It’s starting to look like economic reality is returning to the real estate markets. Time reported July 14, 2010 that inventory levels are rising and price cutting increasing among home sellers across a wide swath of markets nationwide. In a report released by Trulia, “21 of the country’s 50 largest markets cut prices on at least 30% of their listings, up from 10 markets in May.” From the Time article:
“Sellers are feeling the heat this summer as the economic recovery simmers down and home inventory levels climb,” said Pete Flint, co-founder and chief executive of Trulia, in a statement. “We’re seeing more sellers reduce their home listing prices to attract potential buyers.” Housing inventory rose 5% between April and July.
Moreover, waning consumer confidence, continued high unemployment, fears about a double-dip recession and a volatile stock market are all shaking buyer confidence in a possible housing-market recovery. “It’s the perfect storm for creating less demand,” says Ken Shuman, a spokesman for Trulia. “People are nervous.” Recent housing data, including sharp drops in pending home sales, housing starts and mortgage applications for new home purchases, have all served to fan those fears.
Orange County Homes Just are Not That Affordable
Our view is that further price declines are all but inevitable in Orange County because homes just simply are not that affordable. According to DataQuick, the current median home value in Orange County is $445,000. If a borrower puts down 20% (and how many people are able to do that right now?) on a median-priced home, their house payment would probably break down as follows:
Loan Amount: $356,000 (assuming 20% down)
Principal and interest: $1965.85 at 5.25%
Property Taxes: $370/month (assuming 1% assessment)
Insurance: $150/month
Total: $2485.85/month
For an Orange County household with the median annual income of $74,862, the total payment would represent 39.8% of monthly gross income. If there are HOA fees, as there are in many areas of the county, this percentage would be even higher. Assuming federal and state income taxes take another 25% of income, this leaves only around $2200/month to cover food, health insurance, utilities, car payments, and save for retirement. And with jobs so uncertain these days, many would-be buyers might think it too risky to commit so much monthly income to a house payment.
Orange County Price-to-Rent Ratio Points to Further Price Declines
One very good indicator of the long-term stability of home values is the price-to-rent ratio, which takes the value of a median-priced home and divides it by the annual rent payments that would be paid on a similar property. This ratio is useful because it provides a simple way to determine where housing demand will likely flow based on affordability. If the P/R ratio is below 20, then purchasing is probably more cost effective than renting. A ratio higher than 20 indicates that renting is probably the more affordable choice.
According to a Time article published July 2, 2010, “the average P/R ratio in the country’s 54 largest metropolitan markets was 18.8 [at the end of the first quarter 2010], which was 26% higher than its historic average between 1989 and 2003.” The markets that had the highest P/R ratios were “Honolulu, San Jose, Seattle, San Francisco, Orange County, Portland, Raleigh and Charlotte, where the ratio averaged between 25 and 36″ (emphasis added). Because the P/R ratio is above 20 in these markets, renting is probably more affordable than buying and housing demand will likely flow more into rentals.
A key point to understand is that over the long-term, housing will following certain pricing patterns similar to how stocks and bonds do. In other words, though stocks and bonds can be volatile from time to time, they still tend to follow long-term price trends. Home prices do as well because they are directly related to less volatile factors that influence the supply and demand for housing, such as population growth and interest rates. When prices deviate sharply from long-term trends, they tend to revert back at some point in future. The price-to-rent ratio in Orange County and many other markets is very high right now, but if the past is any guide, it will revert back to the long-term trend at some point. The only way for this to happen is for rents to rise significantly (not likely in this economy), or home values to fall significantly. Which do you think is more likely in this crazy economy?
-CH
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