Do We Know If the Housing Market Has Hit Bottom?

Are we there yet? There is some evidence available right now that suggests the housing market is at or very close to bottoming out. People who are seriously considering buying a house need to know if this is true, or just more speculation. Just as with stocks, there is no certain way to know if prices have indeed gone down as far as they are going to and then will rise, but guiding analysis are available to help.

While it is true that, so far as the economy is concerned, rising new home sales and housing starts (which arriving at the bottom of those markets would herald) are more significant, buyers themselves need also to know if the home price market has bottomed. There are several key factors involved in their decisions whether to buy or not, and the economy is close to the top of the list for most people alongside of house prices. Buyers must feel sure their future economic well being will allow them to make this most expensive of purchases. The prudent homebuyer should look at the economy first, and then at prices.

Potential home buyers should ask themselves – seriously – why and what they want to buy. Is it for an investment? Do they want to own and stop renting? Are they okay with buying a foreclosed (i.e., distressed) property?

House Price Indices

Three real house price indexes – CoreLogic HPI, Case-Shiller Composite 20, and the Case-Shiller National index – all show prices (adjusted for inflation) are about the same as they were in January 2000. The peaks were in early 2006, with prices between 65 and 80 percent higher than now. Investors who bought properties in 2000 would on average sell them now for much the same prices, assuming improvements were not significant. Of course, these same investors could have made a sizable profit selling those houses in 2006, but who knew? No one now knows for certain whether prices will soon start back up. The price market typically lags the new homes and starts market, and it’s not yet certain the market has reached its low point.

Purchase or Rent?

If the motivation is to own a home rather than renting, price-compared-to-rent could be paramount in the decision. An astute potential buyer would estimate his/her expected ‘value’ from owning relative to rental payments and freedom from maintenance costs. The former, of course, should be higher than the latter if the decision is to buy.

In a Federal Reserve Bank of San Francisco Economic Letter in October 2004, ‘House Prices and Fundamental Value’, economists John Krainer and Chishen Wei developed a ‘price-rent ratio’. This statistic divides the OFHEO house price index by the Owners’ Equivalent Rent (provided by the BLS), and the ratio has followed the price index very closely since January 1999, even at its peak. If we use price to estimate value from homeowning, then that value compared to renting rose dramatically in the mid 2000s, along with the price ‘bubble’, partially explaining why prices rose so fast. That the ratio is now closer to normal and signifies a much weaker demand for houses, partly due to lingering uncertainty about the economy. Also we see higher preferences for renting, which is indicated by current higher levels of apartment construction. This trend will likely change as the economy moves farther out of recession, but again, the question is when?

Finally, back to supply and demand: home prices are in part dependent on inventories. The supply of properties typically increases during the first half of the year, and nowadays this is much exacerbated by the number of foreclosed homes available, both of which should push prices down or keep them from rising much. While this large inventory of ‘distressed properties’ might be somewhat mitigated by the upcoming settlements of class action mortgage lawsuits, the fact is that these foreclosed homes are cheaper, and along with the usual increase of homes on sale in the spring, there is no concrete reason to assume that the price bottom is at hand. Once prices go back up and stay up for a while, then we will know when the market bottom was.

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To contact the editor responsible for this story: Damien Hoffman at editors@wallstcheatsheet.com