Forecasting the Real Estate “Floor”

While experts run the gamut in their outlook for real estate, sound business practices supercede futile attempts to time the market.

 

Are we there yet?

 

With the summer vacation season in full swing, most of us in real estate are asking our own version of this signature refrain of the family road trip. In our case, it’s a question of, ‘Have we hit the floor?’

 

When can we start looking forward to shrinking inventories, stable prices and an upward trend in the number of transactions?

 

While much of the media is still charging ahead with dire forecasts for real estate, a recent spate of experts are claiming that a housing-market recovery is imminent. Even though this is the news that we’ve been waiting to hear, we need to take it with a grain of salt. As always, the real story is much more complicated and  lies somewhere within the spectrum of the doom and gloom and the upbeat projections.

 

Many of you have recently asked me for my thoughts on a recent Wall Street Journal commentary entitled, “The Housing Crisis is Over” by Cyril Moulle-Berteaux, managing partner of Traxis Partners LP, a hedge fund firm based in New York. When I read the claim in the article that, “It is very likely that April 2008 will mark the bottom of  the U.S. housing market. Yes, the housing market is bottoming right now,” I suspected

that there might be a need to look beneath the surface of his claims. Noting that new home sales are down 63 percent and housing starts have fallen by more than 50 percent from their July 2005 peak; and that housing starts in 2008 will hit their lowest level ever, Moulle-Berteaux emphasized that the same factor that sparked the housing decline is soon to reverse it: affordability.

 

He explained that “by 2005 and 2006, the average monthly income required to service a conforming mortgage on the average home purchased had reached 25 percent. For first-time homebuyers that figure had climbed to 37 percent.”

 

But since then, according to Moulle-Berteaux, “home prices have fallen 10 percent to 15 percent, while incomes have kept growing (albeit more slowly recently) and interest rates have come down 70 basis points from their highs.” Moulle-Berteaux’s conclusion: “… homes on average are back to being as affordable as during the best of times in the 1990s – down to 19 percent of income for the average home buyer and 31 percent of income for the first-time home buyer.”

 

Affordability in March 2008, is actually at 19 percent, back to where it was in early 2004, but one of the key factors affecting affordability in the current market is low interest rates. If inflation increases, in the near future, interest rates could likely go up, which could counter the current direction in affordability.

 

Another factor that Moulle-Berteaux points to as a sign of recovery is the recent decline in new home inventories – from a high of 598,000 in July 2006, to 482,000 at the end of March 2008. Conceding that the current new- home inventory is still at a 25-year high, and equivalent to an 11- month supply, he argues that current levels are similar to those seen at the end of previous housing market downturns in 1974, 1982 and 1991, which in all three instances were followed by a slowing in home-price declines within the next six months. As new home construction begins to undershoot new home sales, which Moulle-Berteaux anticipates is soon to occur at a rate of 50,000 to 100,000 annually, he contends that inventories will drop to 400,000 – or a seven month’s supply – by the end of 2008.

 

While he makes a seemingly compelling argument, we should be careful not to accept such analyses at face value. Moulle-Berteaux does not always paint the entire picture and omits critical information, such as the fact that existing home inventories – which account for a far greater portion of the housing market – are at their highest levels since September 1981.

 

That being said, Moulle-Berteaux is clearly not alone in his assertions that the housing market is showing signs of a rebound. Among those noting positive trends is Professor Karl Case of Wellesley College in Wellesley, Mass. Case looked at the past three housing downturns in 1991, 1982 and 1975, and noticed that the market started to clear when housing starts dropped below the 1 million mark – as they did in March of 2008.

 

At the same time, the National Association of REALTORS® sees signs of

recovery for reasons that include:

•  Fannie Mae and Freddie Mac have announced plans to increase funds available   for home loans.
• The use of FHA loans is on the rise.
• Pending home sales are on the rise in areas where affordability has increased.

In a further effort to stimulate the housing market, Fannie Mae announced that starting June 1, 2008, it will accept down payments as low as 3 percent for single-family, primary residences on loans it purchases.

 

But despite its initiatives to jumpstart real estate, Fannie Mae is not anticipating a housing recovery to take hold until 2010. Addressing business journalists this Spring, Daniel Mudd, president and chief executive of Fannie May said, “Forecasting the bottom of the housing slump is a tricky business, with the many conflicting redictions by economists as proof.”

 

We couldn’t agree more.

 

Clearly, the housing market is a complicated business that does not rise and fall based on one or two factors. And even though real estate is cyclical, we need to avoid the expectation that prescribed patterns or trends are necessarily at play. The current downturn is quite different from the housing recessions of 1991, 1982 and 1975 –due

primarily to the tightening of the credit markets following the fallout of the sub-prime loan market, as well as the historically high rates of foreclosures. A striking similarity, however, between the current housing market and previous downturns in the housing cycle is the dramatic increase in oil prices.

 

It’s perfectly understandable to want to find the definitive forecast for residential real estate and to seek a return to the heydays of housing, but we have little to gain in latching on to any particular forecast or trying to time the market. We have everything to gain, however, by managing expenses in order to survive, doing whatever it takes to generate the leads that we need to thrive, seizing opportunities to build our share of the current market, and emphasizing to clients who are trying to sort through many conflicting messages that real estate is essentially a local business.

 

What’s happening within your local markets is all that’s relevant. You are our

local market’s real estate expert.

 

Written by Gary Keller and Posted on Agent Mountain.