Will Housing Prices Rise in 2011?

It's a simple question with an important answer. Will housing prices rise this year?

The true answer: Who knows? The most important factor in any market is investor psychology, which can't be predicted with any more accuracy than, you know, the collective universe of market pros who have never seen a crisis coming. Ever.

Rather than predict, what we can do with great precision is see where a few important housing statistics stack up against long-term averages. One of the most reliable investment rules is that valuations revert to the mean in the long run. They always do. Whether stocks or bonds or gold or housing, things don't stay crazy for long. There's a magnetic pull toward sanity.

Here's how three fundamental housing numbers compare to long-term averages.

1. Price to income

Sources: Census Bureau, Case-Shiller Housing Index, author's calculations.

Houses are worth what people can afford to pay for them, so prices compared to average income is a handy metric in judging housing valuations.

The first thing that hit about this chart: Holy smokes, how could anyone have denied the housing bubble in 2005-2007? (And many did.)

The second is how far we've come down in the past two years. Reversion to the mean has been ferocious. Price-to-income levels are now roughly 6% above long-term averages after being as much as 60% above trend a few years ago. The decline has been made up of a 30% drop in home prices and a 5% rise in average incomes since 2006.

Even so, we're still above average. And with unemployment high and likely to stay high, large income gains seem unlikely. That leaves home prices susceptible to falling. Another pull toward sanity.

2. Mortgage payments as a percentage of disposable income

Source: Federal Reserve.

Pretty clear here: Still above average by about a full percentage point.

This chart is important because it shows homebuyers' ability to lever up and drive home prices high. In the early '90s, buyers were overmortgaged, so they scaled back. Housing took a downturn. But there was plenty of room to tack on additional mortgage debt 10 years ago, and that's exactly what many people did. Markets exploded.

We're in another down cycle today. Even as indebtedness drops, there's still no room today to take on larger mortgages. And interest rates are already at historic lows! Creditworthy borrowers have been refinancing existing mortgages and slashing monthly payments, giving the reversion in this chart a good artificial boost. Imagine what happens when they start to rise. Shudder.

This has been a consistant theme of this nascent recovery: Even with extraordinary stimulus and low interest rates, it's just not enough to stop the deleveraging. The pull toward normalcy is too strong. His name is Capitalism, he's mad as hell, and he doesn't take no for an answer.

3. Months of housing supply at sales rates

Source: Census Bureau.

Supply and demand. That's all it really comes down to. More buyers than for-sale homes, and prices rise. More for-sale homes than buyers, and they fall.

The bad news is there's still too many homes on the market. It'd take almost 10 months to sell all of the homes currently on the market at the rate things are moving. The rule of thumb is anything above six months causes prices to fall. And none of this even includes "shadow inventory" -- homes that should be on the market but aren't. We've got our work cut out for us.

There are two solutions. One is to stop building new homes and let current buyers suck up the existing inventory. That's essentially happening now. Ask the folks at KB Homes (NYSE: KBH  ) or Lennar (NYSE: LEN  ) how business has been over the past two years. You'll get a look of sheer misery. Housing starts in 2010 averaged about a third of what they did in 1959. New construction basically stopped. Excess inventory is being sucked up. There's Mr. Capitalism again.

The other solution is to increase household formation. Good news: That seems likely. Household formation should average almost 1.5 million per year over the next decade -- well above current recession-clobbered levels -- according to the Joint Center for Housing Studies at Harvard. If they're even half right, supply will be absorbed and home prices will find a way to march higher. It's just going to take time.

2011 and beyond: What now?
If I had to guess whether housing prices rebound in 2011, I'd guess that they won't. There's too much supply, and valuation metrics like price-to-income are still above average.

And if you look at history, you'll see that valuations rarely spend much time at the actual averages. They're either well above average in a bull market, or well below average in a bear market. The fact that we're still above average and falling makes you think that we'll not only crack those averages, but fall below them and remain there for years. That's just how these things work.

We're headed in the right direction, but there's a ways to go.

What do you think?

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.

