Spotting A Bottom In Local Housing

A: Lets take a step back and talk a bit about how one would go about spotting a local housing bottom, as tough a job as you can strive for! First off, its important to note that picking a bottom in housing is extremely local given the variety of factors that are involved in housing fundamentals. However, we can strive to get close to a bottom by analyzing a few local factors + general economic conditions; inventory, affordability (jobs & rates), economic growth prospects, and buyer confidence. In my humble opinion, these are the fundamentals to watch out for. The hard part is combining this analysis and monitoring with your own unique situation to see if buying now or waiting to find a bottom is the better choice.

To pick a bottom you must be forward thinking! You can't wait until the data shows that the bottom was reached and we are already 6 months into the turnaround because by then you missed it and everyone on the sidelines plus speculators will be racing to buy in; unless of course you are more conservative whose investment strategy is geared towards transparency and comfort of buying when the housing environment is rosier. But this discussion is about spotting a bottom, or at lest trying to get as close as possible to finding one before it happens. Here is what I would look for on the fundamentals; you make your own opinions.

Inventory Increases Slowing

With the existing home sales report yesterday we learned that the # of months of inventory on the market right now across the nation hit a 16 YR high! As we are today, there is a 9.6 months batch of inventory waiting to be sold. That means, at the current sales pace and given the current # of units available for sale, it would take 9.6 months to clear out the entire batch! That of course assumes no additional units come to market and sales pace remains constant; an impossible scenario!

In addition, this data metric is not just about the total # of units available. It is also about the sales pace. The reason we reached a 16YR high is because a combination of rising inventory and slowing sales volume. Think about it. If sales volume would have increased instead of slowing, the # of months inventory on the market would not have been as high! Ah, I see the light!

So, there are two very important factors to keep an eye on as prices across the nation continue to fall PLUS one very important dynamic that comes with cheaper homes for sale!

Factors: Watch out for inventory trends! What we need to see to form a bottom in housing is a slowing down in pace of the rising # of units hitting the overall marketplace! When you start to see inventory trends even out and even drop, we might be close to bottoming out.

Dynamic: As prices fall it is prudent to predict that sales volume will increase! And as I just explained, as sales volume increases the # of months of unsold inventory by law will begin to drop! As this inventory metric drops and the # of months of unsold inventory begins to reverse course, you will start to see headlines discussing a bottom and more confidence in housing's future prospects for appreciation.

Affordability

THE LOCAL FUNDAMENTAL! In terms of housing, there are two important elements to affordability; jobs/salary + lending rates. We can keep this discussion short & sweet as long as we remember that jobs & salaries are a local phenomenon (look at Seattle, Atlanta & Dallas whose housing markets are still very strong due to local job growth); rates are more uniformed but vary with personal situations. Don't take my word for it. Check out the Case/Shiller Home Price Index Charts (via MacroMarkets.com) for Seattle, Atlanta & Dallas since they started keeping track and you will notice that the trend STILL is upward with the last update in the 2nd quarter of 2007:

When a local job market is strong, housing will be more affordable than when the jobs market is weakening. This is one aspect to affordability.

The other is lending rates. Lets put aside for a second the fact that alot of people made poor investment decisions and are now suffering for their mistakes; I'm talking about buying a house you cant afford in an environment where lenders would accommodate with loan products that were ticking time bombs.

That is the past, it happened already and steps are in place to prevent it from happening further. Right now, there is talk of the side effects of the credit squeeze effecting the jobs markets and therefore salaries. So let's see how that aspect of affordability is hit. In terms of where lending rates are, we already know that a disconnect has occurred in the lending rate world as risk was priced into the secondary mortgage markets. As bond yields fell with a flight to quality, interest rates rose because there was more risk associated with mortgage lending. In normal times, lending rates would have fell with bond yields; but we are not in normal times.

What do we need to see to spot a bottom? Two things, falling interest rates and a sustainable healthy job environment. These are the areas of most uncertainty! If jobs are lost and salaries with it, how will the buyer pool be effected? If rates continue to rise because risk is still being priced in, how will prices be effected? Here is what to look out for:

Factors: Healthy future local job growth prospects & falling interest rates. Buyers MUST be able to afford a home if there is to be a bottom and ultimate reversal in housing price appreciation! I just don't see how there can be a turnaround if a recession hits OR if interest rates continue to move higher as a result of deteriorating credit markets.

