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.

Comments

[Umm, yeah]

What's the reasoning for 2002 levels as the magic year instead of 2001 or 2003 (or 1990)?

2008 Jul 31 08:42 AM

[TonyCinTX]

Not to speak for the author, but 2002 is the right level, because it was post-9/11 worries that caused the Federal Reserve to lower interest rates to prevent a recession, and this is what triggered the housing boom, easy and cheap credit. Looking at the vacancy rate chart provided, you can see when the vacancies started rising. So 2002 is the most justifiable year.

The only caveat is that we should expect the housing market to grow with the population to some extent, but that will be a tiny boost for a little six year span, and will certainly be regionally dependent on local migration flux.

In truth, eventually we can expect to return to the trend line as it would have progressed without the bubble; this is the nature of bubbles in the stock market and commodities. When rational pricing returns and supply and demand are in sync again, sellers and buyers can agree on a price.

But at the moment, as the author notes, supply far exceeds demand, and as sellers get more desperate to unload assets that cost them money every month, prices will come down and losses will be taken, at first by the sellers, then ultimately as the sellers enter bankruptcy, by the banks.

We may drop below 2002 pricing as the market clears, but that will be the bubble rebound. Ultimately, 2002 pricing holding steady for six months is a pretty good indicator the drama is over.

2008 Jul 31 09:06 AM

[Umm, yeah]

Ok, thank you, TonyC!

2008 Jul 31 09:25 AM

[simplesimon]

I'm one of those rare people who has lived in the same home for 38 years. I watched with trepidation as my little town grew from 5,000 to well over 100,000. I also watched as it seemed the illegal alien population increased logarithmically, until every store was choked with aliens -vis wallyworld where there was hardly room to maneuver a buggy, in fact it was best to try to get what you needed without jumping into that traffic snarl. We all knew what was happening...even jobs we were very wiling to take were all being blottered up, which was alarming. WE also watched as developers of subdivisions and shopping malls were also building at exponential rates. ( rake in 20 cool million, and then leave town..you Mexicans go fiind another developer to work for; we're taking the money and running to the Virgin Islands)"..with more and more exotic billboards announcing with such great pride suggesting such 'unbelievable bargains' of lots in the "Low $200,000" ...excuse me...that is considered "Low"? I don't think so. it means the homes would be carrying $4,000 a month mortgages. And with what kinds of jobs, exactly that could support these debt loads, in addition the three SUV's, and the $20K in consumer debt?...to be paid by the clerk in one of the chain stores? Or acupunture holistic health spas? Yes...I am very sorry to have to say this...but there are a lot of bankers blinded by unmitigated avarice; but in very particular, subdivision developers, and mall builders who should be facing criminal charges...not bailed out. They really oguht to be chased down, and wrestled to the ground, and beaten up a little as they get handcuffed, like on "Cops"..."bad boy, bad boy...wathcha gonna do...watcha gonna do when dey kom fah you"?

2008 Jul 31 09:38 AM

[ACCOUNTANT]

The article is good. However, in regards to the excess inventories, as housing retreats, you will see a progession upwards in quality of housing. What do i mean by that? Houses that were $800,000 and are now $500,000 will become truly affordable for many more people, and the houses that were $500,000 and have dropped to, let's say $350,000 will become affordable for a whole new group of people, and so on and so forth. As you work down the housing order, at the lower end, those houses will become more affordable than rents are in many areas. I think where the true vacancies will occur, ultimately, is in the rental markets - i think you will see rents forced down because of it.

2008 Jul 31 09:38 AM

[jimsep]

A ban on new building sounds like a good idea. The way to do that would be if the banks refused to lend to builders for a while. They are doing that to everyone else, why not the builders? The bad guys are still around, still trying, with "incentives" intead of lowering prices.

2008 Jul 31 10:03 AM

[vaduz]

housing is not a fast market. it will take time to correct the bubble

2008 Jul 31 10:07 AM

[ReEconomist]

In the bubble areas, buyers used all the purchasing power a lender would offer them to buy as much house as they could. (before the bubble, normal home price was 3 or 4 times annual income levels for the area. But during the bubble you had buyers enabled with excess purchasing power bidding up home prices to unsustainable levels. During 2003-2006 borrowers could get the most purchasing power with an interest only loan or other exotic mortgage. Remember, this was a hyped-up environment where the prevailing belief was housing was a sure-fire way to riches, so many people wanted to get a piece of it. A borrower with $1800 a month to spend on mortgage payments, with a 3% interest only loan could service a $720,000 mortgage. People were buying payments not price. The income to home price ratio in many bubble areas went to 10 to 1. Home prices in these bubble areas blasted through the price ceiling, which is the highest prices can rise to based on historical income to home price ratio of about 4-1 with normal purchasing power.

Now it's 2008 and borrowers have essentially the same income levels, but now it's a 6.5% fully amortized loan with tighter standards. That $1800 payment will only service a $284,000 mortgage. This is a home price 4 times income or where it should be. The difference between $720,000 and $284,000 is your bubble.

Plus, today the prevailing belief among buyers has changed from a can't miss mind-set, to a mind-set of caution and prudence.
There is a great explanation of maximum home price levels and the minimum home price levels based on the underlying fundamentals found at www.ushousingmeltdown.....
You can type in a zip code and see what happens to home values when the income to home price ratio returns to the historical norm for the area.

2008 Jul 31 10:21 AM

[sickofthehype]

In any city in this country the first to rebound or hold steady will be the urban areas close to the middle of the action. The further out you go, to the burbs where there's still building going on, the longer the wait it will be.

