affordability

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!