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Have We Hit the Bottom of The Real Estate Market
Friday, August 29, 2008
The Case-Shiller data for June indicate that the rate of decline in house prices may be slowing. For the month, prices in the 20-city index fell by 0.5 percent in June, the slowest rate of price decline since last September. Over the last quarter, prices in the index fell at a 10 percent annual rate, and they have fallen at a 15.9 percent rate over the last year. Nominal prices have now dropped 18.7 percent from their peak in July of 2006.
There appears to be a growing gap in price movements between the high and low-end of the markets in many cities. For example, in Los Angeles, prices in the bottom third of the market fell by 3.2 percent in June, while prices in the top third fell by just 0.2 percent. Over the last quarter, prices for homes in the bottom tier fell at a 12.2 percent annual rate, while prices in the top tier dropped at just a 0.8 percent rate.
There's a similar story in Miami, where prices in the bottom tier fell at a 14.5 percent annual rate over the last quarter, while prices in the top tier fell at just a 4.2 percent rate. Over the last year, prices in the bottom tier have fallen 31.6 percent, which is not much larger than the 25.3 percent decline in prices for houses in the top tier. There's a similar story in Las Vegas, Phoenix, San Diego, and San Francisco.
While there will be some downward bias in this index (houses that fall rapidly in price are more likely to end up in the bottom tier), it seems clear that the lower end of the housing market is feeling the worst effects of the downturn at the moment. This undoubtedly reflects the collapse of subprime lending which supported a disproportionate share of purchases in this segment of the market.
The situation is likely to worsen in the months ahead for two reasons. First, the people who are most likely to be victims of job loss in the downturn will be disproportionately in the low-end of the market. Second, the Federal Housing Administration (FHA) ban on seller-provided down-payment assistance will take effect in October. The prospect of this ban coming into effect is providing a modest stimulus to the housing market at present as homebuyers rush to get in ahead of the ban. This will pull some prospective purchases forward, which will make the situation after the ban takes effect appear even bleaker.
While the slowing of the price decline in the 20-city index may indicate that the slump is coming to an end, it is important to realize both that a 0.5 percent rate of monthly price decline is still quite rapid and that the real price decline continues to be quite fast. Ordinarily, a 6.0 percent annual rate of price decline would be viewed as a serious problem. It is only in the context of the plunging prices of the last half year that this seems modest.
Second, with the sharp pick-up of inflation in recent months, house prices are still declining very rapidly in real terms. Over the last quarter, the CPI, excluding the rental components, increased at 14.1 percent annual rate. This means that real house prices would be falling rapidly even if nominal house prices were flat.
While a reduction in real house prices through inflation will deflate the bubble as surely as a fall in nominal prices, there is a difference in the distributional impact. Homeowners with large mortgages will benefit if the correction occurs primarily through inflation, while lenders will be hurt. Lenders will be repaid in dollars that are worth considerably less than the money they lent.
This situation led to the savings and loan crisis in the 70s, as banks were forced to pay interest rates on deposits that kept pace with inflation. So far, this uptick in inflation has not been associated with higher interest rates. Instead, depositors have accepted large negative real interest rates on their money. However, this situation may not persist for long if the Fed begins raising interest rates.
By Dean Baker