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April 2009 Quarterly Forecast
> The Housing Market Stabilization is Near
Levan Efremidze, UCLA Anderson Forecast
Housing is finally showing green shoots in the East Bay. While the prices have now dropped by more than 28% through December 2008 since the peak of June 2006, according to the fairly conservative OFHEO price index of comparable home sales, California Association of Realtors reported monthly price increases in some California markets for the month of March. The rise for the Bay Area was 1.2%. There were more regions with positive monthly change in California than with negative. DataQuick Services, another real estate research firm, reports a 1.6% increase in Contra Costa County and a -3.4% fall in Alameda County median home prices from February to March 2009. Is housing ready to bottom out? In our previous report we examined affordability of the housing in East Bay and found that a median income family could afford a median home with the current interest rates, assuming that they could come up with the down payment. We also found the supply side of the market was still putting pressure on the prices, with a high inventory of homes for sale and rising foreclosures. In this section we re-examine some of the fundamentals of housing and assess whether the housing recovery is close to a reality.
Figure 11.
Sources: FHFA, UCLA Anderson Forecast
When we look at home buyers – households, they act as both investors and as owner-occupiers. Some individuals are buying homes as pure investors so they can earn a return on their investment through the rental income stream and future price appreciation. Other buyers are occupiers as well as investors. At present, declining home prices produce conflicting incentives for buyers. Lower prices make housing more attractive and affordable on the one hand, while on the other hand a fear of further price falls keeps some buyers on the side lines. Moreover, the first time home buyer federal tax credit in the amount of $8,000 is creating the urgency in the market as it will expire on December 1, 2009. As we see it in the market at present, home sales are rising and could soon overpower downward price pressures.
Let’s look at the Price/Rental ratio to see how attractive the home prices are from the historical investment perspective. The assumption here is that the same incentives that generated the interest in home buying historically will work again when this indicator hits the historical average. The P/R (Price/Rent) ratio is a simplified measure of the value of a home for investor-buyers. Rents are correlated with earnings and therefore the higher the P/R ratio the lower the rate of return to be earned from purchasing the home. Growth rate of rents and market interest rates don’t enter the measure directly, but are kept in mind during the analysis. If it is expected that rental rates will rise in the future, home appreciation rates will remain the same or increase, and costs of ownership are unchanged - investors today would be willing to pay more for the higher expected stream of rental income. Rents normally rise as you come out of a recession.
The East Bay P/R ratio is calculated as the ratio of the median price of homes (OFHEO Index) divided by the shelter component of the CPI. Shelter CPI is used as a proxy for annual rental values. In the East Bay the P/R ratio began an explosive rise during the easy money period of 2003-2006, but after hitting the peak of 2.7 in 2006, the ratio plummeted to the level of 1.84, and is getting close to the 1975-2001 historical average of 1.34. With the current rate of decline it will soon reach the historical average, if prices fall a little more. Also, judging from Figure 12 the P/R ratio fell slightly below the average during the previous two recessions before bottoming out.
Figure 12.
Sources: OFHEO, BLS, UCLA Anderson Forecast
On the supply side, the market is slowly but surely absorbing excess inventory. The inventory of the unsold homes, measured in how many months would it take to sell them at a current pace of monthly sales, has been declining slowly for several months due to record price declines. Inventory now stands at 5 months for the whole of California. Considering that it was above 12 a year ago, it is a huge improvement.
Figure 13.
Sources: UCLA Anderson Forecast.
Monthly residential permits, another supply side factor which predicts the future supply of homes, are still very low from an historical perspective, even when compared to the “pre-housing bubble,” 1990s average. The February and March improvement from the record low January can not be interpreted as a trend yet. Developers are very likely waiting to see the price stability for a few months.
Given the glimpses of the price improvements in some markets of California, including Contra Costa County, substantial gains in housing affordability and the reversion of the other housing fundamentals to their typical values, we confirm that housing is on track with our previous forecast and is likely to start a recovery in the fall of this year. Commercial real estate is not covered in this report, but we will examine it in the next report when we have the results of our next commercial real estate survey in May.
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The Near-Term East Bay Forecast"
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