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The US Housing Market's Road to Recovery: Slower Speed Limits and Stricter Enforcement

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PIMCO expects housing prices to appreciate 8% to 12% over the next two years.

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Finally, the inventory picture would not be complete without looking at homes that may make their way to market via foreclosure, real-estate-owned transactions or short sales with delinquent loans – the so-called shadow inventory, shown in Figure 4. We believe shadow inventory currently stands at just over five million, but not all of these mortgages will be liquidated; we expect the number of homes that ultimately reach the market to fall between three million and four million. While that is high, north of one million liquidations were absorbed in 2012, and the momentum behind inventory drawdown has been extremely positive. One of the main drivers has been the participation of investors, who are attracted to the high rates of return in the low interest rate environment. As housing continues to appreciate and the capitalization rate on real estate declines, it remains to be seen if investor appetite will persist. We believe it will, albeit at a slower rate than in the past 12 months to 18 months.

Affordability

Figure 5 shows "housing affordability." An index value of 100 signifies that a family earning the median income has exactly enough income to qualify for a mortgage on a median-priced home with a 20% down payment. Aside from earlier this year, the affordability index has never been higher.

There are two important assumptions in the index. The first is that a prospective home buyer is able to put down 20% of the purchase price. The average home cost around $224,000 in 2012, requiring a down payment of around $45,000. Compared to times of robust economic growth and low unemployment, today the average household may not have the money or may be less willing to put down a large sum. The second assumption is that the prospective borrower can obtain a mortgage at the current market rate. Given the tightening of lending standards since the crisis, that leap is not a given.

We would also point out that the ratio of new home prices relative to median household income remains above the mean of the past 35 years, as seen in Figure 6, which speaks to the reliance of housing on low mortgage rates.

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