Home Prices – Bottom at Last?

I neglected to point you to the Case Schiller index yesterday: it rose for the second month in a row. The increase was very slight but general across the country. This suggests that the long decline in home prices may be approaching an end.

Just to put this in context: the index covers re-sale prices of the same home in the top twenty metropolitan areas on the country. It is therefore a sliced rather than comprehensive view. Nonetheless it is an excellent data point to follow.

So are home prices at the bottom?

I am surprised that the index has turned upwards. The economy is still so weak that I don’t see a ton of buying power out there sufficient to drive a rebound. In fact I have been more inclined to think prices would still fall further, by between 5% and 10%, as the unemployment situation eroded consumer willingness to commit to long term costs like mortgages.

This general perspective still holds, so obviously something else must be counter-acting it.

There are a couple of candidates.

The huge volume of foreclosed properties available may have attracted sufficient buyer interest that it had a ‘knock-on’ effect of slowing price reductions elsewhere. I find this counter-intuitive. The mass of foreclosed properties should have increased supply so much that prices should have fallen even more. Plus the inventory of unsold homes is still at high levels – this too should have depressed prices. That neither of these volume driven effects worked against prices suggests to me that buyer activity – a short term kick up in demand – must be the root cause of the firming in prices.

This increase in demand is the second and most plausible candidate. Mortgage rates have remained relatively low, and the government’s stimulus package included a first home buyer tax credit worth $8,000 – combine these two and financing a home was significantly cheaper over the spring and early summer than a year ago. Add in the massive reduction in home prices since the peak back in 2007 and you have all the makings of a solid up turn in demand.

If we take a look at the home sale and construction data this story starts to solidify: the entire real estate industry has shown a little life this year. After that devastation of the last two a change was inevitable.

The question then becomes: what of it?

For the reasons I have already mentioned I still feel prices have a way to fall. The best statistic to look at for home prices is the ratio between home prices and the equivalent cost to rent. This ratio has had a fairly stable long term relationship, but then it blew apart after 2001/2002 before launching into the stratosphere by 2005. Anyone looking at that ratio was well aware of the bubble and its impending collapse. Now, however, the relationship is almost back to ‘normal’ which implies there is only a little room left for home prices to fall.

In this context, with that ratio almost back in line, any temporary upward turn in demand would have the effect of increasing prices. I think this explains the Case-Schiller uptick of the past two months.

One word of caution: this firming seems to be weak and therefore could easily be a short term phenomenon based upon the equally short term impact of the stimulus.

A second word of caution: there is no way that home prices are about to launch back into a new bubble. Slow and steady is the way I see home prices going for a few years now: that unsold inventory will have a depressing impact, as will tighter credit standards and weak employment. These underlying and longer term factors will assert themselves inevitably and dampen any hopes of a return to the giddy and utterly ridiculous experiences of the bubble years.

So if you are sitting on an unsold home: don’t think you will be able to sell at those inflated 2005-2007 prices. They are gone. A cold dose of realism is what we require so as to re-establish an orderly and non-bubble making real estate market. This much needed realism will mean a steady flow of homes for sale at prices affordable to buyers without recourse to the absurdities of 2005/2007 mortgage mania.

So: even if prices have a little way yet to fall, as I think they do, the market is very clearly close to the bottom. The Case-Schiller data for the next two or three months will confirm that I am sure.

In other words real estate is about to get really boring. The bubble is well and truly burst.

Phew.