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Monday, July 27, 2009

Housing: Remember the Two Bottoms!

by Calculated Risk on 7/27/2009 02:30:00 PM

With my post yesterday, Economy: A Little Sunshine and the New Home sales report this morning - it is worth repeating: There will probably be two bottoms for Residential Real Estate.

The first will be for new home sales, housing starts and residential investment. The second bottom will be for prices. Sometimes these bottoms can happen years apart. I think it is likely that we've seen the bottom for new home sales and single family starts, but not for prices.

It is way too early to try to call the bottom in prices. House prices will probably fall for another year or more. My original prediction (a few years ago) was that real house prices would fall for 5 to 7 years (after 2005), and we could start looking for a bottom in the 2010 to 2012 time frame for the bubble areas. That still seems reasonable to me.

However it is important to note that some lower priced areas - with heavy distressed sales activity - might be at or near the bottom.

For the first bottom, we have several possible measure - the following graph shows three of the most commonly used: Starts, New Home Sales, and Residential Investment (RI) as a percent of GDP.

Comparing starts, sales and residential investment Click on graph for larger image in new window.

The arrows point to some of the earlier peaks and troughs for these three measures.
The purpose of this graph is to show that these three indicators generally reach peaks and troughs together. Note that Residential Investment is quarterly and single-family starts and new home sales are monthly.

We could use any of these three measures to determine the first bottom, and then use the other two to confirm the bottom. But this says nothing about prices.

Housing Two Bottoms The second graph compares RI as a percent of GDP with the real Case-Shiller National house price index.

Although the Case-Shiller data only goes back to 1987, look at what happened following the early '90s housing bust. RI as a percent of GDP bottomed in Q1 1991, but real house prices didn't bottom until Q4 1996 - more than 5 years later!

Something similar will most likely happen again. Indicators like new home sales, housing starts and residential investment will bottom long before house prices.

Economists and analysts care about these housing indicators (starts, sales, RI) because they impact GDP and employment. However most people (homeowners, potential homebuyers) think 'house prices' when we talk about a housing bottom - so we have to be aware that there will be two different housing bottoms. And a bottom in starts and new home sales doesn't imply a bottom in prices.