January 2012 Inform. Engage. Empower. Residential Real Estate It s always darkest before the dawn. At least that s what we ve been told time and time again for the past five years by the more sanguine analysts of U.S. residential real estate. Ever since housing prices started to slump, the Pollyannas have insisted that the turnaround is just around the corner, only to be disproven by further price declines and stagnant sales. But this time may be different. A number of positive trends suggest that the U.S. housing market may be poised for a long-awaited turnaround: The question for housing is wrapped up with how confident people feel. If the only factors affecting the decision to buy a house were mortgage rates and home prices, we would be looking at a housing boom. David Blitzer, managing director & chairman of the S&P Index Committee. Home prices have declined on average to where they were approximately a decade ago and are now more affordable. The inventory of available properties has declined, as has the average months supply. Distressed sales have recently trended down. With new construction at a virtual standstill since 2008, oversupply of new units is no longer an issue in most markets. The cost of owning is now equal to or less than renting in most markets. Mortgage rates remain at historic lows, and are unlikely to increase substantially any time soon. Population growth and a backlog of pent-up household formations point to rising demand for homes over the next decade. A recent improvement in several key indicators suggests a stronger U.S. economy in 2012. Of course many clouds still linger. Unemployment remains stubbornly high, foreclosures continue to dilute prices in many markets, and the American consumer remains cautious. What s more, the sovereign debt crisis in Europe holds the potential to derail any U.S. recovery. But the case for buying now is stronger than it has been in the recent past and warrants consideration for today s prospective buyer. 2012 McGraw-Hill Financial Communications. All rights reserved. Reproduction in whole or in part is prohibited without the express permission of McGraw-Hill Financial Communications. Contact us at www.visitfc.com or 800-326-7697.
Prices: How Low Can They Go? The drop in average U.S. house prices in the past five years is unparalleled. The median price for a single-family home has fallen from $221,900 in 2006 to $164,100 in November 2011, according to the National Association of Realtors (NAR). The S&P/Case-Shiller Home Price Index indicates that U.S. home prices have decreased 32% from their peak. 1 Much of this drop occurred between 2007 and 2009. Since then, prices have fluctuated near their levels of 2003. With home prices down 32% S&P/Case-Shiller Home Price Indices from their peak, price levels are down to levels not seen since 2003. 25% 20% 15% 10-City Composite 25% 20% 15% Standard & Poor s, S&P/Case-Shiller Home Price Indices. Percentage Change, Year Ago 10% 5% 0% -5% -10% 10-City Composite 20-City Composite 10% 5% 0% -5% -10% -15% 20-City Composite -15% -20% -20% -25% -25% 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Sources: S&P Indices; Fiserve. From a historical perspective, this decline is unprecedented almost as unprecedented as the run-up that preceded it. Since 1920, there have been 18 years in which average nominal house prices decreased. Other than the current decline, the most significant drop occurred from 1929 to 1933, when nominal prices decreased 25.9% over a five-year period. From 1942 through 2006, prices declined in only one year (1990). 2 U.S. Home Price Declines, 1920-September 2011* Year Magnitude of Drop 1921-2.2% 1926-27 -7.6% 1929-33 -25.9% 1938-39 -2.2% 1941-8.4% 1990-1.0% 2006-2011 -30.3% *Declines are not annualized. Source: www.econ.yale.edu/~shiller. The current decline of six consecutive years is the longest straight run ever, well past historical averages, even topping the depression-era four-year losing streak when unemployment hit 25%. The data suggest that the current decline might be long-in-the-tooth and ripe for leveling off. 2
Residential Real Estate Of course, the declines have varied significantly from region to region and city to city. Areas such as Las Vegas and parts of Florida and Southern California that saw construction booms in the first half of the decade have experienced average declines in excess of 50%. Others, such as the Plains states and much of the Midwest, have witnessed declines of under 10%, underscoring the large discrepancies between different areas. U.S. Home Price Declines From Peak Prices by State WA MT ME ND OR VT MN ID WY NV WI SD MI IA NE IL CO AZ KS WV TX VA KY NC TN AR SC MS AK OH IN MO OK NM AL RI CT NJ DE MD -60% to -50% -50% to -40% -40% to -30% GA -30% to -20% LA -20% to -10% FL HI MA PA UT CA NH NY -10% to -0% 0% to 100% Source: Federal Housing Finance Authority Home Price Index. As of September 30, 2011. Declines are measured from the peak of the market within each state. Inventory: Improving in Many Markets The number of homes for sale and their average time on the market are two important indicators of the health of residential housing. An ongoing positive trend is a steady decline in the number of homes on the market. As of November 2011, existing homes available for sale numbered 2.58 million units, which represents a 7.0-month supply at the current sales pace, down from a peak of 11 months in June 2008.3 New homes available for sale at the end of November numbered 158,000 units and represented a 6.0 months supply at current sales rates, down from a peak of 12.2 months supply in January 2009.4 3
