August 19, 2009 (Housing Market Monitor)

By Dean Baker

August 19, 2009

Market rents are likely falling in many areas.

The Census Bureau reported that housing starts fell by 1.0 percent from upwardly-revised June levels. Permits were down by 1.8 percent from June levels. All of the decline was in multi-family units. Starts of single-family homes actually rose by 1.7 percent in July. Single family starts now stand 37.3 percent above their February lows.

Starts in buildings with 5 or more units were down by 16.7 percent, falling back to the low-point hit in April. Starts in larger multi-family units are down by more than 75 percent from the bubble peaks in 2006. The decline has been sharpest in the South, where starts are down almost 80 percent from peaks hit in 2005. This largely reflects the plunge in condominium construction in Miami and other centers of the housing bubble. Starts of multi-family units in the South fell by 15 percent in July.

The falloff in starts and permits in July seems to have left many analysts disappointed following several months of relatively positive news from the housing market. There really should not have been much surprise here. There continues to be an enormous oversupply of new and existing homes in most areas of the country. It would be extraordinary if there were any substantial uptick in construction under these circumstances. While it was reasonable to believe that construction would pick up from the lows hit in the winter and spring, it was implausible that there could be a sustained upturn in construction with such an extraordinary backlog of unsold homes. Until this inventory is whittled down substantially, construction will remain depressed.

There has been considerable misunderstanding about the meaning of the housing market hitting a bottom. Construction and sales have fallen enormously from their bubble peaks and will probably not fall below the troughs hit earlier this year. At the same time, there is no reason to expect them to rise substantially either. The inventory of unsold homes will depress construction, while sales will be held down by both high unemployment and falling house prices. The latter has eliminated the home equity that many current homeowners might have otherwise used to buy a new home.

What has not hit a bottom is house prices. Recent data clearly show that the rate of house price decline has slowed sharply. Barring an extraordinary turn of events, we should not expect to see house prices falling at a 2 percent monthly rate again. However, the only way that the huge inventory of excess supply will be reduced is through further declines in price. Real house prices remain about 10-20 percent above their long-run trend level. There is no obvious reason that we should not expect them to return to their trend level and it is quite likely that there will be overshooting on the downside. This overshooting has already occurred in some former bubble markets, such as Phoenix.

The recent CPI data on rents show the extent to which oversupply is affecting the market. The rent proper index has increased at just a 0.6 percent annual rate over the last six months, while the owner’s equivalent rent index has increased at a 0.7 percent annual rate. There is a great deal of inertia in these indices, since they include all units, not just the ones that came on the market. In many areas, market rents are almost certainly declining. Falling rents will be another source of downward pressure on house sale prices in the next couple of years.

House sale data are likely to be somewhat distorted in the next few months as a result of the first -time homebuyer tax credit that is now scheduled to expire at the end of November. Those hoping to be able to take advantage of this credit will already be in the market looking for homes and will no doubt rush to get in a contract in the next month or two in order to be able to close in time to get the credit. In many of these cases, the credit will simply be pulling purchases forward, leading to a large falloff in sales after it expires.

Dean Baker is Co-Director of the Center for Economic and Policy Research, in Washington, D.C. CEPR's Housing Market Monitor is published weekly and provides an incisive breakdown of the latest indicators and developments in the housing sector.