Housing Market Still Facing an Uphill Climb, Despite a Mixed First Quarter

[Editor's Note: This look at the U.S. housing market is the latest installment in a series of Money Morning quarterly reports that will examine such topics as gold, U.S. stocks and oil. These reports will now be a regular feature at the end of each quarter.]

By Don Miller
Associate Editor
Money Morning

The global financial crisis started in the U.S. housing market, and many analysts believe that if the world economy is going to rebound, the recovery will begin with U.S. housing.

That's why the government has intervened with a spate of measures to stem foreclosures and prop up the market. And it's why for months, investors and analysts alike have poured over housing data looking for any indication of which way the economy might be headed. 

For those who have kept an eye on such statistics as home prices, sales, inventories, and mortgage applications, the data has presented a murky picture. 
Indeed some reports from the housing market have offered a ray of hope:

  • Sales of previously owned homes, which account for about 90% of the market, rose 5.1% in February.
  • New-home purchases, which make up the rest, increased 4.7% from a record low the month prior.
  • The National Association of Realtors' affordability index inched higher to 173.5 in February - an all time high since it was first created in 1971.
  • U.S. mortgage applications soared 32% in March, after the Federal Reserve said it would buy Treasury securities for the first time in more than four decades.
  • Inventories fell. The seasonally adjusted number of homes for sale fell to 12.2 months from 12.9 months in February, based on current sales rates.
  • Affordability conditions continue to improve as mortgage rates fell to near 4.5% and home prices remain exceptionally low.

But that's just the good news.  Here's the other side of the coin...

  • New home sales in January were down more than 10% from December and remain at the lowest level in recorded U.S. history (data that goes back to 1963).
  • Sales of existing, single-family homes have dropped to the lowest level in 11 ½ years, with no end in sight.
  • The median price of a new home is down to $201,100 - the lowest since December 2003. Existing home prices have fallen to a median of $170,300 - the lowest in almost six years.
  • The median sales price fell 19% from 2008 in February, the biggest year-over-year drop since records began in 1964.

So which is it?  Is the housing market finally on the road to recovery or is the good news just more false hope about to be dashed on the rocks of a relentless recession that won't let up?

To find some answers, let's take a deeper look at some of the numbers with an eye towards what they can tell us about the housing market in the days ahead.

Grim Unemployment Numbers Don't Lie

The cold reality is that skyrocketing unemployment is a major threat to the recovery of the U.S. housing market.  Consumers who are unemployed cannot buy homes, much less pay for the homes they're already living in. And even consumers who are afraid that they might be joining the jobless ranks are loath to take on the added risk - making them unlikely candidates to buy a new home either.

Unemployment in the United States has leapt to the highest level in a quarter century and is widely expected to rise further.  The Labor Department reported last week that employers cut payrolls in March by more than 663,000, the 15th consecutive month in the cycle.

That brought job losses in the current downturn to more than 5.1 million.

The U.S. unemployment rate rose to 8.5% in March, the highest in more than 25 years. Economists predict the national jobless rate will probably hit 10% by year-end even if an economic recovery kicks off before then. 

And while an unemployment rate of 8.5% is unmistakably bad - the government's figure may be vastly understating the true extent of the problem. The official rate doesn't include workers who have had hours cut or are filling part-time positions due to the poor labor market. And it doesn't include workers who have given up searching want ads for seemingly non-existent jobs.

When those folks are added to the numbers, the unemployment rate rises to 15.6%, according to MSN Money.

"The weakness is distributed across all components of the economy," Joel Prakken, chairman of Macroeconomic Advisers LLC in St. Louis, told Bloomberg News. "We are going to see several more months of serious bleeding before we see lesser job losses."

Bottom Line:  Unemployment is a lagging indicator and will rise even when the economy gets close to the end of any downturn. Unemployment numbers will probably get worse before they get better. 

Inventories Still Building as Prices Suffer

As unemployment climbs, foreclosures continue to multiply. That only exacerbates an already unappealing combination - more houses being dumped onto the market even as the pool of potential buyers grows increasingly smaller.

Foreclosures rose by 30% over February 2008, according to RealtyTrac.  The company's data showed that foreclosure filings - default notices, auction sale notices and bank repossessions - were reported on 290,631 U.S. properties during the month, compared to 274,399 in January. One out of every 440 homes is in some stage of foreclosure, the company estimated.

What's more, a MetLife study found that 50% of Americans have only a one-month cushion - roughly two paychecks - or less before they would be unable to fully meet their financial obligations if they were to lose their jobs. More disturbing is that 28% said they could not make ends meet for longer than two weeks without their jobs.

