5 Factors To Watch In A Housing Recovery

By Stephen D. Simpson, CFA | July 08, 2010 AAA
5 Factors To Watch In A Housing Recovery

Can the American economy be healthy without a healthy housing market? That is more than just an idle conversation-starter these days. People are tied to housing in many ways; it is often the largest single investment, expense and debt that a person will ever undertake. (Ready to take the plunge? Check out Top Tips For First-Time Home Buyers.)





Given what a powerful force housing was in the economy before the bubble popped, it seems fair to assume it will continue to be significant. Even if people cannot leverage their houses into consumer spending as they used to, the health of housing affects family balance sheets, which in turn impacts small business creation, personal consumption, investment and overall economic activity. After all, what difference does it make if there are ample jobs in North Carolina if you are stuck in underwater mortgage in California and cannot afford to move? (For more on getting out from an underwater mortgage, read Selling Your Home For Less Than The Loan.)

Here, then, are five key factors to watch in anticipation of an eventual housing recovery.

1. Job Growth
Jobs are the prime mover in any economy. Without work, people do not have money to spend- simple. When unemployment goes up, housing prices typically stagnate as people are unwilling or unable to take out mortgage loans and people typically are not eager to move into areas with no jobs. Accordingly, the U.S. economy will have to start adding jobs in a meaningful way before there will be a sustained improvement in housing.

2. Inventories
If you want to see higher prices for any asset, it stands to reason that there cannot be a huge backlog of supply. It is difficult to get top dollar for your house if there are three others on the block just like it and their owners are willing to sell for less. Consequently, investors need to keep an eye on housing inventory and hope for signs of improvement.

Generally speaking, "six" is the magic number in housing inventory. When housing inventories are at less than six months' supply, prices usually rise. When inventories are above six months, prices typically fall.

During the building of the housing bubble, inventories were often below four months' supply. At the worst of the crash, that supply was just over 12 months. Right now, the numbers are all over the place - inventories rose in the back half of 2009, declined to under six in April, and then jumped again in May. Multiple months below six will likely be necessary to start feeling some real optimism. (For more about housing as an indicator for the economy, check out Economic Indicators: Housing Starts.)

3. Prices and New Construction
Along with inventory, it is reasonable to keep an eye on housing prices and new construction activity. If inventory is declining along with prices, you might wonder if frustrated sellers are just taking whatever they can get and cutting their losses - a necessary part of the process, perhaps, but not really a sign of strength. Likewise, at some point we need to see a recovery in new home construction - not only is construction a big marginal employer, but an absence of new construction will likely be interpreted as an indicator of weak future economic performance.

4. Mortgage Loans
Economists certainly watch and comment on mortgage loan activity. After all, if people cannot get a loan, they generally cannot buy a house. That said, it is not such a straight-forward indicator - mortgage loan numbers include refinancings and those must be stripped out. For instance, the June 25th mortgage loan application numbers looked good at 8.8% growth, but the purchasing gauge was down 3.3% (the weakest since 1997) as refinancing demand pushed up the overall number.

Ultimately, there will have to be a revival in lending activity. Mortgage lending is the major business of U.S. banks, and although banks are seemingly content today to borrow at low rates and reinvest in Treasuries (instead of making loans), that cheap money conduit has to end eventually. When these gun-shy banks are eager (or at least willing) to lend again, that will be a strong signal that there is optimism and confidence returning to the economy.

5. Look at Lumber
If investors do not want to follow all of these sometimes-contradictory indicators, there may be a better way. Commodity lumber seems to be uncannily accurate in forecasting future housing performance, generally with a lag of about two to four months. In other words, if lumber prices start moving up, you can generally expect to see good news about the housing market in that two to four-month window.

This is not altogether shocking. First, housing consumes about 88% of U.S. lumber demand (both new housing and remodeling/repair). Second, the commodity lumber market has historically not been liquid enough to attract speculation; the market is more in the control of those who actually produce and use lumber. Consequently, the signals from the lumber trading pit tend to be a little bit "cleaner" than you see in other commodities like gold or oil. (Find out more about this chaotic trading environment in Take A Tour Of The Futures Trading Pit.)

The Bottom Line
Sooner or later, housing will come back. It could be in 12 months or 12 years, but even rampant government bungling cannot stop the market from finding dynamic stability someday. Investors or concerned homeowners looking to gauge the immediate future have a number of economic indicators to process into their analysis. But at a fundamental level, jobs and unsold inventory are two of the biggest factors to consider, along with the signals sent everyday from the lumber market. (Wondering where to put your money? Check out Investopedia Video for easy-to-understand explanations of stocks, mutual funds, options, futures, and much more.)

Catch up on the latest financial news; read Water Cooler Finance: More Spilled Oil, Fewer Jobs.

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