RealtyEconomics | May 9, 2008
Where are we now – with regard to home prices and values from the peak of the housing market bubble. This is the burning question of the moment. Economists, Analysts, Federal personnel, and well everyone in general wants to know – how much have we declined and how much further have we to go. Well, it is difficult to know exactly how much house prices have dropped.
There are several housing indices that measure price and sales volume, and yet each tells a different tale. Mostly known, but the least useful are the sometimes suspect monthly figures of median and mean home prices published by the National Association of Realtors (NAR data has and can be off as much 5% to 10%). NAR data shows median prices are down some 13% from their peak, but these averages do not adjust for the mix of same home transaction exchanges which fluctuates from month to month, and as a result are grossly distorted.
OFHEO - Contrast the NAR data with figures from the Office of Federal Housing Enterprise Oversight. OFHEO statistics have a wide geographic reach and track repeat sales of the same house – unlike the maligned NAR reports. The OFHEO national index suggests mean prices have fallen only about 3% from April 2007. But OFHEO’s data includes only houses which are financed by mortgages backed by the government sponsored agencies Fannie Mae and Freddie Mac. The problem is they only track SF conforming loans from Fannie and Freddie now up to $417,000, but just previously only $359,650 and they also exclude the bottom of the market. These two price points rose the quickest during the bubble and where the mortgage debacle was most fraught. The conclusion is that OFHEO’s data understates the scope of the housing plight.
S&P/Case-Shiller indices, developed by Robert Shiller and Karl Case and produced by Standard & Poor’s includes all types of homes and shows house prices were rising faster during the boom and subsequently declining much quicker now. Although the Case-Shiller data is less than perfect as the index excludes many rural areas as they reveal less of a price decline than the big metro areas do. But none the less, the Case-Shiller index – out of the two previously mentioned indices comes the closest to reflecting the true climate and direction of the market.
Supply – Demand shifts
Currently there is about a 11 month supply of existing homes, and an 12 month supply of new homes on the market, and some estimates even put supply at a 15 month level. The delta between supply and demand suggests that prices should fall significantly more, and by historical standards there is a glut of unsold homes currently on the market. The homeowner-vacancy rate has climbed to record levels of 2.9% as there are some 1.1million more houses for sale compared with the average between 1985 and 2005. While the inventory of new homes is falling slightly as builders have scaled back production, the overall supply is being fueled higher by all-time record level foreclosures.
Regardless of a few months of discrepancy of supply, this is one of the major hurdles in stabilizing the housing market – inventories are rising, while sales are declining. That is not to say that there aren’t willing or eager buyers out there, but with credit standards much higher now, and inflationary pressures mounting on the average consumer – the availability of qualified buyers is diminished.
Using historical measures and data, home prices are still above the levels compared to the fundamentals. Using a model that correlates house prices to disposable incomes and long-term interest rates, analysts at Goldman Sachs forecast that the correction in national house prices is only approximately halfway through its cycle. The analysts expect perhaps another 18% to 20% correction or an additional 11% to 13% decline from the beginning of 2008. Interestingly, their models suggest that six states – Florida, Maryland, Arizona, California, Virginia and New Jersey might even see further declines of 25% or more.
Another way to measure the housing/price/value fundamentals is the relationship between house prices and rents. This is similar to a price/earnings ratio for the housing market. The price of a house reflects the discounted income/value of future ownership, either as rental income or as rent saved by an owner who occupiesthe home.
In a recent reported analysis done by Morris Davis of the University of Wisconsin-Madison, and Andreas Lehnert along with Robert Martin of the Federal Reserve, shows that the rent/price yield in the U.S. ranged between 5% and 5.5% from 1960 to 1995. Consequently that range dropped rather quickly thereafter- reaching a historic low of just 3.5% at the height of the housing (sham) boom. Given the typical and normal pace of average rental growth, Mr Feroli believes that house prices (as measured by the Case-Shiller index) still need to fall by roughly 10% to upwards of 15% over the next 18 months in order for the rent-to-price yield to return to its historical and more importantly – normalized average.
Let’s keep in mind that over the previous six to seven years, national home prices have increased approximately 74% – while net income had only risen 15%. It does not take a genius to figure out and or understand that the huge disparity of those numbers can not, nor should not sustain the recent unjustified, and absurd increase in house values. A 4% to 5% year over year increase has been the average in the previous 40 years – mostly in-line with wages, rents, inflation and GDP as it should be. The markets and the consumer are learning tough lessons right now, and hopefully these realities will stay at the forethought – and not become a convenient short-memory – in lieu of a fast buck.
