Here’s some great commentary from USAA’s interview with one of the top macro-economic analysts on the national real estate outlook. What’s important to note is that one must look at many indicators to have a solid grasp of the state of the national outlook, because only relying on one or two indicators may skew the picture, as was the case earlier this year with builder stocks, which rallied in the early summer before tumbling again in September.
Real Estate: News Still Too Mixed to Call a Bottom
This is our fourth in a series of interviews about the real estate market with Joseph F. Kalish, Senior Macro Strategist at Ned Davis Research, Inc.
USAA: Joe, characterize 2008 for us in terms of the real estate market.
Joe Kalish: We have a set of eight indicators that we’ve developed on the health of the real estate market. When we spoke in early February at least three of the eight were positive, and by early July we were seeing further signs of stabilization, giving us confidence that the market could find a bottom as early as the end of the year. Then, in September, the credit crisis took another leg down, with Fannie Mae and Freddie Mac going into government conservatorship, followed by a near-meltdown of the financial system. The hopeful signs of the early summer have all but faded, and now we see consumer sentiment just falling apart.
USAA: Let’s talk about the indicators that are most negative first.
Joe Kalish: The worst is the inventory-to-sales ratio, which in a balanced market should be six to seven months. We have more than nine months’ supply in existing homes and above 10 in new, with the weighted average about 9.5 months.
USAA: But hasn’t new home building virtually collapsed? Shouldn’t the inventory picture be better without that supply?
Joe Kalish: Yes, but we’re getting more inventory from foreclosures. The 9.5 months is a slight downtick within an upward trend dating back to 2005. Our real concern, and what makes us even more negative, is that there’s very likely a shadow inventory out there that wants to go on the market but doesn’t because the sellers won’t accept current prices. So the 9.5 months of supply probably understates the true inventory.
USAA: What other indicators are very negative?
Joe Kalish: The S&P Homebuilders Index, which is an index of homebuilders’ stock prices, tends to bottom three to five months before the housing market does. The Index actually rose nearly 50% from its January low before falling back and finding a new low as the housing crisis became a financial crisis. The stock market looks forward, and right now it’s telling us the real estate market isn’t good. Another negative indicator is the Mortgage Bankers Association’s index of mortgage applications for home purchases, which recently fell to an eight-year low. If people are interested in buying a home, they first need to fill out a mortgage application.
USAA: So are any of Ned Davis’ indicators positive at this point?
Joe Kalish: Yes, two important ones: affordability and new building activity. New building permits and housing starts have had a dramatic decline, and are now at about half of their 10-year average. This rate of decline is consistent with the cyclical troughs in housing that we saw in 1975, 1980, 1982 and 1991. If we can put a lid on foreclosures, the lack of new building will help the inventory situation. In terms of affordability, remember that there are three factors: prices, mortgage interest rates and personal income. The fact that prices are down while mortgage interest rates are down slightly and income growth remains positive gives us the best affordability picture we’ve had since February 2003. The problem, of course, is what could happen to incomes if we are indeed in what may be a prolonged recession.
USAA: What indicators are neutral?
Joe Kalish: We see 30-year fixed rate mortgages below 6% as being positive, while rates above 6.75% are negative. Lately we’ve been closer to 6% and have on occasion broken through it. We’d really like to see rates get down to the 5% to 5.5% range. Remember that mortgage rates have been stable even though Treasury rates have gone way down, creating a wide spread. If the credit markets continue to unfreeze, we could see the spread with Treasuries come down, which would help affordability. Another neutral indicator is the rate of decline in home sales. Yes, we did see a slight uptick in sales in September, but really, they’ve been in a fairly narrow range all year long. Overall, sales have been declining for three years, and it looks like the rate of decline is stabilizing. You have to stop going down before you can go up.
USAA: What’s the bottom line, Joe? Are we anywhere near out of this thing?
Joe Kalish: We have not hit bottom, and probably won’t see one until the first quarter of 2009 at the earliest. We believe that while the government has taken some steps, they really need to do more to get under the problem, either by stimulating housing demand and/or slowing the foreclosure process. They have to arrest the decline in prices Statistics now show that 16% of homeowners are underwater in their mortgages.
USAA: What kinds of actions are you calling for?
Joe Kalish: Perhaps the government buys houses or provides more capital through Fannie Mae and Freddie Mac. The government could keep potentially foreclosed upon people in their houses by taking an equity stake and sharing in future appreciation. A big part of the problem is that much of the new supply is empty; no one is living in it. So maybe the government buys it out of foreclosure, holds it and sells it later, or turns it into government housing. We expect President-elect Obama will come out with something fairly bold because so many of the problems in the economy – and there are plenty of them – stem from the prolonged fall in house prices.
