New year brings another false dawn for housing

Maybe, just maybe, housing is stabilising. That was the hope at year-end 2006, based on a plateau in existing home sales.

After falling 13.6 per cent from a peak annualised rate of 7.21 million in September 2005, sales of existing homes treaded water from September through December 2006 and came up for air in January and February before submerging again.

Home sales manifested the same pattern a year later, stabilising from September through November at a pace 20 per cent below that of a year earlier. (Existing home sales for December will be reported on January 24.)

There is hope once again that housing has bottomed "" hope that's as audacious as it is misplaced.

"People do not like to borrow money to buy depreciating assets," says Ian Shepherdson, chief US economist at High Frequency Economics in Valhalla, New York. "Until potential buyers can plausibly believe prices will not fall further, home sales will continue to decline."

Prices are the mechanism through which supply and demand find equilibrium. There are too many homes for sale "" those newly built and old ones owners would like to unload "" relative to the demand for them. Prices will have to fall further, with potential borrowers running into tighter credit standards and rising costs associated with buying a home.

Real cost rising
Wait a second. Haven't interest rates fallen in the last six months? Yes, they have. The real cost of buying a home is a function of the actual cost (mortgage rate) less the return (house price appreciation). When home prices are falling on a national average basis, as they are now for the first time since the Great Depression, the real cost of borrowing goes up.

Using the S&P Case-Shiller Index, home prices nationwide fell 4.5 per cent in the third quarter of 2007 compared with the same quarter in 2006. With the 30-year mortgage rate at 6.17 per cent, the real cost of buying a home is over 10.5 per cent.

If this year is anything like last year, a prospective homeowner can't expect to defray the added cost with gains in his stock portfolio. A broad basket of US equities rose 3.8 per cent in 2007, less than the rate of inflation.

The good news for the residential real estate market is that homebuilders have finally gotten the joke and are slashing production, Shepherdson says.

Big foot
"In recent months, the inflow (of homes for sale) has been slower than the pace of sales," which has the effect of reducing the inventory of new homes, he says.

"In the three months to November, the gross inflow of new homes onto the market plunged at a 60.7 per cent annualised pace compared with the previous three months," a cutback comparable to one last seen in the housing bust of 1981, Shepherdson says.

Residential construction may be a small share of the US economy "" 4 per cent in the third quarter "" but it has a big footprint.