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By Jeremy Glaser and Robert Johnson, CFA | 04-24-2014 04:00 PM

Housing Has Plenty of Room to Build

Long-term statistics suggest the housing market will improve, but credit conditions, inventories, and affordability are holding back real estate, says Morningstar's Bob Johnson.

Jeremy Glaser: For Morningstar I'm Jeremy Glaser. What's holding back the real estate market? I'm here today with Bob Johnson, our director of economic analysis, for his take.

Bob, thanks for joining me.

Bob Johnson: Great to be here, today.

Glaser: We've seen over the last couple years that housing has been one of the big stories in driving the economic recovery or some hopes that housing will start to look better. But we've seen some kind of mixed data recently. What do you think is holding back the market from truly looking a lot better? What are some of the big factors there?

Johnson: I think the biggest factor overall is credit, both on the buyer side and on the builder side. I think the consumer gets a lot of attention, but the builder side is just equally as important.

And let me start though with the consumer side. Credit has been tight. Banks have new rules about the capital they have in place. The riskier the capital, the more capital they have to put up. They have to say that they moved people through to the process and checked all of these things in a checklist. If they haven't then the mortgage companies have the right to push it back to the banks and say, "This loan is yours; it's gone bad." And on top of it, the rates that they can charge aren't very high, even compared with the practically zero interest they are paying on their certificates of deposit. It's still not a wide spread. Certainly not a wide enough one to want to make them want to go crazy and do a lot of new mortgage lending.

Glaser: What does the consumer credit picture look like now versus the darkest days of financial crisis in 2009?

Johnson: Great question. One of the ways that we can take a look and see how tight the banks are is look at the FICO score on an average approved mortgage. And FICO is a measurement standard for credit, and it generally ranges from the low 100s up to a number as high as 800. And certainly something over 700 is usually considered pretty creditworthy and something under 600 you probably can't have any hope of getting any kind of loan. And so right now, those FICO scores had been relatively flat since 2009

At the very worst moment of the recession, the average FICO score on an approved mortgage was 760 and at some point in 2013, we were still at about that same 760 level. The last couple of months we've gotten a little better on that number. But we're still drastically above kind of the low 700s where we were in the middle of the housing boom. We've got still relatively tight credit conditions for consumers.

Glaser: The consumers are having trouble getting a loan. How about the homebuilders? They need loans to get these homes up.

Johnson: Exactly.

Glaser: What's happening in that front?

Johnson: The big homebuilders don’t have a problem with capital. I mean they have got many sources. They can go to the bond market and issue junk bonds, or they can go to banks in some cases and get loans on a secured basis. They have got a lot of options. The small builder that’s building one house and has to go to his bank is probably going to have a very hard time to get a loan for his building.

Certainly some of them went through some rough times in 2008 and 2009. That’s going to put a black mark against them if they didn’t do very well during that period or they had to put a couple of houses back to the bank. That will certainly turn up in the record and make it hard for them to get loans. I think that that’s going to be a continuing and ongoing problem.

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