Residential Real Estate, Demographics, and the Economy Presented to: Regional & Community Bankers Conference Yolanda K. Kodrzycki Senior Economist and Policy Advisor Federal Reserve Bank of Boston October 11, 2006
Overview Housing markets have weakened across the nation. It is not clear how a correction will play out, though a major decline in prices is unlikely. New England s current housing cycle looks similar to national. New England population trends pose longer-term risks for housing market.
Nationwide new home sales are down inventories of unsold homes are rising. 1600 1400 New single-family houses sold, thousands July 2005: 1.4 million units 1200 1000 August 2006: 1.0 million units 800 600 400 200 0 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 14 12 Number of months supply at current rate 10 January 1991: 9.4 months 8 6 August 2006: 6.6 months 4 2 July 2003: 3.5 months 0 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 Source: Bureau of the Census.
Sales of existing homes have fallen median selling prices have stopped escalating. 7000 Existing single-family houses sold, thousands Q2 2005: 6.3 million units 6000 Q2 2006: 5.9 million units 5000 4000 3000 2000 1000 0 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 20% 15% Median sales price, percent change from year ago Q3 2005: 14.7% 10% 5% Q2 2006: 3.5% 0% -5% 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 Source: National Association of Realtors.
Home builders are curtailing construction overall housing investments are slowing. 3000 2500 Housing starts, thousands Q1 2005: 2.1 million units 2000 Q2 2006: 1.9 million units 1500 Total Q2 2005: 1.7 million units Q2 2006: 1.5 million units 1000 500 Single-Family 0 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 percent change from preceding period, SAAR 60 50 40 30 20 10 0-10 -20-30 -40 1985 Real private residential investment 1987 1989 1991 1993 1995 1997 1999 2001 Q2 2005: 20.0% 2003 2005 Boston Fed estimate Q3 2006: -17.2% Source: National Association of Realtors.
Housing wealth has stopped increasing. 400 350 Index values, Q1 1980 = 100 OFHEO Index 300 250 200 Total nominal appreciation 1995-2005: 101% OFHEO Index, Deflated by Core CPI 150 100 50 Total real appreciation 1995-2005: 56% 0 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 Source: Office of Federal Housing Enterprise Oversight.
Mortgage delinquencies are high in the subprime category. 4 Percent of loans 90 days past due Subprime Loans 3.5 Q1 2006: 3.34% 3 2.5 2.65% 2 1.5 FHA Loans 1.45% 1 VA Loans All Loans 0.91% 0.5 Conventional Loans Prime Loans 0.36% 0 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 Source: Mortgage Bankers Association.
Housing construction is slowing in New England. 12000 Housing permits authorized 10000 Number of units per month 8000 6000 4000 2000 Total Single family Mar 06: 5,712 Nov 04: 3,908 Aug 2006: 3,602 Aug 2006: 2,642 0 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 Source: Bureau of the Census.
The number of single-family permits authorized is down in all New England states January 2005 - August 2005 January 2006 - August 2006 Percent Change, 2005-2006 Connecticut 5,827 4,906-16% Maine 5,359 4,687-13% Massachusetts 9,320 7,963-15% New Hampshire 4,305 3,596-16% Rhode Island 1,216 1,062-13% Vermont 1,878 1,821-3% New England Total 27,905 24,035-12% United States 1.2 million 1.0 million -12% Source: Bureau of the Census.
