STRUCTURAL BUILDING COMPONENTS MAGAZINE
November 2005 Support Document
Economic Environment
Housing Bubbles: No National Bubble, Some Regions Vulnerable by Al Schuler
INDICATORS TO WATCH
Inventory is a good measure of demand/supply balance – if inventories get too high (over six months supply) that suggests the market may be cooling. Inventory of new homes for sale can be found at (http://www.census.gov/const/newressales.pdf), while inventory of existing homes for sale is available at (http://www.realtor.org). Another item to watch (available at the same website) is how long a completed new home is on the market; as that time lengthens, it indicates a slowing market. The ratio of home price to rent is like a P/E ratio for the housing market. Just as the share price for equities should reflect discounted present net value of future dividends, the price of a house should reflect the future benefits of ownership, either as rental income for an investor or the rent saved by an owner occupier. These ratios are reaching historical highs. The ratio of median single-family home price (http://www.census.gov/const/www/newressalesindex.html) to median family income (http://www.census.gov/) was 3.36 in 2004, 30 percent above the historical norm (1970 – 2000 average); the house price index to rent ratio was 1.26 in 2004, 26 percent above the historical norm (1980 – 2000 average); and mortgage debt to income ratio was 85 percent in 2004, up from 60 percent in 2000 (New York FED).
However, we have 40 year lows in interest rates, so perhaps the traditional ratios might need adjustment. Affordability (ability to make the payments) has always mattered most. With record low mortgage rates, people can borrow more and still make the payments even with no increase in income level. Some would argue that although the home price/wages (income) ratio is indeed lofty, the ratio of mortgages to wages is still manageable. Because of this, we can spend more (proportionally) on a house today than in the past. The problem here is that many of the mortgages in the past two years have been interest only, adjustable rate instruments with little or no down payment – a risky consumer scenario in today’s increasing interest rate environment. For example, over 50 percent of the mortgages in San Francisco fit this description. One other indicator to watch is NAHB’s housing affordability index (HOI) (http://www.nahb.org/page.aspx/category/sectionID=135). The HOI for the U.S. in 2nd quarter fell to 45.9, meaning that about 46 percent of new and existing homes sold in the second quarter were affordable to median income families. This index can vary considerably across the U.S. with least affordable regions being LA where only 3.6 percent of recent sales are affordable to median family incomes in the LA region. In stark contrast, 89.5 percent of recent home sales in Buffalo were affordable. Housing markets are truly regional.
FURTHER READING