House prices in US - how low can they fall?

November 29, 2011

United States house prices

The US housing market has drifted lower, with house prices falling by 7.22% (seasonally-adjusted) year-on-year to Q3 2011, according to the Federal Housing Finance Agency (FHFA) (figures adjusted for inflation). The seasonally-adjusted Case-Shiller index was more negative, falling by 7.42% from a year earlier, and by 1.61% in the latest quarter.

Yet despite depressed house prices, there are positive indicators:

  • Homebuilder confidence was up to an 18 months high in November 2011, according to the National Association of Home Builders (NAHB)/Wells Fargo Housing Market Index (HMI).
  • The number of homeowners who owe more than their homes worth decreased modestly in the third quarter, though levels remained high.
  • The mortgage delinquency rate dropped to  10.53% during the year to Q2 2011, down from 11.17% in during the year to Q2 2010, according to the US Federal Reserve Board.
  • The rental market is expanding. 

Prices are still not bottoming-out

United states house price index

However, house prices still don’t seem to have bottomed out.  Freddie Mac expects that the US housing market will decline over the following months, because of the large inventory of homes with delinquent mortgages.

The number of new single family houses sold in September 2011 was 313,000 units, a 0.9% decline from September 2010.

Average prices were 20.02% down in Q3 2011 from the Q1 2007 peak, according to Federal Housing Finance (FHFA). Adjusting for inflation would make that significantly larger.

Some say prices are now so low that US houses are now actually undervalued. In a study by real-estate firm Zillow Inc. reported in August, US home prices are down from their “fair value” in one-third of nearly 130 housing markets.  Undervalued markets includes: Detroit (25% undervalued), Modesto, California (18%) and Fort Myers, Florida (13%).

However, the study also shows that a lot of markets still appear to be overvalued. Zillow’s analysis used the price-to-income ratio in determining whether housing is undervalued or overvalued.

Economic reasons for expecting a poor outcome for the housing market include:

  • High unemployment.
  • High house inventories, combined with foreclosures and unemployment, are pushing down house prices in certain areas.


US Census Bureau
Median asking price – US$138,400
Median sales price – US$228,100
Average sales price – US$267,600
FHFA: All transactions index
FHFA: Purchase only index
S&P/Case-Shiller®: 10 main cities
Source: US Census, NAR, FHFA, S&P
See also: measuring US house price changes

Are homes undervalued?

United states house prices and rents comparison

The house price-to-rent ratio, the measure of house prices fundamentals which the Global Property Guide favours, does not suggest that house prices, in general, are undervalued. In fact house prices are still above their long-term trend, as is clearly visible from the graphs:

Shrinking housing market

United states house rents

To replace the vacuum created by the mortgage crunch, government agencies have been pumping out more housing loans.

A new mortgage relief plan was announced by President Barack Obama in October 2011, attempting to stimulate the economy and to revitalize the housing sector.

The relief plan is actually a revamp of an existing government mortgage-refinance program, namely, the Home Affordable Refinance Program (HARP).  Introduced in early 2009, HARP allowed refinancing for “underwater borrowers” (borrowers with low-or no-equity mortgages) under certain conditions and qualifications, if mortgages are backed by Freddie Mac and Fannie Mae.

The program was deemed ineffective since it only refinanced 894,000 mortgages by end-August 2011, way below from the government’s 4 – 5 million target.

This time around, HARP’s previous maximum loan-to-value (LTV) ratio has been scrapped and the 2% fees paid by some high-risk borrowers have either been reduced or abolished. Moreover, the HARP deadline has been extended to December 31, 2012.

Despite this, the new HARP has limits. According to FHFA, to be eligible for HARP:

  • The mortgage must be owned or guaranteed by Freddie Mac and Fannie Mae.
  • The mortgage must have been sold to Freddie Mac and Fannie Mae on or before May 31, 2009.
  • The mortgage cannot have been refinanced under HARP previously, unless it is a Fannie Mae loan that was refinanced under HARP from March-May 2009.
  • The current LTV ratio must be higher than 80%.
  • The borrower must have no late payment in the past six months and no more than one late payment in the past 12 months.

united states mortgage lending

The US is one of the few countries with a mortgage-to-GDP ratio over 100%.  Mortgage debt rose from 61% of GDP in 1994 to 1997, to 103% in 2007, before falling to 95% of GDP in 2010.

Critics say HARP is a costly way to stimulate the economy.  Aside from that, the program favours buyers without repayment problems, not delinquent borrowers or those already in a foreclosure process.

