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The Hard Truth About Residential Real Estate
Anyone who believes that housing is on the rebound, and that now is the time to buy, should take a very hard look at the numbers I dredged up for my spring lecture and luncheon tour.
There are 140 million personal residences in the US. Today, there are 19 million homes either directly or indirectly for sale. According to a survey by Zillow.com, a real estate appraisal website, 5 million homeowners plan to sell on any improvement in prices. Add to that 4 million existing homes now on the market, 1 million new homes flogged by companies like Lennar (LEN) and Pulte Homes (PHM), and 1 million bank owned properties. Another 8 million mortgage owners are late on their payments and are on the verge of foreclosure, bringing the total overhang to 19 million homes.
Now, let’s look at the buy side. There are 35 million who are underwater on their mortgages and aren’t buying homes anytime soon, nor are the 35 million unemployed and underemployed. That knocks out 50% of the potential buyers.
Here is where it gets really interesting. There are 80 million baby boomers retiring at the rate of 10,000 a day. Assuming that they downsize over time from an average 2,500 sq ft. home to a 1,000 sq. ft. condo, and eventually to a 100 sq. ft. assisted living facility, the total shrinkage in demand is 4.3 billion sq.ft. per year, or 1.7 million average sized homes. That amounts to a shrinkage of aggregate demand for a city the size of San Francisco, every year. You can argue that the following Gen-Xer’s are going to take up the slack, but there are only 65 million of them with a much lower standard of living than their parents.
Throw in the disappearance of state and federal first time buyer tax credit. You can count on a jump in long term capital gains taxes and state and local property taxes, further diminishing property’s appeal. If you are looking for a final stick to break the camel’s back, how about eliminating, or substantially reducing the home mortgage interest deduction?
Add it all up, and there is a massive structural imbalance in residential real estate that will take at least a decade or more to unwind. We could be looking at a replay of the same 26 year period from 1929 to 1955 when prices remained flat, and we are only 3 years into it! A second down leg in the real estate market seems a no brainer to me, as is the secondary banking crisis that follows. Perhaps that’s why hedge funds have been big sellers of the homebuilder’s ETF (XHB).
What’s a poor homeowner to do? Don’t ask me. I sold everything in 2005 when my research threw up these numbers, and have been happily renting ever since. And if the toilet blocks up, I just call the landlord.
To see the data, charts, and graphs that support this research piece, as well as more iconoclastic and out-of-consensus analysis, please visit me at www.madhedgefundtrader.com . There, you will find the conventional wisdom mercilessly flailed and tortured daily, and my last two years of research reports available for free. You can also listen to me on Hedge Fund Radio by clicking on the “Today’s Radio Show” menu tab on the left on my home page.
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This is why you need to check out the property records for any houses you're considering renting. We had about 15 houses on our list, but after I checked the property records and found that most had option arms with little to no money down, we narrowed it down to 5. We then rented from a landlord who had a reasonable mortgage and who did not HELOC the heck out of the house. We've now been in the same place for 3 years and the landlord always quickly takes care of any problems that arise. Is renting ideal? No, especially when you have young kids like we do who you have to worry about moving from school to school and neighborhood to neighborhood. Would I rather own? You bet, but not when sellers are still asking 3x prebubble prices for houses in our area.
As far as price, we are paying half of what the mortgage would be to "buy" this home and the rent hasn't gone up for 3 years. We are likely to renew for a 4th year at the same rent. Again, if you check out your landlord before you rent, you shouldn't have problems with repairs or getting your deposit back.
Always a good idea to "check out" anyone you plan to do business with.
The rental rates will stay low due to new rentals being picked up for half price by foreclosure buyers. They can afford to rent homes for much less than the prior market rental rates. There will be more demand for rentals due to people with wrecked credit and fewer qualified home buyers.
With property taxes you are always a "renter".
In our area, you can buy a home for less than the cost of construction, which is always a good entry point. I think prices will continue down (see my above post), but if you think prices will eventually return to at least cost of construction (value investors) now is not the worst time to buy. Interest rates are at historic lows, too.
Maybe the FED will replace the air conditioning units in the commercial properties they now "own" when they break...
At the end of the day - you have to live somewhere - I would also rather live in a small house is a smaller community near other fiscally responsible people than in a complex filled with renters some of whom will lose their jobs and income, may damage the property; or end up renting in a condo where 30% of the condo is empty and the only condo fees they're collecting are coming from my rent.