Fool contributor Morgan Housel doesn't own shares of any of the companies mentioned in this article. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (24) | Recommend This Article (47)

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  • Report this Comment On January 04, 2011, at 3:51 PM, mattsmithsd wrote:

    I think it is very difficult to determine if housing prices will rise or fall in 2011. The problem with making a guess about the real estate market is that the market is not based on a National level. In Southern California, housing prices have gone up since the market crash. In other parts of the country, housing prices have continued to fall or stayed stagnant.

    Certain states and cities are continually growing which creates more jobs and encourages people to move into these areas. Other areas are losing their businesses and the state/cities are becoming ghost towns.

    The Real estate market is definitely difficult to compare as a whole throughout our country. However, this year is going to be interesting now that most banks are past their "robo-signing" dilemma and are able to release foreclosures again.

  • Report this Comment On January 04, 2011, at 4:14 PM, apen37 wrote:

    I agree with your conclusion that the housing market will inevidibly rebound; however it shows few signs of doing so by the end of 2011. In my opinion, housing prices will decrease at a much slower rate than they have been during the past few years, but they will not increase. This article helps to show my point of view pretty accurately: http://www.totalmortgage.com/blog/mortgage-rates/what-will-t...

    The values of foreclosed mortgages are diminishing slowly, but this seems to be the only positive sign for the immediate future.

  • Report this Comment On January 04, 2011, at 5:53 PM, bzhayes wrote:

    In your first graph, what is the ratio in 1987 that you normalized the curve against?

    Excellent article: it goes back to fundamentals housing can only cost what people are able to pay.

  • Report this Comment On January 04, 2011, at 6:09 PM, langco1 wrote:

    until the american people get sick of being in a depression and elect a president nothing is going to get better ....nothing...

  • Report this Comment On January 04, 2011, at 8:29 PM, Strega100 wrote:

    As a Real Estate Agent in New England; I agree. And further, w/ 44 months of shadow inventory (properties in various stages of foreclosure) it will be another several years before we begin to see housing price increases.

  • Report this Comment On January 04, 2011, at 9:45 PM, TMFTypeoh wrote:

    Morgan,

    As usual, outstanding!

    Brian

  • Report this Comment On January 04, 2011, at 10:06 PM, FutureMonkey wrote:

    Excellent article Morgan

    Left out 3 salient features, but can't fit everything in.

    Region: already addressed by earlier comment

    Income: There are two moving parts to a price:income ration and mortgage:disposable income. On an individual level, what is a perfectly rational home price or mortgage payment when you have two incomes becomes outrageous if one or both of you lose your job. Until job security and confidence of future income growth the black lines will probably actually dip below the pretty red lines on both the first two charts.

    Human behavior: Fear and Desire = irrational decisions. Sure their are plenty of rational people out there making calculated decisions regarding home purchase vs rent. Figuring out how to leverage a 2nd loan and an investment property into income; but most of us are just people trying to make our lives work. And we are talking about numbers beyond the daily value judgement of most peoples lives. The hyperinflated prices were a product of fear and desire that were unfounded in rational analysis; not just speculative real estate investment, but primary home purchases. Until we come up with a cure for financial decisions being based on fear and desire, I suspect real estate will continue to experience boom and bust cycles to continue independent of how economist predict we will behave.

    FM

  • Report this Comment On January 05, 2011, at 1:10 AM, JavaChipFool wrote:

    Forgive me for rising to the bait of a troll, langco1, but did you note the state of the economy at the last presidential election? If you are going to blame it on the President, give Bush some credit for %ucking things up.

    It looks to me like the economy will be strong enough by 2012 elections, that Obama will be here again-IF the Dems can really make it "about the economy, stupid"

    I don't put it past the elephants and T-parts to make it about something else, though. How they manage to control the message in an obviously liberally controlled and biased media is beyond me.

    Please read the above with a hint of sarcasm and humor...

