With June’s median existing home price
rising to a record-high $236,400 and the median new-home
price at $281,900 (just $20,900 off the November 2014 record of $302,700), what
direction are home prices likely to take going forward? To hazard a guess we
used a metric -- inspired by an Agora Financial 5 Min. Forecast published on 23 July -- wherein median home price
(MP) is divided by median household income (MHI) to derive a price/income
multiple (PIM).
Each month the U.S. Census Bureau reports the median price
of new homes sold; likewise, the National Association of Realtors (NAR) reports
the median price of existing homes sold. The Census Bureau reports median household
income on only an annual basis, however, and the latest data is for 2013.
We first converted the monthly median new and existing home prices to annual
observations by calculating averages for each year (the green and purple lines,
respectively, in the first graph below). To estimate median household income
for 2014 and 2015, we developed an ordinary least squares regression equation (R2
= 0.91) wherein the Census Bureau’s MHI is a function of NAR’s annualized MHI
(reported as part of NAR’s housing
affordability index data series). The derived MHI estimates are shown as
the red segment of the income line in the first graph below.
Several items are noteworthy: Growth in MHI broke off its
long-term trend in the wake of the Great Recession (i.e., since 2007) and -- although
having regained its pre-recession level in 2012 -- has yet to fully recover its
former trajectory. New-home MPs peaked in 2007, bottomed in 2009, essentially
regained their pre-recession level by 2012, and have continued higher since
then. Existing-home MPs, by contrast, peaked in 2006, bottomed in 2011, and
have yet to regain their pre-recession level.
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view
The Census Bureau’s median home price data extends back to
1984 whereas NAR’s data begins in 2003. For the available years, we divided
annualized median home price by annualized median household income to estimate
new and existing home price/income multiples. Prices and PIMs are shown in the
second graph below. PIMs for new homes have ranged from 3.57 to 5.34, for an
average of 4.31; existing-home PIMs have ranged from 3.29 to 4.71, for an
average of 3.86. I.e., on average new home prices have been equivalent to 4.31
times MHI, and existing home prices 3.86 times MHI.
For new homes, the PIM peaked at 5.06 in 2005 -- the height
of the housing boom. It slid to its low point of 4.31 by 2009 and has since
trended to an all-time high of 5.34 in 2015. For existing homes, the PIM peaked
at 4.71 in 2005 (despite the MP peaking in 2006), but two additional years were
required to hit the bottom of 3.29 (in 2011); as with its corresponding MP, the
existing-home PIM has not yet returned to its pre-recession high.
Click image for larger
view
Particularly in light of the new-home PIM presently at an
estimated all-time high and incomes
posting only slow growth compared to home prices (especially on an
inflation-adjusted basis), we think there is greater downside than upside risk
to home prices. The table below shows the implications for prices if the PIMs
return to selected historical levels.
Click image for larger view
For new homes, the best scenario shown involves the PIM
returning to its 2005 level; that would result in a price reversion to $273,334
-- a decline of $15,590. A more dire scenario would have the current PIM
retreating by an amount equivalent to that seen between the 2005 peak and 2009
trough; in that case, the PIM would drop to 4.60 with the new-home MP falling
to $248,576 (a decline of $40,358).
Because the existing-home PIM has not returned to its
pre-recession peak, there is perhaps more upside potential. For example, were
that PIM to once again hit the 2005 peak, the existing-home MP could increase
by $38,922 to $254,622. The most pessimistic scenario involves the
existing-home PIM retreating from its current level by the amount seen between
2005 and 2011; in that case the multiple would slump to 2.57, resulting in the
existing-home MP dropping by $76,888 to $138,812.
For housing starts (new homes) and sales (existing homes) to continue climbing higher, we believe it will be necessary for home prices -- particularly new home prices -- to fall so coherence is maintained with households' ability to pay (i.e., MHI). Until that occurs we believe it will be difficult for housing starts to make more substantial progress toward regaining the long-term average level of 1.5 million units per year.
Unfortunately, as
the table above shows, home-price reductions will choke off the ability of some
current homeowners to refinance or trade up/down, thereby reducing access
to potential home equity that might provide additional economic stimulus. On balance,
however, lower home prices would likely provide the greater economic boon because
the Echo Boom demographic cohort would be able to flex more economic muscle
through greater household formations. Regardless, the path forward in housing’s
march back toward “normal” is likely to encounter several twists and turns. There
will be a variety of counterbalancing impacts to the general economy in the
process that, on net, could prove positive.
The foregoing comments represent the general economic views and
analysis of Delphi Advisors, and are provided solely for the purpose of
information, instruction and discourse. They do not constitute a solicitation
or recommendation regarding any investment.
