Friday, May 25, 2007

When is the bottom of the housing market coming?

I don't know--and neither does anyone else. Here are three things to consider, however:

(1) A good harbinger of the housing market is the months supply measure. When the months supply rises beyond six months, it is hard to make a case for house prices going up anytime soon, unless builders stop building altogether. The reason: it takes about six months to build a house in most markets (i.e., to get from the beginning of the permitting process to the finished product). Thus prices have to fall until the inventory is absorbed.

The good news is that homebuilding has slowed down a lot, and that the months supply measure for new homes fell well below six months in April. The bad news is that the months supply of Existing Home Sales continues to rise, and is currently at 8.4 months. The other bad news (in a sense) is that the Existing Sales number is much less prone to revision than the New Sales number, and reflects actual closed sales, instead of sales contracts. Until the Existing Home Sales months supply number turns around, it is hard to see when the bottom will come.

(2) While the national number is important from a macroeconomic and mortgage securitization standpoint, it is not helpful to buyers in local markets. Some markets have supplies of less than six months, and buyers in these markets, particularly those who are planning to live in one place for awhile, just shouldn't worry about short-term price fluctuations. But other markets have huge supply gluts; in these markets, potential first time homebuyers are better off renting for awhile.

(3) Housing markets have substantial intrametropolitan variation. The detached housing market can be considerably different from the Condo market; housing near transportation lines can retain its value better than housing in far-flung suburbs. Moreover, there are some opportunities in weakness. I was looking at the San Diego MLS listings recently. Houses that would have been out of range for a finance professor a few years ago (i.e., houses with ocean views) are now within range. The principal reason to buy a house is the consumption benefit of the house--when an opportunity arises to obtain a great place to live, it is worth considering. Just don't be naive about it--make sure you plan on living in one place for a long time (in which case resale value doesn't matter so much), that you can afford the place with a fixed rate mortgage, and that you don't mind knowing that its price might go down for awhile before starting back up again.


Anonymous said...

As economists, we should take a stand on what the word "bottom" means with respect to housing markets -- so that it has a somewhat precise connotation, just like the word "recession."

Right now, there is some confusion: Are we referring to construction of new homes, sales of existing homes, prices, or something to do with mortgage defaults.

And then, does "bottom" refer to levels or growth rates? If we have the sequence of growth rates of prices 3, 1, -3, -1, 3, the bottom in levels occurs after -1, but in growth rates occurs after -3.

I think the most natural place to talk about a "bottom" is with respect to price levels. It's unusual to talk about a forecastable bottom, since asset prices should incorporate all known events, but Case and Shiller and others have taught us that excess returns in housing are forecastable based on prior excess returns ... so with that knowledge, and with the knowledge returns to housing are falling right now, and think it's safe to say we still have a-ways to go before we hit bottom.

That's my view anyway.

Richard Green said...

I agree that price level is the most sensible, and it should actually be real price level. Morris' point is well-taken, and is consistent with my point about rising inventories. It ma be awhile...

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