It's no secret that the U.S. housing market is cyclical and in the midst of yet another painful correction. The causes and characteristics of these cycles vary, at least in some respects, but the implications for homebuyers, home sellers and homeowners remain remarkably reliable as the cycles roll by.
Housing cycles aren't all alike, yet over long periods of time, a basic pattern can be discerned, explains Mark Dotzour, chief economist of the Real Estate Center at Texas A&M University.
A cycle doesn't really have a start or a stop, but to pick a point at random, we might say that a housing cycle "starts" when economic activity heats up and interest rates rise. Higher interest rates make housing less affordable, so demand decreases and home prices fall. Then, as economic activity slows and interest rates decline, housing again becomes more affordable and, consequently, demand and prices go up. Then the cycle repeats. Housing tends to lead the economy and thus can be an indicator of future economic activity.
The severity of the current housing cycle has been exacerbated, Dotzour explains, by two factors:
- Lenders flooded the housing markets with subprime loans that enabled borrowers who had poor credit to purchase homes they otherwise wouldn't have been able to afford. These risky loans were then securitized and sold to investors. Demand outstripped supply and prices rose too fast.
- When these risky borrowers weren't able to pay back their loans, the lenders cut off the easy credit. Builders, who had expanded to meet the new demand, couldn't stop building new homes fast enough to match the sudden disappearance of buyers. Supply exceeded demand and prices dropped too quickly.
"In this cycle, we had a real abrupt change in demand (because) a certain segment of the home-buying public, mainly subprime and Alt-A buyers, were just completely shut out of the market overnight," Dotzour says. "Then what happens is that you get too much inventory and prices go soft."
Speculation by investors and home buyers' expectations of a major financial payoff also make housing more volatile than other economic sectors, says Nicolas P. Retsinas, director of the Joint Center for Housing Studies at Harvard University. This factor can be represented along a continuum between consumption, or the purchase of a home primarily for personal use, and investment, or the purchase of a home primarily to generate a capital gain or profit.
The chief risk that cyclicality poses for home buyers and sellers is that local home prices may fall further as the cycle deteriorates.
Where is the Housing Cycle Now?
Whether the current phase is a prudent time to buy depends on an assessment of future prices. Two indicators -- builders' concessions and loan delinquencies -- may suggest prices have bottomed out, according to Dotzour.
Concessions. The "most fundamental" indicator is whether home builders are still offering price concessions and extra amenities to buyers. As long as concessions are on offer, buyers should be wary, Dotzour suggests. Yet builders' concessions can be very attractive, especially for buyers who plan to own their new home for at least a couple of years.
"If you are going to stay more than two years, now might be a good time to buy one of these heavily discounted homes on which builders are offering major concessions....The supply and demand situation is liable to correct itself within about 24 months or so, and at that point, those concessions will be gone," he says.
Delinquencies. Another indicator is the rate of late payments on subprime mortgages. Since the delinquency rate on each "graduating class" of mortgages tends to peak about 18 to 24 months after the loans were originated, the mortgages from 1999-2005 have already peaked, the class of 2006 is starting to peak and the class of 2007 is "still going through the roof with no sign of abating," Dotzour explains. There is no class of 2008 since such mortgages have been virtually extinct this year.
"The party stopped in about July 2007, so if you take that out 18 months, that's the spring of 2009. At that point, the last class of subprime mortgages will have peaked in terms of delinquency....so the pressure on prices coming from foreclosures is likely to peak" at that time or perhaps in another 90 days, Dotzour says.
Homeowners who plan to stay put needn't worry overmuch about housing market cycles, experts agree. "Over the long term," Retsinas concludes, "residential real estate does OK."
(Distributed by Scripps Howard News Service.)