Economic Growth Prospects

In a phrase, we need economic growth prospects to include CERTAINTY, LIQUIDITY, LESS RISK, & GLOBALIZATION. Things we got used to in the past few years that helped fuel the stock market rally, and recently lost due to the current uncertainty surrounding the credit squeeze; except for globalization, however risks remain to global growth as a result of this situation.

We went from high liquidity and low volatility to low liquidity and high volatility virtually overnight! The tradable markets are in shock right now and are still trying to re-price risk and uncertainty to the still unfolding story of the credit markets & secondary mortgage markets. We just don't know who holds what garbage and how deep the hole is. We need this to pass through the system and the losers to be shaken out before any certainty will come back!

With uncertainty comes possible economic slowing and should a recession hit here at home, I don't see how that environment would help in any housing recovery. However, it may help us to spot the bottom as any economic slowdown (which will be accompanied by the Fed lowering fed funds rate and ultimately interest rates to the consumer) should be the next leg down in the national housing market. And buying in towards the back end of a recession BEFORE the eventual recovery may prove very profitable in the long run. Here is what to look for:

Factors: Spillover to US economic growth prospects from the current credit/liquidity squeeze. Expect stocks to price in these risks in ahead of time via a selloff and price in the recovery ahead of time with a turnaround as uncertainty dissolves. We are looking for signs of stabilization and confidence should a slowdown hit the US pushing housing more out of favor with buyers.

In addition, monitor effects on global economies (watch oil prices for an indication on global demand) as that could hit us at home if a slowdown oversees occurs, as well as the pricing of risk. You can monitor the pricing of risk by watching credit spreads. If risk is a concern, credit spreads will widen.

Buyer Confidence

Can someone please explain to me why there is no buyer confidence index for the housing market? One can easily argue that what bulls the housing markets up or down, when all else is normal, are the buyers! When buyer demand and confidence is high, inventory gets eaten up fairly quickly unbalancing the supply fundamental. On the flip side, when buyer demand and confidence is low, inventory quickly builds up putting sellers and pricing in a very bad situation; especially for those that MUST sell.

I have preached this before. Waaaay back on January 18th, 2006, I wrote a post titled, "Buyer Confidence? We Need A Formula!"; one of my favorite posts to this day because there is no such index! In that post I stated:

The national economy and the stock markets have the Consumer Confidence # as one indicator of the current strength/weakness in the overall economy. What current or leading indicators does the real estate industry have; let alone the NYC real estate market? Sales of existing homes? Filed Mortgage Applications? This is a very fast paced city and to keep ahead we must wisely analyze the data for hints of the near future. We need more.

We need a Buyer Confidence index, for housing only, that will help us gauge the strength or weakness of what really makes our real estate market move; the buyers!

Although none exists, and I'm currently trying to change that to add transparency for the consumers, YOU GUYS, we have to rely on our own observations. Look out for:

Buyer Confidence - Buyers get more confident when the economy is strong, jobs market is tight, salary's are high, uncertainty is at a minimum, inventory offers choices, prices are affordable, and wealth effect is in place! In essence, buyer confidence is the ultimate effect of most of the fundamentals I discussed above when they positively relate to the buyer! I know, sounds like a lot to ask for. But it's important, especially OUTSIDE MANHATTAN!

UrbanDigs Says - These are my opinions for those who want a general understanding of what makes for a prime opportunity to buy close to a bottom. In the real world, it's not as cut and dry. Opportunities will pop up even if all these fundamentals don't line up. In addition, trying to time the housing market is EXTREMELY DIFFICULT and should not skew or alter your decision to buy if that decision is a clear one. Understanding your own situation, personally and financially, and combining that with your investment strategy is the way to go when deciding the timing of your purchase. This discussion is for those with very short term investment goals and strategies who are eager to learn under what circumstances the near term housing prospects (remember real estate is LOCAL) may reverse course in favor of appreciation for the years to come.

• Add to del.icio.us
• Digg this!
• Add to Technorati
• Add to Reddit
• Add to Newsvine