Reasonably good news on residential real estate has of late prompted a kind of enthusiasm about housing prospects. It is good to see some improvement in sales and construction activity and these signs, among others, do suggest that the worst on housing has very likely passed. But too much enthusiasm is misplaced. If the free fall is over, much will prevent housing from acting as an economic growth engine for years to come. The economy will grow and the urgency surrounding home values and mortgages will gradually lift, but the best the sector is likely to offer the economy is neutrality.
Not every statistical release in December and January brought good news, but that was the general effect. Sales of existing homes, according to the National Association of Realtors, rose 5% in December alone, bringing them 15.2% above their lows of last July. Sales of new homes, according to the Commerce Department, though dipping slightly in December, still stood almost 6% above their summer lows, while the pace of new home construction at yearend stood almost 21% above its lows of last spring. Unsold inventories of new and existing homes fell to about six months’ supply at current sales rates, well down from the eight-plus months’ supply earlier in the year. Meanwhile rental rates climbed 2.5% over a year earlier, suggesting that markets were firming in this area as well.
Many of these improvements are a natural outgrowth of remarkably enhanced affordability. Prices of residential real estate have declined almost 35% from their highs, and mortgage rates have declined to decades’ low levels. Affordability overall is 40% better than in 2008 and the most attractive in 15 years. Credit standards remain too tight to generate the buying surge that would usually accompany such an affordability improvement, but the change has at least reversed the sales erosion of the last three years. Still, the legacy of that troubled time will weigh on housing for a lot longer yet.
A big part of that drag involves what is called the shadow inventory of unsold homes. These are houses destined for market but not yet counted as inventory. One component of this shadow includes homes held off the market by owners in the hopes of getting a higher price. Mostly on the high end of the price spectrum, these homes will boost existing inventories on the least improvement in pricing or as their owners finally reconcile themselves to the new reality. A second, larger component of this hidden inventory comprises homes eligible for foreclosure but on which lenders have so far failed to move, either because of complex paperwork or because lenders want to avoid glutting the market.
Gauging the size of this inventory, especially the first part, involves a lot of guesswork. But with mortgage delinquencies still running at close to 10.2% of all outstanding mortgages, and charge-offs—though down from the high of 2.7%, still close to 1.5%—the shadow inventory may well exceed the official inventories reported by Commerce and the National Association of Realtors. Conservatively, the combined shadow and revealed stock of unsold homes could then stand at over 18 months’ supply, even at today’s improved sales rates, and conceivably could verge on 24 months’ supply. No doubt this potential explains why residential real estate prices have remained weak despite the sales pickup, falling, according to the Case-Shiller Home Price Index for 20 metropolitan areas, at more than an 8% annual rate during the last half of 2011, a welcome break from the free fall of 2010 and the first half of 2011 but still an indicator of this weight on the market.
Since continued lender caution will prevent too much of a sales pickup, despite improved affordability, this constrained situation should last into 2014 at least and very possibly longer. Pricing promises to stabilize this year, but the hidden as well as reported inventory will cap any general price rise for an extended time while the flow to market of already built homes will likely limit any growth in new construction. The last housing bust, after the savings and loan collapse of the early 1980s, lasted five years before pricing and building activity took a substantive upturn. This event was more severe and should take longer to work out.
Milton Ezrati is senior economist and market strategist for Lord Abbett & Co. and an affiliate of the Center for the Study of Human Capital and Economic Growth at the State University of New York at Buffalo.