Spring brings signs of hope and renewal — except in the housing market

Spring brings signs of hope and renewal — except in the housing market
Barry Ritholtz
Washington Post
April 7, 10:02 AM



Ahhh, winter is finally over. Each year about this time, flowers push up through the soil, trees begin to bud — and the stories about a real estate recovery appear.

Am I skeptic? But of course. To understand why, let’s consider a few questions:

What is shadow inventory?

This is important, as lowering the total inventory of houses for sale is how prices stabilize and sales volume moves higher.

Most buyers are familiar with ordinary inventory — houses listed for sale with real estate agents or by owners. Unfortunately, shadow inventory adds to the backlog. It includes bank-owned real estate, distressed houses not yet for sale, short sales and delinquencies that have not yet defaulted. Foreclosure properties are also in the shadow inventory.

These houses will eventually become part of the total supply for sale. Although there is no official count, estimates of potential shadow inventory run as high as 10 million.

That’s not all. There’s also a huge overhang of underwater homeowners — whose houses are worth as much as 25 percent less than what is owed. The owners don’t qualify for a mortgage modification. They may be delinquent but aren’t in default.

Two-thirds of all U.S. houses have mortgages. Of those, an estimated 21 to 29 percent of the mortgages are underwater, or up to 16 million houses. When prices finally do rise, we can expect many of these no-longer-underwater owners to put their houses up for sale. If only one in three do, that is another 5 million homes in inventory.

Are houses affordable?

Here’s where every discussion of affordability seems to start: the National Association of Realtors Home Affordability Index. In my view, it’s worthless.

Why did I come to such a harsh conclusion? The index offers little insight into how affordable housing actually is. In the biggest run up in housing prices in American history, the index never dipped into the level of unaffordable. Imagine that.

As ridiculous as that sounds, it’s even more absurd when we look at the NAR methodology, which ignores factors such as family savings rates, cash assets, consumer credit, indebtedness, credit servicing obligations, inflation and income gains.

The affordability index looks at the wrong things and ignores the important ones. The correct question is not whether the houses are affordable in theory. Rather, it’s whether potential buyers can afford to buy them.

Why does this matter?

In the real world, buyers have to be able to meet two key financial factors: down payments and mortgages.

Today, most families are cash poor and debt rich. They are deleveraging, not building up savings. Most simply do not have the $40,000 to put 20 percent down on a median priced house.

If you happen to have a down payment, there’s another hurdle: Qualifying for a mortgage. You must have a good credit score, not too much debt, a steady income, good employment history, etc.

The simple truth: House prices are down 35 percent from their peaks and mortgage rates are at record lows, but for those lacking the down payment and /or ability to access mortgage credit, houses are only theoretically affordable — but not for them.

Are the prices cheap?

Few had forecast the steep drop in median house prices.

Some regions that were excessively frothy during the boom — California, Las Vegas, South Florida and Arizona — have seen much greater price drops. Other areas had laws (Texas) or financial conventions (New York City) that mandated significant down payments and other prudent requirements and avoided much of the bloodshed.

The conventional wisdom seems to be that prices have stabilized and are overdue to start rising. The data, however, suggest something else. The most recent Standard & Poor’s / Case-Shiller index of national prices (January) shows prices are still falling, about 4 percent year-over-year.

There are some favorable factors:

• Prices are falling more slowly than they had been earlier.

• Nationally, house prices are back to where they were in 2003.

• The median prices of renting vs. buying now favor buying.

It’s not terrific progress, but it’s a marked improvement over three years ago.

What is the psychology of renting?

As the chart shows, costs of owning vs. renting are back to where they were in 1997, 1988 and 1976. The context is obviously different today. However, this is a favorite metric to show that houses are not all that expensive.

While rentals look less appealing as they go up in price, the other side of the equation is simple mean reversion. By most other metrics, house prices have nearly reverted to the mean.

The relationship between median income and median purchase price is yet another crucial factor, as any buyer who has a down payment and qualifies for a mortgage must earn enough to pay the mortgage.

And therein lies the rub: Real incomes have been mostly flat for a decade. Without real income growth, buying power simply remains flat. As you might imagine, that does not help price recovery in residential real estate.

House prices relative to income have come back down nearly to the mean. The uptick in 2009-10 was based on the first-time buyer tax credit. Once that expired, the prices dropped again.

So prices remain slightly elevated relative to where they have been historically. The variable, of course, is mortgage rates. The Fed’s zero interest rate policy is keeping mortgage rates at unprecedented low levels.

How do asset prices behave following a bubble?

Regardless of the asset class — stocks, bonds, commodities, houses, etc. — assets do not merely stabilize. We have never seen a stock market run up into bubble territory and then revert to fair value. Instead, we careen wildly past that level, to deeply undersold and exceedingly cheap.

That is the marvelous mechanism of markets. It is how assets are repriced, distressed holdings liquidated, capital markets stabilized, fools revealed, speculators punished — and money returned to its rightful owner, the prudent investor.

For a lasting recovery, we need to see houses cheap enough that they fall into “good hands” — long-term owners who can afford their mortgage payments.

Until that happens, houses will stumble along the bottom of the price range. The nation could easily see another 10 percent to the downside — assuming nothing else goes wrong.

This would actually be good news. The government interventions (first-time buyer tax credit, mortgage modifications and foreclosure abatements) have prevented prices from finding their own levels. If they did, houses would be much more affordable, and buyers would come out in droves.

That is how a true housing recovery begins.


Ritholtz is chief executive of FusionIQ, a quantitative research firm. He is the author of “Bailout Nation” and runs a finance blog, the Big Picture. @Ritholtz

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