Weakness in the U.S. Housing Market Likely to Persist in 2008 Commentary by Sondra Albert, Chief Economist AFL-CIO Housing Investment Trust January 29, 2008 The national housing market entered 2008 mired by increased foreclosures and falling prices in many regions of the U.S. The majority of the weakness in the housing market is in the single family housing sector, which saw homeownership rise to a high of 69.2% in the first quarter of 2005 and fall back to 68.1% in the third quarter of 2007. The homeownership rate is likely to continue to fall in 2008 as many people have purchased or refinanced homes on terms that they could not realistically afford. This will lead to further increases in the supply of homes on the market, which will continue to put downward pressure on home prices. The troubles in the housing market became clear in the summer of 2007, with problems emerging from the subprime mortgage sector. These problems have had an impact on the credit market as a whole and have become a significant drag on the U.S. economy, as well as abroad, raising the risks of a recession. Home Prices Began Falling in 2007 The downturn in the housing market followed an exceptional boom fueled by record low interest rates and new financing vehicles created by banks and other lending institutions. Home prices doubled from the end of 1999 to their peak in the summer of 2006, according to the Standard & Poor s (S&P)/Case-Shiller home price index. The S&P/Case-Shiller index measures changes in housing market prices given a constant level of quality, thereby excluding changes in the physical characteristics of houses. The increase in home values provided a much-needed boost to the economy by letting consumers borrow billions of dollars against the value of their homes. The boom was mostly concentrated along the coasts and in the Southwest, and prices did not rise as rapidly in the Midwest or in parts of the South. However, due to the problems in the housing and credit market, home prices began falling in the first quarter of 2007 and fell 4.5% on a yearly basis in the third quarter of 2007. Home prices fell even more for the top 20 metro areas, declining 7.7% on a yearly basis as of November 2007. 20 15 5 0-5 - S&P/Case-Shiller Home Price Index: Composite 20 Index Jan- 02 Aug- Mar- Oct- 02 03 03 May-Dec- Jul- 04 04 05 Source: S&P/ Case-Shiller Feb- 06 Sep- Apr- Nov- 06 07 07
New home construction has fallen sharply, with housing starts down by almost 40% in the year ending in November 2007. 1 In some newer subdivisions in Florida, Arizona, Nevada and California, empty houses outnumbered occupied ones. Home builders have scrambled to reduce inventories of unsold homes and cut back on future construction. Some smaller developers were forced into bankruptcy, and several national builders face an uncertain future. 2 In order for the oversupply of homes on the market to come in line with the decreased demand, some economists are forecasting that prices in some areas will have to fall by as much as 25%. 3 Such a decline would be painful for many existing homeowners but it might allow millions of others to buy property after being unable to do so during the boom. Homes Sales Turn Negative and Inventories Remain Elevated With mortgages more difficult to get and prospective homeowners afraid of prices falling further, the pace of existing home sales in the United States fell to an annual rate of 4.89 million units, according to the National Association of Realtors. This was the lowest level since 1998, and compared to the sales peak in late 2005, sales were down by roughly one-third. Single family home sales were down 22.0% in 2007 from a year earlier. By region, single family home sales in December fell 22.8% yearover-year in the Northeast, 19.4% in the Midwest, 20.6% in the South and 25.4% in the West. The median price of an existing single family home ended the year at $206,200, which was down 6.5% from a year earlier. This was the first full year decline in the thirty-five year history of the series. 4 6500 Existing Home Sales (Thousands) 6000 5500 5000 4500 4000 2000 2001 2002 2003 2004 2005 2006 2007 Source: National Association Realtors The inventory of homes for sale fell to 3.91 million units at the end of last year. That represents a 9.6-month supply at the current sales pace, down from the.1-month supply in November. This is a huge overhang of unsold houses on the market. The average supply of homes on the market since 2000 has been 5.3 months. While the inventory has decreased slightly, homes sales will likely remain depressed through 2008 due to problems in the housing and credit markets. 1 U.S. Census Bureau. 2 Home Seller s Pain is Renters Gain, by Nick Temiraos, Wsj.com (1/15/2008). 3 Forecast by A Gary Shilling. 4 National Association of Realtors.
Months Supply of Existing Homes on the Market 11 9 8 7 6 5 4 3 2000 2001 2002 2003 2004 2005 2006 2007 Source: National Association of Realtors Foreclosures at a Record High The supply of homes for sale on the market has increased sharply from 2005 because of the fall in demand for homes due to the increased difficulty in obtaining a mortgage and the rise in foreclosures. 5 New and existing homes for sale are now competing against foreclosed homes, which sell at a fraction of a price. For example, a four-bedroom house in a Phoenix suburb sold for $775,000 in August 2006, and in 2007 a lender acquired the home through foreclosure. It sold again in December 2007 for $380,000. 6 The downward pressure on prices from foreclosures will likely continue to have a negative impact on neighborhoods throughout the U.S. in 2008. Foreclosures Started (Percent) 0.8 0.7 0.6 0.5 0.4 0.3 2000 2000 2001 2002 2003 2003 2004 2005 - Q1 - Q4 - Q3 - Q2 - Q1 - Q4 - Q3 - Q2 2006 - Q1 2006 - Q4 2007 - Q3 Source: Mortgage Bankers Association 5 The National Association of Home Builders reports the percentage rate of loans in which a foreclosure has been initiated during the quarter as a percentage of the total number of mortgages. 6 Home Sellers Competing for Foreclosed Homes, Wsj.com (1/25/2008).
