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How cheap houses spell bad news

Houses look more affordable than ever. But prices will have to fall further before many Americans can actually afford to buy one.

The end of 2010 brought the start of a double dip that left U.S. home prices down 31% from their mid-decade peak. The latest slide puts the price of the average dwelling far below its long-run average as a share of per capita income, according to Paul Dales of Capital Economics in Toronto.

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Housing is “exceptionally undervalued” by this measure, Dales writes. He says houses are trading at a 21% discount to their average price as a multiple of income, going by the S&P Case-Shiller national composite index.

Cheap houses and low interest rates seem to point toward a housing renaissance. A buyer who takes home the median per capita income can acquire the median-priced house while spending just 13% of disposable income on monthly housing bills, Capital Economics estimates. That’s another low.

Yet low monthly payments alone won’t be enough to keep house prices from spiraling downward again over the next year or two. The issue isn’t what houses fetch now, it’s what they might be worth in the near future – and how many people might be able to foot that bill. Both of those numbers look to be headed sharply lower.

Consider that mortgage rates, though about a percentage point above last fall’s deflation scare low, remain 2 percentage points below their long-run average. With the bond markets at loose ends about the price to be paid for U.S. fiscal laxity, a further rise in mortgage rates looks likely.

Higher rates raise monthly financing costs, cutting the amount buyers can put toward principal payments – and driving down prices in lockstep. Why step in front of that steamroller now?

The other bad news for house prices lies in weak employment and wage trends and tightening standards for financing – which may help explain who has been buying houses lately.

With banks increasingly demanding substantial down payments, even supposedly affordable houses are a stretch for many. The median sales price of a new house in 2010 was $222,600, according to Census Bureau data. That means saving a $45,000 nut, plus closing costs, on the median per capita income of $26,530.

At the average U.S. personal saving rate of 5.8%, doing so would take 29 years. Even using the household median income figure of $49,777, you’re looking at 15 years or so just to get the down payment on hand.

Prices for existing houses, which have been accounting for the vast majority of sales, are lower, which makes the savings math a bit less daunting. Even so, those numbers say the pool of potential homebuyers is not terribly large right now, not with unemployment running near 9% and the labor force thinner than it has been in 26 years.

And so it is that more than two-thirds of existing home sales since last summer were made to cash buyers or investors, while a mere 6% of purchases were made by first-time homebuyers, Dales says.

First-timers accounted for 41% of house sales in 2009 and between 35% and 39% from 2005 to 2008, according to the National Association of Homebuilders. The 2009 number was surely boosted by first-timer tax credits, but it’s clear that it’s not out of line with the recent average. 

So like it or not, house prices are going to keep falling until jobs become plentiful, wages start rising and the outlook for rates becomes clearer. That is, until it becomes clear that a good portion of the population can actually afford those affordable prices.