When will housing bottom in the U.S.?

The other day I got into a conversation with someone about U.S. house prices.

He was of the opinion that we are near a bottom in house prices and was considering buying something in the next few months.

He asked my opinion and I told him I do not think we are anywhere near a bottom. Here are my reasons why we have a long way to go.


1) Supply

The first chart is the inventory of unsold homes in the U.S. expressed in terms of "months of supply" (click on all charts to enlarge). In other words, if not a single home were built in the U.S. going forward it would take "X" amount of months to bring the supply down to zero.

Using statistical evidence compiled by the National Association of Realtors (NAR), they release their calculation of current supply every month.



Currently there is an 11.4 month supply of existing homes on the market. Historically house prices have not found bottoms until house supply declines to 3 1/2-4 1/2 months supply. We are a long way from that level.


2) Affordability

Over history U.S. house prices have generally tracked in a narrow range relative to median income. In fact, from the 1970's to 2001 the historical ratio between median home prices and median income was between 2.6 and 3.0.

I believe prices will decline to re-establish this ratio. Assuming median income will not increase (in fact, in this recession it should decline), it is possible to guess at the "bottom price".

-As of July the median house price in the U.S. was $210,900 (as reported by the NAR).

-As of July the median income in the U.S. was 60,512 (as reported by the NAR).

-As of July the ratio was 3.485. Under the assumption median income does not increase, house prices would have to decrease as follows:

3.0 ratio (the most optimistic view) = $181,536 (a further fall of 14.0%)
2.6 ratio (the more realistic view) = $ 157,331 (a further fall of 25.4%)

If the recession is long and median incomes declines from present levels (which I fully expect they will) then prices will further decline well below those projected levels before a bottom is reached.


Another second way of looking at affordability is the Composite House Affordability Index:



The Affordability Index is also produced by the NAR. It is calculated as follows:

The NATIONAL ASSOCIATION OF REALTORS® affordability index measures whether or not a typical family could qualify for a mortgage loan on a typical home. A typical home is defined as the national median-priced, existing single-family home as calculated by NAR. The typical family is defined as one earning the median family income as reported by the U.S. Bureau of the Census. The prevailing mortgage interest rate is the effective rate on loans closed on existing homes from the Federal Housing Finance Board and HSH Associates, Butler, N.J. These components are used to determine if the median income family can qualify for a mortgage on a typical home.

To interpret the indices, a value of 100 means that a family with the median income has exactly enough income to qualify for a mortgage on a median-priced home. An index above 100 signifies that family earning the median income has more than enough income to qualify for a mortgage loan on a median-priced home, assuming a 20 percent down payment. For example, a composite HAI of 120.0 means a family earning the median family income has 120% of the income necessary to qualify for a conventional loan covering 80 percent of a median-priced existing single-family home. An increase in the HAI, then, shows that this family is more able to afford the median priced home.

The calculation assumes a down payment of 20 percent of the home price and it assumes a qualifying ratio of 25 percent. That means the monthly P&I payment cannot exceed 25 percent of a the median family monthly income.

The higher the number the more affordable housing is. Previous bottoms occurred when the index reached levels of 138-145. It is currently at 117.7 as of July, 2008. We have a long way to go.


Bottom Line:

House prices in the U.S. still have much further to fall. That is a certainty.

To judge when it might be a good time to buy, watch for the following:

1)Existing monthly inventory falls to 3.5-4.5 months supply, and

2)Affordability reaches a ratio of 2.6-3.0 (median house price to median income) combined with an NAR affordability reading of 138-145.

When these three items are met, you know we are near or at a bottom.



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