U.S. Housing Inventory 3,500 3,250 Homes for Sale (in 000s) 3,000 2,750 2,500 2,250 2,000 1,750 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: U.S. Census. As of September 30, 2011. Represents homes for sale only or available for sale or rent. Includes all housing types. The drop in inventory reflects, in part, the dearth of new construction since 2008. Single-family housing starts reached a 30-year trough in March 2009 and recently have languished at less than half of the 30-year average. 5 Permitting activity tells a similar story. During the housing boom, total permits peaked at more than 2.15 million units in 2005, then plummeted to approximately 681,000 units in November 2011 a decline of 68%. 6 Although regional variations are significant, the data suggest a slowly improving supply picture as the oversupply from the boom years is slowly absorbed. Single-Family Housing Units Started 2,000 1,800 1,600 Housing Starts (in 000s) 1,400 1,200 1,000 800 600 400 200 0 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: U.S. Census. For the period from January 1, 2003, through November 30, 2011. Represents new, single-unit homes started, seasonally adjusted. 4
There also is evidence that distressed sales, which still flood the market and depress prices, are trending down, albeit slowly. Distressed sales, which consist of foreclosure and short sales, have represented about 30% to 35% of total sales in recent years, down from a high of 49% in March 2009. As of October 2011, this rate had declined to 28%. Although financial institutions are believed to be holding substantial inventories of distressed properties, the properties appear to be entering the sales markets at constant or slightly declining rates, and their impact on the market appears to have stabilized. 7 Affordability: Owning Is Much Cheaper Now The substantial drop in price has made owning a home much more affordable than it has been for a long time. The Beacon Economics Home Affordability Index measures average home prices in relation to average incomes, based on the percentage of income an average family would need to make mortgage payments on an average-priced home. By this measure, homes are more affordable than they have been in over 40 years. 8 The NAR s Home Affordability Index tells a similar story, with the current level well above the historical average and almost twice the level of 2005. Home Affordability 130 120 110 Affordability Index 100 90 80 70 60 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Sources: National Association of Realtors; Federal Reserve; U.S. Census. As of September 30, 2011. Index represents the ratio of median household income to the hypothetical income needed to qualify for a mortgage on a median-priced home, assuming a 25% debt-to-income ratio. 5
While prices may fluctuate modestly over the next several months, we believe the worst of the housing crisis is behind us. Jordan G. Levine, manager, Beacon Economics Research In many markets, housing costs have declined to the point where they are equal to or less than renting. A study published in November 2011 indicated that monthly mortgage payments on a median-priced home, including taxes and insurance, were lower than average rents in 12 metropolitan areas. The chart below presents a long-term perspective. Historically, costs for owning and renting have been close to one another, and the housing bubble, fueled by the widespread availability of mortgages, caused these costs to diverge. Housing costs have declined to the point where they now approximate renting in many markets. 9 Cost of Owning Versus Renting 225 200 Index Value (1999) = 100 175 150 125 100 Home Prices Owner-Equivalent Rent 75 50 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Sources: McGraw-Hill Financial Communications; Bureau of Labor Statistics; Standard & Poor s. Mortgage Rates: Still at Record Lows Affordability is of course boosted by today s record low mortgage rates. At the start of the new millennium, mortgage rates were more than double their current average. The average rate on a 30-year conventional mortgage was 8.21% back in January 2000, compared with 3.95% as of December 29, 2011, according to the Federal Reserve. For a $150,000 30-year conventional mortgage, that translates into a payment difference of over $400 per month. Many industry analysts expect rates to remain low, even after the economy picks up steam. This is especially important in today s still-recovering economy and in light of banks more stringent lending criteria. 6
Average Thirty-Year Conventional Mortgage Rates 10% 9% 8% 7% 6% 5% 4% 3% 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 Source: Federal Reserve. As of November 30, 2011. Demographics: Long-Term Demand In the long term, demographics is arguably the most critical factor in the demand for housing. Prices and sales are ultimately a function of supply and demand, and demand is influenced by the number of households. Unlike many other developed countries, the United States boasts a growing population. Overall population grew 12% between 2000 and 2010, from 278 million to 312 million, and is projected to add another 24 million by 2020 according to the U.S. Census. This contrasts with Japan, Spain, and Ireland, countries that have also experienced housing busts, but face stagnant population growth. U.S. Population, Millions 350 330 310 290 270 250 230 210 190 170 150 Actual Projected 1950 1952 1954 1956 1958 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 Source: U.S. Census. As of September 30, 2011. Although the rate of household formations dropped steeply in the past few years, it has recently shown signs of recovery. In the past decade, household formations averaged approximately one million per year. With the onset of the recession and housing bust, formations tumbled, falling to a record low of 357,000 in 2010. More recently, they have picked up, and are predicted to rise to between 750,000 and one million new households in 2011. 10 7
