Forces Driving the National Housing Market

Posted by nithi.vivatrat on January 29, 2009

I have been getting a lot of questions about the housing market, specifically regarding my thoughts on where home prices are going and whether this is a good time to sell or buy.

Before proceeding, and without singling out any one person or entity, let me offer this suggestion: use a healthy dose of skepticism when considering the advice/judgments/forecasts from “experts” who have a business/financial stake in how you act upon their predictions.  The economic lessons of late (failing banks, irresponsible lending practices, corrupt investment funds, biased and inaccurate ratings by ratings agencies, and others) should give us pause.

Let us begin with the outlook at the national level (a look at the DC region specifically will come later).  It should come to no surprise to anyone that property values have fallen all over the country: Standard & Poor’s reported this week that its S&P/Case-Shiller 20-city home price index, which tracks month-to-month real estate price trends using data from 20 metropolitan regions, dropped to 154.59 as of November 2008, a decrease of 18.2% from the previous year.  These numbers indicate that 11 of the 20 cities (but not the Washington, DC region) experienced record annual price declines and all 20 regions saw monthly price declines for the third month in a row.

What are some of the big picture forces that drive property values?  On the supply side, despite some recent improvement, housing inventory for existing homes, measured in months of inventory, is still elevated at 9.3 months at the end of December (Merrill Lynch’s David Rosenberg believes 5-6 months is more fundamentally balanced).  Part of this is caused by the time needed for the foreclosures to work themselves through the market.  This is not a one-step process.  As current foreclosures bring down general market prices, it also increases the risk of additional foreclosures, thus weakening the market further.  While the dramatic spike of resetting adjustable rate sub-prime loans should level off by early 2009,  there are still many sub-prime and Alt-A (the category between prime and sub-prime which includes most stated-income loans) adjustable rate mortgages whose rates will reset over the next two years, risking additional foreclosures.  Further expanding the overall supply of homes is the persistent inventory of new homes: the Commerce Department reported today that even though the number of units has decreased from November to December, the sales of new homes (rate of inventory consumption) has plummeted — actually increasing the inventory, when measured in terms of time, to 12.9 months (see here for various economists’ opinions on today’s news).

On the buy side, the critical factor is the economic confidence of potential buyers — and this confidence has been shaken.  In robust economic times, when jobs are secure, salaries are rising, and 401(k)s are growing, economic confidence is high.  People were willing to take on more debt (perhaps more than recommended) to purchase a home.  During the current economic turmoil, however, buyers are asking themselves, “How secure is my job?  If I get laid off, how quickly or will I even be able to find a new one?  Can I pay for my kid’s college?  Will I be able to keep up with my credit card bills and home equity loans?”  In this environment, economic confidence is naturally low, which will drive down demand and negatively impact prices.

For many years, our economy has been fueled by consumption enabled by excessive leverage at the national, corporate (specifically in the financial sector), and individual levels.  When easy credit in the latter two areas disappeared, along with trillions of dollars of paper wealth, there has to be, by definition, an inherent contraction of our economy.  As Merrill Lynch puts it in their report titled “The Frugal Future,” “The buy now/pay later days are clearly behind us.”  National unemployment is now at 7.2%, a 16 year high.  The Labor Department reported today that the number of workers collecting unemployment benefits rose to 4.8 million, the highest level since the government started keeping track in 1967.  These factors, among others, are materially undermining the confidence of potential homebuyers; in fact, the Conference Board reported this week that their Consumer Confidence Index now stands at 37.7, down from 87.3 in January 2008.

So to make a prediction on the direction of home prices is to make a call on how the supply and demand sides of the story will intersect.  I believe there will be greater supply (inventory) of properties on the market than we have been accustomed to of late.  I also believe that we won’t see a true upswing in the economic confidence of potential buyers without first seeing a rebound in general economic indicators such as employment and corporate earnings.  The sub-prime mortgage meltdown may have been a triggering factor in our economic downturn, but home prices will be a lagging indicator of a future recovery, not a predictor.  For these reasons, I believe it will be some time before these forces combine in a way to drive any increase in home prices.

The road to a new equilibrium will be marked with over-corrections in both directions.  For example, a tough economic climate in Fall 2008 causes a poor holiday season for retailers and their suppliers.  Now, those companies may have to close stores and contract their workforces.  So now those workers will have low economic confidence, causing them to slow their purchasing — which causes problems for other companies, who then must let go of employees, etc.  Eventually, the pendulum will swing back the other direction, and the spiral will be positive, not negative.  Housing prices will follow (but not lead).   And the market will do its best to approach equilibrium.

There is nothing about the process of a market finding a new equilibrium, correcting past extremes, and rebuilding consumer confidence that is pleasant for average consumers.  The important note to make, in my humble opinion, is that this process is necessary before other sectors, such as housing and retail, can see a rebound.

I don’t have an easy answer to whether this is the right time to buy or sell a home.  In reality, that has less to do with these overall economic issues and more to do with your personal situation and the dynamics of your local market.  Buying and selling property is driven both by necessity and by desire.  In our current economic environment, many real estate transactions are being driven by necessity.  It is my hope that SmithAdams can objectively assist you in executing your decision, whatever it may be.

Real estate (like politics) is local.  In an upcoming post, I will give you my thoughts on real estate trends in the DC area.

I look forward to your comments.