With the complete government takeover of the residential mortgage market, I think we will see quite a few "strange" things in real estate over the next decade. One prediction I am willing to make is the massive expansion of the "Section 8 Housing Program". This government subsidized housing program may take all the foreclosed homes into that program and fill them with the dregs of society. Mc Mansions filled with Octomoms on welfare and all the "friends" that travel with them. Group homes for poverty stricken senior citizens, more ex-con halfway houses in the middle of suburban gated communities, etc...
If free internet is included in the Section 8 program, this will stave off the revolution much longer. My rise to fill the power vacuum will continue to be delayed...
By the looks of my neighbors they are already doing that.
You should hear the horror stories of the small, aging farm communities that got an influx of new "neighbors" when the Chicago housing projects were closed.
Vix_Noob
Part of the prison plan is forcing families to move from cities to be near members in prison. That changes the demographics of both areas.
I have been doing a great deal of reading and thinking on this subject, too. The downward price spiral will continue for the near future in residential real estate due to the banksters having no incentive to stabilize the market. The risk is now with Fannie and Freddie and they have an unlimited backstopped by the Treasury. Most banks are just servicers of the loans, they don't hold the paper (and if they do it is guaranteed by Fannie, Freddie, FHA or VA). When the home goes into default they proceed eventually with the foreclosure (around here that can take 1-3 years with homeowners getting a free place to live). Eventually they get around to putting the home on the market for at least 10% less than current market prices, so it will sell first and fast. This perpetuates the downward spiral in home prices, and insures the continued massive losses at all the GSEs for decades.
As a result of the continued slide in prices, more homeowners are under water and trend towards default. Plus, the low comparable sales make it impossible for even the best borrowers to refinance at today's historically low rates (sub 5% on a 30 yr. fixed).
So the residential market destruction has little effect on the banks (other than less origination fees), but the destruction of the commercial real estate market will be the bank's Waterloo. In commercial real estate they have no backstop or safety net other than pawning the risk off on the Federal Reserve (as seen in the Red Roof Inn story). It would be nice to know how much risk in commercial real estate has been transferred to the FED, but I still believe the banks are on the hook for trillions in commercial real estate risk. This will be much bigger than the S&L crisis in the 80's and 90's, and may be much bigger than the government's ability to do anything to bailout the banks. An economic tsunami which would wipe out most everything in it's path.
I agree with the overall analysis and conclusion, especially and trends regarding taxes. I have been saying for years that when the Change comes, it will be better to rent than own.
On the other hand, the residential real estate market does not exist. Residential real estate involves thousands unique of submarkets.
When you see stories of Detroit planning to demo 10,000 homes, and you think about similar abandoned properties in many submarkets that will fall into decay, the inventory will likely decrease faster than most people expect.
The coming great correction will affect all asset classes (except perhaps gold) and residential real estate might do better than many other assets.
Henry Chinaski
"The coming great correction will affect all asset classes (except perhaps gold) and residential real estate might do better than many other assets. "
If you outright own your properties. The combination of mortgage and taxes will put most under. The land is the real value. Houses are a dime a dozen, relatively speaking.
If there is a house or apartment on the land, then at least there is rental income to offset the taxes.
People are waking up about debt slavery and the next generation of home owners will have more equity or own property outright.
I wouldn't be a buyer today, but the author's analysis is bizarre. Residential real estate is truly a local business and while the winds may be working against all markets at the present time, "structural imbalances" don't necessarily exist everywhere. The prudent don't sell everything and head for the hills. The prudent compare the cost of owning to the cost of renting and then make the appropriate decision based on numerous factors. While it might not make sense to own in Los Angeles, it might in San Antonio. You'd think somebody who has a column on this site, as opposed to CNBC, might put a little more thought into his free analysis. I may not have a spring lecture series, but at least I can see the forest from the trees. Just saying.
In San Antonio people sweat while not moving at 6 in the morning. Humid. Humid. Humid. Do not move..sweat... San Antonio is HUMID.
I have no idea about the real estate because only people who like to sweat choose to live there.
MFHT is trying to make a MACRO observation. Just sayin'.
HEY!
let's get..... small.....
