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The Housing Elevator: Going Up or Down?

September 21, 2010

by Robert Huebscher

Prices, in any given market, are driven by the number of units on the market relative to the number of buyers.

On that score, the news is dim.  John Burns, who runs a California-based real estate consulting service, made this point in a commentary published last week:

"Prices will decline, potentially significantly. Prices will decline because there is more than a one-year supply of homes on the market, and several bank servicing arms and REO managers [those who manage properties in foreclosure] have told us that they will drop price to get the loans and homes off their books. Only a quick economic recovery, or a government mandate to rent the homes out, can prevent further price declines."

Burns’ view is supported by the National Association of Realtors (NAR), which provides the data series that offers the best insights into the relationship between housing supply and demand – the “inventory” of unsold existing homes:

Inventory of Single Family Homes

The most recent data, as of July, showed that there were 3.35 million single-family existing homes on the market, representing 11.9 months of inventory, versus an average of 7.2 months since mid-1982, when the NAR began collecting data.  Looking more broadly at all existing homes, there were 12.5 months of inventory available as of July, nearly twice the historical average of 6.2 months since the data series began in 1999.

Demand has not been spurred by record low mortgage rates.  Buyers are not in the market.  The Mortgage Banking Association’s index of applications has not surged, despite low rates and the now-expired home buyer incentives.

The greater concern, though, comes from the seven million homes Grant cited as being in the foreclosure process.  Those homes, which Burns and others refer to as the “shadow” inventory, represent nearly twice the volume of existing homes currently on the market.  Even if new home construction ceased entirely (and it’s already pretty depressed), it will take years before existing inventory is reduced to historically average levels – absent significant price reductions.

Burns is at least partially right, in that a quick economic recovery could stabilize prices, but only to the extent that unemployment falls as a result.  A jobless recovery will not stem housing price declines.  Anyone without a job or fearful of losing their job will not be in the market to buy a home and, more likely, may contribute to the inventory of unsold homes, either through foreclosure or through a decision, as do many young people, to move in with their parents.

If you’re in the market for a home, be patient.  Prices are likely to come down even further, depending on the conditions in your local market.  Don’t extend this analysis to the broader economy, though, as the likelihood of a double-dip recession or a booming recovery may be independent of movements in housing prices.   With the growing disconnect between the economy and movement in the markets, this analysis says almost nothing about whether equities are headed up or down.