As the rebound in the U.S. housing market continues to strengthen, with annualized prices rising more than 10% nationally in March and April, some market watchers have begun to warn of a reinflation of the property bubble that burst in 2007 and led to the country’s worst economic slump since the Great Depression.
Standard & Poor’s Ratings Services suggests that, while double-digit gains in prices are unsustainable, it may be premature to view the current state of U.S. housing as being in a bubble. A number of factors are contributing to the increase in home values, including historically low (albeit now rising) borrowing costs, property purchases by investors looking to rent them out, and the undersupply of homes for sale–new houses, in particular–as builders struggle to ramp up after a half-decade of cuts.
We recently raised our 2013 forecast for the S&P/Case-Shiller 20-City Home Price Index to an 11% year-over-year increase, from 8% (see chart). The index is a three-month moving average, and it was up 11% year-over-year as of March. And while that was the biggest jump in seven years, recent increases are from significantly depressed levels. In this light, it pays to remember that a 50% jump after a 50% tumble represents a 25% decline.
Nationally, home prices are back to about 2003 levels–still far off their 2006 peak. That comes amid a bit of a supply-demand imbalance, with the sales of existing homes in April up a 9.7% from a year earlier and existing housing inventory 13.6% below a year earlier–representing a 5.2-month supply at the current sale pace, according to the National Association of Realtors. They were still weaker than expected, largely due to supply constraints, rather than demand. And housing starts plunged 16.5% in April after climbing above 1 million units (annualized) in March, for the first time in almost five years.
Still, while April starts were weaker than analysts expected, the report indicated that builders plan to break ground in the next few months. Permits, a leading indicator for future construction, jumped 14.3% to a five-year high of 1.017 million, suggesting we’ll see a bounce in starts. Even as builders face high costs for materials and a possible shortage of developed lots and labor, they seem to be figuring out a way to skirt these roadblocks. Higher home prices are a big reason why because that tells builders that demand for new houses is rising.
Homebuilders we rate have reported an 11% increase in average selling prices (ASP) so far this year, with several seeing ASPs jump more than 15%. The limited supply of homes for sale in many markets and a shift to higher-priced luxury homes are driving these gains. In addition, home affordability–supported by historically low mortgage rates–is high, which has boosted buyer demand despite relatively modest job and income growth in the past year. We expect homebuilders to continue to enjoy rising ASPs, though perhaps at a slower rate as supply increases.
Additionally, the National Association of Home Builders’ (NAHB) sentiment index jumped eight points, to 52, in June–the biggest one-month gain since September of 2002 and reaching its highest level since March 2006. (A reading above 50 indicates that more builders view sales conditions as good than poor.) The index assessing current sales conditions added eight points, to 56, and the gauge of expectations for future sales rose nine points, to 61–also the highest level since March 2006.
Meanwhile, the number of Americans who own homes has slipped to the lowest in almost two decades, dropping to just 65% in the first quarter of the year, according to Census Bureau statistics. That’s down from a peak of 69.2% in June 2004, and coincides with an increase in investor purchases of single-family homes. Private-equity firms such as Blackstone Group, which has reportedly acquired approximately 26,000 homes, are snapping up properties with an eye toward renting them out until prices reach levels at which they’d sell for a healthy profit.
These purchases, made primarily with cash, are obviously bolstering prices. And while some analysts may see this as artificial–or at least atypical–support for property values, we don’t believe this will lead to rampant overheating of the market. To be sure, prices may fluctuate a bit in certain pockets of the country (investor buying has so far been focused in areas that suffered the most, such as Las Vegas, California, and Florida), but any widespread volatility seems unlikely, in our view. On the contrary, some large early leaps in value are natural, given that prices had probably fallen too far in many of those markets.
There are signs that the housing supply could remain tight for some time. As banks that foreclosed on homes remain reluctant to put them back on the market until they can turn a profit, construction of new single-family homes has also slipped. The 7% monthly jump in housing starts in March–representing a 47% increase from a year earlier–was a function of a surge in multifamily construction, which rose 31%. In fact, single-family starts fell 4.8% in the month–coinciding with the third consecutive monthly decline in homebuilder confidence.
Regardless of the reason, any increase in housing starts is good for building materials and products companies, which have suffered more than five years of retrenchment and cost cutting, with revenues dropping by half in some cases. Many borrowers we rate in this sector trimmed production and jobs, and closed factories and plants. And even with home prices rebounding, we expect overall sales and profitability to be well below their pre-recession levels.
As it stands, our baseline economic forecast calls for an increase in total housing starts of about 28% this year, to 1 million units, and a rise of another 29% next year, to about 1.3 million units. Still, that’s less than the 50-year historical average of about 1.5 million homes.
And while the number of Americans applying for home loans has increased in recent weeks, mortgage rates have climbed to their highest in more than a year, tracking a surge in yields on 10-year Treasuries in the wake of speculation that the Federal Reserve will soon scale back its economic-stimulus efforts. The average rate for a 30-year fixed-rate mortgage has risen to a 14-month high of 3.98%, according to data from Freddie Mac. And while a 30-year home loan at less than 4% still represents a good deal, from a historical perspective, the current rate is well above the all-time low of 3.31%, reached in November of last year. Add to this that U.S. student debt is climbing toward a record $1 trillion, and potential first-time buyers may be squeezed out of the market.
That said, buying can be financially prudent. While rising prices and borrowing costs make purchasing a house more expensive, online residential real estate site Trulia estimates that buying is 41% cheaper than renting, given current mortgage rates. The site also says that even with a 5% mortgage rate, buying would be 34% cheaper than renting in all of the 100 largest metropolitan areas. Amid signs that the recovery in the U.S. property market has taken root, many buyers may be inclined to jump in before prices–and mortgage rates–rise further.
All told, we believe U.S. home prices are low relative to historical values. Nationally, home prices are still 28% below their July 2006 peak. Fundamental indicators such as price-to-rent and price-to-income ratios remain favorable. The ratio of home prices to rents returned to about 16.2 times in the first quarter of this year, down sharply from more than 25 times in 2007 and slightly below the long-term average.
Additionally, housing is still undervalued about 8% based on the price-to-income ratio, which looks at the median sales price of a home relative to median annual incomes. Historically, the typical, median home in the U.S. costs 4 times as much as the median annual income. It’s now at 3.7 times.
In any event, Standard & Poor’s believes that while the current pace of gains in home prices may not last long, it’s premature to describe the market as being in a bubble. In fact, with home values still well below their pre-recession peaks, we expect prices to continue to rise this year.
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