“If you wish to converse with me, define your terms” – Voltaire
When will the housing recovery happen? It is a good question and an important question to millions of people nation wide. Looking at the headlines in the news it is tough to tell where the state of the housing market currently stands. One headline will proclaim the recovery has already begun while another will assert that the recovery is still years away. While there are a number of reasons why there are so many different opinions on the subject, there is one source of confusion that is prevalent in the mass media today. What is this source of confusion? It is the most fundamental question we are all asking, “what is a recovery?” The question seems obvious, and maybe that is why so few take the effort to define what they mean by recovery when they write about an analysis of the housing market or even offer their opinion. I would argue that the question is not as obvious as it may seem and can be defined in 3 very different ways:
- Return to some sort of price appreciation in the market
- Overall pricing returning to “equilibrium” levels – or normal market conditions
- Prices returning to their previous peak before the downturn.
In a normal housing cycle, all three of these definitions may in fact happen at the same point in time and thus can be used almost interchangeably, but in the current situation as will be illustrated these three definitions are distinctly different points in time.
Fundamentally, the housing market boils down to supply and demand. The graph below illustrates the resale data for the Phoenix Metro Area located at www.armls.com from 2002 to now. The graph has been broken into 5 phases as indicated by the green vertical lines. What we are looking at is the relationship between the number of resale homes available as indicated by the red line, the number of homes sold as indicated by the black line, and the median price of homes sold as indicated by the blue bars. The average price is shown by the yellow bars. The first section of the graph on the left hand side is illustrative of a normal market in the Phoenix Metro area that had seen steady annual appreciation for nearly 14 years of approximately 4.5% per year. In this section, there are approximately 27,000 listings on the MLS in any given month and approximately 6,500 homes sold in any given month (seasonality does impact the numbers).
The second phase shows an increase in demand to over 9,000 home sales per month while the number of listings available at any given time drops below 5,000. This was the point in time where homes were selling in a matter of hours after being listed. This resulted in price appreciation well above the historical averages.
The third section shows the demand falling back to below 4,000 per month but listings continuing to increase and finally peaking at almost 200% of the “normal market” conditions.
This leads to the correction phase where the market forces try to bring supply and demand back into equilibrium. In order to do so, one of two things needed to happen. Either many homes needed to be taken off the market or prices needed to fall to increase demand. In this phase listings were reduced from 54,000 back to 30,000 while demand rebounded to its historical pace of 6,000 per month. Median prices plummeted from $250,000 to a low of $118,000.
The final phase indicated on the graph (furthest to the right) is the most recent 3-4 months. Listings have declined to just under 30,000 while sales have increased to approximately 9,000 per month. The median home price has increased from its low to $130,000 and held for the last 2 months.
View the graph for this data here.
The question is, “Is this the housing recovery?” That depends on which definition we are using for the term recovery. Using the first definition, of the end of overall price declines and the return of some sort of appreciation in home prices then the answer is possibly but I would prefer to use the term stabilization for this stage. The data certainly indicates that supply levels have reached more normal levels and the recent sales activity has increased reducing the likelihood of future price declines. In fact pricing has increased the last 3 months and is holding steady.
My preferred definition of recovery is when pricing returns to equilibrium, which is the economically justified price that keeps supply and demand in balance. There are many different methods that have been used to estimate what this price should be but even using one of simplest methods, “cost inflation” where home prices appreciate at the same rate as overall consumer prices, current prices are still below the economically justified prices despite the job losses and economic conditions of the past few years and the sales data suggests that people recognize this and are acting on it.
In any case, there is some early evidence that the correction cycle has hit a turning point and it has in fact been an over-correction. The road back to pricing equilibrium will not happen over night but the string of price declines has been broken presenting a unique opportunity to take advantage of pricing that is below or even well below the long term value of the property.
