The dire headlines coming fast and furious in the
financial and popular press suggest that the housing crisis is
intensifying. Yet it is very likely that April 2008 will mark the
bottom of the U.S. housing market. Yes, the housing market is bottoming
How can this be? For starters, a bottom does not mean
that prices are about to return to the heady days of 2005. That
probably won’t happen for another 15 years. It just means that the
trend is no longer getting worse, which is the critical factor.
Most people forget that the current housing bust is
nearly three years old. Home sales peaked in July 2005. New home sales
are down a staggering 63% from peak levels of 1.4 million. Housing
starts have fallen more than 50% and, adjusted for population growth,
are back to the trough levels of 1982.
Furthermore, residential construction is close to
15-year lows at 3.8% of GDP; by the fourth quarter of this year, it
will probably hit the lowest level ever. So what’s going to stop the
housing decline? Very simply, the same thing that caused the bust:
The boom made housing unaffordable for many American
families, especially first-time home buyers. During the 1990s and early
2000s, it took 19% of average monthly income to service a conforming
mortgage on the average home purchased. By 2005 and 2006, it was
absorbing 25% of monthly income. For first time buyers, it went from
29% of income to 37%. That just proved to be too much.
Prices got so high that people who intended to
actually live in the houses they purchased (as opposed to speculators)
stopped buying. This caused the bubble to burst.
Since then, house prices have fallen 10%-15%, while
incomes have kept growing (albeit more slowly recently) and mortgage
rates have come down 70 basis points from their highs. As a result, it
now takes 19% of monthly income for the average home buyer, and 31% of
monthly income for the first-time home buyer, to purchase a house. In
other words, homes on average are back to being as affordable as during
the best of times in the 1990s. Numerous households that had been
priced out of the market can now afford to get in.
The next question is: Even if home sales pick up, how
can home prices stop falling with so many houses vacant and unsold? The
flip but true answer: because they always do.