Housing Recovery Increasingly Tied to Job Growth

Steps to limit price declines may have helped, but economic growth is now critical.

Home prices in twenty major metropolitan markets dropped 1.3% from September to October, the third straight month-over-month drop, according to the December S&P/Case-Shiller home-price index released in late December. The decline erases a significant share of the modest gain in home values since prices hit their bottom early in 2009, and raises the risk of a double dip in home values over the next year or two.

Economists have been mixed in their views of the likelihood of a double dip in housing values. Peter D. Schiff offered one of the most pessimistic views in his December 30th Wall Street Journal opinion piece “Home Prices Are Still Too High.” He noted that the average annual home appreciation over the twentieth century was 3.35%. If you apply that historic appreciation rate to average 1998 home values (a previous peak), today’s homes are still overvalued by 20.3%. Schiff argues that once government programs to prop up home values are removed, home values will actually drop more than that, perhaps by another 24 – 28% because of unfavorable economic factors, including current unemployment and national debt levels and depleted personal savings.

There are other reasons that support Mr. Schiff’s pessimism. Right now there’s still simply more housing inventory than people who can afford them. Many potential first time buyers already made their move when the tax credit was available. A good share of the remainder probably still remains cautious and the recent declines in home prices will not bolster their confidence. Not everyone is so pessimistic. At the other end of the economic projections are real estate sector trade associations, who habitually issue optimistic projections, perhaps to encourage consumers to buy now, before the price goes up.

The American Homeowners Foundation thinks that we are at or fairly near the bottom of housing prices. Even though prices could soften a little more during 2011, the prospects for improvement in the housing market by the end of the year, and sustained growth thereafter, are better than 50-50.

Mr. Schiff’s views are overly pessimistic for several reasons. Applying a long term growth pattern to a uniform product is realistic, but single family homes are far different today than they were in 1900. The average new home built today is about twice the size of a new home built in 1950, and as the older homes are replaced there is an inherent increase in home values that his analysis does not take into account. If you compare the share of disposable income spent on food in the U.S. today compared to 1900, a logical conclusion might be that most Americans must be starving. A look at the size of the average consumer in a local mall on any weekend would absolutely dispel that notion.

While Mr. Schiff is correct that employment will be a huge factor in housing demand, employment increases always lag behind improvements in other U.S. economic indicators. We are beginning to see healthy improvements in many of those. Retail sales improved substantially over the recent holiday season, and have returned to levels just prior to the recent recession. U.S. manufacturing continues to expand and our exports are back to where they were just before the financial meltdown. Recent surveys show that optimism levels of business heads have also returned to near pre-recession levels. The payroll-tax cut for most workers in the tax package passed last month will also fuel employment increases.

The government programs to help prop up home values were realistically only a bridge to break the free fall in home values until a recovery could take hold. The foreclosure rate in many areas is beginning to decline, most likely because a large share of those homeowners who were or will be in trouble have already worked their way through the system. Some of them are already beginning to work off their excess housing inventory. As those temporary government price support programs begin to expire, there is a good chance that increased housing demand will kick in and prevent housing values from dropping further. If that ends up being the outcome, they will have accomplished as much as could be expected. As new jobs are created that will accelerate. The aforementioned economic indicators suggest than a recovery is in the offing.

It remains true that significant increases in housing prices in most markets will not take place until job growth picks up substantially. Nevertheless, recent indicators suggest that we will begin to see healthy job growth in the coming months, and some predictions are for a healthier housing market by the end of 2011.