When Will Housing Find the Bottom
Column by Tom Binnings
Housing development has a long history of helping lead the economy out of a recession. The housing boom from 1999 to 2005 certainly covered up other fundamental weaknesses in the U.S. economy after the 2001 recession. And now with the heavy supply of housing on the market relative to demand, there is still uncertainty about where we'll find the market's bottom. Some economic analysts forecast another 5 percent decline nationally in 2011 after a 30 percent drop since the housing peak in 2006.
As long as potential buyers are still not convinced we've hit bottom and more foreclosures keep entering the market, prices will be soft. Low interest rates (below 4 percent for 30 years) are only able to provide marginal support. While delinquent loans and those in the foreclosure process peaked in 2010 some wonder what will happen as the private securitized portfolios continue to unravel and delays in the courts system stymie the foreclosure process in states with a judicial foreclosure process for residential real estate. The shadow inventory which includes real estate owned by banks (REO), pending foreclosures, and serious delinquent loans is down nationally to about five months which when added to lower active inventory on the market totals fourteen months -- the lowest level in several years.
Where will housing prices settle out? Some analysts argue for possible reversion of prices to the long-term mean as provided by the 100-year Robert Shiller index. If correct, this implies another 15 percent decline before the bottom is reached -- putting the inflation adjusted value of a home only 10 percent ahead of where home values were 120 years ago in 1890. Based on housing market indices, prices have been relatively stable since 2009, although down a few percentage points since last year.
The problem with the low estimate of existing home prices based on mean reversion is that new home prices are now 45 percent higher than existing homes on average. Typically the new-home premium runs 15 percent. As prices for existing homes have plummeted, the cost of new construction has stayed the same or even increased. As local governments become more financially strapped due to retiring pensioners, eroding sales taxes due to internet sales, and eroding property taxes due to lower real estate values, more and more costs may be pushed onto homebuilders and their buyers. The demand for raw materials from China, India, and Brazil, will continue pushing construction material prices higher as well. The outlook does not bode well for the homebuilding industry in the coming five years as buyers can generally get much better value purchasing an existing home.
As housing vacancies decline in the coming decade, which they will given the large millennial population entering adulthood, and additional housing is needed, the 45 percent higher price of new homes will pull existing home prices up. Even with relatively strict mortgage standards forcing more households into rental housing as opposed to owner occupied housing, home prices will increase as rents rise at a hefty clip. The increasing rents will create greater investment demand for rental properties and home prices will increase. In fact, the relationship between rents, household incomes and home prices are already getting back to longer term normalcy on average; indicating home prices could start rising sooner rather than later. From this perspective, globalism, local government fiscal conditions, and generational shifts may establish a higher bottom in terms of real housing prices -- closer to where home prices are today.
Perhaps a worst case scenario on housing prices can be assessed by looking at Japan where the economy has been stagnant for two decades and population growth is negative due to in-migration policies and low fertility rates. In Tokyo home prices declined by approximately 50 percent over 20 years as population growth embarked on its downward trend and became negative in recent years. So in a modern economy that has had anemic economic growth for well over a decade and very little, if any, population and household growth, hit a bottom at 50 percent from its home pricing peak. It took 16 years for the bottom to be reached and prices have been stuck at the bottom for the last four years in Japan.
In the final analysis, most indicators point to the housing market being at the bottom in terms of existing home prices. In the Denver metro area this is very encouraging as prices have only declined 10.9 percent since 2006 according to Case-Shiller. In fact Denver is second only to Dallas in terms of the best performing housing market among the largest 20 markets in the nation. Given a population growth rate twice the rate of the nation, the Denver metro area should continue to perform well and the new home market should slowly improve in the coming few years.
Combined with 30-year mortgage rates being quoted at under 4 percent for good credit, the time to buy appears to be now. It may even be worthwhile for empty nesters to buy their downsized retirement home while holding their primary residence for a few more years. If one is still in the investment mode, generating savings, putting it into residential real estate with low interest rates and the possibility of higher inflation down the road is a reasonable move.