The states hardest hit by rising foreclosures due to mortgage resets or the inability of homeowners to pay their existing mortgages are concentrated in coastal areas. In particular, foreclosures in California rose more than 400% in the fourth quarter from a year earlier, and default notice filings against distressed mortgage borrowers more than doubled, according to Data Quick Information Systems. 7 Many of these foreclosures were due to adjustable rate mortgage (ARM) resets that left families unable to afford their monthly payments. California and Florida together have 36.4% of all of the prime ARM loans in the country; they had 42.4% of the nation s foreclosure starts for prime ARMs. Similarly, California and Florida together have 28.1% of the subprime ARMs and 33.7% of foreclosure starts for subprime ARMs. 8 Many borrowers who took out ARMs and subprime loans were sold these loans under the premise that they could refinance in the future when the loans reset. This has become impossible for many people due to banks unwillingness, in many cases, to make jumbo mortgages loans. Jumbo mortgages currently have interest rates over 0 basis points higher then conforming fixed rate loans. In addition, due to the fall in home prices, many borrowers now owe more on their house then it can be sold for. A survey conducted Sept. 13-25, 2007, by Peter D. Hart Research Associates for the AFL-CIO shows that of those homeowners whose ARMs had reset, 37% had interest rates at 8% or higher, above the current market rate for prime, fixed-rate loans, and 16% had interest rates at percent or higher. After the reset, the average increase in monthly mortgage payments was approximately $291, a % cut in after-tax payments for a family earning $50,000 a year. 9 This is a significant increase for a working person and in some cases this increase has caused people to fall behind on their mortgage payments. Recently, the House of Representatives leadership and the Bush Administration announced a plan to raise the limits on loans that can be insured or purchased by FHA, Fannie Mae and Freddie Mac. This will assist those borrowers who are able to refinance by making banks more willing to make jumbo loans, which are prevalent in the East and West Coasts where home prices frequently exceed the current $417,000 cap by Fannie Mae and Freddie Mac and the current FHA limit of $362,000. While an increase in the loan limit will assist some borrowers, it will not aid people who were sold mortgages under fraudulent terms and cannot afford to pay those mortgages. Current Market Conditions Favor Renting over Buying The current market conditions favor renting rather then purchasing a home. The housing downturn that has caused the rate of home ownership to fall means that more people are looking for rentals, thus increasing the demand for multifamily apartments. Some would-be buyers have become renters because they cannot get a mortgage in today s tight credit environment; or they are waiting for home prices to drop further; or they have lost their homes to foreclosure. The run-up in home prices in many areas also contributed to the increase in demand for rental apartments. For these reasons the rental vacancy rate fell in 2005 and 2006, and a further decrease is expected to be reported for 2007 when the data is released. While the supply of multifamily rental apartments may be impacted by condominium reversions that is, condominiums turning into rental properties the obstacles to converting condominiums to rental apartments are high. One of the main difficulties is that lenders are often reluctant to lengthen loan terms because rental properties produce income more slowly than condominiums. 7 California Foreclosures, Mortgage Defaults Sour, Reuters.com, (1/23/2008). 8 Mortgage Bankers Association. 9 AFL-CIO. Condo Sales Slump, Spurs Switch to Rentals, by Alex Frangos, Wsj.com (12/5/2007).
11 Rental Vacancy Rates (Percent) 9 8 7 2000 2001 2002 2003 2004 2005 2006 Source: U.S. Census Bureau The large increase in home prices in many regions caused middle class workers such as teachers, firefighters, retail managers and nurses either to buy homes far from their jobs in urban areas or to rent apartments. According to a report by Harvard University s Joint Center for Housing Studies in 2006, the U.S. is losing approximately 200,000 rental housing units each year due to demolition, significantly compounding the ongoing housing affordability squeeze gripping millions of families. The study further finds that while the Low-Income Housing Tax Credit program and other initiatives contribute over 0,000 new units of affordable rental housing each year, this is less than the number of low-rent units disappearing. Nicolas Retsinas, director of the Joint Center, described the situation as follows: We are taking one step forward and two steps back as gentrification in some neighborhoods and continued deterioration in others leads to the removal of vitally needed lowercost rental housing. 11 The shortage of housing affordable for working families is a critical issue for cities seeking to retain their middle class. 11 America s Rental Housing, Joint Center for Housing Studies of Harvard University (2006).