Economist's Commentary: February 22, 2008
Chain Reaction
By Lawrence Yun, Chief Economist
The inventory of homes listed for sale is very high, with about 4 million existing homes and nearly 500,000 new homes on the market. With the spring season just around the corner, when more homes get newly listed, inventory will undoubtedly rise further. High inventory is a big concern because it will further pressure home prices to fall (or lower the price growth in healthier local markets). Falling home prices will cut housing equity and as a result can cut into consumer spending. Consumers have been resilient to date — though decelerating in the fourth quarter of 2007 with spending rising 2.0% (annualized increase) rather than the better than 3% pace of the prior three years. Concerns are related to the future. Consumer spending is derived from two sources of funds — people's paychecks and from gains in asset valuations of financial and tangible assets.
Paycheck disbursement has been quite good. The total salary and wage disbursement was $6.4 trillion in 2007, up $350 billion from 2006 and an additional $350 billion from 2005. However, the stock market has been volatile, while the median home prices fell 1.4% in 2007, shaving off $290 billion off housing equity, in my estimate (housing equity fell by $160 billion from its peak to the third quarter of 2007, according to the latest data from the Federal Reserve, and increased by $2.9 trillion from five years ago to current when looking at the housing boom years).
For many who purchased prior to the housing market boom, they are doing quite well, even with recent price declines. However, the decline is particularly stressful for those recent home buyers who purchased in declining markets. As a result, a shaving off of $290 billion is likely to result in a consumer spending reduction to the tune of about $25 to $35 billion, based on a reasonable assumption of research papers pointing to a drop of 8 to 15 cents per dollar on housing wealth spending. With inventory expected to climb through the spring season and possibly into early summer months, the bloated inventory can further pressure prices to go down and even further negatively impact consumer spending.
Billion and trillion dollar figures are sometimes difficult to comprehend so a comparison context may be needed. $100 billion would correspond to about $1,000 per household in the U.S. A recent fiscal stimulus package was a bit over $150 billion. Post-Katrina rebuilding spending in New Orleans totaled a bit over $100 billion.
It is also possible that inventory could fall notably over the next six months. A vacant home listed for sale always applies downward pressure on home prices. The opportunity cost of carrying a vacant home is high. Thanks to homebuilders having dramatically cut production, the inventories of new homes on the market — which are vacant by definition, have trended down over the past year and a half. It peaked at 573,000 in July 2006 and now stands at 495,000. The decline, however, is small in relation to the total inventory of about 4.5 million homes on the market and well above the 300,000 to 400,000 range for new home inventory prior to the housing boom years.
The big inventory adjustment needs to take place on the existing home inventory. The homeowner vacancy rate has climbed from a historically stable rate of 1.7% in 2004 to 2.7% in 2007. However, a vast number of existing homes on the market is not vacant. Our survey of REALTOR® members about their client's listed home shows that nearly half want to sell the home for traditional reasons of job relocation, marriages, and divorces. An additional 27% indicated listing the home for wanting to trade up, but only if the current home is sold. In other words, a vast majority of existing home inventory is also a reflection of high potential housing demand. A sale will trigger a home purchase. Therefore, what is needed is some trigger to start the process of more and more home sales.
What could be the trigger that sets in motion the chain reaction?
- Buyer confidence and psychology could return at any time due to very attractive mortgage rates.
- Home prices in some markets have fallen very fast. Several Florida and California markets have experienced a15% to 20% decline in home price. Lower prices may entice buyers into the market place — if they believe most of the price declines have already occurred.
- Sales could begin to pick up in many coastal markets as a result of a higher loan limit that will go into effect in a month or two and that in turn would signal an end to the housing slide, thereby boosting consumer confidence even in areas not needing a jumbo loan.
- A financial incentive to first-time homebuyers. Perhaps, a bold move by the government - a second stimulus package - to provide tax credit or down-payment assistance for first-time homebuyers could quickly help stabilize the housing market and the rising absorption can quickly end foreclosure problems. A time limit set to the end of the year should be placed to assure people do not wait on the fence. It can be in the amount of $5,000 to $8,000, which in my estimate translates into a government tab of $10 to $15 billion. This is rather modest sum compared to other government expenditures.
Independent of government policy, it is possible that (1), (2), and (3) could bring buyers back into the marketplace. But guaranteed insurance on housing market recovery can be made from implementing (4).
This is one in a series of commentaries by the Research staff of the National Association of REALTORS®.
