Economic Insights: Housing's Slow Climb Out of the Cellar (Ezrati)

by Milton Ezrati, Market Strategist, Senior Economist, Lord Abbett

The housing market keeps reporting good news. Sales volumes have risen, as has new construction activity. Even real estate prices, after falling for years at an alarming pace, have begun to firm. The whole picture is a welcome change from the steep slide and stark fears of past years, and it promises, at long last, that going forward housing will contribute to the economy's overall health, at least marginally so. But it would be a mistake to take such news too far. The real estate sector still has much to overcome. If the recent flow of data offers reasonable assurances that the worst is over, the remaining impediments will contain any future gains in housing. Still, gains, even when contained, are a vast improvement over the free fall of recent years.

The general picture certainly is upbeat. The Commerce Department reports that new home sales jumped almost 9.7% during the first seven months of the year, and the National Association of Realtors reports that existing home sales rose 2.1%. Neither measure registered a gain in every month, but it is clear that the long decline in home sales has ended. There is good reason to look for sales support, too. Low mortgage rates and past declines in home prices have made housing much more affordable than at the last cyclical peak, more affordable nationally, in fact, than at any time since the early 1990s. Certainly, homebuilders have taken the turn to heart. Even including a June pullback in new housing units stated, this kind of construction activity shows a gain of almost 8% during the first half of the year.

Most encouraging, especially after the intense financial pain of 2008–09 and its aftermath in 2010 and 2011, is the recent rise in residential real estate prices. The much-followed S&P/Case-Shiller Housing Price Index¹ reports that its composite of prices in 20 major metropolitan areas gained every month this year through May (the most recent period for which it has data). Each month showed only a modest advance, but the net increase over the whole time amounted to 2.4%, or nearly 6.0% at an annual rate. That is a far cry from last year's 4.1% drop and much steeper declines in 2010 and earlier. Maybe even more encouraging is the regional pattern. All but three of those 20 metropolitan areas showed price gains. New York City, for example, reported essentially flat, while Atlanta showed a 1.9% annualized decline and Detroit showed a 4.7% decline. Meanwhile, formerly hard hit Las Vegas showed an 8.6% annualized gain, Miami showed a 16.1% gain, and Phoenix showed a 30.4% average annualized home price gain.

But for all the relief, persistent impediments will moderate the pace of improvement. One problem is credit. As affordable as housing has become, banks remain reluctant to lend for mortgages and real estate deals generally. According to the Federal Reserve's senior bank loan officer survey, lenders, though they have eased their credit restraints from the extremely tight policies of 2010, nonetheless remain extremely cautious. Consistent with such attitudes, Fed statistics show only the slightest increase in lending for real estate during the first six months of this year and even a slight dip in such lending activity in July. In time, such restraint will ease further, but the memory of 2008–09 will doubtless impose considerable caution for a long while yet.

At the same time, a still substantial inventory overhang should constrain any price gains. According to the Commerce Department, the unsold supply of new homes on the market amounts to 4.9 months' supply. Though this figure is well down from the six to seven months' supply of 2010 and 2011, this inventory is not especially tight. On the far more important market for existing homes, the National Association of Realtors reports 6.6 months' supply of unsold properties on the market at current sales rates. This figure is also well down from numbers like 9.5 months' supply in 2010 and 12 months' supply in 2009, but it is still high by historical standards, which record an average of closer to five months' supply. What is more, these inventory statistics fail to account for the still large backlog of foreclosures that effectively overhang the market with a so-called "shadow inventory." It is hard to gauge the full extent of this shadow inventory, but, with mortgage delinquencies still at close to 10% and charge-offs at close to 1.5%, it likely exceeds the inventory figures recorded by the Commerce Department and the National Association of Realtors by an amount sufficient to bring the effective supply of unsold properties closer to 12–18 months' sales at current rates.

Certainly, such inventory considerations recommend a more sober interpretation of recent improvements than some are showing. So also does the continued caution shown by lenders, especially where mortgages and real estate are concerned. But if circumstances still argue against undue enthusiasm, they do suggest strongly that the worst of the nation’s real estate problem is behind it. If going forward the figures on prices, sales, and construction will hit occasional snags, the general trend toward healing constitutes a major relief after the great weakness, indeed the free fall of past years. It also makes a continuation in the general economic recovery that much more likely.

¹ The S&P/Case-Shiller 20-City Home Price Index measures the residential housing market, tracking changes in the value of the residential real estate market in 20 metropolitan regions across the United States.

The opinions in the preceding commentary are as of the date of publication and subject to change based on subsequent developments and may not reflect the views of the firm as a whole. This material is not intended to be legal or tax advice and is not to be relied upon as a forecast, or research or investment advice regarding a particular investment or the markets in general, nor is it intended to predict or depict performance of any investment. Investors should not assume that investments in the securities and/or sectors described were or will be profitable. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy or completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.

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