Practical Economics


Finally, a Bottom for Home Prices

Jerome Idaszak

Plenty of people would like to set up their own household. More-affordable houses could bring them into the market.



Housing prices will stop sinking next spring. But recovery will be a gradual process -- too slow to help the economy much next year. Look for prices, which have fallen an average of 31% since 2006, to drop an additional 2% or so in the early months of 2012 and then recover that lost ground by the end of the year.

SEE ALSO: Kiplinger's Economic Outlooks

The growth in 2013 won't be dramatic Come 2013, expect home prices to rise only 3% to 4% -- not too far from the pre-boom average of 4.8% a year, but well short of the bounce that usually follows a housing slump. After the milder housing downturn in the early 1980s, home prices grew an average of 6.5% for six years.

A key signal that the bottom is near: A change in the ratio of average homes prices to personal income -- houses are affordable again. After soaring to 4-to-1 during the housing boom, the ratio is now well below the long-term average of 3-to-1.

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Another reason for optimism: Foreclosure numbers are set to level off after a recent surge to clear up the backlog that developed when banks were found to be rushing though the paperwork for seizing homes. Although the 3.5 million foreclosures still in the pipeline are weighing heavily on the housing market, that effect will diminish when it is clear that the worst has passed.

Look for home sales to tick up next year as well, hitting 5.5 million for new and existing homes. That's up 4% from 2011, the low point since the housing bubble burst.

Demand from abroad will help. Canadians are buying homes in Phoenix; Brazilians are investing in Miami; and Chinese are buying in California, Las Vegas and New York City. To these investors with bulging pockets, good values can be found where the price declines have been greatest.

U.S. investors remain more conservative, largely avoiding single-family homes and diving into the multifamily rental market. It has heated up in recent years, thanks in part to the crowds of former homeowners who need a place to live, as well as to would-be home buyers who are waiting to see if prices have further to fall.

Home starts will jump 15% next year, driven largely by construction of new apartment buildings. Among the strongest areas are Texas, Louisiana, Oklahoma and the Dakotas, where the robust energy industry is lifting local economies and earlier overbuilding was avoided. Other states that have benefited from past restraint are Montana, Washington, Iowa and Nebraska.

Even so, new construction will be only around 750,000 in 2012, down from 2 million in 2005 and far below the pre-crash average of 1.5 million from 1959 through 2006.

Farther down the road, there is plenty of pent-up demand. The lousy housing market has muffled the typical rate of household formation, deterring many young folks from getting their own homes. As a result, there are 2 million new households waiting for an improvement in economic conditions: recent graduates eager to leave their parents' nests and 30-something couples who have delayed marriage or having children. As the economy picks up steam, they will emerge, helping to soak up the glut of foreclosed homes and putting construction on a faster track.

By 2014, the housing market will start to look more like its old self, with housing starts near the long-term average of 1.5 million a year, sales of about 6 million and price gains of over 4% a year.

Shorter term, even the modest reversal likely in 2012-2013 is crucial, easing the crushing weight the housing market has imposed on the economy. Homeowners, who lost a large share of their net worth in the housing crash, have been trying to rebuild their wealth by saving more in recent years. Since the market crash, consumers have held on to more than 5% of income, up from less than 2% during the housing boom. Since consumer spending accounts for two-thirds of economic activity, this uptick in saving and correlating downtick in spending has spelled the difference between a solid recovery and the shaky one the U.S. is experiencing.

Since a good deal of this saving is due to uncertainty -- not knowing just how much more home prices will drop -- reaching a clear turning point is important. Once homeowners know the worst is over, they'll take a breath, start planning their saving for the long term and spend more in the short term.

Of course, the market shift won't make much immediate difference for the millions of homeowners who owe more than their homes are worth. But for the majority with equity in their homes, even a modest gain in prices can change their spending behavior.



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