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Here’s when housing will recover — for real

No part of the economy has dished out a stronger head fake than housing. In the first half of 2013, home prices bounced back, sales rose and it looked like the bust was firmly over. But since then, rising mortgage rates have spooked buyers, sales have trailed off and the ranks of renters have swelled.

So when will the false starts cease and the housing market recover for real? “Several challenges still remain,” Daniel McCue of Harvard University’s Joint Center for Housing Research tells me in the video above. “Sales and construction levels are up but still at depressed levels historically.”

Harvard’s Joint Center just published its annual overview of the housing market, which highlights several things that still must happen for housing to fully recover. A healthy housing market is vital to the economy because it generates spending not just on homes but on furniture, appliances and many other key categories of goods and services. If the housing market is sputtering, the overall economy is likely to do the same, and vice versa. That’s basically what has been happening. Here are five things that need to occur for the housing market to get back to normal:

Twentysomethings must leave their parents’ basements. Between 2007 and 2012, incomes for 25-to-34-year-olds dropped 8%, while many in that age group ended up saddled with much higher student-debt loads than graduates carried in prior decades. So it’s no surprise many traditional first-time buyers are staying out of the market. There’s some evidence college students are getting a better handle on debt, and as younger Americans improve their finances, demand ought to pick up for cheaper homes, allowing some of those owners to sell and upgrade to fancier properties.

Banks must ease lending standards. This has been happening very gradually, since weak and even fraudulent loan underwriting helped cause the housing boom and the bust that followed. But it’s becoming more important than ever to develop programs to help lower-income Americans afford housing. The Joint Center projects that minorities — who tend to have lower income and wealth levels than white households — will account for nearly half of the first-time home buyer market by 2025. If they can’t get loans, the whole market will sag. Some analysts argue that excess spending on affordable housing programs contributed to the housing bust, by making it too easy for people who couldn’t afford homes to buy them anyway. Still, it remains essential to find prudent ways for lower-income Americans to buy homes if they have steady jobs and manage to save some money.

Mortgage rates must stay relatively low. Thirty-year mortgage rates jumped early last summer and are now around 4.2%, which is nearly a full percentage point above the record lows of late 2012. By historical standards, rates remain remarkably low. But consumer finances are also remarkably fragile, which means rates must stay low for a housing recovery to take off. If they drive much above 5% or so, it could seriously crimp the recovery.

Incomes must rise. Jobs are returning, but one missing link of the whole economic recovery has been rising pay. Incomes are barely keeping up with inflation, and if you factor out 1 percenters, whose pay is skyrocketing, average pay in some industries and professions is declining. Since buying a house depends on your ability to save for a down payment, regular raises are key to improving household finances and more home purchases.

Rents need to keep rising. And they probably will. This is obviously a burden for renters, but landlords have the upper hand right now, as fewer people can afford to buy, which is pushing up rents. The higher rents go, however, the more it will make sense to buy instead — provided potential buyers can get loans. If they can’t, it could cause a self-reinforcing cycle of escalating rents and weak sales — which is good for nobody, except maybe landlords.

Putting a time frame on all these developments is tricky, but it’s safe to say they won’t all happen at once. Some economists believe incomes are are set to rise in several industries, due to a limited supply of workers with needed skills. Young workers seem to be gaining their sea legs as they save a bit of money and wear out their welcome at home. Rents are certainly already rising as well, causing discomfort for many tenants.

The last piece to fall into place will be easier lending standards, which could still take several years — especially since regulators are starting to worry about banks taking too many risks on loans (though more with regard to cars than homes). Celia Chen of Moody's Analytics wrote recently that "the U.S. housing market will rebound in the second half of this year and strengthen further in 2015."

Others, such as investor Jeffrey Gundlach, feel another housing bust could be forming. One key factor will be whether interest rates rise before mortgage credit has become more widely available, which would curtail rather than expand the numbers of people who can both afford to buy a home and get approved for a loan. The market is heading toward something that looks like normal — but then again, it has been for a while.

Rick Newman’s latest book is Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.

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