Week of July 21, 2008--Are Home Prices at the Bottom?

On the latest Barron’s Magazine cover was a catchy title—“Home Prices Are About to Bottom”. It startled me, what with all the doom and gloom of late. But Barron’s does have a point. Existing-home sales have leveled out at about 5 million annualized units since last fall, though new-home sales and construction have shrunk approximately 50 percent from their highs.

The core of Barron’s argument is that some housing markets are beginning to show price increases, a combination of greater affordability and declining inventories. The S&P Case/Shiller Index for April showed that values in 8 of its 20 survey cities increased, versus just 2 of 20 in March, for example. And the rate of delinquencies in some of the worst sub-prime securities has been declining for the past 6 to 8 months, per the subprime indexes that track them.

House prices are continuing to decline, of course, but that has increased affordability in those same cities that are seeing sales’ increases. Case-Shiller measures affordability with a ratio of sales price to per-capita income. In Boston, for example, the affordability ratio has returned to a more normal 9 times, from its peak of 12 times per-capita income. This means that a home that once sold for $480,000 at its peak (12 times a $40,000 per-capital income), now has come down to $360,000 (i.e., 9 times $40,000). This is a 25 percent savings, and perhaps signals a bottom for prices in the Boston metro area.

Many coastal areas in Florida and California have not yet settled back to historical averages. Los Angeles, whose affordability ratio peaked at 16 times per-capita income, has come down to 11. But its longer-term average is closer to 8 times. So Los Angeles area prices may have another 20 percent decline before leveling out. The variation in affordability ratios just confirms the maxim that all real estate is local.

Other evidence of a real estate recovery is included in Harvard’s 2008 Joint Housing Task Force study, which emphasizes the inventory “overhang” of approximately 1 million unsold and vacant single-family and apartment units that has to be worked off. But household growth over the next decade 2010-2020 should actually increase to 1.4 million households per year. That and other elements should create a demand for at least 1.8 million new-home completions per year over that time.

Lastly, any recovery is dependent on the availability of credit, of course. And mortgage lenders are hurting at present. The so-called quasi-governmental agencies Fannie Mae, Freddie Mac, and outright government-owned FHA/VA agencies have become lenders of last resort that now account for more than 70 percent of originations.

© Harlan Green 2008