Here in Phoenix things aren't rosy by any means, however, the inventory in the city's central districts and historic areas is decreasing, prices have been holding steady, and sales have increased. This all taking place since the beginning of the year. Now go out about 25 miles and it's a different world. Banks are practically giving away homes. Not to mention fuel prices - even more reason to own in the central locations.

Nobody can predict the market's rebound accurately, because by the time it's happened, we will have already missed the infamous 'bottom'.

2008 Jul 31 10:26 AM

[oddsneds]

the DESIREABLE homes and communities, as opposed to the AVAILABLE homes and communities, will not drop to the "rental income floor", or necessarily to any particular year's prices i.e. 2002 or 1999 or whatever. With inflation (stagflation?) likely to return, and the media destined to scream about it, the perceived benefit of owning a home increases, and the benefit of a fixed rate loan paid off in cheaper dollars increases. People want the stability of a home in a good community they can raise their children in, and build equity in so as to feel more secure as they age. No body wants to buy anything when they feel prices will be lower in a year, but price is as much about psychology and emotion as it is the economics. When the stabiliization comes in the better and mid grade markets it will sneak up on us all and take this doom and gloom market by surprise. As a long term homeowner this is the market we want - kiss the speculators good bye and good riddance.

2008 Jul 31 10:58 AM

[Real Estate Broker]

We're on the right track but we're still a little off course.

Homes will need to adjust to 1998 levels in order for the market to plateua, and then eventually converge back to the 5%/annum norm that has defined the last 50-years in California.

Remember-The real estate market in California tanks about every 15 years. Homes don't actually appreciate at a rate of 5% every year. But if you average-out everything you get a linear progression of 5%.
Three percent real growth and 2% adjustment for inflation.

2008 Jul 31 11:31 AM

[Real Estate Broker]

One more thing-1998 is important because this was the cusp or the pre-tech boom. IE-Before the tech markets exploded the economy.
Point-98 was when the market was closest to its equilibrium, and somewhat void of artificial inflationary drivers.

2008 Jul 31 11:34 AM

[believeItOrNotWeAreEducated]

Tony, 2002/01 levels are correct from a national level. For areas effected by the tech boom, (Real Estate Broker) has it right... there was a fundamental up tick in demand do to the relocation of MANY MANY resources into the area from throughout the country. Unfortunately, even though the demand from a housing perspective was appropriate (i.e. population growth), the driver (tech boom) was artificial in that many of these companies were a creation of Wall Street (Sound Familiar) and not on robust sound economics... hence, most of these same people (engineers, software programmer, etc.) become RealTard (no offense REBroker).

2008 Jul 31 12:06 PM

[believeItOrNotWeAreEducated]

... point being is that in areas that were already in a bubble due to tech investments (i.e. Silicon) (a glitch compared to the one that just deflated), they still need to back out to the appropriate levels associated with real population growth (based on sound real job creation) and wage increases... the data pointing to pre-2000 levels. For those retards who say you live in "prime locations" and aren't impacted - TAKE AN ECONOMICS CLASS.

2008 Jul 31 12:10 PM

[Real Estate Broker]

well put (Mr. Belive it or not).

The only thing that should drive appreciation are real wage increases and population growth. During the boom there was a an inverse relationship between home appreciation (upside) real wage increases (down) population growth (somewhat down).

So clearly, the rampant running appreciation in the RE market was a farce.

Oh and by the way, no offense on the "Realtard" comment. I can't knock the facts.

Well, that and Lawrence Yun-the NAR's chief economist is the biggest spinmaster and Realtard of them all!!

2008 Jul 31 12:51 PM

[Real Estate Broker]

Real Estate is such a no-brainer it's almost not worth talking about. The Data says it all....

So here's a more realistic question to the only person on the blog that seems to know their stuff (Mr. "Believe it or not"):

Who would you rather do? Jack Nickelson or Meg Ryan?

2008 Jul 31 01:14 PM

[believeItOrNotWeAreEducated]

Funny... it all depends. Who thought the market was perpetually going up, took out exotic loans, bragged to their friends about how big and many houses they had, gloated about living in "the peninsula", got caught with their pants down because they didn't do solid research, threw away their retirement and kids education, cried that it was a conspiracy, and left the smart people to hold the bag (i.e. bailouts = inflation = decreased dollar = EVERYONE SCREWED).

... MEG RYAN

2008 Jul 31 01:21 PM

[Real Estate Broker]

...1974 Jack Nickelson

2008 Jul 31 01:43 PM

[rickm]

I think we are going to see two separate housing markets going foprward. One will be focused in neighborhoods characterized by high vacancy rates and it will take years for this market to emerge from the current recession. The second market will be in neighborhoods that are characterized by low vacancy rates and this market will emerge from the market long before the first. This will happen as household formation continues and job growth increases when we emerge from current economic conditions. At this time, buyers who can afford attarctive well kept neighborhoods will push prices in these communities up even as the others languish.

2008 Jul 31 04:21 PM

[Tom Lindmark]

The author of this article conveniently elected to ignore data that contradict his thesis. There is a lot of opinion here with no supporting documentation. Here is a link to an article I wrote that contains a number of links to the most recent data on housing prices and inventory levels with some reasonable interpretation of the data. blog.metro-real-estate.... Take your time and read it and I believe you will see that the situation is changing.

As for the assertion that prices must fall to 2002 levels, where in the world did he come up with that number. Prices will fall until such time as demand stops them from falling. No one knows what that price level will equate to.

2008 Jul 31 04:44 PM