Economics of the Housing Market Remain Unclear

Last Thursday brought encouraging economic news that’s been a long time coming: existing home prices reached the highest point they’ve been in over six and a half years, something that may not resonate with those urban apartment dwellers populating America’s major cities. But for the large portion of the country that own their own home, the connection is elementary.

For all the focus on quantitative easing and the unemployment rate, the single biggest factor driving the great recession and the apparent recovery we find ourselves in was most likely the housing market. Crippled by the explosion of the subprime bubble and slow to recover, the lack of strength in home prices could be precisely what’s been holding back the economy from the big bounce many economists have been predicting for years.

Now, with home prices finally appearing to be on the road to permanent recovery, it may be time to ask if a more robust recovery will ripple across the markets in the same way the disastrous crash did five years ago.

Home values looking strong

The data on August’s buying spree was strong, garnering positive reviews from almost every corner. In a report released by the National Association of Realtors (NAR), sales of existing homes climbed 1.7 percent from July to August, representing a year over year increase of 13.2 percent. And it wasn’t just the volume that was rising. The median sale price of these homes was up to $212,000, up 14.7 percent from August 2012 for the biggest year over year gain in since 2005, in the heart of the housing bubble.

These strong gains would appear to indicate that, at the very least, the historic lows in housing prices may finally be in the rearview mirror. If that’s the case, sunnier days could be coming for the economy. Economists have cautioned for years that real recovery wouldn’t be possible until the housing market had truly, finally bottomed out.

Caution urged as gains in home prices could remain limited

While rising prices and sales are a strong sign, many industry experts pointed out that a major boom isn’t likely anytime soon. Mortgage prices have been on the rise this year as well, going up over a percentage point since May, something that most observers agree will work with increasing prices to taper demand in the near future.

“Monthly sales are likely to be uneven in the months ahead from several market frictions,” said the NAR’s chief economist Lawrence Yun in a statement that observed the potential for a temporary peak in the market. “Tight inventory is limiting choices in many areas, higher mortgage interest rates mean affordability isn’t as favorable as it was, and restrictive mortgage lending standards are keeping some otherwise qualified buyers from completing a purchase.”

Moreover, listings remained largely flat with a 0.4 percent increase in August, and the inventory of homes for sale moved back to a 4.9 month supply from a 5-month supply (a six-month supply is generally considered normal).

“We are of the view that housing is continuing to grow, but we are not of the view that it is robust,” said Fannie Mae’s chief economist Douglas G. Duncan in an interview with the L.A. Times, further observing that many of this year’s gains can be viewed as being bounce-back from historic lows.

What does this mean to the economy?

Precisely what we can expect from a fully recovered housing market isn’t entirely clear. On the one hand, a healthy housing market could benefit the economy in many ways. Homeowners tend to view their houses as an investment, and low prices make them less likely to spend on other things in much the same way that investors may tighten their belts when their portfolio is taking a hit. As such, one of the biggest factors driving the recent recession was the $7.38 trillion hit taken by homeowners when the market crashed and housing prices plunged some 30 percent. That’s money that disappeared from the economy almost overnight, leaving families everywhere scrambling to make up lost ground. It was also magnified by the fact that most homeowners were leveraged, making losses even more acute.

It may be decades before housing prices reach the level they were artificially driven to in 2008, but even a modest recovery would improve financial security for millions of Americans, making them much more willing to make major purchases again.

Murky economics still give reasons for concern

However, some observe that other ways the housing market typically stimulates economic growth may not return with the strength they once had. The job market, for instance, has historically benefited from a strong housing market. Strong housing prices spur construction of new homes, something that means more construction jobs. And The Commerce Department released data Wednesday that appeared to show reasons for optimism. Construction starts for single-family homes jumped 7 percent in August to an annual rate of 628,000 units, a six-month high.

"Homebuilding seems to be holding up decently in the higher mortgage rate environment, probably due to the support of strong underlying fundamentals – thin inventories and steady household formation," said RBS ($RBS) economist Guy Berger.

However, Douglas Duncan observes that developers have been slow to buy new land and bring on more workers. Even if the market rebounds, it’s still likely to produce a few million jobs fewer that it was at the height of the housing bubble.

A shift to a renter’s culture?

Finally, it’s also possible that the housing market will never be as strong as it was as more and more people make a permanent shift to renting. Data from the Census Bureau released at the end of April showed that the rate of homeownership in the United States was down to 65.4 percent, the lowest level it’s been at since 1995.

However, while it’s possible that more Americans are willing to rent and will continue to be into the future, much of this shift may have more to do with more temporary conditions. The housing crisis pushed many Americans out of their homes, and left vacant properties that investors swept in and purchased these cheap properties to turn into rentals. What’s more, there aren’t any strong signs that the shift will be permanent as the aspiration to own a home remains for many if not most renters.

Long term economic effects remain uncertain

It’s not clear where the housing market is headed in America. The inflated prices of 2004-2007 represented historic highs, just as the dramatic crash in 2008 ultimately created historic lows. Without a clear precedent, no one can be certain how the economy is going to respond in the long term. However, with prices clearly on the rise this year, it seems possible that the worst is over.