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Bottom In Home Prices, a Decade Away

MKC_Global's picture




 

Humans
are an optimistic breed by nature. There are some pessimists (or “realists” as
they prefer to be called) among us; but on balance humans believe in a better
future. This ensures that investment professionals will continue to track
investor psychology for many years to come. When the naturally optimistic
demographic becomes a group of Doom and Gloomers (or vice versa), we take
notice. The same is true for participants in the real estate as well as stock
markets.

The
general public seems to believe the bottom in housing has arrived; however, I
believe no one will make any money on their real estate investments for the
next decade. There may be an exception or two with a fixer-upper or a
foreclosure, but buying a home for your primary residence under typical
circumstances will be a net loser. The real estate market has absolutely no
sustainable drivers for a price floor, let alone price appreciation. With
taxes, interest, maintenance and insurance, you are guaranteed to lose money,
especially when compared to what you could be paying in rent for comparable
property.

In addition
to the typical rosy outlook for the future, humans have a consistent tendency
to only remember the recent past-consistently forgetting important lessons from
history. Home owners and real estate investors alike were all too accustomed to
consistently rising real estate prices until 2006, when the subprime mortgage
issues and real estate bubble began to take hold.

Few
people realize that home prices in the United States have only risen in a
sustained manner twice in the last
116 years. Edward Kim, hedge fund manager of 2GTT, LLC, brought this fact to my
attention and I know very few other people who are aware of this reality. This
data can be found below in the American House Price Index created by Robert Shiller.
Other than the two aforementioned periods, all others have either seen
declining home values or periods of stagnant or volatile prices with a net zero
change. In 116 years, only twice have home values appreciated in any rolling 8-year
period, adjusted for inflation. The chart below shows data to 2006, the index
now stands at about 146 for Oct. 2009.

Shiller House Price Index

In
determining what the next decade will bring in terms of real estate prices, one
must look at a number of fundamental factors to determine when a major bottom
will occur. In addition to watching the price levels of real estate, we should
also observe the mortgage markets, interest rates, home affordability, housing
inventory, new construction, mortgage applications and the rate of home sales.
Also, following the stock prices of home building companies may shed further
light into the state of the industry, as the stock market proves to be an
effective tool at discounting news and can be a leading indicator of major
industry turns. Determining an accurate view of these aspects should clarify
the future of the residential real estate market.

Home
Builder Stocks: The stocks of home builders have been weak and declining since
August of 2009 while the broad stock market has rallied substantially. When these
stocks cannot keep up with the broader market, there could potentially be a
problem for that stock’s immediate future.

Mortgages:
The issues now lay with prime mortgages, as standard 30-year fixed loans are
being defaulted on as people lose their jobs. Home values continue to decline putting
more home owners “underwater”, owing more than the home’s value. Also, adjustable
rate mortgages have just begun to hit their reset dates, forcing the owner’s monthly
mortgage payment higher. This number of adjustable rate mortgage resets will
increase each month until they peak in mid-2011.

Rate of
Home Sales: Moderation in the rate of decline in home sales has occurred,
slowing down into Feb. 2009, but has since picked up. 2008 marked the lowest
number of home sales since 1999; but due to stimulus packages, optimistic
thoughts of a housing bottom and home buyer tax credits, this important factor
has reversed for the worse.

Mortgage
Applications: Mortgage purchase applications are declining rapidly; “cliff dive”
was the comment of one analyst. As of January 2010, the MBA Purchase
Applications Index is at the lowest rate since 1997.

Interest
Rates: Mortgage rates are currently very low, and it is a great time to acquire
debt; unfortunately the drivers for higher interest rates in the future are quite
strong. Nobody knows when long-term interest rates will rise, because interest
rates move in very long-term cycles. We will have to wait years for rates to raise,
peak and then decline to meet this
component of the real estate bottom model.