350 300 Existing home sales are falling in New England, especially in MA and RI. Total existing home sales, thousands, annual rate Q3 2005: 289.3 thousand 250 New England* Q2 2006: 254.7 thousand 200 150 100 Massachusetts Q3 2005: 152.4 thousand Q2 2006: 126.4 thousand 50 0 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 *New England total excludes New Hampshire and Vermont, as data for these states is not available in all periods. Source: National Association of Realtors
Median selling prices are similar to last year s levels. 30% 25% 20% 15% Median sales price, percent change from year ago Q4 2002: 25% Q4 2002: 23% Q4 2003: 13% 10% Boston 5% 0% Hartford Q2 2006: 1.7% 0.0% 0.0% -5% Providence -10% -15% -20% 1990 1992 1994 1996 1998 2000 2002 2004 2006 Source: National Association of Realtors
OFHEO estimates that house prices are now falling in Massachusetts, Maine, and the industrial Midwest. Percent change in OFHEO index, Q1 2006 Q2 2006 States with largest gains States with largest declines Washington +15.5% Michigan -2.8% Utah +15.9% Massachusetts -1.7% Idaho +16.0% Maine -0.8% Oregon +17.0% Ohio -0.2% New Mexico +18.0% Indiana -0.2% Source: Office of Federal Housing Enterprise Oversight.
Some New England states have a large and growing share of subprime loans. Subprime loan share of mortgage originations 2003 2004 Change Connecticut 10.2% 17.2% +7.0% Maine 10.6% 10.7% +0.1% Massachusetts 8.0% 15.8% +7.8% New Hampshire 9.6% 12.6% +3.0% Rhode Island 14.0% 25.3% +11.3% Vermont 4.5% 8.0% +3.5% United States 9.9% 14.8% +4.9% Source: Mortgage Bankers Association.
Why is the national housing market correcting? Two views: #1 Prices got too high relative to incomes. Housing bubbles have to burst. #2 Prices rose because interest rates got so low. Now interest rates have risen.
#1 The housing bubble story Assumes that economic fundamentals explain house-price-to-income ratios over long stretches of time. Fundamentals include mortgage rates, incomes and employment, building costs & constraints, amenities. Average house-price-to-income ratios can differ across cities. For any given city, big gap between actual house prices and fundamentalsbased prices indicates overvaluation. Sustained overvaluation housing bubble.
#1 The housing bubble story (continued) Timing of the bubble bursting is unpredictable. Decrease in housing sales volume is a leading indicator. Eventually, sellers adjust their price expectations downward to match what buyers are willing to pay. House prices stagnate or fall.
About one-half of all metro areas are overvalued, according to National City. 160 140 Number of metro areas at least 13% overvalued (317 metro areas total) 145 151 120 100 88 80 60 60 40 20 0 Q4-2003 Q4-2004 Q4-2005 Q2-2006 Source: National City Corporation.
California and Florida have many severely overvalued markets, according to National City. Of the 60 metropolitan areas with overvaluation >= 40 percent: 26 are in California 14 are in Florida 20 are in other parts of the U.S. (including 5 in the Northeast) 0 are in New England Overvaluation among New England metropolitan areas is mixed: Barnstable, MA 34.7% Springfield, MA 18.2% Providence, RI 29.5% New Haven, CT 14.6% Worcester, MA 27.0% Boston, MA 5.7% Manchester, NH 21.5% Hartford, CT 5.5% Source: National City Corporation.
51 metro areas were overvalued by more than 30% at some time during 1985 1995. Almost ALL experienced a significant price decline. 20 18 Number of metro areas with house price declines of: 17 16 14 12 13 12 10 8 7 6 4 4 2 0 Less than 10% 10% - 15% 15% - 20% 20% - 30% Over 30% Source: National City Corporation.
134 metro areas were overvalued by between 13% and 30% at some time during 1985 1995. 106 experienced NO significant price decline. 120 Number of metro areas with house price declines of: 106 100 80 60 40 20 0 14 13 1 3 Less than 10% 10% - 15% 15% - 20% 20% - 30% Over 30% Source: National City Corporation.
House prices usually fell by LESS than estimated overvaluation in the 1980s. 60% 50% Dallas San Antonio Abilene, TX Price Decline Less than Overvaluation 40% Austin Overvaluation at Peak Price 30% 20% 10% 0% New London Boston Hartford New Haven Bridgeport/Stamford Tampa Palm Beach Memphis New Orleans Price Decline Greater than Overvaluation -10% Talahassee, FL -20% Casper, Wy -30% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% Peak to Trough Price Decline Source: National City Corporation, OFHEO.
