Economist's Commentary: July 15, 2008

Bottoms Up?

By Lawrence Yun, Chief Economist

This past week's front cover story in Barron's implies that the worst in housing could be nearing its end. 

The argument is based on sharply reduced new home construction, which helps control inventory, and from rising affordability conditions due to quick, sharp price declines. The argument is also based largely on an interview with Professor Case of the Case-Shiller Home Price Index.

The article is a bit long, but very thorough. I would just add one item to the story. The affordability measure referenced in the story is a straight home price-to-income ratio. I view this metric as inappropriate because most people take out a mortgage to buy a home. The mortgage servicing cost is much lower and good for consumers when mortgage rates are 6.5 percent, as they are today, than if they are at 8 percent as was the case for the most of the 1990s. Therefore, a better metric is mortgage servicing costs in relation to income. If using this metric, the affordability conditions would be even better than as implied strictly by a home price to income ratio.

The mortgage servicing cost conditions are not only falling and good for consumers (due to falling prices, historically low mortgage rates, and rising income), but they point toward under-priced conditions in many markets. For example, the mortgage servicing cost has fallen from 17 percent in the 1990s to 12 percent in Columbus, Ohio. Similar figures can be observed in Pittsburgh and Denver. In fact this very low mortgage servicing cost condition prevails throughout the vast middle-America - nearly every market from the Appalachians to the Rocky Mountains and in between. Rochester, Indianapolis, Kansas City, Houston, Milwaukee … you name a middle-American city and that market appears greatly under-priced.

Any of the middle-American markets that are currently seeing solid local job growth are ripe for a very nice price appreciation. I would say Denver and Houston will be ranked near the top for home price growth over the next three years.

This is one in a series of commentaries by the Research staff of the National Association of REALTORS®. Read more commentaries >

Comments? Questions? E-mail NAR Research.

NAR members, learn how you can add this commentary to your Web site, blog, or newsletter. Read more >