We’ve seen some seriously conflicting housing headlines recently…
The data looks bad:
But anecdotal evidence is building that the housing market is catching fire again:
Buyers compete for short supply of homes in Bay Area – Mercury News
Peter Giovannotto is smack in the middle of a major shift in the Bay Area housing market.
The Peninsula real estate agent recently had a modest Palo Alto ranch-style home draw 38 offers and sell in eight days for nearly a half-million dollars more than the asking price, all par for the course in Palo Alto’s overheated real estate market.
“We started at $1.2 million and ended up selling for $1.65 million,” he said.
So which is it? Are things getting better? Or worse?
The answer is both, if you consider the situation in the proper context.
First off, all of the data points are backwards-looking. For example, Tuesday’s Case-Shiller report includes data from November, December, and January. And homes sales and price data for January or February involves homes that went “pending” at the end of 2011 – a full three or four months ago.
Home prices are driven by Supply and Demand. Not enough homes for sale relative to demand for in a zip code, town, or given street and prices go up. Or, if there simply isn’t enough demand to soak up local supply, Sellers end up lowering prices to compete for Buyers. This Winter was probably the low-point of Demand relative to Supply.
Starting in March or so, we’ve started to see Demand pick up, relative to the still tiny Supply of homes for sale. The result: the bidding wars that we are starting to hear about. And while each zip code and block are different, it’s safe to predict that home prices have indeed bottomed (for now), and will begin rising slightly this Spring.
But that’s not the end of the story…
A Bottom, Not The Bottom
In order to decide if this is “the” bottom for housing prices that we’ve all been waiting for, we have to put where we are at in proper context. We know that Supply and Demand has shifted once again to favor Demand – but is that shift real? Or just a statistical blip?
After all, it wouldn’t be the first time that artificial forces caused home prices to rise before resuming their slide.
Remember all of the foreclosure moratoriums, loan modification programs, and homebuyer tax credits? They brought temporary (and fake) home price increases in the middle of a larger decline.
Consider this “head and shoulders” chart I put together in 2010:
Bay Area Home Prices have continued to decline, as predicted, along that dotted line. Here is the most recent Case-Shiller chart:
So is the the real bottom or another head-fake? To answer that, we have to look at the larger issues at play. On the Supply side, we have an enormous shadow inventory of homes that should be for sale but are not. These include all of the would-be foreclosures and short sales that are currently in some sort of loan mod (of which most will re-default) or holding out hope for a principal reduction. These also include all of the Sellers who want to move or downsize, but haven’t been able to at today’s prices, and all of the new homes and condos in the pipeline to be built and sold.
Is there really enough Demand to soak up all of this Supply in the coming years? Even without tax credits and if interest rates go up again or employment remains weak?
There are several reasons I think that house prices are close to a bottom. First prices are close to normal looking at the price-to-rent ratio and real prices (especially if prices fall another 4% to 5% NSA between the November Case-Shiller report and the March report). Second the large decline in listed inventory means less downward pressure on house prices, and third, I think that several policy initiatives will lessen the pressure from distressed sales (the probable mortgage settlement, the HARP refinance program, and more).
Of course these are national price indexes and there will be significant variability across the country. Areas with a large backlog of distressed properties – especially some states with a judicial foreclosure process – will probably see further price declines.
And this doesn’t mean prices will increase significantly any time soon. Usually towards the end of a housing bust, nominal prices mostly move sideways for a few years, and real prices (adjusted for inflation) could even decline for another 2 or 3 years.
But most homeowners and home buyers focus on nominal prices and there is reasonable chance that the bottom is here.
To which I responded:
While this logic is sound from an economic perspective, I worry that McBride has fallen into the same traps that ensnare too many economists: ignoring both the artificial forces driving the data and the social mood bubbling beneath it.
Most of the fundamental problems we had back at the peak of the bubble still exist today:
- Home prices were out of line with incomes……. CHECK
- Hoards of homeowners were living paycheck-to-paycheck……… CHECK
- Too many people were reliant on home equity and credit cards to support their lifestyles……. CHECK
- Too many people were stretching to live in homes they really can’t afford…… CHECK
- If home prices fell further, more homeowners would give up…… CHECK
- There was no mobility. Nobody had the equity to upgrade, downsize, or move to a new town to take a new job….. CHECK
- The market is dominated by investors…….. CHECK
- Millions of people who shouldn’t own homes somehow did….. CHECK
- There are millions of bad loans on bank balance sheets and losses needed to be recognized….. CHECK
Nothing has really been fixed.
The Grand Illusion
Today we are at a crossroads. Most of the fundamental problems that existed during the housing bubble and bust still exist today. They haven’t been solved, but simply kicked down the road.
We are extending and pretending that everything is okay, hoping the illusion will last until the day when things actually are okay again. If the illusion holds, Bill will be right and we may indeed see home prices rise from here. But if the illusion begins to break down and fundamentals rear their ugly heads, prices could continue to fall again.
Personally, I expect Bay Area home prices to strengthen this Spring and Summer. Not because Demand is booming (though the newspapers will report it that way), but because there simply isn’t anything for sale. Supply is SO low, that it won’t take much Demand to see prices start to rise.
But by the Fall and Winter, I would expect Supply to grow again. I expect we will see a lot more short sales coming to market – mostly HAMP rejects and people who finally give up waiting for a principal reduction. And by the beginning of 2013, after four full years of cutting back, I expect more foreclosures will finally start to hit the market. I don’t expect an outright flood of Supply and collapse of home prices, but I do expect 2013 will look more like 2011 than 2012.
In Five Reasons Why Home Prices Aren’t Bottoming Yet I wrote:
I believe that Uncle Sam will continue doing everything it can to spark Demand while restricting Supply. The result will be most likely the next couple of years being very similar to the last couple of years – with national home prices down another 10% or so. It will be a continued slow, muddled, death-by-a-thousand-cuts process.
IF the job market continues to improve and IF somehow Uncle Sam can convince the millions of underwater homeowners not to walk away despite even lower prices, I wouldn’t expect anything dramatic to happen. Maybe prices drift lower another 10-15% over the next 2-3 years before setting down at roughly where they should be relative to historic incomes, then flatten or even begin to rise.
However, if underwater homeowners start walking away in greater numbers, things could get ugly fast.
In the near-term, we can watch how low the housing Supply is this Spring and Bill McBride will probably be right that prices could stabilize into the Summer and Fall. But beyond that, the willingness of underwater homeowners to hold on, and the willingness of today’s 20-and-30-something’s to buy homes will determine what happens with home prices. Social mood will be driving this train – and that something that economic models have a very hard time predicting.
Beware the bottom-callers who will be out in droves this Spring and Summer. There is still a lot of this story to be written.