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Research Facts & Figures
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April 2010 Quarterly Forecast
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Real Estate
THE HOUSING MARKET: A BOTTOM BUT NO ASCENT
Another stalled sector in the East Bay economy is found in the housing markets. It is the beginning of the fifth year since housing prices and home sales peaked in the U.S. Builders were a little slow to respond to falling demand, but by the beginning of 2007 applications for new residential building permits in the East Bay had fallen off a cliff. Over the past year residential construction has been lower than at any time during the last three housing cycles. Picking a turning point in residential construction is always a risky proposition, and the data are not yet admitting of any signal that East Bay housing is in the throes of an incipient recovery. Hanging over this market is the potential for reductions in government employment in the near term. Nevertheless, there are no signs that the housing market will worsen in the coming months and conditions may be ripe for the opposite to occur.
The 2004-2006 exuberance in housing markets drove prices to unsustainable heights above fundamental norms. Housing is an investment as well as a purchase of shelter and therefore must carry a positive return. After adjusting for inflation, the historical return in the East Bay (1975-1995) was about 0.6% per quarter. If the return is calculated through 2002 it is slightly higher. Sustained appreciation above those returns is only possible if immigration adds substantial incremental demand to the housing market. The 2004-2006 incremental demand was not from a larger population, but from speculative purchases based on anticipated continued appreciation. The subsequent wave of foreclosures resulted in an unprecedented decline in home prices in the East Bay. This leads us to our first sign of a turn in the market. If one invested in a home in the East Bay in 1975 and sold it today, the home would have earned almost exactly the 1975-1995 average rate of return and less than the 1975-2002 average rate of return. In other words, all of the excess in price appreciation from the speculative bubble has now been wrung out of the market.
On the down side home sales are no longer picking up. After an initial boost driven by government incentives home sales have fallen back to very low levels. While sales are still above those of late 2008, they are not robust by any means. Does this mean more price depreciation? The Case / Shiller S&P index of home prices for the entire San Francisco MSA has been rising steadily over the last four months and prices as measured by the FHFA index have stabilized and are not falling. So pricing data indicate a bottom, but weak sales suggest it is not a very solid bottom.
What is encouraging though is the reduction in inventory. There are various estimates of inventory available, but the best estimates all suggest that inventories in the coastal areas of California, including the Bay Area are now at very low levels. So, combined with low inventories, the existence of some buyers in the market, little new construction coming onto the market, and prices which now make the East Bay housing affordable once again all increase the chance of a near term turn in real estate and residential construction. These are the precursors to builders being able to plan new construction and thus a recovery in residential construction.
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