Reprinted from: The Wall Street Journal By CYRIL MOULLE-BERTEAUX
May 6, 2008; Page A23 The dire headlines coming fast and furious in the financial and popular
press suggest that the housing crisis is intensifying. Yet 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. How can this be? For starters, a bottom does not mean that prices are
about to return to the heady days of 2005. That probably won't happen
for another 15 years. It just means that the trend is no longer getting
worse, which is the critical factor. Most people forget that the current housing bust is nearly three years
old. Home sales peaked in July 2005. New home sales are down a
staggering 63% from peak levels of 1.4 million. Housing starts have
fallen more than 50% and, adjusted for population growth, are back to
the trough levels of 1982. Furthermore, residential construction is close to 15-year lows at 3.8%
of GDP; by the fourth quarter of this year, it will probably hit the
lowest level ever. So what's going to stop the housing decline? Very
simply, the same thing that caused the bust: affordability. The boom made housing unaffordable for many American families,
especially first-time home buyers. During the 1990s and early 2000s, it
took 19% of average monthly income to service a conforming mortgage on
the average home purchased. By 2005 and 2006, it was absorbing 25% of
monthly income. For first time buyers, it went from 29% of income to
37%. That just proved to be too much. Prices got so high that people who intended to actually live in the
houses they purchased (as opposed to speculators) stopped buying. This
caused the bubble to burst. Since then, house prices have fallen 10%-15%, while incomes have kept
growing (albeit more slowly recently) and mortgage rates have come down
70 basis points from their highs. As a result, it now takes 19% of
monthly income for the average home buyer, and 31% of monthly income for
the first-time home buyer, to purchase a house. In other words, homes on
average are back to being as affordable as during the best of times in
the 1990s. Numerous households that had been priced out of the market
can now afford to get in. The next question is: Even if home sales pick up, how can home prices
stop falling with so many houses vacant and unsold? The flip but true
answer: because they always do. In the past five major housing market corrections (and there were some
big ones, such as in the early 1980s when home sales also fell by
50%-60% and prices fell 12%-15% in real terms), every time home sales
bottomed, the pace of house-price declines halved within one or two
months. The explanation is that by the time home sales stop declining,
inventories of unsold homes have usually already started falling in
absolute terms and begin to peak out in "months of supply" terms. That's
the case right now: New home inventories peaked at 598,000 homes in July
2006, and stand at 482,000 homes as of the end of March. This inventory
is equivalent to 11 months of supply, a 25-year high - but it is similar
to 1974, 1982 and 1991 levels, which saw a subsequent slowing in
home-price declines within the next six months. Inventories are declining because construction activity has been falling
for such a long time that home completions are now just about
undershooting new home sales. In a few months, completions of new homes
for sale could be undershooting new home sales by 50,000-100,000
annually. Inventories will drop even faster to 400,000 - or seven months of supply
- by the end of 2008. This shift in inventories will have a significant
impact on prices, although house prices won't stop falling entirely
until inventories reach five months of supply sometime in 2009. A
five-month supply has historically signaled tightness in the housing
market. |