I don't think you should consider the ranks of the unemployed and the ranks of those under water on their mortgages to be separate groups. There's probably a lot of overlap.
There is a solution to this dillema of oversupply and decreasing demand in residential and commercial real estate. The federal government could pay states to condemn and demolish the "marginal" properties that are clogging the system and driving down prices. And with the crew currently running things in DC, I'm surprised it hasn't made it to the top of the list.
The largest supply of affordable housing by far is "marginal" housing. For working class and lower class families this supply far outstrips any type of government supplied or subsidized units.
Tearing down marginal neighborhoods is incredibly shortsighted, because the the govt turns around and says "we need to build more government housing."
It might happen. Another option showing why power will not shift to the East. Because one option to a saturated market is to destroy enough.
Areas of the world which do not build now are screwed big time.
Just like a guy waiting in a queue to buy his food and seeing the person at the front eating, eating, eating and making himself vomit when he gets filled so he can eat even more.
Hah, the old broken window stimulus idea. Build something, tear it down, and build it again. Yeah, that's the ticket. I'm sure that will cure our economic troubles and bring us back on a path of economic growth. One question: who is going to pay off the banks who are currently holding those mortgages and construction loans at par?
The FED
It worked, and on a grand scale -- I believe it was called W.W.II.
Worked for who?
Don't be thinking about that, man.
We don't need WWIII and we don't need what is going on in the Koreas right now. Those psychotic, insulated and isolated, North Korean hermit-kingdom leaders don't know the value of backing down in a lose-lose brinksmanship scenario.
WWIII or even 'just' a major regional war in Asia wouldn't just be economic pain, that would be way too much blood and tears for the entire world.
Doc Occ
Smoke and mirrors to take everyones mind, Asia and the US, off the death of the economy.
You really think if NK blew up a SK ship that everyone from the UN to the US wouldn't be making daily headlines? That boots wouldn't be on the ground and resolutions in the air?
China whispered in the NK ear, assuming it was a NK action, " go along the rewards will be great". I expect food shipments by the end of summer.
Rogerwilco
Each one of those properties represent a taxable asset. You really think cities want to lose that revenue? Besides what do they use all the new open space for tent cities for the homeless?
@ Gully
Why does it have to make sense? The states need money and the feds can hand it out to "solve" a problem. If property tax receipts decline, politicians will simply raise the levy.
History teaches that a revolution will eventually put an end to the madness.
Inventory sits at well over a decade. Those are the ones not being hidden and not being foreclosed on.
No one has a job, and those who do are scrimping.
The world economy is about crash worse than it is already.
Unless BIGOV plans to give away homes, this looks bad for the next century.
The trend of delinquency rates on both residential & commercial is clearly in a bull market as can be seen in the chart here:
http://exploitthemarket.com/images/resid-comm-delinqrates2010Q1.JPG
(FRB data of 100 largest banks....Delinquent loans are those past due thirty days or more and still accruing interest as well as those in nonaccrual status. They are measured as a percentage of end-of-period loans.)
If all this is true why was the congress & presidents trying to increase home ownership with subprime mortgages
Delinquency rates will soon come down. But not for any good reasons.
They will come down because the delinquency inventory is starting to get cleared out via foreclosures.
Expect house prices to drop another 15% from here, probably over several years - a long, slow grind down.
Delinquency rates have already begun to moderate. Because the banks are not pursuing nor reporting delinquent homeowners in markets where they have no chance of recovering their losses. Hence the slow down in pursuit of rapid foreclosures or processing in states like AZ, CA, FL, NV, IL, GA, etc. They would rather engage in repos against prime properties in moderately strong markets rather than add liabilities to their balance sheets.
15% is unbelievably optimistic.
Expect upwards of 50% or more aggregate residential RE price DECLINES.
Anyone expecting a mere 15% will get absolutely clobbered.
No, I will just make more money that I thought I would shorting housing sensitive stocks.
Since the market seems to believe housing prices are going to go up or something, given the way many housing-related stocks are priced.
But I stand by my prediction - delinquency rates are going to start decreasing, slowly, as liquidations outpace new additions. The MSM will point out that it means things are getting better, when they are not.
Expect a corresponding drop in retail sales as people are forced to pay for shelter again.
And can you imagine what any increase in mortgage rates due to Ben's continual printing could do! Ouch!