The Excess Inventory of Housing Units for Sale - Essay Example

? A New House – Decision A New House – Decision There has been a big upside down in the US economy in last 2-3 years and there has been a big turmoilin the housing sector in particular. The country is at the threshold of most difficult and challenging times in the history. Those who are thinking to buy their first house have a stupendous task to decide whether this is a right time to buy or not. Economy of the country is in downhill. Unemployment rate is hovering around 9 percent quarter after quarter. As such, we live in most uncertain times and decision of this magnitude must be analyzed from many perspectives. Purchasing a new home is a major decision requiring a substantial financial outlay where the wrong decision has long-term financial consequences. Any wrong doing on this part is likely to affect our financial health for many years. Wisdom tells that one needs to take the help of economic tools available for such crucial decisions. It is required to scan existing state through various economic theories to assess where US currently stand as a country and what will be the future of housing sector in US. Based on this vision, whatever decision is taken to procure a house will be called a rational decision and that will be based on our findings and future directions. It will be appropriate to take a note on some of the things to get the idea as to what is the state of affairs in US economy. 1. Unemployment rate in the month of February, 2011 has been found to be 8.9 percent not showing any respite. In fact, it is hovering around 8-9 percent month after month and that is an indication that economy is still not showing any appreciable upward trend to declare that US is out of the grips of recession. (Labor Force…) 2. Crude prices are again on the rise and moving between $95- $100. This has been more significant after Libyan crisis. Prices are likely to be in the turbulent state for some more time to come. 3. US GDP growth rate is showing a slight rising trend in last two quarters and numbers are between 2.6 and 2.8 percent showing a ray of hope for recovery but a firm trend can be determined after seeing the performance of at least 2-3 quarters more or until 2011. The point to be noted here is that in the year 2009 GDP numbers were in negative and in second quarter it went up to -6.8 percent perhaps the worst quarter in last several years of US history. (United States GDP…) Having seen some of the important economic indicators, it will be worthwhile to look at the housing inventory in the country. The excess inventory of housing units for sale or on rent is estimated to be 1.2 million units at the end of 2010. (Berg, Robert 2010) Once this excess stock of dwelling for rent or sale is absorbed, market can be said to have come to its equilibrium and to its normal operation then only there is a chance of any real growth in the property market. Economic Principles of Demand and Supply and Equilibrium The market forces of demand and supply is the foremost economic principle to decide about the price of housing at any given time. Demand and supply of any commodity is not a static thing in the market and keeps on changing time to time. Housing demand started rising from January, 1993 when median price of housing was approximately $125,000, which peaked in 2006 to reach at about $250,000. (Median and Average…) The burgeoning demand of the housing was due to cheap credit available from the banks and other lending institutions. At any moment, demand is either from genuine investors who require housing for their own consumption and it is also due to the speculative forces at play. Nevertheless, regardless of the reason demand outstripped the supply and pushed the prices up. It is not possible to segregate the wheat from chaff that is to say the market is always a mix bunch of genuine investors and speculative investors. Speculative investors will leave the place as soon as they see the first sign of weakness because their sole aim is to profit from the investment. Economic principle prevails; speculators or short term investors will cross the post and will become sellers. As prices start moving downward, short term investors aka speculators will start dumping their good increasing the supply. The cycle continues until the market reaches at equilibrium where demand and supply matches and market stops falling further. (Mankiw, Gregory) Market is so large that it is not easy to identify when the market has reached equilibrium. Constant reviewing the housing index does give some clue apart some other economic factors. Average fall in the median price from the top between 2006 and 2010 has been observed somewhere around 25-30 percent. (Median and Average…). Housing inventory data, quarter after quarter is another clue as to how demand supply equation is taking shape over time. This understanding of economic factor affecting housing prices is at macro level; however, at micro level many other issues come into play such as area specific growth, local government policies, change in demographics and so on. Marginal Benefits and Marginal Cost: The understanding of marginal benefit and marginal cost can be applied further to scan through the decision of buying the housing unit. A true economic thinking will weigh the decision from this perspective. (Mankiw, Gregory) Housing is not only an investment but also an essential commodity for our consumption that satisfies our need for shelter to protect us from external environment. Needless to say that we all require a shelter where we can rest in the night, cook our food and to fulfill other basic needs. If we don’t buy house, we need to have one on rent for meeting our basic requirements. Typical rent is found to be 0.5-0.6 percent of the cost of housing per month and also assumed for our working of the case. If the cost of housing is $150,000, one needs to pay $750-$900 per month on rent. Same can be compared with the mortgage cost of the housing considering 10-15 percent down payment and mortgage period 20 years. Of course, it is the market who decides about the mortgage cost. There are three possibilities on this: A. My mortgage cost is less than $900 per month. B. My mortgage cost is equal to or slightly more than $900 per month C. My mortgage cost is substantially higher than $900 per