  • Report this Comment On January 05, 2011, at 4:13 AM, akutach wrote:

    Following an unprecedented housing bubble (within memory) could it be possible that mean reversion has a relative component that's never been seen before? When I talk to people interested in buying (about 6 or 7 making a purely anecdotal survey), the focus is on the 30% drop from the top - not absolute value, and not reasonable cost of ownership. Explaining rent to own cost disparities and associated costs of ownership are usually (all but 1) rebutted with "Yeah, but interest rates are so low and the price is so much less than it was."

    Is it possible that many people who went through the bubble just don't see anything especially risky with a monthly payment of 40%+ of their gross double income because it's been the only way they could get the house in the past? And they expect to have to continue to do it so they will.

    The explosive loans are gone (or suspended) now, but if underwriting practices haven't reverted to what they were 20 years ago then perhaps the median line in your graphs of income:loan and payment as % of disposable income need to be reevaluated.

    alan

  • Report this Comment On January 05, 2011, at 7:42 AM, Venkyj wrote:

    I think Morgan House's analysis is wonderful and very professionally articulated. Since there is nothing for me to add, I can only agree, completely, with his (her?) deduction.

  • Report this Comment On January 05, 2011, at 10:10 AM, shaileshnita wrote:

    This is an interesting article and I agree with the author about the prediction.

  • Report this Comment On January 05, 2011, at 12:47 PM, slpmn wrote:

    Venkyi, for clues to Morgan's gender, check out the Fool home page and look for his(her) picture under the "Featured Columnists" heading. I'm going with "him".

  • Report this Comment On January 05, 2011, at 1:01 PM, TMFDiogenes wrote:

    @venkyi, @slpmn

    You got it right -- Morgan's a dude.

  • Report this Comment On January 05, 2011, at 3:14 PM, TDRH wrote:

    Great post. Price to median income is an interesting chart as well. It demonstrates the shift in demand caused by the alternative financing mechanisms and looser lending standards.

  • Report this Comment On January 05, 2011, at 4:43 PM, dave665 wrote:

    With all the foreclosures out there, people should expect prices to fall for at least another couple of years. Probably another 25% at least. And that is if interest rates stay low. Interest rates could rise dramatically since inflation (in food, energy, everything BUT real estate) is about to rise in a big way. And paying more for food means less to spend on houses for most people. Inflation will not bring up prices on everything equally... some prices will skyrocket and others (real estate) will suffer for a long time.

  • Report this Comment On January 05, 2011, at 5:43 PM, langco1 wrote:

    housing prices rise? only in dreamworld...people want to see the economy improve? try electing a president next time!!

  • Report this Comment On January 06, 2011, at 7:36 AM, Danl48 wrote:

    Of course housing prices could rise...Here's how...

    Now that jobs are starting to bounce back. Just repeat the last process. Have every mother's uncle come on talk shows, have every bank take out ads on tv and news paper's real estate sections claiming that the future is 'rosy'. Claim that housing prices are beginning to rise! Claim that everyone has new 'equity' in their existing homes! THEN, start the robo calls to millions of Americans that they could 'refinance' and take some of that 'equity' out and buy, say, a new car or better yet, a bigger house!! Maybe even a second home! Start writing mortgages for anyone that can sign his name. Then, bundle up these new, dubious mortgages and sell them as investments, Oh, and be sure to have someone like Paulson, in the back room, quietly, 'shorting' those investments. Yeah, now that the same clowns have the keys again, the housing prices could definitly 'rise' again soon .

    Lord, help us all.

  • Report this Comment On January 06, 2011, at 11:49 AM, UmmmNo wrote:

    Great empirical data and good comment regarding a need to restore sane underwriting “akutach”.

    There is one other shark lurking just beneath the waves that will keep the housing market from regaining steam for many years. Consumers are financially trapped in their homes and new buyers are being lured into the same trap.

    Sellers, especially builders of new homes “buy-down” the rate on the mortgages offered by their subsidiary lending companies instead of reducing the purchase price. Low interest rates on new mortgages can make the monthly payments seem affordable to even experienced buyers. After all, who arrives at their mortgage closing already thinking about selling their home? Let’s hope that everyone’s brother-in-law is no longer speculating in real estate and the majority of homes are being purchase by people that actually intend to live in it.