#2 The interest rate story Backs out equilibrium price of owner-occupied housing, based on likely returns. Key determinants include interest rates, rents for comparable units, tax laws, reasonable estimates of capital gains. House prices can differ across cities. (continued)
#2 The interest rate story (continued) For any given city, big gap between actual and equilibrium prices indicates one of two things: People using flawed information OR People s decisions based on factors that economic models don t include Eventually, house prices return to equilibrium.
Interest rates got very low in the early 2000s and lenders offered new mortgage products 16 Interest rates, percent 14 12 10 Effective Mortgage Interest Rate 8 6 10 Year Treasury Yield 4 2 0 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 Source: Federal Reserve Board, Federal Home Finance Board.
Careful study by Himmelberg-Mayer-Sinai concluded that house prices in most markets are not much higher than equilibrium levels. In Q4 2003, only 4 metro areas (out of 47 total) had an imputed rent on owner-occupied housing greater than prevailing market rents. By Q4 2005, 26 metro areas were overvalued by this measure. However, very few markets were severely overvalued. Overvaluation in Q4 2005 Number of metros Less than 10% 11 10% - 15% 4 15% - 20% 5 Over 20% 6
Increase in interest rates puts downward pressure on prices. But, as in the housing bubble story: Timing is unpredictable Decrease in home sales is a leading indicator Eventually, sellers adjust their prices to match what buyers are willing to pay House prices stagnate or fall So our housing market data don t tell us which model is correct!
House price declines are correlated with recessions. 1980s case study of 41 state house price booms: 15 states had a recession In 13, house prices fell. 26 states had no recession House prices fell in only 7. Source: Kodrzycki and Gerew Using State and Metropolitan Area House Price Cycles To Interpret the U.S. Housing Market, forthcoming.
Combining and extrapolating: National home prices likely to be flat in 2006, rise modestly in 2007 14% 12% 4-Quarter Percent Change in US House Prices 10% 8% 6% 4% 2% HMS extrapolation Q4: 2007 Key assumptions for 2006-07 Personal income +5% annually Mortgage rates +100 b.p. in 06, flat in 07 Rents flat HMS extrapolation Q4: 2006 National City extrapolation Q4: 2006 National City extrapolation Q4: 2007 Q4: 1990 Q4: 1994 0% -2% 0 10 20 30 40 50 60 70 80 90 100 Number of Metro Areas with a House Price Decline (out of 183) Source: Kodrzycki and Gerew Using State and Metropolitan Area House Price Cycles To Interpret the U.S. Housing Market, forthcoming.
How about New England housing markets? Overvaluation measures not out of line here, as they were in the 1980s. Interest rate movements same as national. Economy and demographics different from national both plusses and minuses.
Fortunately, construction is not a major driver of the New England economy 14% 12% Construction employment as percentage of total nonfarm employment 10% Nevada 8% Arizona 6% United States 4% New England 2% 0% 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 Source: Bureau of Labor Statistics.
Slow regional population growth limits demand for housing. 35000 Population Thousands for NE and MA, Ten-thousands for US 30000 25000 20000 15000 10000 5000 0 United States New England Massachusetts 1980 1990 2000 2005 Source: Bureau of the Census.
High presence of baby-boomers poses risks over the coming decade. Share of population ages 45 to 64 years old: United States: 25.0% New England: 27.0% Move to smaller living quarters and retirement locations spread out over time? More patient sellers less panic selling? Risk: Will young adults want to locate here?
Conclusions A housing correction is happening nationwide, damping economic growth. House prices are inherently hard to predict. A best guess is flattening prices, although some markets will likely see a drop. New England is not especially out of line. New England s differences from the nation: Construction is not a big driver of the regional economy. Slow population growth limits demand and poses some risks ahead. Keep your eyes on the rest of the economy!