Will Home Prices Fall Again?

The question I'm hearing most often at the moment is, "Do you think home prices will fall again?" My answer is, not unless the job market takes another dive. Take a look at the chart below, which shows the Case Shiller home price index and the unemployment rate for the Bay Area.

The current recession is unusual because it was brought on by falling home prices. Financial institutions and households both were highly leveraged at the peak of the housing market. As a result, their balance sheets suffered serious damage when home prices fell. Economic demand naturally fell, leading to the current recession. (As you can see from the chart, home prices began falling rapidly before unemployment started climbing. That's consistent with the idea that falling home prices caused the recession.)

That's not the normal pattern. Normally, job losses lead to falling home prices, as in the last recession. When the job market stabilizes, home prices tend to stabilize as well. That's what happened in the last recession and it appears to be happening again. The job market stabilized around June of 2009 and since then, Bay Area home prices have increased by roughly 15%.

I wouldn't bet on continued price increases, but as long as the unemployment rate holds steady, my guess is that home prices won't fall appreciably from here.

Note: I didn't have time to make this case as strongly as I'd like. I'll have more to say about it soon.

New Home Sales Hit Record Low, Builder Confidence Suffers

Sales of new single family homes fell to 276,000 units in July, on a seasonally adjusted annual basis. That's the lowest sales total on record, going back to 1963.

Sales in the west region came in at 44,000 units in July, on a seasonally adjusted annual basis. That's also a record low, going back to 1973. Sales had been improving until the end of April, when the home buyer tax credit expired.

Note: Sales of new homes are recorded when contracts are signed. For existing homes, however, sales are recorded when transactions close. That's why existing home sales fell only modestly in May (following the April 30 expiration of the tax credit), while new home sales fell abruptly.

Not surprisingly, builder confidence is suffering. After hitting a record low of 8 in January 2009, the NAHB Housing Market Index had risen as high as 22 in May 2010. The index has fallen back sharply since then, however, to it's current level of 13.

Evidently, builders' hopes were buoyed by tax-credit-induced sales. Did they not see the end of the tax credit coming?

Expiration of Tax Credit Hits Bay Area Housing Market

The National Association of Realtors announced yesterday that existing home sales were 27% lower in July than they had been in the prior month. The annualized sales rate of 3.83 million units was the lowest since the NAR began keeping records in 1999.

Sales had been rising rapidly as the April 30 expiration date for the home buyer tax credit approached. The subsequent drop-off in sales was therefore widely anticipated. (The same pattern was observed with the original home buyer tax credit, which expired on November 30, 2009.) Still, the scale of the decline came as a surprise. In a survey of economists by Bloomberg News, nobody had predicted such a large decline.

Housing is far more expensive in San Francisco than in other parts of the country. Consequently, the tax credit might have been expected to have a relatively small impact on demand. Surprisingly, however, home sales fell almost as much in the City as they did in other regions. Between June and July of 2010, home sales fell roughly 21% in San Francisco. The July 2010 total (452 units) was 17% lower than the corresponding figure for July 2009 (543 units).

Housing Market Slows Following Expiration of First-Time Buyer Credit

The housing market has slowed dramatically following the April 30th expiration of the first-time home buyer tax credit. Take a look at the chart below, which shows the NAR's Pending Home Sales Index.

The index tracks the number of purchase contracts that are signed in each month. It is normalized that the average for 2001 is 100.

In order to qualify for the tax credit, buyers had to be in contract by April 30th. There was some question as to how large an impact an $8,000 credit would have on buying activity. Now we know. Nationwide, pending home sales fell 30% from April to May. In the western region, pending home sales fell 21%.

Anecdotally, the San Francisco housing market seems to have slowed as well. I'll address this in an upcoming posting.

Mortgage Defaults May Have Peaked

Almost 20,000 Notices of Default (NOD's) were recorded in the Bay Area during the second quarter of last year. Default activity has fallen rapidly since then. In the fourth quarter (the latest available), the number of NOD's came in more than 30% lower, at roughly 13,600.

San Francisco County has experienced a similar decline in default activity. There were 607 Notices of Default recored in the City during the third quarter of 2009. The fourth quarter figure came in almost 25% lower, at 465.

Note: The abrupt decline in NOD's during the third and fourth quarters of 2008 resulted from lender uncertainty in the face of legislative changes. Keep in mind that the chart shows recorded Notices of Default, not actual instances of default.

Two quarters don't make a trend. But the recent stability in home prices and employment suggest that mortgage default activity will continue falling.

Bay Area Housing Market Recovery Continues

Bay Area home prices touched bottom in April of last year, and now appear to be almost a year into recovery. According to the Case Shiller indexes, single family home prices are 15% higher than they were at the bottom of the market. They've increased in every month since then, albeit at a slowing pace.

The Bay Area condo market also has bounced back, but its recovery has been less impressive. Condo prices are only about 7% higher than they were at the bottom of the market.

Job Market Stability Brings Relief to Housing Market

Since peaking at 11.0% in August 2009, Bay Area unemployment has been trending slowly downward. January's reading of 10.3% is the lowest since May of last year. Nationwide unemployment peaked at a (seasonally adjusted) rate of 10.1% in October 2009. January's reading came in slightly lower at 9.7%.

Most economists expect unemployment to remain high for the remainder of 2010. That's not good news for the housing market (especially in areas with a lot of underwater homeowners), but stable unemployment is far better than rapidly rising unemployment. Take a look at the chart, below, which shows the recent trajectories of home prices and unemployment in the Bay Area.

Bay Area home prices remained stable until the job market began to deteriorate. Prices then fell rapidly as unemployment rose, but stabilized once again when unemployment plateaued. (A similar course of events played out during the 2001 recession, although the current price decline has been far more severe.)

Some smart economists believe that the U.S. economy is not yet out of the woods, and could slip back into recession later this year. Let's hope that it doesn't work out that way. If so, then Bay Area housing prices may have reached a point of stability.