The Subprime Mess Hits Some Harder Than Others

by Lawrence Yun, Senior Forecast Economist

No Recession in Sight

The subprime "mess" continues to make news. The subprime market woes have led to lenders tightening lending standards, and so there will be further weakening in home sales. The already delayed housing recovery – now postponed to the fourth quarter of this year – will not measurably dent housing inventory levels even as homebuilders significantly cut back on new construction. As a result, the national median home price is projected to decline for the first time since the Great Depression era. Prices are expected to fall 0.7% in 2007. But as industry professionals are well aware, the health of the real estate market is determined by local factors. Aggregate national figures can mask the exciting up-and-down dynamics that work at the local level. The drop in home price is a national average.

Not All Markets Are Created Equal

Some markets like Portland OR, Raleigh NC, and Austin TX could experience price gains close to 10%. For homeowners, that means their homes will yield an immediate one-year wealth gain of about $20,000. Other markets like Portland ME, Washington D.C., and San Francisco appear to have passed their low points and are poised to start making meaningful positive price gains.

Still, it is likely that other markets will see a price decline. Markets that have endured or will see job cuts or large net out-migrations are very prone to further rises in inventory and price declines. Cleveland and Detroit come to mind. (Owning is much cheaper than renting in these markets so it would be interesting to see if keen investors begin to pick up properties and rent them out.)

Markets like Phoenix, Miami, and Las Vegas have undergone unusually large swings in inventory attributed to a high presence of second homeowners and speculators. They leave two big question marks as to price drop: how much and when. The latest 12-month job figures show that Phoenix was the third top job producer with 89,200 net new jobs – right behind Dallas and Houston. South Florida and Las Vegas are also adding jobs, although the growth rate has been cut due to weaker construction employment. Home prices in these regions had essentially doubled during the real estate boom – so some correction in prices is understandable.

Florida, Arizona, and Nevada have also consistently been the top recipients of new people moving in from another state. As evidenced by a strong rise in health care related employment in these regions, many newcomers are of an older generation. With a rising number of new retirees with each of the next 20 years, the long-term prospects are as sunny as the region’s weather. The question is about the short-term. Inventory is excessive, and new completions of new condos are in the pipeline as well. But jobs and in-migration are demand boosters. Builders may be finishing up on old projects but certainly are not eager to start new ones. Housing permits in these three markets are running about 50% below their peak levels in 2005 – a sure indicator for declining inventory later in the year.

Time is Not Always Your Friend

Trying to market time often leads to regrets. Advice: Those with financial means would do well to go ahead and buy now rather than later. Why? Long-term prospects are bright. Mortgage rates will be higher later. Each 0.1% percentage point rise in rates cuts home purchasing power by 1%. Mortgage rates are projected to be 6.6% by year’s end – up from their current 6.1%. That is 0.5% percentage point rise in rates. Waiting, therefore, means losing 5% in purchasing power. If prices fall by 5%, then the buyer who may have initially thought of getting a better bargain will not, in fact, be really better off. It is a wash with 5% lost in housing purchasing power. If prices do not fall, then the buyer is worse off.

The subprime mess and the housing contraction are the major reasons for slower economic expansion in 2007. There were 127,000 fewer residential construction-related jobs in the past 12 months versus about 200,000 annual additions in the prior three years. But a recession is unlikely. Steady-spending consumers and rising exports because of improving foreign economies more than offset any economic decline from the housing sector. The one wildcard is business spending. Corporate profits are high and the stock market is doing fine. But corporations surprisingly cut back on plant and equipment purchases in late 2006. That is likely to have been a fluke. A modest rise in business spending (out of companies’ ample cash flow) assures that economy will escape recession.

See forecast charts

Copyright NATIONAL ASSOCIATION OF REALTORS®
Reprinted from Realtor.org with permission.