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Housing: Now Actually Cheap

It happened sometime over the past month or so. Few noticed; fewer celebrated.

This, though, is a pretty big deal: The ratio of nationwide housing prices to median income is now below the long-term average.

Sources: S&P Cash-Shiller, Census Bureau, and author's calculations.

Of course, nationwide statistics aren't terribly relevant to any one person. Local markets range from dirt cheap (Las Vegas) to still pricey (Seattle). Taken as a whole, however, the housing market is now -- and really just now -- at a level we can safely call affordable. Or rational. Maybe even cheap. An average income can now purchase an average home. This is the first time that's been true in years.

So what happens from here?

Who knows. Forecasting home prices is just as fruitless as it is for other market -- even more so, actually, since it's a highly leveraged, highly meddled market. Still, there's reason aplenty to think prices have more withering to do.

Home prices, like all markets, are guided by supply and demand. Demand is how eager we are to buy. Supply is the number of homes available for sale. Average monthly sales divided by homes available for sale gives a months-of-supply figure, which is provided by the Census every month. The current level, 6.5 months, happens to be fairly close to average. That's the good news.

The problem is what happens after adding in so-called shadow inventory. Shadow inventory is the homes that should be for sale, but aren't. The biggest contributors by far are banks. Bank of America (NYSE: BAC  ) , Citigroup (NYSE: C  ) , Wells Fargo (NYSE: WFC  ) , and JPMorgan Chase (NYSE: JPM  ) all hold a glut of homes stuck in limbo somewhere between foreclosure and being placed on the open market. Analytics firm CoreLogic estimates there's now close to 2 million of these homes in shadow inventory, representing a nine-month supply. Add that to the official inventory of 6.5 months, and months of supply explodes far above healthy levels. Simply put, too many homes are either for sale, or are about to become for sale. This should put pressure on housing prices for at least the next year. Basic economics: It wins every time! 

Another impasse to recovery: buyers' mentality.

After bubbles burst, markets tend to mope around at a bottom for years while the wounds heal. It isn't until the nightmare is long forgotten before things perk up and a real recovery takes hold. It's like the old relationship saying: The opposite of love isn't hate. It's indifference.

As homeowners, we aren't even close to that point yet. A recent survey by Fannie Mae found that 67% of us think now is a good time to buy a home. Three-quarters think home prices will rise or stay flat over the next year. Two-thirds say homeownership is a safe investment; 57% say a home has as much potential as other financial assets. Almost 90% say owning is superior to renting.

All of these assumptions are questionable at best. Robert Shiller of Yale has shown that, historically, home prices return close to nothing after inflation. As I discussed a few weeks ago, the way mortgages amortize combined with the short length of time most of us own homes for often skews our perception of the benefits of owing vs. renting. A home should be an affordable place to live. Nothing more than that. The fact that so many Americans are clinging to bubble-era mentalities that can be easily countered throws cold water on the idea that we've changed our ways.

So homes are cheap. Just don't assume we're out of the woods. Bubbles that take years to inflate take years to heal.

Fool contributor Morgan Housel owns Bank of America preferred. Follow him on Twitter @TMFHousel.The Motley Fool owns shares of Wells Fargo and JPMorgan Chase. The Fool owns shares of and has opened a short position on Bank of America. 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 (9) | Recommend This Article (12)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 01, 2011, at 2:21 PM, sailrmac wrote:

    The financial aspect of the decision to buy or not buy a house is a discounted cash flow, ROI model like any other. Interest expense, principle paydown, maintenance, insurance, tax consequence, gains or losses in price, interest rate, down payment, rent saved on equivalent, etc. are all inputs.

    We use rules of thumb, what we heard from others, etc. because we either don't have the skills to build a discounted cash flow model or are just too lazy.

    For a decision this big, being too lazy is a very poor excuse. Spending 8 hours on your day off putting together and understanding a model is quite reasonable when you consider you are investing 2-7 years worth of income in it.

  • Report this Comment On June 01, 2011, at 2:56 PM, cmfhousel wrote:

  • Report this Comment On June 01, 2011, at 2:57 PM, Gato337 wrote:

    Good article! However, even if the next year is a good time to buy a home at a bargain price - many won't take advantage simply because people lost a big chunk of change in the 2008/2009 crash. Many pulled out of the market out sheer fear and desperation, and didn't get back in to reap the benefits of the past 2 years of recovery. Im thinking that the average american is going to be focused on rebuilding their safety nets and attempting to catch up with their retirement accounts (mostly failing I might add). The idea of putting a huge downpayment on a new home and commiting to a mortgage is likely far down their list of priorities.

    On the other hand, investors who have some money to spare might be able to make lemonade with all the lemons on the market, but like you said - its a local thing and not the best idea for everyone.

  • Report this Comment On June 01, 2011, at 5:25 PM, 11x wrote:

    I wonder what the bearish/bullish sentiment we're seeing now typically compares to historical numbers. You'd have to be pretty pessimistic to think that renting is better than owning... I mean, it is a financial decision but quality of life also plays a big part of it. Most people take satisfaction in owning their own home. They can do as they please with it and have something to show for it. I haven't paid any attention to bearish sentiment but it seems lower now than it was a few years ago, based off my anecdotal evidence.

    But look at the chart; real estate prices tend to be smooth. A lot smoother than the stock market. Had it not been for government intrusion via first time homebuyer rebates, we'd be below 1 right now probably. I would predict that we'll be below "1" in the near future and the index will sort of pan off over the next few years until it starts going back up again.

    Where did you get this at? I'd love to see Phoenix. I'm planning on my first home purchase but the market was absolutely nuts a few years back and it will be years before things get back to "normal."

  • Report this Comment On June 02, 2011, at 1:41 AM, sliderw wrote:

    "Average monthly sales divided by homes available for sale gives a months-of-supply figure" -- you have the first 2 quantities flipped.

  • Report this Comment On June 02, 2011, at 10:07 AM, DivingDan wrote:

    The Robert Shilling report doesn't take in to account the simple fact that if you don't own you have to spend money to rent. Sailrmac has it right to include this aspect in his ROI type calculations.

    Also I have saved money on loans by using the equity in my house to have a HELOC available. It gives me a better interest rate that is tax deductible than a car or personal loan could ever match.

  • Report this Comment On June 03, 2011, at 1:29 AM, ynotc wrote:

    Asset; something that returns cash

    Liability; something that reduces cash.

    A home is not an asset until it is sold unless it is a rental and you are the landlord. Stock is not an asset until it is sold unless you recieve a dividend.

    You couldn't be more right. Homes should be an affordable place to live. Unfortunately it became a status symbol for many like all other items we purchase.

  • Report this Comment On June 06, 2011, at 12:54 PM, hachmujt wrote:

    NYT interactive calculator, Is It Better to Buy or Rent?

    This is a great resource, a must see in my book.


  • Report this Comment On June 28, 2011, at 7:32 AM, giantschnauzer wrote:

    Can the author provide another chart using the median instead of the mean ?

    The median is often a better measure of housing affordability as the addition of high end houses skews things a lot.

    If, for example, you have a market with 100 houses for sale, and 10 sell for over !,000,000 but the rest go for under $100,000-- does the mean (at least $190,000) or the median (under $100,000) give a better picture of affordability of what's actually available?

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