Fundamentals That Drive Housing Market Performance

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The Basics

With home prices continuing to fall at a rapid rate, everyone wants to know when the housing market will reach bottom and when prices are expected to recover. Although nobody can predict the future and both good and bad times seem to continue longer than they should, a solid understanding of the fundamentals can serve as a leading indicator for price appreciation or depreciation in your markets.

We are now incorporating our market fundamentals grades, which show the overall health of each metro area, into the market data we provide with this column. A composite of 24 variables of housing demand, supply and affordability, these grades show that improving fundamentals usually results in increasing appreciation and vice versa — sometimes with a 3- to 5-year lead time. The graph of the San Diego metro area shows how improving market fundamentals in the mid-1980s and late-1990s preceded the home price appreciation of the late-1980s and early-2000s. It also shows how price appreciation continued to rise even as the market's fundamentals eroded. Interestingly, some markets such as Seattle appear to appreciate in line with the fundamentals.

We don't consider any of the 20 largest housing markets to have healthy fundamentals, and — no surprise — several major markets are performing at their worst levels in the last 27 years. The market fundamentals in the Dallas and Fort Worth, Texas areas each receive a grade of C due to their solid levels of demand and good affordability, despite heavy levels of supply. On the other end of the spectrum, abysmal demand and supply issues plague the F markets such as Riverside/San Bernardino and Chicago. We would also consider Miami, Fort Myers, Fla.,

Minneapolis and New York (a market yet to see a correction in price) to be among the group with unhealthy fundamentals.

Housing is cyclical and market fundamentals fluctuate over time. Because markets do not necessarily cycle together, an average across all metros is not particularly telling, but we have come across some overarching themes. As shown in the graph on the next page, the average market fundamentals were worst in the early 1980s, mostly due to poor affordability as the result of very high interest rates, and best in the late 1990s, as demand and affordability fundamentals peaked together.

Conclusion

Those who are the most informed are prepared to make the best decisions. When the fundamentals are improving, take on more risk. When the fundamentals are eroding, take on less risk. Focus on those drivers of demand, supply and affordability to position your company to embrace the opportunities in the cyclical housing business.

To see the latest grades for major housing markets across the country and for more analysis of understanding housing market fundamentals, visit www.realestateconsulting.com.

Author Information

John Burns helps many of the largest companies in the industry with strategy and monitoring market conditions. He can be reached at jburns@realestateconsulting.com.