THE TRUTH ABOUT THE HOUSING MARKET

On any given day, it’s likely you can find conflicting news stories related to the recovery or impending crash of the housing market. I’ve found it interesting in the past few days that there are those who are calling on the Government to just “let housing crash.” The idea of less or no Government intervention in the housing market is, believe or not, a welcome idea to most builders. Builders know that one reason the market continues to bounce along the bottom is that potential buyers are continually wondering what incentive may be coming next from the Government. The sooner the Government sends a clear message that the party is over, the better off the market will be.

One thing that is very concerning, however, is the idea that an end to Government intervention would necessarily mean a drop in home prices, and even further, a drop in home prices that might even become permanent. This idea is pure speculation, and definitely not borne out by the facts. Following is my argument for why this theory is not based in fact:

The term “home prices” as defined by the Government and independent groups that track home price movement, is nothing more than average sales price, calculated by taking the total dollar value of sales for a particular period of time, divided by the total number of homes sold. Obviously, if you have a lot of smaller, less expensive homes sold during a particular time period, the average sales price will be lower. During the boom years, the proverbial McMansions were selling all over the United States. The average home being sold was larger, and therefore more expensive, than the average home sold a few years earlier. As the average sales price increased during the boom years, this was reported in the media, and interpreted as an increase in home values. People anxious to by a home before prices went even higher, were quick to pay prices that were simply not justifiable based on the cost to build the home. In a few areas of the Country, namely California, Arizona and Florida, the feeding frenzy for homes simply got out of control, and home prices rose to levels absolutely unsustainable.

Over the past two years, a combination of factors, but mainly the $8000 tax credit, has attracted first-time and lower cost buyers to the housing market. As a result of smaller, less expensive homes being sold, the average sales price has dropped significantly. Despite how the media may love to spin it because it makes for more exciting news, the 30% drop in “home values” that has been reported over the past two years, is actually much more accurately described as a 30% decrease in the average size of home being sold. That’s not to say that home values haven’t dropped in some areas. But it should also be noted that home values have definitely not dropped the same in all areas, mainly because some areas of the Country never had the unsustainable run up in prices during the boom.

The point that must be made here is that over the past two years, an onslaught of smaller, less expensive homes being sold, has played havoc with the average sales price numbers, and have artificially skewed the way we measure home values in this Country. Going forward, with the absence of tax credits and all the other incentives designed to help first-time home buyers, it seems likely that the average sales price will begin to tick up, not due to an increase in home values mind you, but because of an increase in the average size of home sold. Based on what I am seeing in our local MLS, the inventory of homes under $200,000 is tremendously low compared to a year ago, and the number of new homes under $200,000 is almost non-existent. For this reason, I believe that the basic law of supply and demand will actually push the price of smaller homes higher. So far in the month of September, it appears that the average sales price of homes sold will be significantly higher than in previous months. The difference: an almost total lack of the smaller home sales prevalent during the months leading up to the end of the tax credit.

Even more important than the fact that going forward, sales of larger homes will be more prevalent, and will push average sales prices higher, is the simple and provable fact that it is relatively impossible for home building costs to decrease. It is a fact that the cost to build a home today is more than the cost to build the same house in 2006. And, despite the rhetoric, even during the boom years, most builders in areas other than CA, FL and AZ, were making profits in the range of 12%-15%; certainly an acceptable profit level for any business. What this all means, is that with the exception of CA, FL, and AZ, most builders in most parts of the Country simply cannot afford to build homes for less than they were building homes for in 2006. So what is the likelihood of reducing direct and/or indirect building costs? Not very. One of the most significant costs related to housing is crude oil. The amount of freight involved in the construction of a home is tremendous. The raw materials have to be transported to a place of manufacture, then from the manufacturer to a distributor, then from the distributor to the actual home under construction. Then, there is the cost of fuel for construction equipment. But, the most significant portion of cost related to crude oil is in the use of petroleum based products used in homes; carpeting, plumbing pipes, vinyl flooring, vinyl siding, paints and finishes, roofing shingles and much, much more. The bottom line: unless we are likely to see crude oil prices at $35/barrel some time soon, it is a good bet that the cost for freight and petroleum based products will likely increase, not decrease. Other things contributing to the cost of a home are copper, lumber and lumber products such as OSB, and gypsum for drywall. There is absolutely no evidence that these items are likely to decrease in cost any time soon. In fact, there is evidence that as the housing market begins to eventually recover, there will be a lack of sufficient supply to cover demand. In the short uptick that the housing market saw in early spring, OSB more than doubled in price, mainly due to the fact that because of the housing crash, there are limited OSB manufacturers still in business. Any sustained recovery in housing will likely bring to light the fact that this Country no longer has the ability to produce the number of homes that will eventually be needed to keep up with population demand. The result will be a steady increase in costs, not a decrease.

The unfortunate part of all this, in my opinion, is the likelihood that the same people who are encouraging a total collapse of the housing market, know full well the facts that I have presented here, and they are very much aware that the long-term direction of home prices is up, not down. Those same people are positioning themselves to take advantage of the ultimate upward direction in housing. Meanwhile, the average buyer is still sitting on the sidelines, believing the myth that somehow, now is not the best time in decades to buy a home. No matter the ups and downs of the housing market over the next several months, the trend will continue to be upward, and at some point, when it becomes obvious that the housing market is not just recovering, but beginning to charge ahead, some unfortunate people will discover that they simply waited too long.