Signs of a recovering market

Svenja Maarit Gudell, senior economist, Zillow

As published in Scotsman Guide's Residential Edition, May 2012.

Home values in the U.S. have been declining for nearly five years and are down 25 percent from their peak. Everyone is asking: When will the housing market recover? How will we know when we are in recovery mode? Although there is no magic formula, there are a host of factors that can be considered signals of a recovering market.

First, it is important to get a sense for how many homeowners are in delinquency and facing foreclosure in a given market. These consumers feed the foreclosure pipeline, which will depress prices further in that market. Chicago, for example, clears foreclosures through the judicial system, which adds time to the process. An analysis done by the Federal Reserve Bank of Chicago shows that Cook County, Ill., has a lower transition rate — the rate of foreclosed mortgages exiting foreclosure — and therefore higher inventory rate of foreclosed homes than Wayne County, Mich., home to Detroit. This extends the foreclosure pipeline and depresses home values well into the future. In improving markets, we expect to see a low delinquency rate and a decreasing number of foreclosures.

Next, a market in recovery likely will have a low unemployment rate. Washington, D.C., for example, had an unemployment rate of 5.5 percent this past December. This was below the national rate of 8.5 percent in the same month, partly because of several key industries that are faring well in the aftermath of the recession. Health care, education, government and military are among the industries currently hiring and thriving.

Consumer confidence also plays a part in how well a metro area’s housing market performs. Consumers who feel good about the economy and feel secure in their jobs are more likely to buy a home. The U.S. Census Bureau reports that there are currently almost 22 million doubled-up households. As the economy improves and consumer confidence increases, some of these people will be potential homebuyers.

When evaluating a local market, we also look at investor activity in the area. The rental market has been a bright spot on the periphery of the housing crisis, and any activity that shows investors buying property is a good sign. It is particularly good when investors purchase distressed properties to convert into rentals, because it helps put a floor on housing prices and may revitalize neighborhoods. Cities like Miami have seen an influx of foreign investors buying homes, including distressed properties.

We also consider how far prices have fallen already. One helpful ratio is the price-to-income ratio. A market that is nearing recovery will show a price-to-income ratio that has moved closer to its historical levels, assuming no fundamental changes in that market. In an analysis comparing price-to-income ratios, we found that although some markets, like Las Vegas, have fallen below their historical price-to-income ratio average (measured from first-quarter 1985 to fourth-quarter 1999), others, like Boston, still remain above their historical levels. Detroit has fallen significantly below its historical average, but we don’t necessarily expect a return to historical levels, as there may have been a sea change because of fundamental changes in local housing demand.

Last, we look to the future. The Zillow Home Value Forecast blends several models to produce the change in the Zillow Home Value Index over the next 12 months for top metros and the nation as a whole. Of the top metros we forecasted, only Los Angeles and Washington, D.C., are likely to experience a bottom this year as they start their recovery process, but cities like Phoenix and Riverside, Calif., are not far behind.

Svenja Maarit Gudell joined Zillow’s industry-leading economics and analytics group in 2011. She produces real estate data and performs econometric analysis, including foreclosure and negative equity research, on more than 150 markets. Gudell received her Ph.D. in finance from the University of Rochester. She previously worked for Analysis Group in Boston and the Federal Reserve Bank of New York as an assistant economist in the International Research Group. Contact Zillow at (206) 757-2701.