    This process robs “mad as hell Capitalism” from taking the healthy bite out of prices that is warranted and desperately needed. Homeowners continue to be “upside-down” in the single largest financial deal they will make in there lives. Those that manage to make their payments are stuck in their homes for fifteen to twenty years. It is akin to a car dealership selling you a Ford Focus for $50,000, but offering you an auto loan with terms that keep your monthly payments under $200. Would any sensible consumer do that? They have, and continue to do precisely that when it comes to buying a home. Our sample consumer will need to drive that Ford for a very long time and park it in the same garage for an even longer time. You can’t take your low rate mortgage with you in 5 or 10 years (national average expected time Americans live at 1 address) if you decide to sell the home and unless you have made massive principal prepayments on the mortgage in those 5 or 10 years, you will owe a fortune to your lender at that future closing. Prices are inversely related to home prices, so don’t expect that future buyer to pay the same price you did when they can’t get a loan for the low, low rate you received. Rates will go up. No one expects them to go lower. How low can the yield get on bonds?

    So, I hope all the current homeowners and consumers about to purchase a home really love the neighborhood. If you don’t win the lottery, you may want to go ahead and add to your last will and testament, the name of your grandchild that will get the property when you die.

  • Report this Comment On January 06, 2011, at 11:52 AM, UmmmNo wrote:

    I meant prices are inversely related to rates

    oops

  • Report this Comment On January 06, 2011, at 12:48 PM, Lakewooder wrote:

    Varies by location. I have a good friend who lives in the Inland Empire where most of the homes in the neighborhood are underwater by about $200,000. How long will people continue to pay those mortgages? The futility will set in at some point and they are going to walk if they are able.

    In my neighborhood near Downtown Dallas (East Dallas/Lakewood) there is high demand and we have had good price appreciation with no bubble. Things have been a bit slow over the last year or two but now things are picking up (we are lucky to have the best public schools in the city and now IB will be offered). Developers are starting to build apartments again - many in TODs around our 100 miles of rail (DART).

    Ironically the demand is created in part by people moving in from other bad Real Estate markets, like California.

  • Report this Comment On January 06, 2011, at 1:55 PM, UmmmNo wrote:

    Absolutely Lakewood. The bigger the bubble in your region, the more upside you probably are. That is if you purchased a home in the last 5 or 6 years.

    The highest percentage of home buyers are not "first time home buyers". That means they either have to sell the one they are living in (and take a financial bath), or walk away from their upside down loan (and take a financial bath). Either way, the general pressure on home prices will continue to be down everywhere. No region is an island, whether they are Inland or on Lakewood.

  • Report this Comment On January 06, 2011, at 3:57 PM, jagray wrote:

    I am a contractor in the state of Florida (Orlando area). Real estate is definitely a local issue. My opinion is that there is still to much inventory in our area. In fact when you consider there is very little demand for new homes, plus the simple fact that people out of work should not even consider buying a new or older home. It may very well be several more years before an upswing occurs, regardless of what the banks, real estate agents, politicians, etc say.

  • Report this Comment On January 07, 2011, at 2:23 PM, NotEntitled wrote:

    "Walking Away" from an over priced, upside down home and into an underappreciated (comparatively) home with a low interest rate and low to income ration is not going to happen as likely as is suggested. Your credit worthiness is going to suffer as a result of "Walking Away". So your terms, conditions, & interest rate on a new house won't seem quite as attractive as first glance. I would like to see, hear, read about folks who have dumped the financial anchor and what the trend is in finding new "digs". In my situation I am hoping a rent-to-own option will help me lock in the best "deal" once out from under my Anchor. But otherwise this is a clear factual article that should be tought in high school economics 101. Keep up the great work.

  • Report this Comment On January 09, 2011, at 10:02 PM, afersha wrote:

    @langco1: you sound bitter (and insane). Stick to trolling and please, avoid shooting any representatives.

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