Housing Market: Overview and Demand

I have been delaying this post for a long time. Now everyone, including hardcore housing bulls, recognizes that housing bubble has bust. Many people, including many housing stock CEO's, are saying that the housing has bottomed an turn around is just round the corner. I don't believe it. I believe housing will not turn before fourth quarter of 2007. What that does mean is that as a six month leading indicators, housing stocks are a buy during first and second quarter of 2007.

The housing price like the price of any assets in capitalism is a result of supply and demand.

Let us analyze the demand side of the market. The people who buy a house are either a new buyer or existing buyers. New buyers are moving out of the rental market or their parent's house while existing buyers are either upgrading to a bigger house or buying a second home. Existing buyers also involve people buying houses as investment to rent. Of course, I didn't mention a speculative buyer that was rampant during the last stages of the housing bubble. In this market that is a very small percent of buyer, if any.

Though the buyers are a big diverse group, there are just few economics and non-economic factors that affect the supply side of the equations.

1> Affordability: Interest rate & Home Prices
2> Future expectation: Job market
3> Rent Vs Buy (financial & emotional benefits)

Interest rate has been pretty favorable for the housing market. Though interest rate ( till 2004, after 2004) inched up a little in the middle of 2006. It has not gone up dramatically to push the morgage payments above affordability for the current buyers. My view is confirmed by very low foreclosure rate. Also, the top three primary reasons for selling the current home are

1> it was too small (19%)
2>the neighborhood was less desirable (13%)
3> so they could be closer to their job (10%)

While interest rate have been keeping steady, it is the house prices that increased to a level where affordability has been affected. The post stock market interest rate fueled housing bubble has pushed the house above the affordability threshold. I don't expect the interest rate to increase in 2007, but for housing to be affordable; the house prices have to drop.

Like interest rate, job market has been very favorable for the housing market. The unemployment rate has averaged 4.6 for 2006 and fell all through the 2006. Additionally, the consumer confidence has also been very upbeat. My outlook for 2007 is not as rosy as 2006. In fact, most economist expect the unemployment rate to inch up to 4.9 percent by the middle of 2007. In fact, I would expect the unemployment rate to go above 5.0 (low of the natural unemployment range) sometime in 2nd or third quarter of 2007.

Please don't get me wrong, I am not forecasting widescale lay offs. I am just not as convinced the capacity of US economy to create the jobs at the rate it has been to take care of the increasing labor force in a softening environment. The figure on the left shows the rate of increase of US labor force. In Dec 2006, US economy created 303,000 new jobs and still the unemployment numbers increase by 23,000 because the labor force expanded by 326,000. So, with increased unemployment rate there will be a downward pressure on consumer confidence as well as housing demand.

The last part of the demand is the rent vs buy financials. The recent run up in the housing prices have swung the pendulum towards the rent option. In fact, the current rental businesses has been doing very well and all the rent promotions during the housing boom have disappeared. To confirm, just look at the REIT's earning. As the housing bubble bust, the REITs which own and manage apartments and rental properties have been on a rampage. Some of the REITs stocks have increased by more than 40% in 2006 and I expect them to do very well in 2007 also.

We will look at the supply side of the housing markets in the next post. Till then a question for all you guys. What is the key reason that makes rental market supply much in-elastic in the short & medium term (1-2 years) compared to condo supply?