On top of that, 19.8% of all homeowners now owe more than the value of their home on the open market, according to the research firm FirstAmerican CoreLogic. If you include those homes that are near negative equity - meaning they'll be upside down if prices fall an additional 5% or less - one-quarter of mortgaged U.S. homes could be underwater.

That is having a profound effect on prices.  The S&P/Case-Shiller Index shows prices in the 20 top metropolitan areas plunging 19% from a year earlier, and 29.1% since they peaked in 2006, the biggest drop on record.

And it's not just the bubble markets that are losing value now. A whopping 134 of 153 U.S. metropolitan areas experienced year-over-year price declines in the fourth quarter of 2008, the National Association of Realtors reported. That's 88% of U.S. cities, up from 79% the quarter prior and the highest on record.
"Existing home sales popped in February, but they did so at the expense of pricing. More homes turned over, but only because sellers were more aggressive on price in many of the U.S.'s hard-hit markets," Mike Larsen, real estate analyst with Weiss Research wrote in a note to clients.

Bottom Line: Until significant portions of inventory are taken off the market, prices will not begin to move up.  Prices could retreat another 10% from here. 

Credit Markets Still tight

Standing in the way of any hopes for housing is the ever-looming issue of whether banks will become more willing to lend.

When U.S. mortgage applications soared 32% in March, lost in the shuffle was that more than 78% of the loans were refinances, as record low interest rates spurred a surge in demand for home refinancing loans.

"The likelihood is the trend will continue with more refis than actual purchases," Daniel Penrod, industry analyst for the California Credit Union League in Rancho Cucamonga, Calif., told Reuters.

But mortgages are far more expensive than they appear, especially for people borrowing large amounts or trying to refinance.  People only get that rock bottom 4.5% interest rate if they put 20% down, borrow $417,000 or less, and boast a high credit score (730 to 750). 

Fannie Mae (FNM) and Freddie Mac (FRE) now add a quarter-point "adverse market delivery charge" because of declining home prices in slumping markets. They have also initiated "risk-based pricing," which raises fees on people with less than a perfect borrowing profile.

And the days of "stated income" loans where you don't have to document your earnings, and option adjustable-rate mortgages, where you could choose to pay less than the interest due, are long gone.

"Despite the perfect storm for a buyer of home prices continuing double-digit declines and interest rates at all-time lows, the missing ingredient is the financing. Institutions still are very hesitant to lend, or they've ratcheted up their standards so hard that people are having a tough time meeting them," Penrod said.

Appealing to one specific market niche - first-time buyers - is critical to turning around the entire market, National Association of Realtors spokesman Walter Molony told Reuters. As more first-time buyers step into the market, the people they buy houses from can afford financing for a new house.

"The market heals from the bottom up," Molony said. "That's what provides liquidity to help people to sell their existing homes and to trade up and ultimately buy a bigger home or perhaps a new home."

Bottom Line:  Banks are still faced with capital ratio problems and likely will continue to demand higher credit scores and substantial down payments.  It will continue to be difficult for first-time buyers to get into the market, and for current homeowners to refinance.

What to do Now

Today's housing prices are dropping and will continue to drop until inventories are significantly reduced.  The ultra-low interest rates of a weak economy should eventually stir buyers to action.  When meaningful buying occurs interest rates will rise.

If you are in position to refinance an existing mortgage: Now is an opportune time to take advantage of interest rates at historic lows.  But make sure you're going to keep that new mortgage with those lower payments long enough to recoup your upfront costs.

If you are looking to purchase a new or existing home: Keep your powder dry. The time to start contemplating buying real estate again will be after the U.S. housing market has made a bottom in prices and after U.S. home prices start to increase.  For now, wait for a confirmed bottom - which may be defined as six months of increasing prices -before you venture into the market.

[Editor's Note: Money Morning Investment Director Keith Fitz-Gerald says the ongoing financial crisis has changed the investing game forever, making uncertainty the norm and creating a whole set of new rules that will quickly determine who wins and who loses in today's global investing markets. Fitz-Gerald has already isolated these new rules and has unlocked the key to what he refers to as "The Golden Age of Wealth Creation." His key discovery: Despite the gloom, investors may well be facing the greatest profit opportunity of their lifetimes.

In his newly launched Geiger Index investing service, developed after more than a decade of work, Fitz-Gerald has amassed a winning streak of nine-straight profitable picks. Check out our latest insights on these new rules, this new market environment, and this new service, the  Geiger Index.]

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