Home Prices Rise – Again

Perhaps we’ve finally touched bottom in the housing market. The monthly Case-Shiller Index reports that home prices rose for the fourth straight month in July. The gain was very modest at 0.9% compared with June, and was still 4.1% below July 2010, but there may be the semblance of a trend appearing. It had to happen sometime – prices are 31% off their 2005 peak and even the most pessimistic of us has to agree that they will eventually firm up.

I have suggested before that we had overshot prices on the downside, meaning that just as irrational enthusiasm pumped them up to ridiculous and unsustainable levels in the 2001 through 2005 mania, the subsequent decline has been equally as sharp, perhaps too much so. The decline as we know was fueled by a combination of economic collapse, the subsequent debt retrenchment of households, and the chaos caused by the flood of distressed sales, foreclosures, and banking implosion. The retreat in prices now appears to have gone a little too far. The numbing effect of the unwinding of the bubble has left households extraordinarily cautious about taking on new debt – even in those cases where the capacity to take on debt exists. There continues to be a belief that prices will fall further which becomes self-fulfilling since it withdraws demand and thus presses prices down. Similarly that banks are over-reacting to their stupidity on the upside by tightening credit conditions more than the market calls for in order to compensate for the toxicity of their old portfolios. And the ongoing failure to deal with the jobless nature of the recovery is having a negative effect on consumer psychology even when the actual threat of job losses has eased somewhat.

In other words fear grips the market and forces it to drop below levels supported by incomes and other normal factors.

So it might be that the slight bounce in prices is simply the market creeping back to a low, but more sustainable price level.

Sustainable, that is, given the economy’s evident weakness.

I am not suggesting a return to the absurdity of the bubble. I am simply arguing that the continuous plummet down has abated and the market is trying to find its feet at a new and much diminished level. This will, I think, take time. Indeed the gains of the past four months may disappear if the economy does not begin to improve substantially, so the risk is more down than up.

All of this, of course, needs to be taken with a gigantic grain of salt. While I normally place a great deal of value on long term trends and relationships, especially in real estate, which is why I warned about the bubble to begin with, I am also mindful that within the current malaise those relationships may have broken down. In which case my argument that we have overshot on the downside should be set aside. Then again that would go for pretty much all analysis and we would be simply grasping at straws.

Nonetheless, and for now, house prices appear to be finding their feet. The pressure from foreclosures will continue, but seems to have crested. Incomes are not going anywhere, but debt levels are declining, so purchasing power is slowly returning. This is still a buyer’s market, especially considering the “shadow” inventory of homes people would like to sell but prefer not to at current prices. But the worst is over.

I don’t expect the real estate market to get back to “normality” until 2014/2015 – the backlog of foreclosures, high unemployment, and weak incomes prevent it – but we are taking the first tentative steps in that direction.

Phew.