Monica McNamara's Ocean City Blog

Economic Insights

December 9, 2008

Even as the housing market continues its decline, hints of future stabilization have emerged. Of course, builders continue to cut back sharply on new construction, and will likely do so for some time to come. But with existing home sales up slightly during the past few months, the inventory of unsold homes has begun to inch downward.

By spring 2009, that inventory should drop enough to erase the need for any further cutbacks or real estate price declines. Even before matters reach that point, the intensity and severity of the declines should begin to moderate.

The best news on housing comes from the sales figures. In the past few months, buyers have begun, at least tentatively, to respond to the greater affordability of homes. The National Association of Realtors (NAR) tracks affordability by comparing average family incomes with the cost of supporting a fixed-rate mortgage on the average priced house. On this basis, affordability troughed late last year, but with this year’s sharp real estate price declines and monetary policy at last stabilizing mortgage rates, this measure of affordability has improved dramatically.

Today,home ownership is as affordable as it was in 2003—at least for those who can get the credit, which is, of course, a much less diverse group than in 2003. Some buyers clearly have responded. NAR data show that sales of existing homes, after falling more than 30 percent between 2005 and mid-2008, have picked up during this second half of the year, rising by about 3 percent between June and October (the latest month for which data are available).

Builders, of course, have no reason to respond yet. The sales improvement is tentative, and besides, the economy still carries a huge inventory of unsold homes. Though that overhang has dropped a bit—from almost 12 months’ supply of unsold homes at the peak last April to just under 10 months’ supply in September—it still greatly exceeds the more normal four to five months’ inventory. And so builders continue to cut back on new construction. In October,starts of new dwelling units fell to an annualized rate of 791,000, down 4.5 percent from September, nearly 40 percent from a year ago, and 60 percent from their high of spring 2006. Builders doubtless will continue to cut back until the inventory overhang shrinks a lot further. Those cutback plans are clearly evident in the data on permits for new residential construction, which fell by 12 percent between September and October and are 40 percent below year-ago levels.

Of course, cutbacks by builders can only do so much to relieve the excess inventory, since the bulk of housing for sale in this country comes from already existing stock of which new construction represents less than one-fifth of the houses on the market.

But given the reasonably sharp cutbacks in new building and a gradual rise in the sales of existing homes, the national inventory of unsold homes should continue downward in coming months and will likely reach a more sustainable range by March/April next year. At that point, builders’ cutbacks should all but cease, along with layoffs in the construction sector. Given the wounds of the past two to three years and the likelihood that lenders will remain restrained, new residential building and real estate activity generally will probably hold close to those lows for some time following, probably well into 2010.

Given the ongoing pressure of excessive inventories, homeowners and those who hold their mortgages will likely continue to suffer real estate price declines until the market approaches that stabilization point next year. Those price declines are certainly evident in the data. The NAR notes that between June and September (the most recent month for which data are available), the price of existing homes in the United States fell by about 11 percent, with the greatest declines in the Midwest and the West and the least pressure in the Northeast. The more popularly quoted Case-Shiller index of housing prices loosely confirms this view. Because the Case-Shiller index concentrates on only 20 major metropolitan areas where activity moves up and down more violently than in the rest of the country, it tends to show wider swings than the NAR data. Case-Shiller indicates that home prices have fallen by about 20 percent during the past year, with the largest declines in Phoenix (30 percent) and Las Vegas (34 percent). But allowing for the differences in accounting methods, the two indexes tell pretty much the same story. This downward price pressure, too, or something close to it, will likely remain until the excess inventory finally gets worked off in spring of 2009.

Even though building activity (the ultimate stabilization of home prices), and the residential real estate market in general, will wait for some months yet, there is reason to expect the intensity of the downward pressures to moderate in the interim, especially as the worst of the inventory excess begins to dissipate. What is more, those parts of the equity and bond market that are connected to real estate could begin to lift even before circumstances stabilize fully, including the valuations of mortgage-backed bonds and the stocks of the financial institutions that own them or depend on them in other ways.