Home
Affordability: With all other criteria being equal, declining home prices mean
affordability is rising. The important question to ask is how affordable are homes and will they get even more reasonably
priced? All the other criteria here suggest they will. The National Association
of Realtors releases its NAR Affordability Index every month. According to this
index (the data is available from 1988); we currently have homes that are the most affordable on record. This index
only once, for one month, dipped below 100 (over 100 means affordable and under
100 means unaffordable). It now sits adjusted at 145 and unadjusted at 176, the
highest levels on record. Only once before has the index ever showed that homes
were unaffordable! Barry Ritholtz of The Big Picture points out, if the index
can’t indicate when homes are overvalued, how can we conceivable use it to
determine when homes are affordable?

Inventory:
Currently real estate inventories are high. In early 2009, Credit Suisse
estimated that inventories would rally to 11 months worth of supply placing
them at the highest level since at least 1988. This is insignificant compared
to the “shadow inventory”. The shadow inventory is comprised of all
properties/units that will be on the market, but are not yet listed. This
number is estimated to be extremely high and is comprised of several items:
bank owned properties (including Fannie Mae and Freddie Mac) that have not been
put on the market yet and the number is rumored to still be growing,
foreclosures in process, new condos in high-rise towers not yet listed and
current property owners waiting for a rebound in prices to sell. Amherst
Securities Group, LP estimates there are 7 million units in shadow inventory or
135% of a full year of existing home sales.

Housing
Starts: Since 1959 (with some exceptions), whenever the number of housing
starts dropped below 1,000,000 it signaled at least a temporary low in housing
prices. As of March 2009 housing starts dipped to 510,000.

Observing
the rental market will be necessary as well. Currently, rental vacancies are at
30-year highs, depressing rents. If the real estate market cannot make a bottom
due to the consumer wanting to own their own home, it could make a bottom from
an investment valuation standpoint of income potential. Unfortunately, this also
is changing for the worse. As residential rentals rise in number and their
corresponding rents fall, home values themselves must decline to warrant any
investment.

A tiny
part of a large series of needed inputs to the real estate bottoming model is
unfulfilled. Real estate, like long-term stock market cycles, takes many years
to play out. I continue to be shocked, as people comment as to why they should
buy a home (or even worse a condo) now more than ever before. I am convinced
that if this data were for any other industry, people would feel the same way I
do. We are brainwashed with the belief that owning your own home is the
American Dream. However, when people are conditioned into believing a home
should be the cornerstone of their portfolio, they blind themselves to the
overwhelmingly negative data. 

 

 

 

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Sat, 01/30/2010 - 21:03 | 212165 Anonymous
Anonymous's picture

Unfortunately, I might counter the view on a generation of decling values. The feds have always subsidized real estate and will likely support and prop up real estate. Futher, the population is growing much faster than new housing construction, creating an increased demand, not only to absorb existing inventory, but boost price levels. Lastly, the forecasted high inflation will bail out hard assets such as real estate. Look back to the stagflation of the 70's, prices rose well.

Wed, 01/27/2010 - 21:10 | 208512 Anonymous
Anonymous's picture

San Diego Market: All one has to do is look at the immense amount of high end inventory hitting the market in La Jolla, Rancho Santa Fe etc. These homes are the reason for the Median price increase. This is misleading. This huge amount of inventory will be dropping in price over the next year or so. This will pull down the entire San Diego housing market. Do not be fooled.
These are the people who treat their mortgages like a business deal and not a moral obligation. They will walk. Understanding this will save you hundreds of thousands. The cliff is approaching.

Wed, 01/27/2010 - 14:08 | 207897 foldvary
foldvary's picture


he huge increase in the money supply will create high inflation just as in the 1970s. The prices of tangible items will rise, including land. High inflation will bail out real estate. Also, the population is growing faster than the construction of houses, which will add to the demand. 

    Wed, 01/27/2010 - 18:19 | 208353 Anonymous
    Anonymous's picture

    Real estate is interest rate sensitive, unlike a tangible assets such as a loaf of bread. While the price of bread would rise with high inflation, real estate would be depressed by high inflation (high interest rates).

    Wed, 01/27/2010 - 19:38 | 208437 Anonymous
    Anonymous's picture

    Yes, but wouldn't interest rates rise in tandem with escalating inflation? So, during inflationary times, would not hard assets, real estate, etc begin to rise? I agree however that at some point, interest rates will begin to bite and then prices will decline again. But, in the intial stages of inflation, accompanied by rising interest rates, you will again see real estate rise, at least in the short term.

