Barron’s: This Real Estate Rout May Be Short Lived

The Barron’s cover story this weekend is Bottom’s Up: This Real Estate Rout May Be Short Lived. Surely a welcome bit of analysis ahead of a week that’s sure to be monumental as Fannie Mae and Freddie Mac are poised for a Fed bailout. Credible analysis too, not just propaganda.

The article actually starts by advocating for a Fannie/Freddie bailout and agrees with the consensus that they’re too big to fail. It also mentions the proposed legislation that would allow the FHA to refinance about $300 billion in subprime mortgages. Then it pins a lot of its analysis on the work of Karl “Chip” Case, the Case half of the S&P Case/Shiller Home Price Indices, and one of the most well-versed housing data crunchers in the country. According to the piece, Case is:

…among those who think home prices may be nearing a bottom. Case notes, among other things, that new housing starts fell to 975,000 in April from a peak rate of 2.27 million in January 2006, and that three declines of similar magnitude — from more than two million to less than one million — have occurred in the past 35 years. “Every time this has happened before, housing-market activity has rebounded within a quarter and caught experts by surprise,” he says. “In many areas, particularly outside the overbuilt markets of Arizona, Florida and Nevada and the huge bubble market of California, home prices may well stabilize” and begin to recover before the end of this year.

Case acknowledges history might not repeat, as the U.S. could be on the cusp of a painful recession. Unlike the three prior dips of a million-plus starts — in the first quarter of 1975, the second quarter of 1982 and first quarter of 1991 — the latest slide was triggered by insensate speculation and suicidal lending practices rather than the traditional factors of rising unemployment and interest rates and slowing economic growth. Thus, he says, a protracted dip in the economy would temper his optimism, though the official measures of economic growth don’t indicate a recession yet.

Perhaps even more notable is Case’s preferred method of analysis: the ratio of home sale prices to per-capita income in various areas, and specifically the 20 core markets covered in the Case/Shiller Indices. This price-to-household-income ratio is returning to more historically normal levels in many bigger markets:

Case prefers to study the ratio of sale prices to per-capita income in various locales — already has improved affordability. The change in such ratios varies by market, with Florida, Arizona and Nevada typically tracing short boom-and-bust cycles because any surge in speculative demand quickly is followed by overbuilding, due in part to the abundance of cheap land. The ratio in Phoenix, for example, has been reverting to a more typical six times home prices to income, after soaring to nine times in 2005 and ’06.

Most volatile are popular metro areas, such as Los Angeles and Boston, where housing demand is high, along with restrictions on development. Los Angeles’ affordability ratio doubled from 2001 to 16 times at the height of the housing boom, before dropping back to around 11. The Boston market never grew so frenzied, perhaps because it was far from the center of the subprime-lending business in Southern California, where an array of bad business practices flourished. Boston’s housing-affordability ratio peaked at 12, and since has returned to a more normal nine times prices to income.

We still agree with the predictions that 5-10% more declines are coming, and that because of massively tighter loan guidelines, we will skip along whatever bottom we do find for awhile. Nevertheless, markets need some good news right now, and Barron’s author Jonathan Laing’s stories have moved markets before. So brace yourselves for another exciting week.