Home Prices Will Recover Very Slowly

04/23/2009 12:12 pm EST


David Wyss

Adjunct Professor, Brown University

David Wyss, chief economist of Standard & Poor’s, says home prices will continue to fall, but inventories are gradually being reduced and affordability improves.

Sharply lower home prices and homeowners’ debt difficulties helped push the entire US economy into an extended recession. But an in-depth look at the data on housing starts, sales, inventories, and prices, especially by region, shows signs that the housing market is stabilizing.

We expect starts to recover slowly after reaching a nadir this year of 560,000—the weakest since World War II. This recovery should take 2010 starts to 860,000, but that’s still below last year’s 900,000 and a far cry from the 2005 peak level of 2.1 million.

Combined sales for new and existing homes this year will likely level off at around 4.2 million and remain near that rate through 2010 before accelerating to 5.0 million in 2011.

Still, in our view, recovery will be slow for a variety of reasons. House prices are now down 29% from their July 2006 peak, according to the S&P/Case-Shiller house price index. According to First American CoreLogic, 8.3 million mortgages, or 20% of all mortgages, were under water (mortgage value exceeding home value) at the end of 2008. Defaults on both mortgages and other consumer debt are at record highs, contributing to the problems at financial institutions.

Even though we believe we’re near a bottom in starts and sales, we expect prices to drop for another year, falling an additional 17% and bringing the total decline to 37% from the July 2006 peak in the S&P/Case-Shiller index.

During the boom years—roughly 2003 through 2006—we estimate that the US built about two million more houses than the demographics demanded. The trend level of housing starts is about 1.6 million units, [but] the current level of starts probably eliminates somewhat fewer than 1.0 million units a year.

We see some encouraging signs that sales may stabilize. The improvement is bolstered by the large number of distressed properties (defined as properties in foreclosure or being sold as “short sales,” below the value of the mortgage), which accounted for 45% of all fourth-quarter sales, according to the National Association of Realtors.

The main reason we thought home prices were too high back in 2005 was the rise in the ratio of average home price to average income. Historically, that ratio averaged 2.7; in late 2005, it peaked at 3.4. The drop in the average home price since 2006 has cut the ratio back to 2.6 at the end of 2008, below its historical average. The ratio now suggests that home prices are back to normal.

The excess inventory of unsold homes makes it likely that prices will continue to decline for another year. During the boom years, the US built too many houses at too high a price. To restore equilibrium, we believe the cost of homes must come down to levels consistent with incomes and the US must build far fewer homes.

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