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.
