Sentiment among U.S. homebuilders declined in September even as Lennar Corp. (LEN) said Monday it saw a slight pick up in demand last quarter. That’s a mixed to gloomy picture, at best.
However, although high levels of foreclosures, unemployment and household debt are still hurting home prices, there are indications the worst of the downturn is close to over, according to GMO, the Boston-based asset manager led by legendary investor Jeremy Grantham.
“The long-term fundamentals for U.S. residential real estate are sound,” writes GMO analyst Edward Chancellor in a new white paper prepared by the firm.
When the economy eventually recovers and unemployment declines, “household formation will rebound,” Chancellor adds. “Home prices will pick up together with construction. Another housing boom will follow.”
Chancellor sees nine indicators of the housing market being at or near its long-term cyclical bottom:
The healing passage of time. Five years have passed since U.S. housing prices peaked. “That’s about the average amount of time it has taken for real estate markets to trough after previous housing bubbles,” the analyst says.
Valuations are no longer over-stretched. For the first time since 1981, median monthly mortgage payments are lower than rents. “Following the decline in long-term interest rates, this is one of the best times ever for Americans to buy a home,” says Chancellor. After all, mortgage interest rates are at record lows.
Speculators replaced by investors. At the bottom of a cycle assets typically move from weak hands to strong hands, Chancellor writes. “The share of speculative purchases financed with mortgages has come crashing down since the 2005 peak, while the number of cash transactions (an investor proxy) in June rose to 29 percent of total existing home sales,” he says.
Credit crunch is over. “Although delinquencies on mortgages remain high, one should not exaggerate the tightness of the mortgage market,” says Chancellor. The number of foreclosures has turned down over the last year. The latest Federal Reserve loan officers’ survey suggests that credit conditions are loosening, he adds.
End to deflation. The Fed has kept short-term rates at zero for three-and-a-half years. “[Fed Chief] Ben Bernanke has shown a grim determination to ward off deflation. We have experienced successive bouts of quantitative easing, with more to come if necessary,” Chancellor writes. In the 12 months ended July 2011, the U.S. consumer price index climbed 3.6 percent.
Overhang of excess housing supply has diminished. During the bubble, housing starts were far above average, notes Chancellor, but this overbuilding has been offset by several years of below-average housing starts. “Single family housing starts are running at less than half their long-term trend,” he writes. “The overhang on the housing market resulting from excessive construction in the bubble years has thus largely disappeared.”
Housing glut exaggerated. The supply of houses for sale remains very elevated relative to current demand, writes Chancellor. “But, then, homes sales have fallen to a 30-year low. If demand were to recover to normal levels, then today’s excess supply would evaporate to be replaced by a shortage.”
Pent-up demographic demand. The long-term fundamentals for the U.S. housing market are sound. “The population is forecast to grow by around 10 percent over the current decade, which is only a little below average,” says Chancellor. “Household formation has fallen to 40-year lows in the aftermath of the global financial crisis.”
Extreme pessimism. “Last September, a Time magazine cover story suggested it was time to ‘re-think homeownership,’” says Chancellor. “There has even been talk of a ‘new paradigm’ for U.S. housing with the claim that household formation will not regain its long-term trend and that renting will be permanently preferred to homeownership.”