    Wed, 01/27/2010 - 18:15 | 208348 Anonymous
    Anonymous's picture

    Real estate is interest rate sensitive, unlike tangible items such as a loaf of bread. While the price of bread would rise with inflation, real estate would be depressed by high inflation (high interest rate).

    Wed, 01/27/2010 - 13:34 | 207807 Anonymous
    Anonymous's picture

    I'm a research scientist at a largish Silicon Valley company who rents because the prices are still too high in the valley for me to be able to pull the trigger and buy (I am married with 3 children in a single income household). Looking that the housing listings in the area where I'm renting now, it seems that prices really haven't dropped substantially, so it looks like any plans to buy are on hold indefinitely.

    Here's the question: what is more likely for the near future:
    A) Continued slowing of money velocity leading to deflation, stagnant wages, low mortgage rates, and a gradual softening of home prices, or
    B) A slow pickup of the economy with higher inflation, a slow ratcheting up of interest rates, and growing wages (marginal real growth, though).

    I suppose in either case, it doesn't make much sense to buy in the near term. For A), you'd want to wait until the prices get to a reasonable level with the rates remaining low, which seems about at least 2 years away, and for B) you'd want to wait until the mortgage rates peak and start coming down again, which seems 5-10 years away.

    Any thoughts?

    Wed, 01/27/2010 - 13:14 | 207755 Anonymous
    Anonymous's picture

    Who knows when, but I know where. The median national house price needs to drop to about $130 000. Where are we now? $185k? So another 30% to go.

    Where does my "magic number" come from? From about 2.5 times the median household income. And I think I am being optimistic about the multiple. Unemployment is over 17% right now and rising. Banks aren't lending simply because there are few credit-worthy borrowers and because the banks are still all broke.

    Imagine just for a while what would be happen to house prices if interest rates went up by 5%! And we are going to be there sooner than later.

    Wed, 01/27/2010 - 11:16 | 207586 Anonymous
    Anonymous's picture

    I see complete and total home price recovery within 1-2 years.

    By recovery of course I mean a return to reasonably affordable levels.

    Wed, 01/27/2010 - 10:06 | 207503 Anonymous
    Anonymous's picture

    I'm in a Florida home that sold for 395K in 07.
    According to Deeds and Records payments, it cost 150K to
    build. So 1.6 acres in rural SW Florida was worth $245,000?

    Based on current selling price for lots and replacement cost,
    its worth about 180K; which is 30K more than than current prices.

    I expect that values may scrape along at this level for 10 years
    or more even if retiring Baby Boomers provide some
    support for the market.

    Obama is expected to propose a "Freeze" in government spending.
    This is typical government underreaction. Significant cuts are
    actually needed.
    What we will see is a 10-15% cut in public sector wages
    and employment. This will pull the shades on the one bright spot
    in real estate. Public sector has largely ignored the effects of this
    recession, but will eventually be forced to make their own contribion.

    Tue, 01/26/2010 - 03:14 | 206213 -273
    -273's picture

    Since the days of cheap oil seem to be a thing of the past, and expensive oil a thing of the future, the car based suburban model will no longer work, as people can no longer afford the long commutes (if they even have jobs left to commute to), so I see very little possibility of prices recovering (in the suburbs) in 10 years, or for that matter for the following decades either.

    http://www.youtube.com/watch?v=Q3uvzcY2Xug

    Wed, 01/27/2010 - 10:18 | 207507 Blindweb
    Blindweb's picture

    +1

    Entire areas are going to be wiped out.  At some point I'm going to buy in an area with a strong train system, strong historic water routes, area for localized food production, and not too close to military targets. 

    The outskirks of the NY Metro area may eventually see a rise in prices as people realize the large number of paper-shuffling office jobs and their service support jobs are unsusaintable and migrate out?

    Tue, 01/26/2010 - 03:07 | 206212 Anonymous
    Anonymous's picture

    I believe many of you are using crystal balls to forcast a market that does not include the estimated 15 million(?) currently unemployed and the millions of bankrupt and foreclosed homeowners who no longer have any credit to buy a house. This is one of the main reasons residential real estate has stopped moving.Take away the extended unemployment benefits, the bankster bailouts,and the continued raising of the federal debt ceiling and this Depression becomes crystal clear.

