The modest recovery in house prices over the past four months caught almost everyone by surprise, including those who are now explaining it away as an obvious byproduct of artificially low interest rates and the home-buyer tax credit.
The recovery’s momentum is slowing, however, and it seems likely that house prices will now resume their fall and drop another 10%-15%.
First, prices are still too high.
As these charts from Calculated Risk show, price-to-rent and price-to-income ratios have not yet reached their average levels from before the bubble. Normally, after a bubble like this, ratios would be expected to fall through their long-term averages and trade below those levels for several years.
Calculated Risk has detailed observations about the current state of prices here >
Second, two of the key forces that contributed to the bubble are continuing to unwind:
- Lending standards are still being tightened
- Consumers are reducing their debts
Third, the unemployment rate is still shockingly high and will likely remain elevated for years. This will likely shrink the amount of money that consumers have to spend on housing.
Fourth, nearly a quarter of all households still have negative equity, which is a prime cause of foreclosures. The more foreclosures that hit the market, the more housing supply there will be, and the more pressure this will put on prices.
Fifth, inventories are still high, especially if you include the “shadow inventory” of foreclosured houses and impending foreclosures, which some people estimate to be as high as 7 million units (vs. the 3.5 million that are currently on sale).
Sixth, rents are declining, as Americans take advantage of the tax credits and low interest rates to buy instead of rent. This temporarily improves demand for existing houses, but it doesn’t eliminate the overhang of housing supply. As rents fall, the price-to-rent ratio for houses rises, and renting becomes more attractive again. House prices then need to fall to bring the ratios back in line.
Seventh, the current “affordability” of houses will change fast if rates begin to rise. Houses are very affordable right now–if you have a solid job, lots of savings, and aren’t deeply underwater on your old house. If and when rates begin to rise, however, this will quickly make them less affordable.
The good news is that, after what we’ve been through, another 10%-15% decline will feel like a walk in the park. It does seem likely that the house price decline will resume in November and December, though. If so, it will be interesting to see what impact that has on the stock market and the rest of the economy.
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