Sunday, March 30, 2008

Mauldin: Where is the Bottom in Housing?

by Calculated Risk on 3/30/2008 02:05:00 PM

John Mauldin writes: Where is the Bottom in Housing? (hat tips: many!)

Mauldin provides a good overview of the housing market. His analysis is based on information from John Burns Real Estate Consulting and T2 Partners. Both Burns and T2 have made their presentations public.

There is all kinds of charts and information available, but I'll comment on a couple of points. Mauldin writes:

Bottom Line? There is no Bottom in Sight

[Burns] most likely timeline is that resale stability will come back by 2011, and it will be even earlier for the homebuilders. He is projecting 6,000,000 home sales (new and existing) in 2008, but falling to only 4,000,000 in 2009. Low sales volume and high foreclosures will delay inventory reduction, which is required for there to be a stable market.

This means that home ownership will fall to 66% of the population in 2009 from the recent high of 69%. He thinks that may overcorrect to 65% in 2010. When I asked him why the overcorrection, he said it has to do with psychology. Housing will go from the greatest investment in 2006 to a bad one by 2009. The market typically overcorrects at the end of every cycle. It will take rising prices to lure the marginal homebuyer back into the market.

We discussed the recent rise in the price of the homebuilder stocks, which he attributes to short covering. Many of the homebuilders, public and private, are selling land at 16% of book value, or are trying to. He suggests that many of the privately owned homebuilders are in the worst shape.

Bottom line? We are nowhere near the bottom in the home markets.
First, on sales, I think Burns is too optimistic for 2008 and too pessimistic for 2009. Right now we are on pace for just under 5 million existing home sales in 2008, and 600 thousand new home sales (and sales will probably fall further). A forecast for 6 million total sales in 2008 is probably too high.

Similarly a forecast of 4 million total sales in 2009 is probably too pessimistic. The reason Burns is probably too pessimistic on total sales in 2009 is because prices will likely decline further than Burns is forecasting (helping sales). Burns is only forecasting a 16% nationwide price decline from peak to trough. Based on the Case-Shiller National index, house prices are already off 10.1% as of the end of 2007 - with much more declines likely in 2008.

Also according to Burns, there are "3.5 million excess homes that need to be filled by qualified buyers". This is really a confusing metric. Burns arrives at this total by adding excess vacant units to his estimate of future vacant homes due to the declining homeownership rate.

But this approach really confuses a few numbers and concepts. Burns estimate of 1.55 million "vacant homes" is about right, but this includes about 560 thousand excess vacant rental units! (see Inventory, Inventory, Inventory) So a decline in the homeownership rate cannot be added to this number directly - or there would be some double counting.

Also Burns is probably too pessimistic on the decline in the homeownership rate. Recent academic research by Matthew Chambers, Carlos Garriga, and Don E. Schlagenhauf (Sep 2007), "Accounting for Changes in the Homeownership Rate", Federal Reserve Bank of Atlanta, suggests that there were two main factors for the increase in homeownership rate between 1994 and 2004: 1) mortgage innovation, and 2) demographic factors (a larger percentage of older people own homes, and America is aging).

The authors found that mortgage innovation accounted for between 56 and 70 percent of the recent increase in homeownership rate, and that demographic factors accounted for 16 to 31 percent. Even as we unwind some of the excesses of recent years, not all innovation is going away (securitization and some smaller down payment programs will stay). And the population is still aging, so the homeownership rate will probably only decline to 67%, or maybe "over correct" to 66% - but will probably not decline to 65% or lower. (No one has a crystal ball, so maybe Burns pessimistic view will be proven correct).

And one more point on the declining homeownership rate: this is probably better viewed as a head wind for demand, not as additional supply. Using an excess inventory number of 1.6 million or so is probably more useful when discussing supply.

Even with these minor flaws, this is a good overview.