Housing

I haven’t commented on the state of the housing market lately so this morning’s release of the monthly home price data compiled by the Federal Housing Finance Agency gives me a chance to rectify that.

The news, like so much of what we see and hear at the moment, is very slightly improved over that of earlier this year. Is that good? Well not great, but moving ever so slowly in the right direction.

The FHFA collects data only on homes financed through the agencies that comprise the government mortgage provider network: Fannie Mae, Freddie Mac, and the various Federal Home Loan banks. The data is useful because it based upon repeat sales – in this way it resembles the Case-Schiller Index – and so tracks prices for the same house through time.

On this basis the FHFA estimates that home prices rose 0.3% in July, which is the latest month for which it has compiled data. This follows an increase of 0.1% in June, and makes three consecutive months of gain. That’s the good news.

On the negative side I am concerned that the June number was revised down from 0.5%, and year on year prices are still showing a decline: this July’s figure is down 4.2% from last year’s and is 10.5% off the 2007 peak.

None of these numbers are as dramatic as those of the Case Schiller Index which shows a 15.4% decline in the last year alone.

Since the two indices are calculated on such different sets of homes they cannot be compared directly and we are left simply to remark on any similarities in trends.

Both are showing the same kind of slope: down sharply last year, continued down early this year, and now a noticeable ‘bottoming out’ effect with prices up and down month to month , but with a very small positive movement discernible.

So is the housing market on its way back to health?

That depends on what you mean by health.

I don’t see a way for the market to rebound with anything like the intensity of activity we saw during the height of the bubble. Those absurd days are gone – mercifully. With all the key market actors severely burned by the experience it will be a while before we return to the years of reliable double digit price increases – without strong re-regulation of the banks I cannot eliminate the possibility entirely, but I have to assume that even the banks are reticent to lose a ton more money on rubbish real estate loans. So funding will be less available and credit standards will, hopefully, return to something like respectability. This will limit the cash flowing into housing and so dampen all that Greenspan ‘exuberance’.

Just as important: buyers are now cramped. The tighter credit standards will inevitably limit the number of eligible buyers for each home, so with demand decreased another source of exuberance is eliminated. Buyers are also struggling with debt burdens accumulated during the silly season of earlier this decade. With wages flat lining for a long time now, and under pressure currently, affordability becomes critical. The significant drop in prices already has made homes much more affordable than they were, but I question whether we have made sufficient adjustment for the market to recover completely.

My suspicion is that prices have dropped enough to eliminate only the effects of the ridiculous financing – sub-prime mortgages being the obvious example – we saw during the bubble years. Those kinds of loans increased the ability for people to buy homes by expanding the number of ‘creditworthy’ buyers. The result was not just to enable more people to buy houses, which was the positive social effect that was touted by the de-regulators of the past decade or so, but it also drove prices way up beyond ‘normal’ levels of affordability. Add these two effects together and we produce a market glutted with demand and overpriced at the same time.

The next step in rounding out the picture is to understand that this state of affairs stimulated construction. In fact real estate construction became our biggest single source of job growth throughout the Bush era. When the bubble finally burst we ended up with a massive over-construction of homes – supply is way out of whack with demand. The inventory of unsold homes is slowly being whittled away, but it remains at historically high levels.

Adding all this together we can now answer the question about the health of the housing market: it is suffering from a humongous hangover. And like anything or anyone in that situation it is both turgid and volatile at the same time – it is very sensitive to loud noises. ‘Fragile but increasingly steady’ just about captures the picture.

Very slowly life is returning to normal. There are huge geographical differences: the prize for the worst hit locality has just shifted from California to Nevada: the mountain states are still seeing quite large price decreases, whereas the Pacific coats has begun to firm up a bit. Even Florida has hit bottom, but it could begin to fall some more if the overall economy doesn’t get going soon.

Sellers of existing homes seem to be in shock at the prices they now have to accept as reasonable. The prevailing price level is so far down from its peak that some sellers appear willing to try to wait for a rebound rather than sell now. This creates a kind of ‘grey’ inventory – homes that the owners would like to sell, but which are not listed as for sale officially. In Manhattan this problem is particularly acute – it almost doubles the inventory of homes for sale.

Then we have to add to inventory newly constructed homes that the builder is not listing for sale because to sell at prevailing prices would undermine the financing arrangements that underpin the construction. This effect has released a flood of condominiums in New York City as rentals rather than as sales, creating yet another distortion in the market that makes perceiving the market’s health very difficult.

Further: much of the ‘recovery’ in prices we have seen this year was driven by the tax incentives for new buyers: this helped arrest the decline in qualified buyers for a while. That effect will now fade away and thus reveal any underlying trend it may have masked.

Lastly: given the very difficult job and therefore income position that the population at large finds itself in, it becomes extremely hard to predict a sustained and steady recovery in prices. There will be pockets of strength: all those Goldman Sachs bonuses will inevitably continue to distort New York real estate prices, but the general trend will be one of very slow gains.

We are only now at the bottom of the cycle and there are no sources of strength that justify a bold forecast: affordability is still low; credit is less available; households are financially weak and risk averse; sellers are shell shocked over prices; foreclosures are high and rising – this puts downward pressure on prices; many owners are stuck with negative equity and therefore cannot sell – this reduces potential inventory for sale; builders are still sitting on piles of unsold homes; and the banks are evaluating their loans to builders – I foresee a burst in loan losses and commercial real estate bankruptcies that will distort the market next year.

As I said this is one heck of a hangover.

Prices will stabilize – I think they need to drop a little more [another 5% to 10%] for a solid rebound to take effect. Without a further decline things will have to wait for personal incomes to grow to bring affordability back into normal ranges, and that looks unlikely for a year or so.

All of which implies that this morning’s data is a very accurate reflection of the market: very weak price recovery coupled with big geographical variation and no real evidence of strength.

That’s the way I see real estate for a few quarters – maybe years – yet. I doubt we will return to the price peak of 2007 for many years to come: somewhere between 2015 and 2018 looks about right for that. Meanwhile housing will underperform as an investment, and there will be plenty of deals.

Buy a home certainly, but invest somewhere else.