By Carole Hawkins, [email protected]
With economic recovery also comes a measure of fear of a slide backwards or a double-dip recession.
But in the case of today’s housing recovery, the danger of dips appears to be in the past.
A Federal Reserve Bank economist, analyzing national housing data in three different ways, showed the long-awaited housing recovery has finally gained traction.
John Duca is vice president and associate director of research at the Federal Reserve Bank of Dallas. He spoke on understanding the residential real estate recovery at the Bergstrom Center for Real Estate Studies’ February Trends and Strategies Conference.
In short, too many homes were built during the housing boom, Duca said. Before the 2000s price run up, home production reliably tracked whatever was happening to incomes and interest rates.
Then, U.S. fiscal policy and subprime lending changed the game.
“A lot of times in capitalism, what happens in panics is – in good times, people try something new,” he said.
Normally the United States needs to build 1 million new homes a year in order to replace demolished homes and to allow for population growth.
In the 2000s “way too many” houses were built, Duca said, and the only way to sustain that growth would have been through a permanent rise in the homeownership rate.
Subprime lending and federal policies regulating banks did that - temporarily. They increased homeownership from 65 to 69 percent over a five-year period.
It seems small. But at any given time, only 5 percent of homes are for sale, so even a 1 percent or 2 percent increase in homeowners entering the housing market puts serious pressure on new construction.
The loosening of credit and increased demand for homes spurred a construction boom that would not last.
That’s because the credit conditions underlying the subprime loans were shaky.
As long as home prices rose, people in subprime loans – loans with little money down - could refinance or sell their houses at a higher price if their finances fell into trouble. The good times masked their credit problems. After home prices peaked, they couldn’t sell or refinance, and the loans started to go bad.
Investors who’d financed subprime mortgages took the hit.
“People realized a lot of these investment-grade rated private mortgage-backed securities that had funded the subprime stuff - these were not investment grade. A lot of them were junk,” Duca said.
Investment dried up, home lending dried up.
Home construction declined 75 percent, the lowest drop since the 1960s, when the federal government first began collecting data, Duca said. Homeownership rates fell back to 65 percent.
The housing market bottomed in 2011 and has since improved.
“So, is the national recovery real?” Duca said. “We’ve seen the recovery in house prices, but let’s dig a little deeper.”
Duca checked three other measures to test the temperature of the housing market.
Housing inventory has tightened.
In a balanced market there will be a six-month supply of existing homes for sale, and price changes will match inflation, Duca said.
In a tight market, months of supply go down and prices –– adjusted for inflation –– go up proportionately.
During the mid-2000s the supply of homes was at four months –– meaning there was high demand compared to inventory.
During the bust there was more than a six-month supply of homes for five out of six years.
The turning point came in 2011. By early 2012 the supply of for-sale homes fell below six months. Real prices rose 4 to 5 percent in 2012 and in 2013.
Today for-sale inventory sits at five months. The tightened market means home prices will continue to rise, Duca said.
One way home shoppers decide whether buying is a good deal is by comparing home prices to rent.
But, they are willing to pay a higher price compared to rent when interest rates are low and home prices are going up, because the costs to own are lowered and they’ll benefit down the road from the home’s appreciation.
Economists follow the price-to-rent ratio to measure how bullish shoppers are on buying versus renting.
During the housing boom, price-to-rent ratios soared 40 percent.
During the bust, they returned to a normal range. They rose modestly during the housing recovery.
The return to a normal ratio shows a stable recovery, Duca said.
In normal times between 60 percent and 70 percent of homes sold are affordable to median-income households, Duca said.
Affordability is tracked by the National Association of Home Builders/Wells Fargo Housing Opportunity Index. It assumes owners are borrowing at the prime mortgage rate with 10 percent down and getting a mortgage payment that is no more than 28 percent of their monthly income.
During the housing boom, affordability plunged to 40 percent. In the bust, for those who could qualify for mortgages and had the courage to buy, the affordability rate soared to above 70 percent.
Then in 2013 and 2014 rising home prices returned affordability levels experienced in the mid- to late 1990s, back to a normal range.