above market rates. Good luck with it; it would be like passing plans to keep tech stocks at 80% of their former bubble valuations. That's essentially the goal it seems. In the very long run it will be better for everyone to buy homes they can afford and not have to stretch their budget to the max, but of course people who bought in 2005-2006 won't be happy to hear that.

www.fundmymutualfund.c...

[oth]

You know for whom a 35-40% correction is housing prices is good news? People (like me) who just bought a house with 10%down and 6% rate at the highest of the market. Let me explain: now I can sit and relax and keep an eye on the big 800K house I could not afford two years ago and wait for its price to come down to 500k where it should have been all along. Okay, I'll have to cut the price of my existing home down 200k to sell it, but it is still better that the guy who bought the 800k house and will have to carry his 300k loss forever with a frozen rate, right?