by Jed Smith, Managing Director, Quantitative Research
Every month the press is filled with commentary on the latest housing
market figures. Some of the stories would benefit from additional perspective.
In this month's “Behind the Numbers,” we focus on some of the housing market
problems in the news: supply, demand, and the outlook. Of course, all housing
is local, so the information needs to be considered in conjunction with
knowledge of local market conditions
In the past year approximately 33 percent of existing home sales at the
national level have involved distressed properties (foreclosures, short sales)
selling at discounts of 15 to 20 percent from non-distressed market
prices—exerting a major negative impact on overall market prices. There has
also been concern over a potential shadow inventory of distressed properties:
as of the first quarter of 2010 over 6.5 million homes were in foreclosure or
had overdue mortgage payments. Possibly as much as 75 percent of the shadow
inventory will ultimately be sold as distressed. However, given the ongoing
time delays for problem resolution it appears that distressed properties will
enter the market at approximately the current or a slightly increased rate for
the next few years. Foreclosures are a major negative market influence in terms
of price, consumer confidence, and expectations; however, a tsunami of shadow
inventory appears unlikely.
There are a variety of techniques for measuring expected housing sales
based on economic factors, demographics, financial markets, etc. A simple
trending of the existing home sales market based on sales rates during
1988-2000, a time period before the recent market
run-up/de-leveraging/decline/recession situations, suggests a pent-up demand in
the neighborhood of 15 percent relative to today’s sales. That is, existing
home sales could be expected to be possibly 15 percent higher in a normal
market. We are, however, far from a normal market, given that we have been
through major financial de-leveraging, the Great Recession, and that consumer
mood is at best shaky.
A number of homeowners who have deferred listing their homes due to market
conditions may also now reenter the market, resulting in increased home
inventories as the economy recovers. Once the employment numbers improve,
pent-up demand may help to increase sales. In the short run, however, we may
actually see additional inventory on the market as a result of listings by
deferred sellers.
The supply of all types of new housing units has been reaching new lows, declining
from single family starts at over 1.7 million per year in late 2004 to 454
thousand in June 2010. The demand for new housing units ultimately depends on
family formations, sales for vacation homes, and replacements for units
demolished or destroyed. Based on assumptions about demolitions and second
homes, the graph indicates that in recent years, the projected demand for new
homes has actually exceeded supply. Decreased new construction obviously makes
major headlines in the short run; in the longer run it should help to bring the
overall housing market into balance.
There will always be an inventory of unsold homes on the market. An
increase in the inventory of unsold homes indicates that there is an excess
supply relative to demand. The graph shows how prices tend to rise as supply
falls. During the first part of 2010 the months’ supply of inventory decreased
from earlier highs—accompanied by stabilizing prices. In June, month’s supply
increased to 8.9 months from the previous 8.3 months. If the increase proves to
be a temporary adjustment due to pent-up listing of homes, then prices should
continue to stabilize, particularly if employment increases. If inventory
supply continues to increase without adequate job increases, the housing market
will be subject to additional pricing pressures.
The above comments provide a perspective on how the housing market is
positioned to resolve its problems:
·
First, the level of
distressed sales is likely to continue for the next several years, negatively
impacting prices and the new construction market at entry level. However, a
tsunami of additional distressed property sales appears to be unlikely.
·
Second, the existing home
sales market appears to be below normal projected growth, apparently held back
by employment problems and mediocre consumer mood. The data suggest that there
is pent-up demand, but a greater economic recovery, particularly in jobs,
appears to be necessary before the demand is unleashed.
·
Third, new home
construction appears to be below long-run demand. In the longer run this will
reduce the total supply of homes on the market, working to firm up prices.
·
Fourth, the inventory of
existing homes on the market in June was approximately 8.9 months, an increase
in housing inventory, possibly due to additional listings developing as the
market starts to recover. An increased inventory at this point could become a
negative for prices unless an expanded economic recovery releases some pent-up
demand.
Assuming that the economy is not hit with a “double dip” recession, all of
the data seem to indicate favorable prospects for sales—unlikely to decrease in
the short run, positioned to increase once the economy adds additional jobs. In
the case of prices, there are no indicators of major changes either way unless
the inventory of unsold homes increases significantly. At the local level,
areas with stronger job recovery, improving economies leading to fewer
foreclosures, and local economies able to unleash additional pent-up demand
should experience somewhat greater improvement. The comparison of local numbers
(jobs, foreclosures, short sales, inventories, etc.) with national numbers
provides a context for the evaluation of specific markets.