month. Alternative A, indicates that marginal benefit is much higher with no marginal cost. Marginal benefit is that I will become owner of the property after mortgage is paid out in 20 years, which will not be the case if I rent the house. I will also get the benefit of future appreciation of property. Alternative B indicates that with slightly additional cost in terms of mortgage, I will reap the benefit of owning a housing unit. Even when I add the opportunity cost of down payments made, it turns out to be not substantially higher, say not more than $1100 per month. My decision matrix says that paying $250 per month additionally; I will become the owner of the house after 20 years and I will reap the benefit of future appreciation of property. Certainly, marginal cost is not substantial against the marginal benefits. Alternative C indicates that marginal cost is substantially higher compared to the marginal benefits. Assuming, mortgage cost per month comes almost double $1700 per month having taken into account the opportunity cost of down payment in the calculation. We have to keep in mind that rent will increase or decrease in tandem with the property prices and on other economic conditions. So our decision should take into account the aggregate rental cost of all 20 years and not first year’s rentals while making a decision; however, mortgage cost will remain constant once we have entered into a contract with lending party. Secondly, property prices may go up and down after we enter into the mortgage contract so again we can guesstimate what will be the housing cost after 20 years referring the past record and assuming the other things remain same. In short, we need to know what appreciation of the property we are likely to have in next 20 years. Strength of Economy The strength of economy plays a vital role in our above example of evaluation of marginal benefits vs. marginal cost. As economy gains strength, employment will increase and there will be a larger demand of housing units. That will increase the rental cost and simultaneously the cost of housing will also move up. With the strength of economy one needs to pay higher rental but if he or she has already entered into the mortgage contract, one need not bear any extra cost as terms are fixed for 20 years. Thus, one is safeguarded from any extra burden if property prices move up. With higher property prices, mortgage cost will also move up. A new dynamics will set in with the same decision matrix to decide on marginal cost and marginal benefits. It is possible that aggregate demand in the country increases with the strength of economy but in certain states or area or at specific locations there is no increase in demand because economy in that particular region has not improved and therefore there is no increase in rental and property prices. It is essential to identify the specific locations where economic activity has increased or likely to increase in near future for any reason whatsoever such as change in government policies or any technological reason or due to some demographic shift. Economic activities are not same throughout the country. Some areas swing into action fast and some less. It is crucial to keep watch on this. That is the reason why location is an important and crucial aspect while buying our housing. (Mankiw, Gregory) International Trade and Domestic Economy: International trade also plays an important part in deciding the strength of economy. Applying the theory of comparative advantage, Imports are plenty where in the consumer gets benefit of the low cost of good. Currently, trade balance is not in favor of US. The increased export will increase the level of economic activity and reduce the balance of trade. US can concentrate in the areas where they lead the world. Education industry and tourism can do a lot in boosting the US economy, which will decrease the unemployment rate and increase the growth rate of GDP of the country. High technological areas where US have edge over rest of the world can do a lot in boosting the US economy and GDP. If such changes happen in US, economy will move up and increased growth in GDP will be a sure sign of booming economy. That is the time to think positively to buy a house from the macroeconomic perspective. (Mankiw, Gregory) Conclusion: Summarizing, my decision to buy a house will have a following directions. GDP data for 4 continuous quarters should show upward trends establishing revival in the economy. Added to this, economy shows continuous decrease in unemployment rate for the same period. Simultaneously, I would check for the demand and supply dynamics of housing units. If unsold inventory of housing is on decline and reaching to the near equilibrium point, it will be a sure sign of market reaching to a stabilization stage and chances of further decline in the price will be minimal. As already discussed earlier, currently unsold inventory of housing is estimated at 1.2 million units at the end of 2010. These data are to be reviewed quarter after quarter. Alternatively, I will apply the logic of marginal benefits derived against the marginal cost. With near negligible marginal cost coupled with considerable marginal benefits, I will go and procure the housing unit. If marginal cost is substantially higher against marginal benefits, I will discard my decision to procure housing. Having said above, the present macroeconomic factors do not satisfy my criteria of investing in a house and I would prefer to wait for at least two more quarters to review the decision again on above ground References: 1. Labor Force Statistics from the Current Population Survey Online from http://data.bls.gov/pdq/SurveyOutputServlet [Accessed on 3/7/2011] 2. United States GDP Growth Rate Online from http://www.tradingeconomics.com/economics/gdp-growth.aspx?Symbol=USD [Accessed on 3/6/2011] 3. Berg, Robert 2010. Housing Inventory Data Online from http://www.woodbiomass.com/woodbiomass/news/North-America/Wood-Energy/RISI-VIEWPOINT-UPDATE-US-Census-fourth-quarter-2010-housing-inventory-data.html [Accessed on 3/6/2011] 4. Median and Average Sales Prices of New Houses sold in US. Online from http://www.investmenttools.com/median_and_average_sales_prices_of_houses_sold_in_the_us.htm [Accessed on 3/6/2011] 5. Mankiw, Gregory N. Principles of Economics, electronic edition, P 4-13, P 177-179. Read More