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6 Signs of a Healthy Real Estate Market

March 4, 2011, Michele Lerner, Investopedia

Economists, investors and homeowners are all eagerly anticipating the return of a healthy real estate market. Even potential homebuyers want to know when the market will shift so that they can make their move into homeownership at the right time.

A variety of indicators such as home prices, sales volume of new and existing homes and the number of foreclosures can all be used to analyze whether the national real estate market is functioning well or should be on life support. But anyone looking at real estate needs to remember that all real estate is local. While prices may be still dropping in many sections of the country, they are on the rise in some pockets or have stabilized. That said, here are some indicators that can be reviewed to determine when the real estate market has reached a healthy place.

1. Prices and Affordability
The Standard & Poor's/Case-Shiller National Home Price Index is considered to be the most reliable report on home prices across the country. Data released in February 2011 for the fourth quarter of 2010 showed a decline of 4.1% over the fourth quarter of 2009. This is the fifth straight month of national price declines nationally, with home prices increasing year over year only in San Diego and Washington. The 20-city composites are only 2.3% above their most recent bottom point in April 2009. A healthy market would need, at a minimum, stable prices.

On the flip side of the price issue, however, is affordability. A recent Wall Street Journal article says that on a national basis, the cost of a home is about 19 months of total pay for an average family, the lowest level in 35 years. The article says that prices usually average about 24 months of pay, meaning that more families can afford to a buy a home now. The National Association of Realtors (NAR)'s Housing Affordability Index for December 2010 was 185, meaning that a family earning the median income has 185% of the necessary income to qualify for a conventional loan (with 20% down) for a median-priced single family home.

2. Foreclosures
One of the worst problems in the real estate market is the number of foreclosures, because these sales are generally at bargain prices and drive down overall home prices. According to RealtyTrac, about 26% of all homes sold in 2010 were foreclosures, down a little from 2009. A healthy real estate market depends on a limited number of foreclosures. (To learn more, see Investing In Foreclosures Not A Get-Rich-Quick Venture.)

3. Payment Delinquencies and Underwater Homeowners
Looking ahead to estimate future foreclosures, the Mortgage Bankers Association (MBA) reports that mortgage delinquency rates have fallen to their lowest levels since late 2008. Loans that were one payment past due were at 8.22% at the end of December 2010. An even more positive sign is that borrowers who were 90 days or more late, and therefore likely to face foreclosure, dropped to 3.63%. The lower the level of mortgage delinquencies, the healthier the market.

Another potential precursor to foreclosure can be an underwater homeowner, owing more on the mortgage than the value of the home. These homeowners, who represent almost 30% of homeowners according to Zillow, have fewer options for refinancing or selling if they need to move. In a healthy market, very few homeowners will owe more on their property than its value.

4. Inventory
Most economists say that a six month supply of homes represents a healthy market. NAR reported in February 2011 that the 3.38 million existing homes on the market represents a 7.6-month supply of homes. Another indicator of a robust real estate market is the sale of about six million homes per year. NAR reported a seasonally adjusted annual home sales rate of 5.36 million in January 2011, an increase of 2.7% over December's home sales reports, but still below the target goal of six million homes.

5. Investors
Many economists watch investor activity to check the pace of the real estate market, in particular to notice when prices have hit bottom. Investors, who went dormant a few years ago, have recently jumped back into the real estate market and are snapping up bargains. Often, these investors are paying cash for homes in order to bypass the lengthy mortgage application process. All cash transactions accounted for 32% of all home sales in January 2011.

6. Pending Home Sales
NAR's Pending Home Sales Index is a leading real estate market indicator that looks at sales contracts on existing homes. NAR says an index of 100 generally represents a historically healthy real estate market. The Pending Home Sales Index for January 2011 declined to 88.9%, which NAR says is 20.6% above the cyclical low in June 2010.

The Bottom Line
Individually, none of these indicators show that the United States has achieved a normal housing market on a national basis, although there are signs of health that could indicate a slow but steady recovery this year or in 2012. In addition, some local markets have already begun the recovery process with increased sales and rising prices.