What About Home Prices?

The question on everyone’s mind is: what will happen to prices? The answer: prices will decline, potentially significantly. Prices will decline because there is more than a one year supply of homes on the market, and several bank servicing arms and REO managers have told us that they will drop price to get the loans and homes off their books. Only a quick economic recovery, or a government mandate to rent the homes out, can prevent further price declines. Hopefully, tremendous affordability and investor appetite for REO will create a pricing floor that isn’t too far below today’s prices. Price declines are already showing up in the new home market. In the 3 months following the April 30 tax credit deadline, home builders dropped price an average of 3%.

How much further will prices fall? That varies by market and price point. We recently sent our best estimates by MSA to our clients, and we are updating our Land Acquisition and New Home Sales Forecast reports, which pinpoint where the distress is located in a specific market. Keep in mind that Case-Shiller and median prices have overstated the correction on most homes, so the declines reported in the newspapers will be far less than what is really occurring in the market.

Our free macro data on all of the markets is as follows:

Economic Growth............................................................................D+
Economic trends were mixed this month, as Real GDP declined but is still positive, while the employment market gradually improved once again. However, most believe the economy is slowing and we agree. Lower GDP growth, driven by slower consumer spending, is a clear sign that the pace of the recovery is slackening. Though job growth, unemployment, and jobless claims have improved, job growth will have to come faster to maintain any kind of momentum. There is even early talk of some form of new stimulus, but chances of this are dicey given the enormity of the federal deficit and the upcoming election.

Leading Indicators...........................................................................C-
The leading indicators for the economy were mixed compared to last month. Although some metrics such as corporate bond spread and temporary workers improved, the Leading Economic Index and the stock market were both down. The Leading Economic Index decreased to 4.1% from 5.1%, and the ECRI Leading Index – also an indicator of future U.S. growth – fell to the lowest level since July 2009. The year-over-year change in the LEI, however, has been positive for 15 months and the ECRI is still far above the trough. The money supply is up and bond spreads are down. The former could lead to increased spending while the latter is an indication that lenders, at least, are less worried about defaults. The attitudes of those who would make hiring decisions (captured in the Vistage CEO Confidence Index and the CEO Economic Outlook Survey) reflect general confidence in continued economic growth, although these surveys were taken a few months ago. Corporate profits and cash positions are strong. Temporary employment has increased by 22% year-over-year, which is compared to a drop of 25% this time last year, and companies are slowly adding temporary staff to the payrolls. Stocks worsened this month. All four major indices we track – the Dow, S&P 500, NASDAQ, and Wilshire 5000 – are down 4-6% this month and 3-5% year-over-year. The S&P Homebuilding Index also declined this month, falling 6% from last month. This index has been hammered recently and has declined 30% from the most recent peak in April as weaker than expected home builder orders and CEO commentary worried investors.

Affordability......................................................................................C--
Affordability continues to be excellent with low mortgage rates and tamed home pricing nationwide. Our housing-cost-to-income ratio ticked down slightly to 26.7%, and housing affordability remains excellent compared to history. Though home prices eased downward a bit and incomes were only very slightly higher, the key income to price ratio is still at 3.4, almost equal to the long-term historical norm and a level conducive to market health. Affordability continues to be bolstered by historically low mortgage rates. The 30-year fixed mortgage rate decreased to 4.36% this month, while adjustable mortgage fell to 3.52%. The Fed’s overnight lending target rate remained at a range of 0.00% to 0.25%, which is the lowest level on record. The share of ARM applications increased to 5.8% this month, but is still far below the peak level of 35% of total applications in early 2005.

Consumer Behavior..........................................................................D+
Consumer behavior improved modestly this month as most of our metrics remain on trends indicating gradual improvement. Consumer sentiment increased slightly to 68.9 but remains well below the historical average. The Consumer Confidence Index, which had declined over the past two months, improved this month to 53.5, but is also well below the historical average. The credit outstanding per household has fallen 10.8% over the last year to $7,367 per household. The personal savings rate increased to 6.4%, and is only slightly lower than the recent peak of 6.9% in May 2009. The Misery Index did increase this month, rising to 10.7 from 10.6 the previous month. This was the result of a slight increase in the inflation rate.

Existing Home Market.......................................................................D
The existing home market again worsened this month, due to a continuing “hangover” of the demand pulled forward by the expired federal tax credit. Seasonally adjusted annual resale activity dropped to 3.83 million homes this month, according to the National Association of Realtors (NAR), and has decreased 25% year-over-year. On a rolling 12-month basis sales have decreased 2.6% compared to the previous month, but has increased 10.7% year-over-year.. The national median price of an existing single-family home ticked down to $183,400 currently from $183,500 the previous month, after improving for the past two months. This increase is, however, partly due to a change in the mix of homes as more upscale distressed properties come onto the market. The median existing home price has decreased 4.6% year-over-year. The S&P/Case-Shiller U.S. National Home Price Index improved once again, and has returned to positive territory this quarter for just the second time since late 2006, increasing 3.6% year-over-year. The number of unsold homes increased to 12.5 months of supply, which is above the historical average of 7.3 months. Perhaps most worrisome, pending home sales decreased sharply again this month to the lowest level on record as the post-tax credit environment remains harsh. Longer-term, 23% of homeowners have mortgages higher than their home values, with the worst concentrations in the same states hit hardest by the boom and bust – California, Nevada, Arizona, Florida.

New Home Market..............................................................................C-
The new home market generally worsened this month, as both new home sales and builder confidence worsened. After increasing the prior month, new home sales dropped 12% to 276,000 transactions on an annualized basis. This is down 32% year-over-year and is the lowest level on record going back to 1963. Like existing home sales, the poor showings for May and June are undoubtedly skewed by the April 30th end to the federal tax credit. It should be noted, however, that the sample size used by the Census Bureau to calculate new home sales is extremely small and the confidence interval consequently large. The rolling 12-month total decreased slightly this month to 357,000 transactions, and remains near historically low levels. The median single-family new home price decreased to $204,000, and is down 5% year-over-year. Supply is a concern, as the months of unsold homes metric increased to 9.1 and is still above the historical average of 6.2 months. The volume of new homes for sale, however, dropped very slightly to 209,000 homes, a level well below the historical norm. Builder confidence was down again, reflecting the post-tax credit downturn.

Housing Supply...................................................................................F
Housing supply indicators were mixed this month, but generally worsened. All of these metrics, moreover, remain at very poor levels from a historical perspective. Single-family starts were down, as were single-family and multifamily permits. Total completions decreased markedly, in fact, to 587,000 units, a 33% drop from last month. This is a historically low figure and is partly due to builders reducing construction activity with the passing of the federal tax credit. Seasonally adjusted new home starts increased this month due to a larger gain in the more volatile multifamily sector. Total permits decreased to 565,000, due to declines in both single-family and multifamily permits. Permits are now down 4% year-over-year, an indication that supply has stabilized. Although vacancy rates in the U.S. have improved in recent quarters, the majority of the U.S. remains oversupplied compared to history, with only six states undersupplied, all with small populations except Texas. The homeowner vacancy rate decreased this quarter to 2.5%, which is down from 2.6% last quarter.