In recent weeks, we were in several meetings where analysts made the bullish argument that affordability had improved to the point where home prices could fall no further. While affordability has indeed returned to normal levels (as shown by the 5.2 reading on our Housing Cycle Barometer below (click here for an explanation of the barometer), we beg to differ.
First of all, affordability swings dramatically with interest rate fluctuations, as evidenced by the drop last year that occurred when home prices fell $32,000 while rates fell 0.7 percent. Rates have risen since then and prices reported by the National Association of Realtors have risen (clearly some statistical anomaly as we are purchasing closing data for almost 200 counties and the trend is very different). The bottom line is that rate changes impact affordability significantly, and changes in underwriting criteria are not considered.
Secondly, stable home prices occur when demand and supply are in balance and homes are affordable to most home buyers. In the following map, the blue areas are affordable in comparison to their own history, and the red areas are expensive in comparison to their own history (many of these markets reached a nine on our "Housing Cycle Barometer" (HCB) earlier this decade:
All told, U.S. affordability may be average, but I challenge you to find a market where demand and supply are in balance.
We are in the process of forecasting demand, supply and affordability for the 100-plus markets we track. We are not projecting price increases in any market.
Economic Growth: C-
The economic growth indicators continued to perform at below-average levels. The employment sector weakened this month, recording the second straight month of year-over-year losses in non-farm payroll jobs. The unemployment rate rose again to 5.7 percent in July, which is just above its historical average. Second-quarter gross domestic product (GDP) growth rose slightly from the previous quarter, but remained slow at a 1.9 percent annual rate. Worker productivity fell in the second quarter to 2.2 percent year-over-year and retail sales growth improved to 3 percent year-over-year, while personal income growth declined slightly to 5.7 percent. Inflation continues to rise, with the Full Consumer Price Index (CPI) now at 5 percent and the Core CPI (all items less food and energy) reaching 2.4 percent.
Leading Indicators: D
The leading indicators continued to perform poorly, which suggests that economic conditions are not likely to improve in the near future. The stock market returns were essentially flat for the month of July but continued to exhibit year-over-year declines of 9 percent to 14 percent. Home builders’ stocks improved slightly from the previous month, but also continued to fall year-over-year, evidenced by a 38 percent annualized drop in the Standard & Poor’s Homebuilding Index. Oil prices eased slightly in July but continue to hover near record highs against the weak dollar, the impact of which is being felt in consumers’ wallets. The Leading Economic Index fell and remains negative year over year, suggesting further weakness in the economy. The Purchasing Managers Index also fell slightly, and a declining Non-Manufacturing Index suggests contraction in this sector. Residential investment continues to decrease as a percentage of overall GDP, falling to 3.5 percent, which is its lowest share in 16-plus years.
Mortgage Rates: B
Despite an increase in mortgage rates during the month of July, rates still remain relatively low by historical standards. The 30-year fixed rate rose to 6.52 percent by month-end, while the one-year adjustable rate rose to 5.27 percent. The spread of 125 basis points was the highest in nearly three years. The Fed Funds rate remained at 2 percent after the Federal Reserve resolved to hold rates flat. The Mortgage Bankers Association reported that the share of adjustable-rate mortgage (ARM) applications continued to decrease to a very low 7.3 percent of all loans originated during the last week of July. The performance of subprime loans issued in the first half of 2006 continues to weaken, as measured by the ABX 06-2 BBB- series index, which has declined 88 percent in the last year.
Consumer Behavior: D
While many of the components of consumer behavior improved in July, they represented only slight improvements from very poor levels. Consumer confidence rose to 51.9 for the month, improving only slightly from a 15-year low. The University of Michigan’s Consumer Sentiment Index rose in July after posting its lowest value in 28 years during the previous month. The Consumer Comfort Index also improved slightly, but remains near its historical low. While the dollar volume of equity per owned home is quite high, the debt percentage of home value (LTV) is currently at its worst level in history. Revolving consumer credit outstanding continues to grow, increasing at an annual rate of 6.2 percent.
Existing (Resale) Home Market: D
The existing-home market remained weak with few signs of improvement. The annualized existing-home sales volume dropped below 4.9 million transactions, and is down 16 percent in the last year and down 33 percent from the peak, but the improvement in NAR’s Pending Home Sales Index suggests sales activity may increase in the short term. The decline in sales activity and a slight increase in the inventory of homes for sale to nearly 4.5 million homes has pushed the supply level to 11.1 months of inventory. Prices in the resale market have fallen nearly 7 percent year-over-year to a median of $213,800, according to NAR.
New-Home Market: F
The new-home market was a mixed bag this month, with improvements in inventory levels but still weak overall conditions. The new-home sales volume continued to fall, dropping to 530,000 annual transactions, which is 33 percent below the sales volume one year ago and 63 percent below peak activity. Builders continued to report weak conditions, with the Housing Market Index reaching an all-time low of 16. New-home prices continue to record year-over-year depreciation. On a positive note, the level of unsold new homes fell to 10 months of supply, including a decline to four months of unsold completed new homes.
Housing Supply: D-
The supply of housing improved slightly, earning a "D-" this month, largely due to increased volumes in the multifamily market brought on by forthcoming changes in construction codes in the Northeast. The annual volume of new-home completions rose to 1.17 million but remains comparable to levels of the early 1990s. Although single-family starts declined in June, total starts rose slightly from the previous month to 1.07 million units due to a significant increase in multifamily starts. Permit activity witnessed a similar trend, with multifamily permits rising nearly 40 percent for the prior month to 478,000 units as annual single-family permit volume fell 3.5 percent sequentially to 613,000 permits issued in the last year. Year-over-year, total permit activity has fallen 24 percent.
John Burns is the founder of Real Estate Consulting in Irvine, Calif., which monitors changes in real estate market conditions and provides consulting services, including strategic planning, market research and financial analysis. He can be reached at jbrec@realestateconsulting.com.
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