Rosenberg: Home prices may drop as much as 20%

David Rosenberg, Chief Economist at Gluskin Sheff, has recently given a couple of different views about the near term future for housing prices. These views are different only in degree: both are negative.

Home Prices May Drop 20% Further

First, he has suggested that prices may have 20% to fall, on average to reach a bottom, as seen in the following graphic:

I would add some caveats.

1. Interest rates were higher on the mid-1990s. If you adjust home affordability to the lower interest rates of today, there is no reason to argue for as big a drop as 20% from here based on a historical cyclic comparison.
2. If interest rates rise rapidly, the historical comparison would be biased to the down side and, at first blush, one is tempted to say that housing prices could drop more than 20% from here if interest rates rise above those of the mid-90s. One offsetting pressure could come from increased demand arising from buyer fear of higher future interest rates. This fear could push demand forward and support prices.
3. Higher interest rates could well be accompanied by greater economic activity and increased employment. This would provide home price support due to increased demand. The downside of higher interest rates, particularly if they reach above the levels of the 1990s, would be suppression of economic activity and employment. Thus higher interest rates accompanying economic expansion could weaken the expansion.

Housing Prices May Drop 10% Further

In another graph, Rosenberg provides data that could be used to argue that home prices could have another 10% to drop:

A caveat here would include:

The 10% drop to the two historical bottoms shown requires that all other assets remain at current valuations. If we use the stock market as a proxy for all other household assets*, then a drop of 10% in the market would push the ratio to 29%. A further rise of 15% in stocks pushes the ratio down to 24% and no further drop in home prices is needed to reach the bottom ratio values of the 1960s and the 1990s.

*Note: Using the stock market as the proxy for all other household assets is a very gross assumption and could lead to misleading conclusions. Significant other possible assets include cash and equivalents, commodity investments, bonds and small business interests, which may, in total, be larger than investment in stocks.

Median Price Lows of 2009 Will be Taken Out

Six months ago I projected that the median price lows of 2009 would be taken out to the downside in 2010. See here and here. The following table shows the status of median home prices as of January, 2010:

The two big uncertainties in the housing market are the future course of the economy and the number of foreclosed properties that will come to market over the next 2-3 years. These two factors are related. The rate of growth of mortgage delinquencies is related to the unemployment rate, discussed here. The number of foreclosures coming to market in 2010 has been estimated to be greater than in 2009, with numbers remaining high in 2011 and possibly 2012.

It’s the Economy, Stupid

If the economy continues a modest recovery in 2010, with a GDP grow the entire year near 2 – 2.5% (my best guess), housing prices could go through a long bottoming process in 2010, possibly extending into 2011. The bottom in prices in this scenario would probably be within 5% to 10% below current levels.

If the economy is weaker than I project (let’s be honest again – it’s a best guess – then the lows in prices could well exceed 10% from here. With a double dip recession, Rosenberg’s most pessimistic projection is well within reach and could in fact be exceeded

If we have a strong recovery, especially if GDP growth for 2010 gets near or exceeds 5% for the entire year, then whatever the lows are in the first quarter will be the bottom in prices. The low should be close to current prices, within a couple of percent.

Anyone calling the timing and price for the housing market bottom is really making a prediction on the overall course of the economy for the next 12-24 months. Since Rosenberg has had a relatively negative outlook on prospects for the economy, his projections for housing are among the lower outlooks.

John Lounsbury provides comprehensive financial planning and investment advisory services to a small number of families on a fee only basis. He has a background which includes 34 years with a major international corporation, 25 years in R&D management and corporate staff positions. Since 2002 he has operated his own sole proprietorship business. John is also one of the top ten authors at Seeking Alpha and a featured commentator at TheStreet.com Real Money.