    Tue, 01/26/2010 - 02:13 | 206182 Anonymous
    Anonymous's picture

    "Banks must not be allowed to carry these over-priced assets on their books as it is nothing short of fraud to do otherwise."

    Unfortunately its also the Fed. The Fed bought almost a TRILLION DOLLARS of Fannie and Freddie Mortgage Backed Securities at FACE VALUE (100c on the dollar) over the past year ignoring the fact that private markets were not paying these.

    It was a giant windfall to the likes of Bill Gross and other bond fund banksters at the expense of taxpayers. These were garbage securities.

    Tue, 01/26/2010 - 00:19 | 206119 Anonymous
    Anonymous's picture

    The average family income is around $45,000 per year. By historical standards, this average family could afford a mortgage on house costing between 2 and 2 and 1/2 times their gross income. You mean to tell me house prices aren't $90,00 to $112,500?

    Current housing prices are just one big lie! Only a fool would buy today when they know it will be worth a lot less in a few months. Prices can not exist for houses way beyond the average family's ability to pay for them.

    There is no doubt our future is for house prices to come down to realistic levels - even if that means losses must be taken by individuals and banks. Banks must not be allowed to carry these over-priced assets on their books as it is nothing short of fraud to do otherwise.

    That's life - win some, loose some.

    Tue, 01/26/2010 - 00:06 | 206105 Anonymous
    Anonymous's picture

    rothbard thought it was great american scam and thats what spited him to hate keynes

    Tue, 01/26/2010 - 00:01 | 206098 graspthemarket
    graspthemarket's picture

    I wrote about this topic in an article...Here are two paragraphs from it that connect directly to this conversation.  If you want to read the whole thing it speculates about real estate in the "Greater Depression": http://www.graspthemarket.com/articles/20100110b.php

    ...Let’s see what happened in speculative housing areas in the 1920s. Galbraith stated, “In 1925 bank clearings in Miami were $1,066,528,000; by 1928 they were down to $143,364,000.” That is virtually an 85% reduction of value of bank clearings. Henry Blodget in Newsmakers wrote, “Home price declines are already approaching those in the Great Depression, when they plunged 30% during the 1930s. With prices already down almost 20%, it's not a stretch to think we might exceed that drop this time around.”

    According to wsj.com, “Prices in places like Miami, Las Vegas and Phoenix have roughly halved from the highs in early 2006, according to Case-Shiller.” If speculative properties fall more than prices in the 1920s, prices would still require another 80% off of these levels for a total of 90% reduction. To make other areas worse than the Great Depression, properties could fall 50% or more to “stable” areas. To reach these levels, prices still need to fall another 33% from current levels.

    Mon, 01/25/2010 - 23:53 | 206089 economicminor
    economicminor's picture

     

    There is a disconnect between where the income comes from and real estate prices.  Besides real income from value added endeavors which have been devastated by moving production off shore, prices/values are held up by unemployment insurance and pension distributions. Who is it that bought a lot of those MBS, both residential and commercial? The pension funds? And much of the service economy is supported by same pension fund distribution. The retail economy is also being supported by all those who have quit making payments but are still in residence. Once these people are evicted and have to rent and the UI runs out, the decline in RE prices will accelerate.

    Also as this happens, pension funds and annuities will get hammered. As will retail sales and then the stock market as pension funds sell to maintain distribution.   Declining stock values will further hammer pension funds which will further hammer retail sales... as the cycle of reducing the pyramid of debt continues..

    I don't see real estate prices coming back to these levels in a generation or two.

    People talk about inflation but there is only one way to inflate that will affect this dynamic and that is to send huge payments to all taxpayers.. as in helicopter drops. Otherwise, printing money will just go to the speculative banksters who will drive up commodities and cause even more damage to the rest of us. It will also accelerate the decline.

     

     

    Tue, 01/26/2010 - 04:06 | 206224 MrPalladium
    MrPalladium's picture

    +1000  Spot on connection of all the relevant dots!

