The Elusive Housing “Fair Value”

Over the past few years, I have frequently referred to US housing as over priced and over valued by traditional metrics. These include:

• Median Income vs Median Home Price (mentioned yesterday)
• Ownership Costs vs Renting Costs
• Market Value of Housing as a percentage of GDP
• Housing Inventory Supply vs Sales Rates

During the Housing boom and credit bubble, prices moved several standard deviations away from the norm to extremely over bought, over valued levels. As prices have come down, these metrics are getting closer to typical levels. They remain elevated, but no longer outrageously so, as they revert back to historic means.

Those who are now calling a housing bottom (despite having done so for years) are finding comfort in this mean reversion. They shouldn’t — and for three reasons. The first is that asset classes which become wildly over-priced do not merely revert to the mean — they tend to carom straight through the mean, eventually becoming significantly under-valued. You see, if you only spend time above the mean trend line, and never below it, well then, that cannot possibly be the “mean” — the line down the middle.

Second, we know the recession plus a glut of foreclosed homes creates a “self-reinforcing cycle.” Job losses and income decreases lead to more distressed sales, with prices especially pressured. Falling prices make put mortgage holders underwater — holding homes worth less than the mortgage. This leads to walkaways, jingle mail, and even more foreclosures. All of this adds up to an even greater excess supply of homes for sale. More supply equals lower prices. The entire vicious cycle continues.

But the third issue is the biggest one of all. Its something we touched upon previously in NAR Housing Affordability Index is Worthless. None of the factors outside of price and interest rates are constructive to home sales. Outside of the $8,000 buyers tax credit, all of the rest of the factors impacting sales are deeply in the red:

1) Employment:  Job losses and unemployment data remain at deep recession levels;

2) Down Payments: Surprisingly few buyers have a cash down payment of 20%. Some banks are now asking for down payments of 30%. Unless we go back to LTV of 90 and 100%, that reduces the pool of qualified mortgage applicants.

3) Debt servicing: Many mortgage applicant do not qualify in terms of 25% of monthly gross income available to pay for Mortgage Principle and Interest. This is a function of the prior debt binge — credit card, HELOC and auto.

4) Credit: As the above #3 implies, lots of potential buyers damaged their FICO credit scores in the last round of leverage; Qualifying for a prime loan is problematic for these folks;

5) Non-purchase costs:  have risen dramatically. The biggest being local property taxes, and energy. The silver lining is energy prices are more reasoanble lately, and thanks tot he recession, maintenance and repair costs (especially labor) are the cheapest they have been in years.

All of these factors relate to the process of qualifying for a mortgage, and the financial wherewithal to buy a house.

The bottom line: Fair value for Housing is a concept that under normal economic circumstances is dependent upon many different factors. But during the current secular economic shift, it is even more elusive. There are an increasing number of families who might have qualified for a standard conforming mortgages in the past, but no longer can today.

And, the trend for many potential buyers is heading in the wrong direction even faster than prices are coming down. The gap between the potential home buyers and actual home buyers is not getting better, its getting worse.

We are still no way near a bottom in housing . . .

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Previously:
NAR Housing Affordability Index is Worthless (August 13th, 2008)
http://www.ritholtz.com/blog/2008/08/nar-housing-affordability-index-is-worthless/

No Housing Recovery Before Further Price Declines (February 21st, 2009)
http://www.ritholtz.com/blog/2009/02/no-housing-recovery-before-further-declines/

Homes: Still Too Pricey to Stabilize (February 18th, 2009)
http://www.ritholtz.com/blog/2009/02/homes-still-too-pricey-to-stabilize/

NAR and Housing Forecasts (June 2007)
http://bigpicture.typepad.com/comments/2007/06/nar_and_housing.html

Tracking NAR Spin (April 2008)
http://bigpicture.typepad.com/comments/2008/04/tracking-nar-sp.html

See also:
For Housing Crisis, the End Probably Isn’t Near
DAVID LEONHARDT
NYT, April 21, 2009
http://www.nytimes.com/2009/04/22/business/economy/22leonhardt.html