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It seems that whenever something happens in the housing market, a flock of articles pop up explaining why the signs are ominous and housing is destined to flounder. To me, the oddest one has to do with existing home sales this year. Prices have risen, and the inventory of homes for sale has fallen. This happy concurrence has been met with tsk-tsking that both changes will harm the recovery.

The rationale is that the shrinking inventory is causing the house price rise, making homes less affordable and undercutting the buying needed to sustain the recovery. However, these shifts are actually welcome signs – proof that housing is finally shaking off both the Great Recession and the excesses of the preceding housing bubble. Here is the picture, showing three key measures: Existing home sales (green line), inventory (purple) and the ratio of the two (orange).

Now, let’s walk through the graph’s timeline:

1. The 2001 recession following the Internet bubble-burst had little effect on house sales and inventory. Note that the ratio of sales to inventory held steady around 2.5.
2. Then the housing bubble took hold, driving sales up. Inventory also rose but at a slower pace, pushing the ratio up to a peak of over 3.
3. In late-2005, early-2006 the reversal in the housing market took hold. Inventory jumped both because of the natural buildup of unsold homes amid falling sales and because of speculators deciding to sell properties. These contrary moves (sales down, inventory up) produced a sharp drop in the ratio to a low of only 1.2.
4. In 2008 and 2009 the Great Recession and housing bubble-burst kept the ratio low as sales remained down and financial strains kept the listing coming.
5. Then, beginning in 2010, sales began their steady rise eating into the inventory, producing a fast rise in the sales-to-inventory ratio.
6. This year the moves have taken us back to what Realtor.com calls “equilibrium.” Note that sales, inventory and the ratio have all completed their recovery to pre-bubble levels

That last observation deserves emphasis: The existing house sales, the for-sale listings and the ratio between the two are back to the healthy levels that existed prior to the housing bubble and the subsequent Great Recession and bubble-burst. In addition, Realtor.com’s recent press release states the quality of listings is up, as shown by the “median days on the market” declining 10% since last year to 93. Moreover, the sales/inventory/price improvements are occurring virtually everywhere, even those markets previously hardest hit.

So what about “too-high” price rises harming affordability?

Price recovery is beneficial, not harmful, for a number of reasons. Before discussing them, it’s important to remember that the commonly tracked and analyzed pricing is for the “median” house – i.e. the sale price of the house in the exact middle of all the sales that take place. This statistic is unaffected by the skewed nature of sales prices (from the bunched-up lower-priced houses to the spread-out $1+ million homes). However, it has been affected by the large volume of low-priced foreclosure sales and short sales.

With that in mind, here is the picture:

As a reference, I put in new home pricing (purple line). It is a cost-basis indicator that is typically more influenced by the types of houses being bought (e.g. McMansions vs. down-sized homes) than by supply shortage/excess. Therefore, the rise of new home prices above those in the housing bubble is not a sign of excess, but a reflection of building costs (inflation effect) and the desire for, perhaps, more upscale houses with the latest bells and whistles.

Now let’s look at the existing house sales price pattern. The rise that began in 2012 reflects the improved sales/inventory picture we saw before. Also, as the percent of forced sales declines, the median price is more reflective of a normal market, although it remains below the bubble peak. As a result, notice what’s happened to the ratio of new-to-existing home prices: It remains at a low level compared to the “normal” pre-bubble period, indicating further rises in the existing home prices are likely in store.

The price rises offer a number of beneficial signs:

• The first good news is that we’re seeing the result of declining sales volume for the typically lower quality houses in the must-sell category
• The second benefit is to homeowners, for two reasons:

1. Higher house values have been shown to create higher confidence and spending

2. Equity (i.e. price less mortgage) is low or negative for many homeowners, so even relatively small price rises can have a significant effect on equity. From the 9/30 Barron’s. page M1 –

“A recent Ned Davis Research report says rising home prices have helped home equity advance for the sixth straight quarter, up 6.5% in the second quarter. Home equity is effectively equal to mortgage debt for the first time since the third quarter of 2007. Continued gains in house prices should improve homeowner solvency and reduce the number of underwater mortgages.”

• The third benefit is to mortgage lenders and holders of mortgage-backed securities. Price increases improve the quality of holdings and the desirability of new loans/securities.
• Fourth, price gains benefit buyers. Yes, this may seem wrong because “affordability” apparently takes a hit. However, price rises actually enhance buying in three ways:

• Mortgage lending is more attainable, with less stringent credit requirements, more down payment flexibility and better appraisals
• For homeowners wanting to move, there is a better market (price and speed) to sell into
• Increased confidence of buyers. Rising prices encourage people to consider buying houses, especially after suffering through a housing slump. The higher prices mitigate doubts and worries about jumping in at the wrong time. For renters, price gains resurrect the compelling, competitive view of a home being a good investment.

The bottom line

The decrease in existing for-sale housing inventory and the increase in sales and prices are neither abnormal nor ominous. Rather, the housing market is emerging fully from its bubble-and-bust period with regained health. Inventory levels, sales and prices also set the stage for continued improvement. Therefore, we can expect to see more good news coming – most likely when the 2014 spring/summer selling season emerges. It looks as though 2013 could be the pivotal year needed to produce a bright future in housing.