New home buyers face higher down payments and mortgage rates, and stricter loan requirements, as home loan limits on FHA, Fannie Mae and Freddie Mac lending have been reduced from $729,750 to $625,500, from October 1, 2011.

Mortgage rates are still high?

United states interest rates

The US Fed’s key rate remains unchanged at 0.13%, having been cut in December 2008. The rate can hardly fall further.

Home mortgage rates are of course higher. As of October 2011, the average interest rate for 30-year Fixed Rate Mortgages (FRMs) was 4.07%, while the average rate for 15 year FRMs was 3.35%. One-year adjustable rate mortgages (ARM) have an average lending rate of 2.92%.

In 2010 and 2011, interest margins ranged from 2 to 4 percentage points, up from 0.2 – 1.5 percentage points from June 2006 to August 2007.

So despite the key rate drop from 5.25% in August 2007, actual lending rates have changed much less.

Falling foreclosures and delinquencies

United states real estate

The good news is that the mortgage delinquency rate has fallen to 7.99% in Q3 2011, down from 8.44% in the previous quarter, and from 9.13% in Q3 2010, according to the Mortgage Bankers Association (MBA).  A similar trend is also seen in the US Fed data, with Q2 2011 delinquencies down to 10.53%, down from 11.17% in Q2 2010. The all-time high was 10.42% at end 2009.  The seasonally adjusted delinquency rate was 3% or less from 1994 to 2007.

The recent decline in the delinquencies and foreclosures may have helped the housing market. Most delinquencies end up in forfeiture, so the reduction of delinquencies reduces the supply of houses coming from foreclosures.

However, the drop in foreclosure activity is not a clear signal of a market recovery.  “Unfortunately, the falloff in foreclosures is not based on a robust recovery in the housing market but on short-term interventions and delays that will extend the current housing market woes into 2012 and beyond,” James Saccacio of RealtyTrac.

“The October foreclosure numbers continue to show strong signs that foreclosure activity is coming out of the rain delay we’ve been in for the past year as lenders corrected foreclosure paperwork and processing problems,” adds Saccacio.

“Recent state court rulings and new state laws keep changing the rules of the foreclosure game on the fly, creating more uncertainty in the housing market and threatening to prolong the road to a robust real estate recovery.”

Home builder confidence is up, construction is still weak

Construction remains low compared to pre-crisis levels. In 2004 and 2005, housing unit building permits exceeded 2 million, but in 2010, the number was down to 603,000 units.

united states home sale chart

Due to increased rental demand, a slight increase in housing starts I expected in Q4 2011. NAHB sees an increase in housing starts in the latter part of 2011 and an even more significant performance in 2012.

Rental market is picking up

In contrast to the weak appetite for buying homes, the rental market is strong and is expected to expand further in 2012.

United states housing construction

Rents rose by more than 5% in tight markets such as Washington, DC, New York, and San Jose. Meanwhile rents rose by an average of 2.5% in the South and 1.7% in the West.  Large apartment owners are using the opportunity of rising rental demand and tight supply to push rents up. And an even stronger rental increases are expected in 2012.

Yet this trend should not be overstated. Rental vacancy rates were 9.8% in Q3 2011,  higher than the average boom-period vacancy rate of 9.7% (2005 to 2007). From 1990 to 1997, the average rental vacancy rate was only 7.5%.

According to the Housing Vacancy Survey of the 2010 Decennial Census, metropolitan areas with historically tight rental markets such as Los Angeles, New York, and Boston have the lowest vacancy rates.

Rental vacancies are below pre-crisis levels, and will be 5.5% in 2012, according to CBRE Econometric Advisors (CBRE-EA).  The vacancy rate fell from 7.4% in 2009, to 5.3% in 2010.  The US Census has differently based figure, seing a decline in vacancies from a 2008-2009 average of 10.33%, to a 9.8% vacancy rate in Q3 2011.

Unemployment remains high; budget control act

The US economy is expected to grow by 1.5% in 2011, down from 3% growth in 2010. Unemployment remains high at 9% in October, slightly down from 9.1% in the previous month.

united states economic performance chart

Unemployment rates during the pre-crisis period ranged from 3% to 5%, and only started to hit the 9% mark in 2009.

Aside from US’s high unemployment rate, the recently-passed Budget Control Act, enacted in August 2, 2011, aims for a deficit cut of US$ 1.1 trillion over a decade, and will rule out most stimulus spending. Inflation is forecast to be 3% by end-2011, higher than last year’s 1.65%, and higher than the Fed’s long term goal of below 2%.  Other issues such as the recent Occupy Wall Street protests, EU’s debt crisis and the presidential candidates’ bid for the 2012 elections are also currently having a negative impact in the US economy.


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