    Mon, 01/25/2010 - 23:47 | 206084 trillionaire
    trillionaire's picture

    For those that "saw this coming" and sold their house before prices went down, they are under pressure to buy another house before the 1 year tax penalty occurs.  I'm guessing we will see "pops" in the housing market as people are "forced" to re-enter the housing market thinking it is better to own something physical than to pay tax on any gain they incurred and receive "nothing" for the cost of that tax.

    Tue, 01/26/2010 - 02:30 | 206199 i.knoknot
    i.knoknot's picture

    good point, but enough folks are pulling outta their IRAs in spite of the tax hit, i'd bet they're doing the same on CapGains rather than be forced into another big risk.

    interestingly, if you are right, it would an interesting graph seeing the sales and buy-backs a year later... when the talking heads declare 'housing is recovering'... it might be folks rolling back in to avoid taxes, rather than any real confidence.

    Tue, 01/26/2010 - 01:03 | 206150 Eternal Student
    Eternal Student's picture

    I wouldn't bet on that. Most people won't owe a single cent. The first $250K is tax-free if you're single; $500K for married couples. That covers more than what most homes go for these days.

    If you sold at the right time, in the right place you can buy outright and not owe any taxes.

    Mon, 01/25/2010 - 23:37 | 206067 Mr Lennon Hendrix
    Mr Lennon Hendrix's picture

    When rent bottoms we will know how much the houses are worth.  I say we test the bottom of that 100y graph (above).  the stock market is about to be shocked by the housing market too.  numbers are scary folks, and nobody knows!  fan an fred are worthless, sorry 'Merica.  runtelldat!  

    Mon, 01/25/2010 - 22:19 | 206005 BigBagHolder
    BigBagHolder's picture

    So I guess this means there is negative inflation, right?

    Im just saying... housing is 1/3 of the consumption basket.

    Mon, 01/25/2010 - 22:56 | 206043 ghostfaceinvestah
    ghostfaceinvestah's picture

    Yup, something 2/3rds of American households already own will go down in value, while things they pay spot price for (food and energy) will increase in price, and Bernanke will claim victory over the inflation monster.

    Mon, 01/25/2010 - 23:34 | 206068 Mr Lennon Hendrix
    Mr Lennon Hendrix's picture

    +11

    Mon, 01/25/2010 - 22:20 | 206004 Bruce Krasting
    Bruce Krasting's picture

    I saw one of those rental investment opportunities this weekend down in West Palm. 2 brm main house, two bedroom cottage in the back plus a pool. 1920's vintage. The last guy paid 625k. He put a bundle in it and did a nice job. It is 4 sale at 425k. Looking for a bid.

    At 10 times expected rent it comes to a $300k value. That is something like a cash on cash yield of 5% when all is said and done. So I am a buyer of that nice property should it get down to that level. About a 1/3 of what it was a few years ago.

    This is somebody's nightmare.

    Tue, 01/26/2010 - 02:26 | 206193 i.knoknot
    i.knoknot's picture

    calculated risk keeps posting about dropping rents...

    move with your multipliers :^)

    Mon, 01/25/2010 - 22:40 | 206026 Daedal
    Daedal's picture

    Bruce Krasting is capitalizin' on a trend that's negatively rising.

    Mon, 01/25/2010 - 22:08 | 205996 Quantitative Wh...
    Quantitative Wheezing's picture

    I would venture to guess that real estate prices will never again reach such overinflated levels.  Let's assume that prices will drop 80% from their peak.....how long will it take to reach 2007 levels again??

    Tue, 01/26/2010 - 02:24 | 206192 i.knoknot
    i.knoknot's picture

    never is a strong word. maybe in terms of hours (or gold, etc.) spent vs dollars spent, given the probability of inflation sometime down the line.

    close friend watched his folks sell their home in weimar germany for unheard of high marks only to be buying the proverbial "loaves of bread" with the take a few months later.

    tie your pricing to value, and your point stands.

     

    Mon, 01/25/2010 - 21:50 | 205982 Anonymous
    Anonymous's picture

    The previous decade was the lost equity decade.

