Some Real Talk on Housing

Another month, another round of negative housing data, and the pattern has become so repetitive that it's hard to think of anything original to say about it. However in the wake of last month's round of "housing bottom" predictions and in recognition of the current round, let's briefly discuss what a bottom to the housing market will actually look like.

The first thing to recognize is that the housing market is merely correcting itself after a period where it was inflated into a bubble by a combination of poor lending standards/practices, over-speculation, over-leveraged and/or under qualified buyers, etc. Now that these "bad actors" have been removed from the market, prices are declining back to where they would be if the housing bubble hadn't occurred.

Once we understand that the housing market is going through a post-bubble correction, we can see that we shouldn't be looking for a bottom as much we should be looking for pricing stability. We also know that pricing stability cannot happen until the housing market has given up nearly all the gains of the housing boom era. At the moment (per Marketwatch) it appears that we've only turned back the clock to 2004, and have bit of a ways to go before anyone can make any credible claims of housing having reached a bottom.

The other factor to consider is inventory because the housing boom saw a surge in the number of homes being built, and the demand for these homes didn't come from a population surge, it came from speculators, people looking to upgrade, and people who weren't really qualified to be in the housing market. As these people leave the market (or are forced out), the number of vacant homes is steadily increasing. Consider the chart below:

Graphic courtesy of the WSJ

As of the end of Q1 the number of vacant homes had nearly doubled from its historical norm of around 1.5% to around 2.9%, a figure doesn't factor in foreclosures or empty homes that have been pulled from the market. This means that that the actual number of empty homes is higher than the above number indicates, especially in the current era of foreclosures and the pending completions of housing projects that were started during the boom.

Now I've always suspected that many housing development projects were being primarily built in response to demand from the speculators who accounted for 25-33% of homes purchased during the boom. If I'm right it means that there isn't enough real demand from people who are actually buying a home to live in to fill up all the new developments. Additionally, let's not forget that the housing market is unique in that you don't necessarily need new inventory to have a fluid housing market because people buying or often selling (and vice-versa) giving you a musical chairs effect, in other words not all housing sales have an impact on available inventory. These two factors will make combine to make filling up the excess inventory somewhat difficult.

In order to put the level of vacant homes in perspective in terms of what it will take to return to historical averages, consider this passage from the WSJ:

To get this vacancy rate back to something like normal, about one million homes would have to find new owners. With mortgage rates climbing, that could take awhile, short of a ban on new-home construction.

Better yet there would need to be enough people who don't currently own homes (and are financially read to buy) to go out and buy every home currently going through foreclosure, homes that were pulled off the market and to fill up recently (or soon to be) completed housing development projects, then you would need an additional 1 million non-home-owning individuals to come along and purchase homes that are currently empty.

Considering everything that needs to fall into place for the vacancy problem to be resolved, it stands to reason that it's going to take a while for the number of vacant homes to return to historical levels. Unfortunately the vacancy problem is the real issue that needs to be fixed for housing prices to stabilize, because it could serve to put downwards pressure on housing prices even after we give up all of the housing boom era gains.

As you can see it's going to take a lot of things coming together for housing market to stabilize, because not only do we need to shed the pricing gains of 2002-2006, we also need to resolve the inventory problem as well. Any analyst who isn't discussing a bottom coming to housing in terms of clearing through the vacancy issue and returning prices back to 2002 levels should be ignored, because they're not actually discussing what needs to happen for housing prices to stabilize.

You can read more about the vacant homes report here.

The Marketwatch report on housing can be found here, and FT coverage on the subject can be found here.