Fiserv Chief Economist: Optimistic Signs for Housing, But Watch Overall Economic Recovery
The latest quarterly analysis of home price trends based on the Fiserv® Case Shiller Indexes® had some good news for real estate nationally. Homeowners in a number of areas are finally seeing prices stabilize after years of decline. And good affordability has both home seekers and realtors excited.
We asked David Stiff, chief economist at Fiserv, for his take on the direction of the housing market, including what to look for in the months ahead and whether now is the time to buy.
In the coming months, what factors will you be looking at to determine whether the housing market is improving? What are potential stumbling blocks?
I will be keeping a close eye on the existing home sales numbers to see if the housing recovery that started last fall is gathering momentum. Existing home sales can be volatile from month-to-month, so I am not concerned if a single monthly report looks weak. I will also be looking at market statistics compiled by local realtor associations, multiple listing services and university real estate centers, particularly in the extreme housing bubble/crash metro areas. Months-supply numbers indicate if a market has too much or too little inventory, which is often a good indicator of future price changes. If months-supply (active listings/sales) is less than six months (as it was in both Phoenix and Orlando in March), then there is usually upward pressure on home prices.
If the overall economic recovery stalls (as it did last summer), then I expect that the housing market recovery will also stumble. Last year, rising gas prices, weak job growth numbers, and a near default on U.S. government bonds caused consumer confidence to drop, contributing to further weakness in housing. Although these risks remain, it seems that they now have less potential to undermine (slowly) growing consumer confidence. After hitting a peak in April this year, gas prices have started to fall. Congress is unlikely to start battling over the debt ceiling until after the November election. And job growth has improved, averaging 190,000 per month since last September.
Each market has unique characteristics. What are common characteristics for the markets that may rebound the fastest?
The markets that had the largest home price crashes are likely to have the strongest home price rebounds over the next five years. In the long-run, home price appreciation tracks fairly closely with household income growth. But in the short-run, as we learned during the housing bubble, home prices can race far ahead of household income. However, unless households suddenly become willing to allocate much more of their spending to housing, short run home price bubbles cannot persist.
Imagine that home prices are attached to household incomes by a rubber band. During the bubble, home prices were much too high relative to income, stretching the rubber band (almost to the breaking point in some markets). When the bubble burst, home prices were “slingshotted” back toward household income. In many markets, after six years of falling prices, the ratio of home prices to income is substantially lower than it was prior to the bubble. For the entire U.S., the price-income ratio has returned to its 1991 level. This means that the rubber band is now being stretched in the opposite direction – in the former bubble markets, prices are now too low compared to income.
So, in many extreme bubble /crash markets, home prices should rebound strongly over the next five years. But these short-term rebounds don’t mean that these markets will continue to be robust over the long term. In many of these markets, the housing sector contributed more than one-half of local economic (and income) growth during the bubble. Large inventories of foreclosed homes will constrain housing construction in the crash markets, limiting the contribution of the housing sector to household income growth. So, even though prices could jump by double-digits as the price-income rubber band snaps back, long-run appreciation will be limited weaker income gains.
With current levels of affordability, does that mean it’s time to buy?
Relatively speaking, houses are very inexpensive right now. But, the decision to buy should always be based on your own personal financial situation. For the U.S. on average, buying a house is now cheaper than renting. But this is not the case in many expensive housing markets. Many people are willing to pay a premium to own their home instead of rent, but make sure that you account for all of the costs of owning a home when you make buy-versus-rent comparisons. If you have a fixed rate mortgage, your mortgage payments will remain constant while rents rise. So, if you own a home long enough, buying is usually cheaper than renting (unless houses are over-priced). The upfront costs of buying a home (mostly mortgage closing costs) mean that it may take many years before you break even on a home purchase. The New York Times has a very useful calculator for making buy-versus-rent comparisons, including estimates of how long it will take for you to break even with renting.
A reader on Facebook questioned the accuracy of the current forecast that home prices are stabilizing. He points to an April 2010 statement where you indicated a “prolonged recovery beginning in 2011,” while prices in many areas actually continued to decline. How would you respond?
Forecasting is based on data, and while the fundamentals of housing market data are clearly strengthening, there remain reasons for skepticism. As mentioned above, a sustained recovery in housing depends on continued improvement in the overall economy and the absence of events that lower consumer confidence. The importance of consumer psychology on the economy in general, and on housing markets in particular, is often underestimated. Although U.S. economic and financial system exposure to Europe is limited, the current flare-up in Euro-debt problems could become an event that causes U.S. consumers / homebuyers to retreat.
Within housing markets themselves, however, fundamentals are stronger than they were at the beginning of 2011. So even if overall U.S. economic growth falters, the likelihood of stabilizing home prices is increasing. Home prices were 4 percent cheaper at the beginning of this year compared to 2011. Factoring in household income gains and the decline in mortgage interest rates, houses where 12 percent less expensive at the start of 2012 than they were at the start of 2011. This substantial improvement in affordability has drawn in more buyers. Existing home sales were 5 percent higher in the first quarter of 2012 compared to a year ago. At the same time, inventories of foreclosed homes (REO) continued to drop. Consequently, we started the year with a more balanced housing market – more demand because of lower prices and reduced supply due to smaller foreclosure inventories.
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