    This decade is the lost real estate decade!
    What a f'ckin disaster!

    Keep shuffling the deck chairs ...

    Mon, 01/25/2010 - 21:27 | 205958 digalert
    digalert's picture

    I sold a house last October and got just a little over what I paid in 88'.

    Mon, 01/25/2010 - 21:25 | 205952 Eternal Student
    Eternal Student's picture

    10 years? Maybe. I'd say it's at least 5 years. Have a look at this update of the well-known Credit-Suisse chart:

    http://5minforecast.agorafinancial.com/the-second-wave-too-big-to-fail-l...

    Notice that we're in the eye of the hurricane. And add 6-12 months to the end of it, since that's typically how long it takes between the Notice of Default, and when the house is on the market.

     

    Tue, 01/26/2010 - 17:21 | 206785 aaronvelasquez
    aaronvelasquez's picture

    The graph indicates no defaults after 2012.  Maybe Credit Suisse believes the world will end with the Mayan Calendar, but it would seem prudent to anticipate more resets and foreclosures through 2015.

    Mon, 01/25/2010 - 21:46 | 205978 Anonymous
    Anonymous's picture

    It may be 6-12 months from the official "Notice of Default", but around here the notice of default seems to be a year or two AFTER the "owner" has ceased making payments.

    Three homes in my HOA are being foreclosed on right now, and the "owners" (residents? squatters?) were all between 2-3 years in arrears on their mortgage payments (meaning they stopped paying sometime in 2006 or 2007 -- IOW before the market crash). Our HOA board is anticipating 3x to 4x that number of homes are in arrears of 12 to 24 months (the post-market crash people); things are NOT looking good (and we are in the midwest, an area that did NOT experience the really big "bubble" in home prices).

    Mon, 01/25/2010 - 23:17 | 206052 Eternal Student
    Eternal Student's picture

    This is quite true, but it apparently depends on where you live. I've been keeping track of foreclosures in some of my areas, and it's been 6-12 months.

    But, as you point out, the name of the game for the Banks is to keep things off of the books, in  general. This is what the Stuy town foreclosure was all about recently. And there was an identical situation in the SF Bay Area. In both cases, the banks were "working" with the company, just to keep the loss off of their books.

    Thanks for mentioning that.

    Mon, 01/25/2010 - 22:58 | 206044 ghostfaceinvestah
    ghostfaceinvestah's picture

    I was gonna say, it is at least two years if you defaulted anytime in the past few years.

    Anyone getting booted after 6-12 months is damn unlucky.

    Tue, 01/26/2010 - 00:03 | 206101 Anonymous
    Anonymous's picture

    then consider me damn unlucky....7-8 months before
    notice of default....forclosure at month 10...

    however, fannie / freddie bought the property
    so it will be interesting to see how quickly
    it gets me into court....

    Mon, 01/25/2010 - 21:15 | 205942 Gimp
    Gimp's picture

     

    You are correct, the real estate market is moving like a snail going up a slide. I have been trying to sell two pieces of real estate for two years and am currently asking 1996 prices which has generated some interest. Carrying cost alone has eaten up any potential profit. If all goes well and I sell both properties this year it will be at least a decade before I venture back into the RE market.

    Mon, 01/25/2010 - 21:08 | 205935 lawton
    lawton's picture

    There will be about another 20% drop so I could see it being another decade also before prices are as high as today and if we go into a depression it may be another 15 years or more...

    Tue, 01/26/2010 - 00:00 | 206096 Anonymous
    Anonymous's picture

    i think you are a bit optimistic...i see 20-30%
    drop in prices and 15-20 years before prices
    recover in real terms...

    of course some markets were much less distended
    than others so anecdotal evidence to the
    contrary will abound....but in terms of indices
    i do not see recovery at all any time soon....i
    think it will be 2-5 years before a bottom is found
    (if ever) due to pathological interventions into
    the markets by blobama, bernanke, and a host of
    other quacks...

    and that bodes ill for the stock market - not
    because of causality but because both suffer
    from the same underlying weaknesses...

    Mon, 01/25/2010 - 21:06 | 205934 Madcow
    Madcow's picture

    1980.

     

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