The Long, Slow Road Back for Residential Real Estate

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The Long, Slow Road Back for Residential Real Estate

Homes reached their highest price point about two years ago. Until that time, everything looked rosy for homebuilders and sellers of existing homes. At the time, it was the norm to ignore voices of caution, including those of the Trends editors; builders just kept on building.

This culminated in a peak of building that occurred a number of months after the peak in prices. That lag was crucial, though predictable. First, it takes time to finish homes that are under construction; and second, it was natural to believe that the slowdown in sales at the time was temporary after a long bull market. In any event, new home sales always lag new home completions.

As a result of this, however, the nation was treated to a glut of new houses, for which there was no ready market. Suddenly, as 2005 turned to 2006, the gap between new homes being built and new homes being sold began to widen from about 320,000, the historical standard, to 768,000 by that March.

Historically, there has always been an inventory of new homes that runs somewhere between 65,000 and 125,000. Those numbers remained stable for 30 years from 1975 to 2005. But by September 2007, home inventories had risen to 185,000. This is roughly double the average.

As anyone familiar with economics knows, the laws of supply and demand never rest, and with too much supply, demand began to slip, with all-too-familiar consequences. Prices dropped. Inventory piled up. New housing starts stalled.

Brian Wesbury, in a recent column, predicted that housing starts would continue to decline for at least another year.1 Sales of existing homes are already down by about a third since 2005. Sales of new homes are off by 44.6 percent. These are the levels we last saw in the late 1990s.

Fortunately, the gap between new homes being sold and new homes being completed is now moving back into normal territory: about 357,000, at present. But, even now, to get to historic norms, homebuilders need to reduce inventory by about 105,000 units.

Housing inventory cycles typically last about three years. And, this excess inventory will continue to depress the prices of new and existing homes until it is eliminated.

So, what is ahead?

As Fortune2 magazine recently explained, homes, like equities, follow some well-known economic rules that can help us peer into the future. Just as stocks were bid up beyond realistic valuations in the ‘90s, home prices were unrealistically bid up in this decade. And, just as companies have fundamental values based on future earnings, homes have their own fundamental values based on real economic factors...

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