Daily Finance offers a very interesting perspective on housing values. The point of the article is that new homes have historically averaged around 4X income. Also, that in the last deep recession they dipped to 3.5X value. I believe this article bears serious consideration. I also would warn that the last deep recession was coupled with extraordinarily high interest rates. Without this factor, 3.5X seems an unlike end result. Nevertheless, ignoring history is risky business.
When will housing finally hit bottom? Pick a year, and you can find an analyst’s opinion to support your guess. One respected housing expert sees a bottom in six months, while other equally experienced observers see a bottom in 2013, followed by a decade of slow improvement.
Though there is no reliable guide to the future, data from the past at least offers a range of possibilities. As imperfect as the past may be as predictor of the future — history tends to echo, rather than repeat — it does alert us to cycles and patterns that may play out going forward.
Why is this so? For two reasons: Human psychology reliably swings between euphoria and caution in the marketplace, and the business cycle of rising debt and overexpansion followed by contraction of credit and retrenching is a regular feature of free markets.
Income Leads the Way
One standard way of assessing the underlying valuation of housing is to compare it with income. When homes are soaring in value, they rise above the historical average of four times median household income. When houses fall in value, they dip to 3.5 times median household income.
The ratio accurately reflects peaks and valleys in residential real estate: Housing prices rose to a peak in the late 1970s and then fell sharply in the deep 1981-83 recession. The resurgent economy boosted prices for seven years, leading to another peak in valuations in 1990.
For various macroeconomic reasons, housing then stagnated for about a decade, drifting below the historic mean of four times income. These factors included the relative balance of supply and demand between home buyers and sellers, and the greater attractiveness of stocks and bonds to investors in the 1990s.
We all know the story of the Great Housing Bubble — low interest rates, disavowal of risk management, subprime loans to unqualified buyers and investor wariness after the dot-com stock market crash all led to a massive sustained surge in home buying.
In the early 1990s, home sales averaged about 4 million a year. By the mid-2000s, that number had nearly doubled to 7 million sales a year.
This imbalance between supply (limited) and demand (rising due to the influx of marginally qualified buyers and investors) led to seven years of skyrocketing valuations. But nothing goes up forever, and the global financial crisis ended the housing bubble’s seemingly unstoppable ascent.
The Fed Takes Over
Once the Federal Reserve and federal government finally acknowledged that housing prices were in a recessionary free-fall, the Fed stepped in to maintain superlow mortgage rates by purchasing $1 trillion in mortgages, and government agencies offered a slew of programs aimed at stabilizing the housing market and home prices.
As the chart reveals, these unprecedented efforts have provided a modest stabilization in valuations. But the limits of government intervention are painfully clear: According to the Treasury Department, about half of the borrowers who had mortgage modifications done in 2009 were behind in payments by the first quarter of 2010.
The fundamental headwinds to any sustained rise in home values are substantial. Foreclosures have risen for the ninth month in a row, even as housing inventory continues to rise. (I first reported on the bulging foreclosure pipeline back in August of 2009. More recently, I reported on the worrying numbers behind underwater homeowners.)
Other commentators have also noted the fundamental drag presented by the excess supply of existing housing units and the huge number of homeowners with negative equity (i.e., the mortgage exceeds the market value of the house).
Indeed, some analysts see a second leg down in housing prices as inevitable. There’s nothing fancy or complicated about the reason: When supply exceeds demand, prices fall until a new equilibrium is reached
So When’s the Bottom?
At this point, the guessing game moves from “when will housing bottom?” to “how much further will housing decline?” Some analysts are staking out future drops in the neighborhood of 5% to 8%.
Two interesting features in the chart above suggest targets for both the housing bottom and the eventual low point in valuations. Bubbles tend to rise and fall in symmetry, meaning that a bubble that took seven years to reach its apex typically takes about the same period to time to retrace to its starting point.
By that reckoning, the housing bubble, which took off in 2001 and ended in 2007, will need about seven years to complete the retracement to historical valuations. That would put the bottom in the 2013-14 time frame.
As for valuations, market-watchers have long noted that “it’s different this time” is a remarkably inaccurate basis for valuing anything. Thus, we can look to the last deep recession in 1981-83 for some clues about where housing valuations may be heading — to about 3.5 times median household income.
This ratio of income to home prices is useful because it follows regional variations: Higher-income areas will have higher home prices, but the ratio will likely be about the same across the nation.
“It’s different this time” has a close and equally inaccurate cousin: “it can’t happen here.” But of course it can.Those counting on a timely resurgence in home valuations ignore the fundamentals of supply and demand at their own peril.
See full article from DailyFinance: http://srph.it/9uXjhX
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