Saturday, January 3, 2009

Is Housing Market Beginning to Stabilize?

How close are home sales and housing values to "bottoming out"? This headline in a recent Business Week attempted to show that housing prices in many cities were already below their “correct” prices using household population, mortgage rates, and relative income levels. But, it hedged the results by saying that there was a +/- 14 percent error factor in the results!

This included San Francisco (- 16 percent), San Diego (-19 percent) in California, and Phoenix, Arizona, still 4 percent overvalued. So is there a more meaningful way to measure home values? This is crucial, as banks (other than government-owned Freddie Mac, Fannie Mae, FHA/VA) will not be ready to lend again until they are sure of future housing values.

Among the factors that directly determine housing values are household incomes, mortgage rates, population growth and the supply of housing. All else—rents, default rates, and even the credit crisis—derive from these factors.

Only some of these factors are beginning to turn positive. Perhaps the most important is household income, which has shrunk 1 percent to $50,233 from 2000-2008 after inflation, while personal household debt including mortgages ballooned from around $8 trillion to $14 trillion over that time. The main factor that will turn around household incomes is both lower inflation, and better tax breaks for wage earners. To date it is only the top 1 percent of income-earners whose incomes have improved since 2000.

But population (and household formation) continues to grow. Harvard’s Joint Center for Housing Studies predicts 1.2 million households per year will be formed over the next 10 years that will require housing. This much pent-up demand will be the basis for a recovery, once housing values stabilize.

And interest rates should continue to remain low, both due to government efforts and the recession. So it is static household incomes and a 1 million plus excess of unsold housing—a result of the housing boom—that are weighing down housing values. The federal proposal for cheaper mortgage rates that would specifically target home purchases should help to lower housing inventories.

That is why the housing recovery will be so uneven. The old rust belt regions have seen the biggest loss in incomes, which is why cities like Columbus, Ohio and Indianapolis are 14 and 16 percent undervalued, respectively, according to the Business Week article. Values are even lower in cities like Dallas and Houston, Texas because of overbuilding; where housing is undervalued 31 and 34 percent, respectively.

But Chicago, New York, and Los Angeles—our largest metropolitan areas—are already at their “correct” price level, according to Business Week. In fact, only 4 of the 25 cities surveyed seem to be overpriced.

The incoming administration’s middle class tax cuts and proposal to create or retain at least 2.5 million jobs in the next 2 years can help to solve the drop in household incomes. Housing values nationally have returned to 2004 levels, which is why it is important to arrest any further decline in values.

© Harlan Green 2008


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