Home Prices to Drop Further, But Recovery May Be Ahead

It's still too early to tell exactly when this housing slump is going to end, with house prices just beginning to soften, mortgages at risk of defaulting beginning to hit reset dates and lending standards that are starting to tighten, according to researchers at the Harvard University's Joint Center for Housing Studies.
By: Amy Hoak: The Wall Street Journal Online
One thing's for sure: Before the sun shines again on the housing industry, a good amount of excess inventory will have to be sold, according to the center's "State of the Nation's Housing" report, released Monday. Employment growth will play a role as well in the recovery, as will interest rates, the report said.

In a telephone interview, Nicolas P. Retsinas, director of the center, said the housing industry was going through a "bumpy landing." Yet despite the severe contractions in home sales and starts seen during this correction, home prices have flattened but haven't crashed, and as a result, "we're not seeing a return to affordability," he said.

"If you were an economist, you would think that prices would have fallen precipitously," Retsinas said. Instead, home-price gains have been near flat, relative to the high appreciation rates seen over the first half of the decade - which in many markets amounted to home price gains of 60% or more during those five years, he said.

According to the report, median house prices increased at least 10% in 2006 in 23 of 149 metropolitan areas studied; prices fell in 34 of the metros. Of the 11 metros that had declines of greater than 3%, nine were in economically depressed areas in the Midwest - suggesting local economic trends had a greater influence on markets than national trends.

Home prices should slide further, however, according to the report. As for home sales figures, Retsinas said sales of existing homes could bottom out and begin to recover by the end of this year, with the new-home market following in 2008. The Mortgage Bankers Association also expects the market to hit its bottom at the end of the year, gradually improving from there as homes become more affordable.

And after markets burn through excess inventories, demand for new and remodeled housing will be lifted to new highs, the report predicts. In fact, if it weren't for some of the population trends - including the influx of immigrants into the country - the slowdown could have been much worse, said Moises Loza, executive director of the Housing Assistance Council.

The correction

Records were set for home sales, single-family starts and house-price appreciation in 2005. The next year ushered in contrasting numbers, according to the report.

Total home sales fell 10%, starts fell 13% and house-price appreciation slowed to a few percentage points in 2006. Between the end of 2005 and the end of 2006, the number of vacant homes on the market jumped more than 500,000 units, the report noted -- and that figure might even understate the overhang because some homes including seasonal or occasional-use homes might be brought back on the market when conditions improve.

Falling interest rates and unprecedented house-price appreciation started the boom, inspiring more Americans to become homeowners and more investors to buy with the intention of flipping their properties to make a quick profit. Builders tried to meet the demand, but lag time between predevelopment work and completions brought about bidding wars. "Affordability" products with lower initial payments helped more people jump into homeownership.

The study pegs the turning point of this boom in late 2005, when rising mortgage interest rates and higher home prices started forcing out buyers. Indeed, affordability remains an issue for many low- and middle-income Americans, the report pointed out, calling for a combination of structural and public policy shifts to address it.

"In just one year the number of households spending more than half their income on housing increased a startling 1.2 million to 17 million in 2005," Rachel Drew, research analyst for Harvard's Joint Center of Housing Studies, said in a news release.

Now, too, stricter standards of some lenders are having an effect on the ability of some would-be homeowners to get into the market, said Jonathan Kempner, CEO of the Mortgage Bankers Association. While products such as subprime and Alt-A loans were "controversial for some people," they did address the affordability issue for many Americans.

"Some people will have to wait longer on the margin," delaying their home buying, he said. Already, evidence of that wait is showing up in new and existing home sales, he added.

A look ahead

The report also points out the persistence of a wealth effect in 2006, which kept Americans borrowing more against their equity to support their spending. The amount of home equity cashed out set a record last year, as the volume of refinances dropped. The effect of the housing slowdown on consumer and remodeling spending hasn't been seen yet, according to the study.

Look farther ahead, however, and the outlook for housing is bullish.

For one, the baby boomers will continue to move into the age where second-home ownership is at a high. Evidence of this demographic trend has already been seen, with the sale of vacation homes hitting a record in 2006, according to the National Association of Realtors. Read more.

At the same time, children of the baby boomers will continue to move into the ranks of homeownership, boosting housing demand.

In addition, immigration is expected to hit a record 12 million between 2005 and 2015.

The upcoming growth in new households puts estimates for new-home demand at about 19.5 million units from 2005 to 2014, surpassing the 18.1 million units added between 1995 and 2004, according to the report.