Annual Household Formations, 2000-2011 4,000 3,500 3,504 3,000 Net Households Created 2,500 2,000 1,500 1,000 500 831 1,088 1,981 722 1,343 1,041 1,627 772 398 357 1,144 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: U.S. Census. As of September 30, 2011. Housing formations may also be boosted by pent-up demand in the aftermath of the housing bust, as gun-shy buyers again return to the market. Surveys have shown that there may now be more would-be buyers out there. For example, the National Association of Home Builders (NAHB)/Wells Fargo Housing Market Index rose for the third month in a row in November. In announcing the most recent increase, the NAHB noted that builders are reporting more inquiries and more interest among potential buyers than they have seen in previous months. 11 The moving-back-in-with- Mom-and-Dad phenomenon is creating a growing backlog of pent-up households. Charles Lieberman, former head of monetary analysis at the Federal Reserve Bank of New York But potential buyers may be awaiting more solid evidence of a turnaround before buying, as suggested by today s high number of sales cancellations. Other prospective buyers have been stung by underwater mortgages and are reluctant to commit. Still others recent graduates in particular are living at home to save money, the so-called boomerang generation. These trends have helped depress home sales in recent years but are likely to provide a boost once the economy picks up steam and the housing recovery gains its footing. The Economy: A Turn for the Better Perhaps the most encouraging development on the home front is the improving economic outlook. Talk of double-dip recession has given way to a sunnier outlook and improving growth projections. In fact, a number of recent metrics point to improvement in the year ahead: Unemployment has edged down to 8.5%, its lowest level since February 2009. GDP growth is now forecast at 2.9% for 2012 (World Bank), in line with long-term historical averages. Orders for durable manufactured goods surged 3.8% in November, and total orders were up 9.5%, year-to-date. Corporate earnings are on a tear, with earnings growth for the S&P 500 estimated to come in at a torrid 23% in 2011, and 11% in 2012. The Conference Board s index of leading economic indicators is 18% higher than it was at the end of 2008. The Conference Board s Consumer Confidence Index increased again in December, to levels not seen last spring, indicating that consumers are more optimistic that business conditions, employment prospects, and their financial situations will continue to get better. 8
A Matter of Confidence An improving jobs market, businesses greater willingness to invest and hire, and consumers higher spending in the second half of 2011 all indicate more momentum for the U.S. recovery. Beth Ann Bovino, PhD, deputy chief economist, Standard & Poor s Of course, not all is rosy on the housing front. Sales remain choppy, a glut of foreclosures have yet to be sold, and there are large discrepancies in inventory and prices from region to region and city to city. What s more, 22% of mortgages remain under water, clouding the prospects for a huge portion of home-buying Americans. 12 On the economic front, although talk of a double-dip recession appears to be behind us, unemployment remains stubbornly high and a strong growth momentum has yet to occur. Any significant shock such as a dismantling of the euro could pull the rug out from the incipient economic recovery as well as the housing market. That said, housing s prospects today appear to be brighter than they have been in a while. Prices and inventories are down, mortgage rates are low, homes are more affordable, and the economy appears to be poised for higher growth. The foundation for a housing recovery would seem to be set. The only missing ingredient is confidence. Confidence that a recovery is imminent, confidence that a house is still a good investment, confidence to take a chance confidence in the future. Now it s up to us. Endnotes 1 Source: S&P Indices, December 27, 2011. 2 Source: www.econ.yale.edu/~shiller. 3 Source: National Association of Realtors. 4 Source: U.S. Census Bureau. 5 Source: Standard & Poor s Housing Views, When Will Housing Start to Contribute to the Economic Recovery? September 14, 2011. 6 Source: U.S. Census Bureau. 7 Source: National Association of Realtors, Distressed Real Estate: Down to 28 Percent of the Market, December 2, 2011. 8 Source PR Newswire, Beacon Economics Home Affordability Index Indicates Housing Most Affordable in Over 40 Years, October 2011. 9 Source: The Wall Street Journal, Stronger Lure for Prospective Home Buyers, November 26, 2011. 10 Source: U.S. Census. 11 Source: National Association of Home Builders. 12 Source: CoreLogic. 2012 McGraw-Hill Financial Communications. All rights reserved. Reproduction in whole or in part is prohibited without the express permission of McGraw-Hill Financial Communications. Contact us at www.visitfc.com or 800-326-7697.