The Good News In Housing’s Bad News

In the first quarter of this year, home values fell 3 percent, the largest quarter to quarter drop since 2008. That’s bad news for homeowners who want to sell, but for the market as a whole, the renewed spate of falling prices is a sign that things may soon be on their way up.

On the surface, the current drop in prices looks like a new down cycle, since prices rose from April 2009 until last summer. It seemed we had already reached the bottom of the trough and were on the rebound. However, that rise was an artificial one, spurred by the first-time homebuyer’s credit.

The credit, which aimed to create demand, in fact simply shifted it, causing those who would have bought homes anyway to do so earlier. The acceleration of home-buying activity temporarily raised prices but did nothing to correct the underlying imbalance between supply and demand.

Meanwhile the Obama administration did everything in its power to distort the supply side of the equation by stalling foreclosures. Like the first-time homebuyer’s credit, this temporarily kept prices from falling. But while policy wrangling may have kept some people in homes they could not afford a little longer, it did not change the fact that those homes would eventually need to be put on the market.

As I have written before, the key to restoring the housing market to health is to let the sickness run its course. People who moved into houses that they couldn’t afford during the easy-money boom period now need to move to homes that they can afford. The recent spate of falling prices is a sign that these people are finally moving on with their lives, allowing the housing market to move on as well.

While house prices are down, activity is up, showing that the market’s process of realignment is moving forward. Existing home sales increased 3.7 percent in March to a seasonally adjusted annual rate of 5.10 million, from 4.92 million in February. The Pending Home Sales Index, which measures sales under contract, increased even more, rising 5.1 percent on a month-to-month basis. Since home sales typically close 45 to 60 days after a contract is signed, the Pending Home Sales Index provides a better indication of the current level of activity.

The fact that real estate sales take time to close also means that we may be closer to a rebound in prices than the first quarter numbers seem to show. The sales recorded in the first quarter were largely the completions of contracts signed near the end of last year. Therefore the low average prices were likely, at least in part, a product of the heavy load of foreclosures that hit the market then after being previously held up by paperwork issues. Fannie Mae and Freddie Mac saw a 23 percent increase in the number of foreclosed homes they sold in the first quarter of 2011, compared to in the fourth quarter of 2010, according to The Wall Street Journal.

The lousy weather that affected much the country last winter played a role as well. After all, most people like to see a house before they buy it, and that can be hard to do when it is buried in several feet of snow.

Still, even as the increased activity eats into the supply of homes on the market, demand is likely to remain suppressed, at least for the time being. A full recovery in prices will take time. The unemployment rate remains high, at 9 percent for April. And even those who have enough income to consider buying may not be able to qualify for a mortgage. Banks, still wary of any remotely risky lending, are pickier now about prospective borrowers than they were before the boom. The government continues to provide critical life support to the mortgage market, with some 90 percent of new mortgages receiving government backing.

The low prices, however, are drawing in more investors who often pay cash, adding a strong source of demand. Investors accounted for 22 percent of sales activity in March, according to the National Association of Realtors. The risk of inflation has made real estate more attractive for domestic investors looking to add hard assets to their portfolios as a hedge. Meanwhile, the weak dollar has made U.S. properties particularly cheap for foreigners.

In the longer term, the real boost to the housing market will probably come from demographic shifts. The segment of the population now in their 20s is particularly large as a result of the baby boom echo. In the next five to 10 years, these boomers’ children are going to start raising children of their own, and many of them will want to buy homes to do it. In time, their families and incomes will grow, leading them to seek larger homes, creating a steady source of demand that will carry us into the next decade.

Now that the first-time homebuyer’s credit is gone and the fervor for stopping foreclosures at all costs is fading, the housing market is back under the control of natural forces. The return to something approaching economic normalcy presents the deceiving appearance of a relapse in the housing market. But by starting to let the market follow its own course, we are also starting to let it truly recover.

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About Larry M. Elkin 564 Articles

Affiliation: Palisades Hudson Financial Group

Larry M. Elkin, CPA, CFP®, has provided personal financial and tax counseling to a sophisticated client base since 1986. After six years with Arthur Andersen, where he was a senior manager for personal financial planning and family wealth planning, he founded his own firm in Hastings on Hudson, New York in 1992. That firm grew steadily and became the Palisades Hudson organization, which moved to Scarsdale, New York in 2002. The firm expanded to Fort Lauderdale, Florida, in 2005, and to Atlanta, Georgia, in 2008.

Larry received his B.A. in journalism from the University of Montana in 1978, and his M.B.A. in accounting from New York University in 1986. Larry was a reporter and editor for The Associated Press from 1978 to 1986. He covered government, business and legal affairs for the wire service, with assignments in Helena, Montana; Albany, New York; Washington, D.C.; and New York City’s federal courts in Brooklyn and Manhattan.

Larry established the organization’s investment advisory business, which now manages more than $800 million, in 1997. As president of Palisades Hudson, Larry maintains individual professional relationships with many of the firm’s clients, who reside in more than 25 states from Maine to California as well as in several foreign countries. He is the author of Financial Self-Defense for Unmarried Couples (Currency Doubleday, 1995), which was the first comprehensive financial planning guide for unmarried couples. He also is the editor and publisher of Sentinel, a quarterly newsletter on personal financial planning.

Larry has written many Sentinel articles, including several that anticipated future events. In “The Economic Case Against Tobacco Stocks” (February 1995), he forecast that litigation losses would eventually undermine cigarette manufacturers’ financial position. He concluded in “Is This the Beginning Of The End?” (May 1998) that there was a better-than-even chance that estate taxes would be repealed by 2010, three years before Congress enacted legislation to repeal the tax in 2010. In “IRS Takes A Shot At Split-Dollar Life” (June 1996), Larry predicted that the IRS would be able to treat split dollar arrangements as below-market loans, which came to pass with new rules issued by the Service in 2001 and 2002.

More recently, Larry has addressed the causes and consequences of the “Panic of 2008″ in his Sentinel articles. In “Have We Learned Our Lending Lesson At Last” (October 2007) and “Mortgage Lending Lessons Remain Unlearned” (October 2008), Larry questioned whether or not America has learned any lessons from the savings and loan crisis of the 1980s. In addition, he offered some practical changes that should have been made to amend the situation. In “Take Advantage Of The Panic Of 2008” (January 2009), Larry offered ways to capitalize on the wealth of opportunity that the panic presented.

Larry served as president of the Estate Planning Council of New York City, Inc., in 2005-2006. In 2009 the Council presented Larry with its first-ever Lifetime Achievement Award, citing his service to the organization and “his tireless efforts in promoting our industry by word and by personal example as a consummate estate planning professional.” He is regularly interviewed by national and regional publications, and has made nearly 100 radio and television appearances.

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