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The Sullivan Group Market Observer
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Part two of a two part series on looking at the housing market from another angle.
When the housing market took a dive in the early 1990s, the cause and effect were of little resemblance to that of today. For one, the 90s downturn was related to a fundamental restructuring of the economy, where we went from a manufacturing based economy to an information based one. And California was on the receiving end of this transition – as it proceeded to lose over 500,000 jobs and take nearly 10 years to regain momentum. Meanwhile, many metropolitan areas such as Denver, Phoenix and Las Vegas benefited from California's pain during that time.
But unlike the days of that economic restructure, today's downturn – which is set against generally solid economic fundamentals – brings a different set of challenges centering around the law of supply and demand. Not to mention a larger geographical impact. The whole southwest is facing the consequences of "deficit spending" related to housing demand. Traditional demand would've kept home prices at bay, but because of over-zealous speculators, we sold more homes over the last few years than we should have, and for higher prices than we should have. Now we will have to wade through an over hang of supply that varies by market, but is most acute in the areas where developable land was plentiful in the early 2000s.
Conventionally, demand for housing has been driven by job growth, in-migration, immigration, changing demographics (such as move-down buyers and second homes) and life changes (divorce, boomerangs finally moving out). What was not a factor in housing demand previously, but was at the heart of the recent boom, was the expectation of rapid appreciation.
Think back to why your parents bought the home you grew up in: a great place to raise a family in a safe neighborhood, with good schools and near work. A place to put down roots. Did you ever hear your parents talk about "flipping" their home or "doubling their house's value"? Unlikely. As a result, housing tenure (the average time a resident stays in a home) has decreased significantly in the last 30 years.
Housing was never considered a liquid asset, until recently. In the last few years, one would think that homes could be moved as quickly as penny stocks, or that they were ATMs. But if you believe in the basic laws of supply and demand, this appreciation and cashing out of homes couldn't last. Demand would slow once home prices reached a certain point. And that time has come.
Although an increase in interest rates has not helped, the real culprit in today's downturn was in large part these speculative buyers, who influenced the meteoric rise in prices and pushed affordability to historic lows. But thanks to hindsight, history can share a valuable lesson.
In the past, if the ratio of home price to income hovered around four-to-one, the housing market was probably stable. Ratios lower than this, however, signified an even better market – one that could sustain solid demand and modest price increases (like Phoenix from 1996 to 2003 and Las Vegas from 1996 to 2002). Markets that moved away from these ratios quickly did so at the peril of upsetting a long standing tradition of stable and self-sustaining demand.
Consider the following:
Ratio of Detached Resale Home Price to Median Household Income
| Market | 4Q1990 | 4Q1995 | 4Q2000 | 4Q2005 |
| San Diego | 5 to 1 | 4 to 1 | 6 to 1 | 11 to 1 |
| Las Vegas | 3 to 1 | 3 to 1 | 3 to 1 | 6 to 1 |
| Phoenix | 2.8 to 1 | 2.6 to 1 | 3 to 1 | 5 to 1 |
The Perspective? While these ratios look unfavorable for cities like Las Vegas and San Diego, one must also take into account the availability of land (or lack thereof). So in the instance above, San Diego's increase is affected by more than meets the eye: the implication for its downside may not be as significant since it offers such little developable land. Further, Las Vegas and Phoenix continue to pull strongly from the higher priced and higher income regions of Southern California, so their ratios are not quite as leveraged as they initially seem.
As the housing market continues to soften, what we do know for certain is that demand has to have more to it than the expectation to flip a home in six months and make $100,000. So when the market does pick up again, don't let speculators trick you into thinking consumer demand will always be on the upswing. The housing market is an organic being and after being overheated, it must cool down. As one key indicator of any market leveling off, keep an eye on unsold inventory numbers. Once these numbers flatten (and then hopefully decrease), it will be a solid indicator of ramping conditions.
>> To see part one of this two part series, click here. <<
Volume 4
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What was not a factor in housing demand previously, but was at the heart of the recent boom, was the expectation of rapid appreciation.
- Tim Sullivan
When A Market Cools, Active Adults Take Pause
NAHB's 50+ Housing Magazine
By Tim Sullivan
Click here to see why a cooling market impacts the Active Adult more so than any other segment
Note: The housing affordability index is designed to measure the degree to which a "typical" middle income family (one earning the median U.S. income) can afford mortgage payments on the typical (median-priced, existing single-family) home. Assumes 20% down and housing payment-to-income ratio of 25%.
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