real estate

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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.

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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.

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Weekend Round-up: Home Sales Bounce Back

This has been a quiet week for data. Today’s only significant item being the sales of existing homes report from the National Association of Realtors. And the news is good: sales rose at a 7.2% rate in July reaching a seasonally adjusted 5,240,000 level – the highest since August 2007.

The strongest growth came in the Northeast where sales jumped 13.4%. The weakest region was the West where sales actually fell 1.7%.

The numbers clearly illustrate the effectiveness of the government’s incentive program, the first time buyer tax credit drove much of the strength, which combined with the continued drop in prices – the median price of a home nationwide dropped 15.1% over the past twelve months to $178,400 – brought the low end of the market back to life.

July’s growth makes this four months in a row of rising activity, so I think it is reasonable now to say that the housing market is on the upturn; but I would not go as far as the NAR though and declare that momentum is building. There are a few rocks to navigate past before we can say that.

I would not be at all surprised to see one or two months of decline out of the next six. The reason is that the tax credit will be ending shortly, so after the surge created by the stimulus package wears off, we will be left to see what energy exists in the economy without the government prop. Obviously the massive decline in prices over the past year or so has brought housing affordability back within the realm of reality. Will that drop be enough?

Only somewhat.

The problem real estate now has is the adjustment going on across the economy as we adopt new and tighter credit underwriting standards, and as consumers continue to shed debt. That will restrict the pool of potential qualified and willing buyers.

One of the loony aspects of the bubble was that prices rose way beyond historic affordability levels only because mortgages were cheap and easy to obtain. Underwriting standards collapsed and consequently the pool of potential buyers expanded rapidly. This made real estate a sellers market for years: prices surged on the back of this flood of credit and affordability ratios were shattered.

Now we are unwinding that process. So it is natural and sensible to assume that affordability will have to revert more to historic ratios – the proportion of income allocated to real estate has to drop. Not only this, but we are going back to the days of proper down payments and the elimination of the terrible loan underwriting that brought us the sub-prime disaster.

And, of course, the basic economy is still only just recovering and unemployment remains a major problem.

So, for all these reasons, once the government’s stimulus goes away late this year, I expect the rebound in housing to moderate significantly. I don’t foresee a return to decline, but I think gains will be slow and steady. Next spring will be a buyers market – the pool of eligible buyers is shrinking, and the supply of unsold homes is still increasing despite the recent strength in sales – even in July we had an increase in the inventory of homes on the market to about 9 months worth of sales. And this doesn’t even take into account those homes whose buyers would like to sell but who are waiting – forlornly in my opinion – for prices to edge back up.

Still: it is pleasant to see housing bounce back a little. Real estate investment will play a small, but noticeable, role in getting GDP rolling over the next few quarters. If we could just get the job market back to life 2010 would be looking good.

It’s nice to end the week on an upbeat note!

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The Mortgage Crisis

In my post earlier today I argued that the recovery would be constrained by the state of the job market and that we may well have two parallel economies for a while until the employment situation improved and sparked an increase in consumer confidence.

The latest data on home mortgages seems to support that view.

One in eight home mortgages is now one or more payments in arrears. And the trend is worsening. Foreclosures are also picking up steam despite the administration’s efforts to encourage renegotiation.

The states most affected are the usual suspects with Florida being the leader in both foreclosure and arrears: 12% of the state’s mortgages are in foreclosure proceedings and 23% of mortgages are in arrears. Those are awful numbers. Next on the list come Nevada, Arizona, and Michigan. There is nothing really new about the fact these states have real estate markets that have collapsed.

What is new is that the cause of arrears and foreclosure has shifted. At the beginning of the crisis the collapse was sparked by sub-prime borrowers failing to pay as their interest rates shot up from the original teaser rates. Now the bulk of the new problems stem from unemployment: people who have lost their jobs and are now unable to maintain their home payments. A consequence of this is that the kind of mortgages now in trouble has shifted: at the onset of trouble it was those sub-prime borrowers accounting for the bulk of the failures. Now prime loans account for over a third.

The conclusion is obvious: unemployment is beginning to bite hard. Even well constructed and sensible loans are falling into arrears as the job market takes its toll on worker incomes. This will, with certainty, limit the upside of the recovery until jobs once again become abundant.

Meanwhile consumers will remain very conservative and save more than usual. And the more they save rather than spend the more likely we will run into difficulty next year.

Excessive thrift may well be our biggest problem in 2010.

How odd is that?

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Today’s News: Home Prices and [Lack of] Confidence

Two pieces of news were released today: the Case Schiller Index of home prices, and the Conference Board’s consumer confidence survey. The message: very mixed.

The good news is that for the first time since 2006 there was a slight increase in home prices across the country. Prices in the twenty city index rose 0.5% in May, the latest month covered, compared with a 0.6% drop in April. This slight pick up had the effect of slowing the annual decline: for the year ending in May the same index shows a decline of 17.1%, whereas the decline for the year ending in April was 18.1%.

The message here seems to be that the bottom of the housing price cycle may not be too far away. Whether there are one-time effects at work distorting the figures we will have to wait and see next month: for instance, the activity created by recent tax credit for first time home buyers may have produced a slight firming in prices. Nonetheless when we add this data point to the decent new home sales figures yesterday the overall tone of the real estate sector does seem to be improving. This is a long way from a recovery – and there are plenty of reasons to hope we don’t get back to the way we were a few years back – but at least the dizzying descent appears to be drawing to a close.

That is not the message we get from consumer confidence which dropped unexpectedly last month. The index now stands at 46.6, whereas it had been 49.3 in June and 54.8 in May. So clearly there has been a significant souring in the public’s mood over the past two months. The importance of this is clearly linked to consumption: as long as consumers feel less confident they will tend to spend less. That will undermine any incipient recovery.

In all likelihood we will see the end of the recession later this year for the simple reason that inventories will need replenishing and that drives GDP upwards – just as any investment does. Whether there is enough activity to maintain growth into next year is now the question. The optimists are still calling for overall GDP growth in the 2% range during 2010, a series offadingconsumer confidence figures and we have to question that optimism. With real estate investment unlikely to recover much strength, and with businesses still waiting for stronger signs of consumer activity before the commit to re-hiring the best guess for GDP next year is slow – perhaps closer to 1% than to 2%. That will have all the hallmarks of stagnation: a poor employment market along with very low growth.

We really need the employment picture to change quickly if we are to avoid such a stagnation. It is very hard to see why consumers would suddenly start to spend much again without a decent job outlook.

Anecdotally the stimulus is now kicking in by stemming job losses, and we are getting the first proper analyses supporting that view. If that turns out to be a true trend then the hope is for the rising tide of job loses to taper off later tis year. Unemployment will still keep rising, but the damage to consumers will abate as they realize they have weathered the storm. Once the tide turns in the job market the rest of the economy can fall into place.

We will get a better handle on that later this week with the weekly initial claims data. Then on Friday we will get our first look at second quarter GDP, which should come in around at a decline of 1.5% – the first quarter saw a decline of 5.5%. If that is the case then this will be a rare four quarters in a row of decline, but it will also give us hope that the third or fourth quarter will see a return to growth.

Stay tuned.

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