Thursday, July 17, 2008

How to recognize the "bottom of the market"

(Money Magazine) -- This is already one of the worst national housing downturns in half a century. But what's really scary is that judging from the still-huge overhang of unsold homes - one of the key indicators of the market's prospects - things could get worse. In fact, much worse if the economy slips into recession.

But real estate is a local game. Your region could be in far better shape than the country as a whole. Median prices for existing single-family homes in a third of the country's metro areas are actually higher than they were a year ago, according to the National Association of Realtors.

Remember too that during the boom, regions moved at different times. Las Vegas and San Diego were among the first markets to take off. Boston spiked early as well, but not to the same degree. And Albuquerque and Portland, Ore. soared later.

This isn't to say that you'll be able to precisely time the market. But keeping track of a few key indicators will give you a general sense if a turnaround is near.

For starters, pay attention to changes in your local job market. The more new jobs created, the greater the demand for homes. Conversely, an uptick in unemployment - or a persistently weak labor market - can warn you a recovery may still be far away.

Of course, this is just one indicator. Here are the key questions to answer to determine how healthy your market is - and if it's anywhere near coming back.

Is the housing stock shrinking?

The problem in most markets today is simple: too many homes and too few buyers. Therefore, the best signposts to look for are a significant reduction in the supply of homes and a jump in sales, says Mike Larson, a real estate analyst with Weiss Research.

But getting local data on inventory and sales isn't that simple. Your local realtors association or a competent agent should be able to provide you with basic supply and sales figures, though the type of data will vary. So be sure to ask for as much as you can: monthly inventory of homes in your area, average days on the market and total number of homes for sale.

The typical inventory in a stable market is about six months' worth of houses, and homes tend to stay on the market for about 90 days.

Ideally, you'd want your market to be close to these levels. San Francisco, for instance, is slightly above it, with 6.3 months of homes for sale. But because of the local nature of housing, it's more important to see whether your region's housing stock is returning to its pre-housing-bubble levels.

As for sales, because housing is seasonal, pay attention to year-over-year growth in home sales, not monthly changes, says Joel Naroff, chief economist for Commerce Bank. In other words, see how many homes sold this August vs. last August - not July.
Are home prices falling at a slower pace?

A telltale sign of your local market starting to heal: The rate of home-price declines should start to slow.

If you start to track these figures, be patient. "You need at least three months of smaller price drops to be confident the market is really shifting, since housing numbers are really volatile and are affected a lot by the weather,".

So if you're a buyer who's looking for the best deal, wait at least that long. If you're a seller, be even more patient. That's because even if prices stabilize, they could stay low for a while. In fact, it likely will be months before prices rise again.

Is it cheaper to rent than to own?

Here's a useful back-of-the envelope calculation: Take the price of the type of home you want in your market. Now call around or ask your broker to see how much it would cost annually to rent a similar property in the same region. For example, if you can purchase a home for $540,000 but can rent a similar one for $36,000 a year, your so-called price-to-rent ratio would be 15.

In general, buying starts to look attractive when the P/R ratio is around 15 or lower, says Newport. (The current national average is 12.5.) As your market's P/R ratio falls, more sellers are likely to come into the market. So demand could pick up and help stabilize home prices.

Of course, 15 is just a ball park. For a more sophisticated analysis, see how your market's current P/R stacks up to its pre-housing-boom levels. For price-to-rent ratios for dozens of key markets, check out the table at the bottom of the page. Then, for comparison, ask local realtors and rental agencies for an estimate of prices and rents back at the start of this decade.

In Miami, for instance, the ratio jumped from 12 in 2000 to nearly 30 in six years, according to Moody's It has since fallen to 22, but that's nearly double what it was at the start of the decade. "That's a pretty big premium," says Larson.
Are houses more affordable?

Unless a significant percentage of households in a market can afford to buy homes there, sales won't rise. It's as simple as that. So check your region's affordability level.

The National Association of Home Builders calculates this figure - which it calls its housing opportunity index - for about 220 metro areas. The index considers a home "affordable" if no more than 28% of median family income in that area is required to pay for it.

The national average is 53.8, which means that slightly more than half of the homes purchased recently were deemed to be affordable. But again, it's not fair simply to compare local data with national averages. So if you really want to know if conditions are improving, check if your region's affordability index reading is climbing. In St. Louis, affordability has risen from 77% a year ago to 80% today.

Now there's one more indicator you might be aware of: foreclosures. The rate of foreclosures in your region is certainly one sign of the health of your market. But this is a lagging indicator. It can sometimes take six months or more from when a homeowner first defaults to foreclosure.

Also, remember that a primary reason defaults are occurring today is that home prices are tumbling. With no equity, owners cannot refinance out of unaffordable mortgages. To refinance, then, many homeowners would have to see prices not just stabilize but rise.

So "by the time foreclosures peak and start falling, the market will have already bottomed out and turned around," says Larson. In other words, buyers will have missed the sweet spot.

Money Magazine
First Published: July 15, 2008: 5:46 PM EDT


Anonymous bought in 1981; life is good said...

On three month charts: it won't work. It is a surefire method to catch a knife falling.

Better to chart monthly since the locality's peak onto a 12 month display. In that way you won't mistake the annual selling seasons' peak values for an overall market upturn.

The risky nature of this market is demonstrated recently by the typical low of the year-- November and December -- being higher than the following market peak in May and June. Prudent buyers would wait at least until next August (yes, I mean 2009) before jumping in.

That said, depending on how the option ARM breakdown happens or is averted, I don't think the market is safe until May 2011 in areas like California that have substantial option ARM mortgages.

If you can, compare the default/foreclosure rates from the previous downturns of 1980's and 1990's and their median price behaviors. If you view foreclosures as the direct cause of the downturns, then you will see that this dropping market has just begun.

3:44 PM  
Anonymous Janis Mara said...

Hey, great job of describing the significance of monthly rental payment vs. monthly mortgage payments. Doug. That's a tricky one, though vitally important. I appreciate it!

10:12 PM  

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