Two sides of a coin

By David Lereah, Chief Economist
National Asssociation of REALTORS®

How, in the name of  real estate, can a local market experience a dramatic drop in home sales and still continue to post healthy price increases? And, will prices eventually fall? Sound familiar? These are the most frequently asked questions that I've been confronted with in recent weeks. Let me tackle these questions head on. It is true that some local markets are experiencing a significant drop in home sales while price appreciation maintains some strength (i.e., stays positive). But other markets are showing signs of price softening. Those cooling markets that continue to boast price appreciation are still in transition? from a sellers' market to a buyers' market. Usually, in the early stages of such a transition, sellers continue to list their properties with large price increases, while buyers no longer have the appetite to bid on those lofty-priced homes. Sellers need to better read the market (they should listen to their REALTOR®!) and list their home at a more reasonable price. Unfortunately, most of these sellers are still not being realistic. As a consequence, their properties are remaining on the market longer with little interest from buyers, costing sellers lost opportunity money. If most sellers in a local market refuse to lower their price expectations, then most listing prices do not change -- thus, the market continues to post a positive appreciation rate, but at reduced volume. We are observing this phenomenon in some cooling metros across the nation. For example, the Riverside-San Bernardino metro posted a 4 percent price appreciation in the first quarter of this year. Similarly, Daytona Beach posted a 7.3 percent increase, while Nassau-Suffolk (Long Island) posted a home price appreciation of 2.5 percent, to name a few.

Mr. Lereah's article was written based on real estate activity during the first six months of the year. His reference to home price appreciation does not apply to the Central Ohio area as we've experienced a 1.3 percent decrease for the first eight months of 2006. However, he makes some very good points we thought you might appreciate. Central Ohio home sales were almost three percent ahead of last year for the first half of the year, July and August saw 14.1 and 5 percent decreases respectively. Inventory has been as much as 29 percent higher than last year. This has lessened slightly over the last few months so we ended August with an inventory 21 percent higher than last year. With the 18,753 homes on the market and recent level of sales at 2,732, Central Ohio has a 6.8 months'-supply of homes (compared to a 5.39 months'-supply this time last year)

Some cooling metros have already begun a descent. During the first quarter of this year Boston registered a negative 7 percent appreciation rate; Miami a negative 13.7 percent and Sacramento a negative 4.8 percent. All of these metros are also exhibiting a drop in sales, rising inventories, lengthening days on market and a softening in home prices.

In some markets inventories have skyrocketed. Miami posted a 17.2 month-supply for the first quarter of this year _ compare that to a 7.2 months'-supply posted a year earlier. Similarly, the Sarasota-Bradenton metro registered a 16.1 months'-supply in the first quarter of this year versus a 7.2 months'-supply a year ago.

Other markets have also experienced a rise in inventories, but on a smaller scale. Boston's months'-supply rose to 7.2 in the first quarter of this year compared with a 2.9 months'-supply in the first quarter a year ago, Los Angeles's month's supply rose to 5.2 in the first quarter of this year versus a 3.0 months'-supply a year earlier.

But there is another side of this housing coin. Half of the nation is warming, not cooling. States like Texas, Utah, New Mexico, Ohio, North Carolina, and South Carolina have experienced positive sales growth during the first half of the year. This suggests that the fundamentals for purchasing homes remain solid. Mortgage rates remain below 7 percent, while the supply of homes for the nation as a whole is at a balanced 6.5 months'-supply. In addition, the economy remains healthy, creating job and in come gains, providing consumers with the confidence and wherewithal to purchase homes.

Looking ahead, I believe the current correction in most of our cooling real estate markets will be short lived. This is because there is an army of households and investors waiting to get back into the housing market.

Remember, today's housing correction is unlike previous ones. There is no recession; no net job losses; and interest rates are not rapidly rising to historically high levels.

Households possess the desire and financial ability to purchase real estate -- they are only waiting for the right opportunities to present themselves. These households have postponed their buying decisions this year. That will result in a great amount of pent-up demand next year.

Similarly, investors are waiting to get back into the housing market. Investors seeking competitive returns continue to look at real estate against the relatively weak performances of stocks and bonds. The existence of pent-up demand will minimize the size of price softening.

This is not to say that all of our nation's housing markets will experience the same soft landing. Some markets are actually fragile, vulnerable to a weakening local economy and/or rising interest rates. These markets are in a weakened state because they are experiencing affordability problems. Most major metros in California and some in Florida qualify. Households in these locations had to stretch their incomes by utilizing interest-only and adjustable-rate mortgage loans to pay for homes that are priced significantly higher than the nation's average. As interest rates continue to rise, mortgage costs rise in these markets, possibly resulting in mortgage delinquencies and defaults, inhibiting both real estate activity and local economic growth.

The Federal Reserve is walking a fine line with regard to their current interest-rate policy and the housing sector. The economy and particularly the consumer are showing signs of weakening, but inflation pressures are rising. With each interestrate hike, inflation takes a blow, but so does the economy. If the Fed over-shoots, we end up with higher mortgage rates and a sluggish economy having difficulty creating jobs. Both harm the housing sector, which, in turn, harms the entire economy again.

We can only hope that Chairman Bernanke and the Fed deliberate carefully and are able to adroitly walk this tight rope.

Want more insights from NAR Chief Economist David Lereah? Visit REALTOR.org to see some of his latest comments from press interviews and speeches at www.REALTOR.org/Research.nsf/ Pages/housingoverview.