international analysis and commentary

The American real estate market is back to life


For years the housing market has been driving the American economy, laying out the ground for the bubble of the “mid-aughts” (the first decade of the century) and then, in 2007, plunging the United States into the deepest crisis since the Great Depression. Now real estate is once again positively contributing to economic growth. In fact, the latest data on home prices and outstanding mortgages paint the picture of a sector in the midst of a decisive recovery. Experts generally agree that the outlook remains upbeat going forward, though further growth will depend in part on decisions made in Washington and though caution is heeded for certain areas of the country.

According to data released at the beginning of December by the US Federal Reserve, the third quarter of 2013 marked the first rise in mortgage debt (+0.9% on an annualized basis) since 2008, a sign that American households might finally be done deleveraging. In the meantime, the US National Home Price Index is up more than 11% year-over-year. Additionally, permits for new constructions hit a nearly six-year high in October. Finally, though home sales slowed over the summer as interest rates increased marginally, the pace seems to have picked up again in the fall.

“2013 has been an extremely strong year for real estate, the year of the housing rebound,” says Susan Wachter, Professor of Real Estate and Finance at the Wharton School of Business of the University of Pennsylvania. “I expect 2014 to also be a good year: prices and constructions will continue to increase and foreclosures will continue to decrease. The only concern on the horizon is interest rates.”

All eyes are on the Fed, which has recently announced the much-anticipated decision to start “tapering” (gradually pulling back from its Quantitative Easing (QE) policy). The move is likely to drive interest rates up. “The overall economy is not necessarily strong but it is growing and everybody agrees that the reliance on QE is not sustainable,” says Wachter. “But the Fed is aware that tapering might hurt the housing recovery, so whatever rise in interest rates there will be, it will be slow.”

The other side of the equation has to do with new constructions, which have been rising but are still well below where they should be. “Population growth hasn’t slowed, immigration hasn’t slowed, so we need to build approximately 1.5 million houses a year and right now we are building about half of that,” says Bill Wheaton, Professor of Economics and Real Estate at the Massachusetts Institute of Technology.

Along with the fall in home prices caused by the recession, another factor hampering new constructions is a low rate of household formation. According to data from the US Census Bureau, in the twelve months leading to September 2013 only 380,000 new households were created. On average, this figure should hover around 1 million a year. Obviously this is also a consequence of the financial crisis. Young people are having difficulties finding employment and therefore postpone striking out on their own and instead remain at home with their parents longer. But with the job market now slowly improving, household formation should soon follow suit.  

Crucially, this year’s rise in prices, sales and outstanding mortgages has seemingly taken place in a healthier context than before the recession. As a reaction to the excesses of the subprime mortgage market up until 2006-2007, lending standards have been greatly tightened in the recent past. “In the last three years nobody has been able to get a mortgage without good credit and a 20% down payment, so even if rates are low the terms of lending are stricter” says Professor Wheaton. “Gradually, as home prices start to recover more and more, there will be a little relaxation to down payment requirements, which have been somewhat constraining, and I think that is a welcome change.”

Though the housing market seems to be healthy overall, some analysts fear that artificially low interest rates and rapidly rising prices might be an indication that another bubble is brewing. Yet, in his latest Bubble Watch report, Trulia Chief Economist Jed Kolko estimates that average prices continue to be below their fundamental value in the fourth quarter of 2013, 4% on average across the country. As a reference point, Kolko adds that at the peak of the bubble in the first quarter of 2006 homes were 39% overvalued, before becoming undervalued by 15% in the last quarter of 2011. “Home prices have fallen so far below their fundamental value that they have significant upside potential for the next ten years,” says Wheaton. According to Kolko’s analysis, however, there are a few troubled spots across the country that are worth watching out for. The Orange County and Los Angeles metro areas, both in California, already appear to be at least 10% overvalued. Austin, in Texas, trails them closely, along with a number of other cities across both of these states.

Finally, regulatory developments in Washington could also have a hard-to-predict impact on the future of the real estate market, as the fate of Freddie Mac and Fannie Mae – the two government-sponsored enterprises that own or guarantee about 60% of all home mortgages and which were placed into conservatorship in 2008 – hangs in the balance. At the moment, there are several proposals on the table in Congress to either overhaul or eliminate them. “Whether they should continue to buy mortgages or just insure them it’s a very complicated and difficult question,” says MIT Professor Bill Wheaton. “What I wouldn’t want to do is just get the government out of the mortgage business altogether since that would raise rates significantly. We need a government guarantee at a minimum.”

In sum, a degree of uncertainty remains, casting some shadows on near-term housing prospects. Nevertheless, the American real estate market appears to be in a far better and more sustainable place than it was both in the bubble years and during the recession.