November 5, 2008 (Housing Market Monitor)
Will House Price Declines Accelerate?
A sharp drop in prices will be needed to restore balance to the housing market.
Recent economic data provide reason to believe that the rate of price decline in housing may accelerate sharply over the next few months. October car sales show that consumers have adopted a completely different attitude toward spending. The talk of a Great Depression and the other fear tactics used to pass the bank bailout bill last month scared consumers out of spending. This fear is likely to spill over into the housing market, with families being more hesitant than ever to spend excessively on a new home.
Of course, access to credit will also be a factor. With close to a fifth of all homeowners underwater, many potential long-term homeowners will have the same difficulty coming up with a down payment as first time home buyers. And after deducting realtor fees and other closing costs, as many as a third of current homeowners may have nothing left over from the sale of their current home to be used toward a down payment on new house.
The positive side of this falloff is that sellers may finally come to grips with reality and be willing to accept lower prices. This is more likely with developers who are having increasing difficulty obtaining the credit needed to finance their inventories. At the rate of price decline seen over the last few months, the bubble would not be fully deflated until the summer of 2009. It is possible that a process of capitulation by sellers could bring prices back to trend levels much sooner.
Part of this process will involve prices being transmitted through different segments of the market. In many of the bubble areas, some segments of the market have largely deflated, while others have been much less affected.
For example, in Washington, D.C., prices in the bottom third of the market (under $330,000) have fallen by 31.0 percent from their peak level two years ago. Prices in the top third (over $480,000) have fallen by just 14.9 percent, with prices in the middle third having dropped by 25.4 percent. As a practical matter, this has meant that prices in many more distant suburbs have fallen by close to 50 percent over this period, while prices in closer in suburbs have only experienced modest declines.
This means that the already substantial price differences have been amplified enormously. In many cases it will be possible to find a house for $250,000 in a more distant suburb that is comparable to a home that would sell for $750,000 in a closer in suburb. With such enormous price differentials, people will opt to move from nearer in suburbs to more distant suburbs, putting substantial downward pressure on the price of houses in the closer in suburbs.
The condo market is likely to also experience substantial downward pressure in many areas. The inventory of unsold condos nationwide was equal to 14.3 months demand in September. Such an enormous oversupply virtually guarantees sharp declines in price; the only question is the timing.
The growing financial stress on many families is also likely to increase the downward pressure on house prices in many areas. Families that are holding onto multiple homes are finding this more difficult, both as they face higher financing costs and, in many cases, the threat of job loss. This will increase the number of units placed on the market.
The additional downward pressure on prices is in fact a positive development in the housing market, since it will bring prices back to their trend level more quickly. Once the process of bubble deflation is completed, there is hope that prices will stabilize and then begin to rise again with inflation as they have historically. There is no way that there will be a resumption of normal rate of construction any time soon, but a necessary precondition is the elimination of the huge backlog of unsold homes. This cannot happen without a sharp fall in prices.
is Co-Director of the Center for Economic and Policy Research, in
Washington, D.C. CEPR's Housing Market Monitor is
published weekly and provides an incisive breakdown of the latest
indicators and developments in the housing sector.