A look into a housing inflexion point brought on by a dysfunctional real estate market

You would think that with all the surefire bets in housing that people would be dialing up their realtors and heading out every weekend to make those lustful multiple offers presented in PowerPoint format on properties. Yet the overall market data shows a different story. The house horniest of them all, investors, are clearly pulling out of markets including sunny and inflated California. Apparently home prices do matter when making investment decisions. Cash strapped hormonal buyers will keep on buying but housing prices are set on the margin. That margin is becoming razor thin on current volume. I find it interesting that the biggest housing supporter of them all, the National Association of Realtors is also somewhat tepid on this recovery. Why? Because home sales volume is pathetic. Keep in mind they make money on selling and buying. Volume is key. Their model doesn’t work so well with banks holding onto properties like Gollum holding onto the ring and the foreclosure process being dragged out like the forever college student enjoying year 10 at Santa Monica City College. You see this overarching trend occurring in many metro areas across the country. Investors have been propping up the market since 2008. They are now slowly pulling back. You are also starting to see a convergence of analysts putting out their predictions on how overvalued housing is and backing it up with mountains of data. The other side of the argument points to prices. Sure, they’ve gone up but value is created by actual price and that is sort of the point. The answer as always isn’t so simple but using your thinking cap it is important to understand that housing is not a “no brainer” decision in this market.

Still going into massive debt

It is interesting how corrections always follow a similar pattern. At first, every market in every area is going up. The euphoria stage. Idiots can buy and make out like bandits. Of course they attribute this to sheer mental agility versus blind luck. Ask the 7,000,000 foreclosure recipients and question them about their mental agility in their buying decision. Slowly the winds change. All of a sudden sales start slowing down. Prices stagnant. Those house horny sellers are not getting their delusional asking prices for simply slapping on a new coat of paint and installing some stainless steel Whirlpool appliances. Didn’t the housing cable show say I would have 10 above list price offers by the first week? Then you get the hilarious responses of “does anyone really think that prime Manhattan Beach is going to drop in price?” Really? Manhattan Beach has something like 35,000 people but Los Angeles County has 10,000,000. We are talking about a city where 0.35 percent of a county live. Where in the hell will the other 99 percent live? Our focus is on the broader market. Niche super prime areas may correct but even if they do, the plebs will have little luck scoring a Malibu home on the household income figures we are seeing. My point here is that suddenly, the focus is on ignoring the larger trend for easy super prime markets to make the case that hey, housing will always go up. Even today, you have places like Compton, Palmdale, Riverside, all surging up in prices. This happened as well in 2007. The unfolding goes something like this: “Sure Palmdale went down but this is out from the city hubs.”

“Sure Paramount went down but this is in a lower income area of Los Angeles County.” “Sure Pasadena went down but only in certain parts of the city.” “Sure prime Pasadena went down but not as much as other areas.”

You catch the drift here. One important thing to note is that people are leveraging back up. An interesting presentation was made by Jeff Gundlach on why homeownership is overrated and why he is shorting homebuilders. Some of the slides focus on topics we covered but they are worth looking over:

deleveraging myth


First, there is really no deleveraging going on. The cheap money from the Fed has been used to inflate the markets back up. It has worked. Households are also back into deep debt and buying homes with little money down or using ARMs to stretch their budgets. The idea that cash is abundant in US households is simply not the case overall. You have a small portion of hyper-rich households but they are not focused on Mar Vista or other hipster markets of Los Angeles. They are looking at Beverly Hills or Santa Monica for example. The big money is in the financial markets (bonds and stocks) and real estate is not the main focus at the higher echelons. Because of this, we see a massive plunge in homeownership since household incomes are really weak in the US.  

Homeownership rate plunging

The drop in the homeownership rate is epic:

homeownership rate

This is a massive trend here. Since people have to live somewhere, we have simply expanded our market of renters in the US. Some of it has to do with shifting priorities but I assure you, if you gave these Millennials or GenerationX people the ability to access toxic mortgages like interest only loans with no down payment, they would let their house horny juices flow. Thankfully, since the entire mortgage market is virtually government backed, they are checking incomes. The drop in the homeownership rate largely reflects a weak economy for those future home buyers.

Housing affordability all based on low rates

Housing affordability is all about the monthly nut. That is why the modest 100 basis move in interest rates last summer basically stopped the mania right in the middle of its slobbering delusion:

housing affordability

See how quickly prices change with modest interest changes? The Fed is already telegraphing higher rates and we are already seeing inflation permeate the market in healthcare, college, food, and other important items. The only place that is stagnant is with household income growth. The magic of lower rates is that it boosts house prices even if incomes remain stuck. Investors looking to rent places out realize that rents need to be paid with actual net income from those living in the immediate area.

Household formation slow (you know, with kids at home and all)

The most important aspect of this all is the weakness in household formation. We have many folks living a life of arrested development in California. Folks driving around in leased foreign cars yet living with mom and dad deep into their 30s and 40s. They want the trappings of the past but simply cannot afford it. A few of my contacts were telling me that in places like Irvine, you have Asian investors making up a large portion of purchases and also, older households with built up equity (meaning 50+). A similar trend in Culver City although more with older households in their 40s and 50s. Those first time buyers in their 30s are battling it out for condo fodder with massive HOAs that usually aren’t factored into budget considerations. Keep in mind even in these more sought after markets inventory is building up. Household formation is at multi-generational lows:

household formation

California has 2.3 million adult-children living at home, largely because they can’t even afford a rental let alone pay current prices. The above chart is a nationwide chart highlighting that this is a national trend.

Living at home all the rage

Some might think that living at home is only for expensive markets like L.A. County or San Francisco but this is also a national trend:

young adults at home

The young chewed on the hardest punch of this recession. Many bought during the peak of the housing bubble with some of the funkiest, stench-filled, and financially disastrous loans of all-time. You can see the end result. The homeownership rate collapsed and has yet to recover even though this is year five of the easy money recovery. Yet many did not go out and rent. No. Many are now living back at home. Basically anything that can be juiced with debt (i.e., college tuition, housing, cars, stock market, etc) has been reinflated to record levels. The question is, how much juice is left?

Living at home because of weak employment prospects

Those making the case that there is this hidden pool of pent up demand fail to look at the actual data of these future buyers. Many are living at home because they are economically struggling:

living at home

Roughly 32 percent of 18 to 34 year-olds are not employed. Might be a reason for so many living at home. Keep in mind that the rate continued to rise in the midst of this debt induced rally in stocks and housing. The housing market was pushed up by investors, easy money, and a lack of inventory. For those wanting to buy, inventory is moving back up but in some areas, you still have a good amount of house horny buyers battling it out. Yet prices are made on the margin especially with real estate. The market is definitely hitting an inflexion point. But in real estate, just like the above trends, booms and busts don’t happen with a big bang or pop but with a slow shift like turning around a giant naval ship. The fact that we have many reports discussing the overvalued nature of real estate, investors shorting homebuilders with 40-slide presentations, and household formation cratering you have to realize something else is going on.

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