When Do You Think Housing Will Bottom?
Home Value Losses Increasing
Interesting Analysis of Case-Shiller Home Price Index Data
(This post is from The Affordable Mortgage. Read it and share your comments)
An analysis of the publicly available data which constitutes the S&P/Case-Shiller Home Price Index produces some interesting conclusions.
Introduction
During the mid-1990s the Government proactively pursued the goal of increased homeownership for the poor, the credit-challenged, minorities and inner-cities.
Many tools were employed but the primary incremental policies used to achieve this goal were:
- Revisions to the Community Reinvestment Act which directed lenders to make loans to people who could not otherwise qualify for them based on merit
- The reallocation of Fannie Mae’s/Freddie Mac’s expenditures towards subprime loans which constituted a large and recurring supply of capital to fund subprime loans and a huge potential profit opportunity for the fee-based mortgage industry
- Pressure brought to bear on lenders by the GSEs to meet subprime lending goals
- Regulatory influence over the lending industry
Increased access to credit with generous terms caused demand for houses to expand, transaction volumes to rise and inventories of for-sale properties to tighten. As a result, home prices began to rise nationally at an unsustainable pace in 1997.
Framework for Analyzing Case-Shiller Data
Since home prices began to decouple from the fundamentals of value in 1997 it makes sense to analyze current home values relative to the sustainable levels which existed before the Housing Bubble distortion. Analyzing what these values would be today adjusted for inflation provides an interesting perspective on where home prices should be and potentially allows us to project where they are heading.
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Housing prices are expected to generally track inflation because it is logical that they should do so (as the cost of inputs including materials, labor and land rise with inflation and excess price appreciation will lead profit-seeking builders to increase supply) and because several hundred years of housing price data clearly establishes this trend.
Analyzing the Data
Looking at the Case-Shiller figures since January 1997 proves interesting.
While the 10 City Price Index has fallen 30.2% from its peak value in June 2006, the index needs to fall an additional 34.4% from current values to reach inflation equilibrium with January 1997.
Eight of the 19 markets analyzed need to fall by in excess of 25% to reach inflation-adjusted, pre-bubble valuations and 10 markets need to decline by more than 20%.
The most overvalued markets continue to be New York and Los Angeles which need to fall an additional 41% from current levels.
Some may draw comfort from the observation that many markets analyzed are approaching inflation-adjusted equilibrium, but this perspective may prove to be optimistic. Most of the factors which determine market prices are far less favorable today than they were in 1997. The supply of houses is excessive, inventories are higher, credit is tighter, expectations for current/future price performance is negative, subprime loans no longer exist, and the primary mechanism which propelled prices to unsustainable heights (affordable mortgages) are no longer available.
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Potentially of even greater concern though are those markets which are not currently overvalued relative to 1997.
Detroit and Cleveland are actually trading in real terms at less than prices twelve years ago. These cities have been impacted by rust-belt and auto industry issues and are unique cases. But they may provide insight into what happens to housing prices in economic downturns. Slumping economic activity and high unemployment have depressed housing values. But which one of the remaining 17 markets analyzed isn’t experiencing an economic slowdown and rising unemployment?
Even more shocking are the markets of Las Vegas and Phoenix. Each has effectively reached equilibrium but both are experiencing rapid price declines which are accelerating. In fact these two were the worst performing markets year-over-year for January with Phoenix down 35.0% and Las Vegas down 32.5%. It seems likely that both markets will trade at substantial discounts to real 1997 prices in the near future. This is amazing as each was a recent boom town, in states with growing populations and without the macro-economic challenges of Ohio and Michigan.
This should scare anyone who hopes that price declines will cease once we return to pre-bubble prices. It appears that the fundamentals which influence value, not the protestations of Washington DC, determine asset prices.
Based on my understanding of the primary causes of the Housing Bubble, my expectations for the Affordable Mortgage Depression and my interpretation of the Case-Shiller data, I expect every market analyzed to see home price index values fall below inflation-adjusted, January 1997 levels.
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