Outlook for Home Prices May Be Degrading

by John Lounsbury

Average home prices are virtually unchanged from July 2009 to July 2010 according to the latest report form First American CoreLogic, which provided the data for the following graph from Calculated Risk. The graph has notations added by the author.

Click on graph for larger image.

The 15% further price decline from July levels inferred from the graph is a larger decline than the 11% projected in April to be the drop expected to reach the low point for 2010. So far, little of that projected decline has been experienced; average house prices are little changed from December, 2009.

As I reported a few months ago, there are views of declines deeper than either 11% or 15%. Dave Rosenberg, Chief Economist at Gluskin Sheff, has used the methodology of Prof. Robert Shiller, Yale University, to construct the following graph:

Click on graph for larger image.

This graph implies a 20% drop to the historic median and suggests that, to equal the levels of the last housing collapse, a drop of more than 40% would take us to the levels of the 1920s and 1930s. Reaching those levels would be a decline of 60% from the peak in 2006.

If just the projections of 11% to 15% decline are realized, there could be a significant impact on foreclosure activities as more people move further under water and give up hope on ever benefitting from a housing market recovery. The number of foreclosures is likely to be larger under such a condition than if prices were not to fall significantly further.

There are several reasons to question whether these projections are likely to prove accurate:

1. There is no a priori reason that average or median prices should return to a trend line extension from the 1975-95 time frame. This basically based on three low points in the historical curve. While it is not unreasonable to return to the historic ”support level”, could changes in demographics (older average age) support higher home prices? Perhaps prices will not return to that low level in this real estate cycle. One possible reason that further declines may not reach the level 15% below current prices is that sales patterns may change. We have gone through a surge in first time and low price home sales as a result of the tax credit programs of the past 12 months. There may be a shift to higher priced homes constituting a higher proportion of the market. Even though a $500,000 home in 2006 may sell today for $300,000 (a 40% mark-down), that sale will raise the average and median home price.
2. There also is no reason that prices might not drop below the line drawn. It is not uncommon for excesses in one direction to create over reactions in the opposite direction. There certainly are a number of market forces in action here. These include:

   a. Continued endemic unemployment;
   b. Projected high levels of foreclosure activity over the next couple of years;
   c. A continued level of net household formation far below historical levels;
   d. A continued burden from overbuilding during the housing bubble; and
   e. Tightening credit standards likely over the next few years.

3. The national averages are being smoothed more now than in the past couple of years by price recovery variations across the country. Here are two tables showing year-over-year price changes in the weakest and strongest markets:

Weakest Markets (Click on table for larger image)

Strongest Markets (Click on table for larger image.)

While there appears to be growing diversity in residential real estate markets, right now real estate prices appear to be weakening on average. From the CoreLogic report:

“Although home prices were flat nationally, the majority of states experienced price declines and price declines are spreading across more geographies relative to a few months ago. Home prices fell in 36 states in July, nearly twice the number in May and the highest since last November when national home prices were declining,” said Mark Fleming, chief economist for CoreLogic.

Looking at the CoreLogic tables it is obvious that the national average price being flat year over year has received a big boost from the strong markets in California and New York. This boost may be fading. From DQNnews.com we just learned that Southern California demand is falling. Sales volumes in August were down 2.1% from July and 22.7% from June, the last month of the federal income tax credit program. Sales volume has declined 13.8% year-over-year from August 2009. The boost might just flame out – lower demand might dampen the California price improvement.

Of course, if the two large markets of Florida and Illinois had been flat, the year-over-year change for the nation would have been positive.

What happens to the national averages will depend more and more on trade-offs of local market changes. The part of the housing decline where 90% of the country is in sync is probably over.