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Economic Insights

The residential real estate market should continue its modest improvement in 2014-15—with positive implications for the U.S. economic recovery.

Beneath its typically erratic month-to-month pattern, the housing recovery has slowed. Some of this was bound to happen. The sharp rebound registered earlier last year was hardly sustainable. Because the Federal Reserve's talk of tapering raised mortgage rates last summer, the inevitable slowdown in the pace of recovery turned to a modest decline. But for all this, moderate continued improvements in residential real estate look reasonably secure in 2014-15, and with it greater security for a continuation of the admittedly slow economic recovery overall.

The Picture So Far
During the first half of 2013, housing appeared to be roaring back. Sales of existing homes—all those properties that had been languishing behind the for-sale signs for years—jumped at a 17.7 % annual rate between January and July. Sales of new homes followed a more erratic pattern, but rose at a 29% annual rate on balance during the first six months of the year.1 Real estate prices increased in response to the renewed demand. According to the National Association of Realtors, the median sales price of a home rose nationally at a 41% annual rate between January and June.2 A different price measure, the S&P/Case-Shiller Home Price Index,3 rose at a 19.1% annual rate during this same time.4

This kind of a surge was unsurprising, but always unsustainable. Given the depths to which residential real estate had sunk, a strong initial bounce was typical. But such surges also typically tend to run their course quickly. The signs were all there. The greatest gains occurred in Florida, Nevada, Arizona, and California—the states that had seen the worst downdrafts. Elsewhere in the country, the gains were much more moderate. Meanwhile in June and July, bond yields and mortgage rates jumped in response to talk from the Fed about tapering the flow of new liquidity in its quantitative easing program. The average mortgage rate offered by lenders rose more than 100 basis points (bps) between June and September, all but ensuring a more pronounced slowdown in the pace of recovery, more, in fact, than was already built into the market dynamic.

Accordingly, between July and year-end, it began to look as though the housing market had relapsed into decline. Sales of existing homes fell at a 15.1% annual rate from July through November (the most recent month for which data) fell at a 15.4% annual rate between June and December.5 Median sales prices for existing homes, as tracked by the National Association of Realtors, slipped at a 15.9% annual rate during this time,6 while the S&P/Case-Shiller Price Index showed gains at an 8.1% annual rate between June and November (the most recent period for which these data are available),7 still strongly positive, but slower than earlier in the year.

Now What?
The natural question now is to ask whether the housing recovery can regain traction in 2014 and 2015. The probabilities indicate that, yes it can and will, but at a much slower pace than averaged early last year. Though Fed policy will edge up mortgage rates, affordability remains high, and lenders will likely become less reluctant to extend credit to residential real estate.

Housing remains remarkably affordable, at least by historical standards. To be sure, it is down from where it was between 2009 and 2012, or earlier in 2013. Real estate prices, up on balance nearly 10% during the last 12 months, have outpaced the growth of median household income, up only 2.1% during this time, and mortgage rates have gone up by 125 bps. The burden of servicing a mortgage on the median property has gone from 12.3% of median family incomes a year ago to 14.7% last November (the most recent period for which data are available). Taking all this into consideration, the National Association of Realtors estimates that, nationally, a home is 16.1% less affordable than it was a year ago. On this basis, it would be reasonable to look for a slowdown in the pace of recovery, but since even today’s reduced affordability is better than any time in the past 40 years (except for the past four years), it also is reasonable to expect a recovery to continue.8

Affordability will probably lose still more ground over the course of the next 12–18 months. Though household incomes will undoubtedly rise, any gains will run only slightly faster than last year at best. Constrained employment growth will hold back the pace of any gains, as will the retarding effect on wages of still-high rates of unemployment. Though housing price gains also should slow, they nonetheless will likely outpace income growth. And, of course, continued Fed tapering will raise mortgage rates, perhaps by another 100 bps over the next 12 months. On this basis, affordability may well deteriorate by another 10–15%. But even with such further deterioration, affordability will remain almost 30% better than its best levels of the 1980s, 1990s, and earlier years of this century, again excluding the last four years.

The recovery could get some small extra momentum in 2014–15 as lending institutions become modestly easier about extending credit in real estate. After the 2008–09 financial crisis, most lenders, understandably, wanted nothing to do with real estate. According to the Fed, they cut back on their lending in the area by 5–6% a year in 2009 and 2010, and by about 2.4% a year on average in 2011 and 2012. Even early last year, as the housing recovery gained momentum, banks cut their mortgage exposure by 1.2%. This reluctance to lend has kept many buyers from taking advantage of the historical affordability that developed during this time. But December showed the first modest rise in real estate lending, albeit only at a 2.4% annual rate. This new willingness to extend credit to the area seems to have extended into January, on admittedly very preliminary data. If the availability of credit continues to improve, the recovery will receive help, especially since housing will remain historically affordable, if not quite as affordable as it was last year. Still, given the remembered pain of 2008-09, it is unlikely that lenders will change their attitudes fast enough or far enough to change the expected slow recovery into something substantively more robust.9


1 Data from the Department of Commerce.
2 Data from the National Association of Realtors.
3 The S&P/Case-Shiller 20-City Home Price Index measures the residential housing market, tracking changes in the value of the residential real estate market in 20 metropolitan regions across the United States.
4 Data from Standard & Poor's.
5 Data from the Department of Commerce.
6 Data from the National Association of Realtors.
7 Data from Standard & Poor's.
8 All data from the National Association of Realtors.
9 All data from the Federal Reserve.

ABOUT THE AUTHOR

CRITICAL RELEASES IN THE WEEK AHEAD

Milton Ezrati examines the key economic and financial releases scheduled for the coming week. 

KEY MOVER:

ISM Mfg. Index for January*
Mon., February 3, at 10:00 a.m. ET
Previous: 57.06% • Prospect: 55.0%

The previous, high statistic suggested more rapid growth than the fundamentals can support, suggesting a downward adjustment in January, but still an indicator of continued growth.
*Source: The Institute of Supply Management.

OTHERS TO WATCH:

Factory Orders for December*
Tue., February 4 at 10:00 a.m. ET
Previous: +1.8% • Prospect: +0.7%

Indicators are for a modest slowing from November's too strong release, but still expansion.
*Source: Department of Commerce.

Unemployment Rate for January*
Fri., February 7, at 8:30 a.m. ET
Previous: 6.7% • Prospect: 6.8%

Payroll Employment for January*
Fri., February 7, at 8:30 a.m. ET
Previous: +74,000 • Prospect: +140,000

The payroll release for December was less than even this slow recovery can support, inviting an improvement in January, but still not robust growth. The unemployment rate could still rise, though, as some frustrated workers return to the search.
*Source: Department of Labor.

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