2/25/14 – An Update on the Housing Market

Posted by Brad McMillan, CFA, CAIA, MAI

Find me on:

This entry was posted on Feb 25, 2014 9:27:49 AM

and tagged Commentary

Leave a comment

Housing has been doing a back-and-forth over the past couple of days, with a number of stats down. Existing home sales were down 5.1 percent in January, with average home prices falling, and housing starts and homebuilder expectations also showing declines. At the same time, other stats, including price increases, remain very strong. In fact, in 2013, home prices rose the most since 2005. What’s going on?

The big picture here is that we should expect moderation in housing and understand that it’s actually a healthy thing. Within that big picture, we can look at several factors—weather, rising mortgage rates, and lower affordability—to decide whether the expected moderation in the housing recovery is going to turn into something worse.

First, the big picture. The chart below shows the relationship between house prices and the number of homes sold divided by those for sale—in other words, supply and demand.

1

What this tells us is that demand has dropped a bit relative to supply, so price growth should slow. But even slower growth is still growth, and the chart suggests growth could decelerate to around 5 percent per year, which is still above inflation.

This is a good thing. There’s a word for multiyear double-digit price increases, and that word is bubble. We have seen a recovery in housing prices, and if price increases were to continue at the current rate, it would mean another bubble. Having prices normalize, and then grow at the inflation rate or slightly above, is sustainable and healthy.

Second, let’s look at weather. Per Capital Economics, there are reasons to believe that weather was a significant contributor to the slowdown in housing. While starts got hit, the declines were greatest in the areas with the worst storms and actually rose in the West, where weather was better. In addition, building permits declined by less than starts—probably not a coincidence given that permits are done in indoor offices, rather than out in the elements. Nonetheless, the data suggests that weather had a real effect on housing, but this will pass as spring approaches.

Another factor is affordability, which relates to rising interest rates and property values, both of which make houses less affordable. Per the chart below, you can see that housing affordability has in fact declined.

2

Yet, despite the decline, it’s still more affordable than at any other time except for the past several years. Affordability continues to be quite strong overall.

The question remains, though, whether any moderation could turn into something worse. Here we need to look at effective demand and available supply. There are two components to effective demand for housing: household formation and affordability.

Looking at household formation, the run rate is around 1.375 million per year, according to David Rosenberg of Gluskin Sheff—well above the actual housing construction rate toward the end of last year—which suggests strong demand for the existing supply. Looking at affordability, per the chart above, the ability of the new households to afford a home remains strong. Effective demand is there.

From a supply standpoint, average months’ supply on the market is about five months, which is quite tight on a historical basis. Starts are running well below the usual level of around 1.5 million, so new houses are not going to swamp the market—quite the reverse.

Given strong effective demand combined with low supply and supply growth, the chances for the current moderation in housing values to turn into a sustained decline appear slim. Much more likely is sustained growth, once the weather improves.

Personally, after snowblowing my property too many times this winter, I can’t wait.

Upcoming Appearances

Tune in to Bloomberg Radio's Bloomberg Businessweek on Friday, February 28, at 3:45 P.M. ET to hear Brad talk about the market. Stream the show live at https://www.bloombergradio.com/, listen through SiriusXM 119, or download Bloomberg's app, Bloomberg Radio+.

Tune into Yahoo Finance's The Final Round on Thursday, March 12, between 2:50 and 4:00 P.M. ET to hear Brad talk about the market. Exact interview time will be updated once confirmed. Watch at finance.yahoo.com

Subscribe via E-mail

New call-to-action
Crash-Test Investing
Commonwealth Independent Advisor

Hot Topics

Have a Question?

New Call-to-action

Conversations

Archives

see all

Subscribe

Disclosure

The information on this website is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Please contact your financial professional for more information specific to your situation.

Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets.

The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. All indices are unmanaged and investors cannot invest directly into an index.

The MSCI EAFE Index (Europe, Australasia, Far East) is a free float‐adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada. The MSCI EAFE Index consists of 21 developed market country indices.  

Third party links are provided to you as a courtesy. We make no representation as to the completeness or accuracy of information provided at these websites. Information on such sites, including third party links contained within, should not be construed as an endorsement or adoption by Commonwealth of any kind. You should consult with a financial advisor regarding your specific situation.

Member FINRASIPC

Please review our Terms of Use

Commonwealth Financial Network®