(Quick Note: Dear reader….. I can drop a substantial amount of economic and statistical data on you to support the points below. However, if past is any indicator any such economic data would put most readers to sleep within 10 second. Plus, a volume of data/analysis can be published in regards to every single point below. As such, I offer only a quick summary and my conclusion for your reference. Should you require any additional information about the thesis below, please contact me directly. )
Yes, I called it perfectly in 2006-2007 and now I am saying that it is not over.
Before we can understand where we are now and where we are going in the future we must understand where we came from. The Real Estate run up that we have experienced between 1997-2007 has no historical precedent. Real estate data going all the way back to 1790 clearly shows that the US housing market basically appreciated at the rate of inflation. Yes, there were some bubbles and substantial declines, but overall, appreciation at the rate of inflation is an appropriate way to look at the US real estate sector.
A QUICK HISTORY LESSON:
All of that changed in 1997 when Bill Clinton signed The Taxpayer Relief Act into law, basically allowing $250,000 in tax free capital gains in real estate. While real estate was already appreciating at a good clip at that time, that law added fire to the trend.
Later, fearing significant economic slowdown in 2002-2003 the Bush administration added a huge amount of jet fuel to the Real Estate Bubble by cutting interest rates and making mortgage finance available to everyone (even to the dead people). As people used to say, if you can fog a mirror you can get a mortgage. Of course, all of that led to the largest finance bubble in the history of mankind that “kind of” melted down in 2007-2009. I say “kind of” because most of those excesses are still in the financial system and will have to be worked through in the future.
WHERE ARE WE NOW?
Issue #1: US Home Ownership Rate Is Plunging
On historical basis, home ownership rate in the US is in free fall. Take a look at the chart. I think it speaks for itself.
Issue #2: Real Estate Affordability Is Plunging
Take a look at the chart as it speaks for itself. The affordability index is in free fall as well. Most likely due to higher interest rates and rising prices.
Issue #3: Interest Rates Are Going Up
The trend has shifted up and the 10-year rate is up 100% over the last 12 months. I gave detailed interest rate analysis here. Please take a look here.
Issue #4: US Economy & The Stock Market Is About To Turn Down (Big Time)
Please read “The Long Awaited US Stock Market Decline Is Likely Here” as to why.
Issue #5: Who Is Buying All Of These Properties For Cash Today?
Chinese buyers, hedge funds, banks themselves, investors, speculators, etc….. Who cares!!! Remember all those Japanese investors buying everything they could in California and Hawaii in the late 1980’s. I wonder how that turned out for them.
On a more serious note, notice that I didn’t say Average American Family. That is the only category that we should track if we want to accurately predict the future trend in the US Real Estate market. Every other category is irrelevant over the long run. And guess what? They are not buying. See the charts above.
Issue #6: Bear Market In Real Estate (sucks people back in)
As I have said here before (US Real Estate At A Turning Point), this is how the bear market works. This is the stage #2 bounce, before the big decline (stage #3). The bear market tends to suck people back in, offer them perceived safety and a high return before slamming the door, ripping their head off, drinking their blood and taking all of their money. The US Real Estate market is topping in Stage #2 run up here. That is why you are seeing so many divergences. The market should turn down soon. Beware.
FUTURE OF REAL ESTATE:
Real estate is not made of Gold. There is a tremendous amount of land available in California, Florida and all over the US. There is no housing shortage. As such, expect real estate to decline significantly in order to revert back to its natural inflation adjusted mean. It might take a few years, it might be different for various cities, but one way or another the market will get there.
HOW FAR DOWN?
Let’s do very simple math for the San Diego market. It doesn’t have to be exact for our purposes.
Setup:
- San Diego Median Family Income: $61,500
- As Per Various Financial Guidelines Families Shouldn’t Spend More Than 30% Of Their Income On Housing. That means a $1,500/monthly payment.
- Median Home Price in San Diego: $500,000 (pushing that level again as per Trulia.com)
- Interest Rates: 30 Year Mortgage 4.72% (Rates as of 9/4/2013)
With such fundamental input variables median house value should be $290,000 -OR – A 42% DECLINE ($1,500x360month@4.72%)
What if interest rates go to 7% over the next 5 years, which can easily happen?
The fundamental value of the median house drops further to $225,000 -OR- A 55% DECLINE
Also, don’t forget that markets oftentimes overshoot to the bottom, just as they set blow off tops. In such a case I wouldn’t be surprised to see a median price of $150,000- 200K -OR- A 70%-60% DECLINE
You say impossible….. I say study financial markets. Nothing is impossible.
Now, I understand and agree that there are various market forces at play that make the picture a lot more complicated. Interest rates, timing, mortgage finance, cash buyers, the FED, foreign buyers, speculation, location, supply/demand, etc…. However, fundamentals will always prevail over time. Everything else is just temporary bullshit.
ADVICE:
Your house is not an investment. Don’t be confused. It is the place you live and raise your family. If you are happy with your house, have a fixed interest rate, can afford your monthly payments and don’t care if your house depreciates in value, I would stay put.
If you find yourself in a contrary situation……..I would consider various options.
Did you enjoy this article? If so, please share our blog with your friends as we try to get traction. Gratitude!!!
good analysis, and a large amount of this does seem accurate. I’d argue that your right with what is happening currently, but the result will be slightly different. you’re argument seems to be “houses are unaffordable, they will need to be more affordable, here’s what people currently make, this is how prices should decrease” – you’re right, but i believe it’s more likely that inflation is coming hard, like 70’s & 80’s style, where a “normal” % rate on a mortgage went up to 15%+, and inflation will be in the high single digits, possibly even 10-12%. this would kill savings… which the average family earning 51K does not have. that average family would also see it’s wages rise with inflation… and they’d still spend the 30% on housing, either renting (paying a landlord who owns) or buying. either would increase demand for houses, or at least keep it in line.
IMO – you’ll see regional variances, and it’s not great in places like SD, but for most of america things are pretty good for real estate. (i.e., midwest & mountain states, south except “tourist & speculator” areas like Florida)
Hi Steven,
Thanks for your comment. I agree with you in regards to inflation. However, my timing work shows that inflation will only really kick in after 2016 (on a small scale) and get into your range of above 10% after 2020 at the earliest. As such, the market has enough time to first collapse before inflating it all away. – Alex
Alex, interesting article. Please realize that I do not hesitate to say that you probably have a lot more insight into economics and investing than I do. The fact that you write about it pretty much tells that story.
However, at the beginning of the article you asked people to basically “trust” you simply because you wanted to simplify the matter without throwing out a lot of statistics and jargon that typically “lose” people. The issue with this is that you resorted to typical methods to underly your points; you relied on graphs that have some issues when looking at things from a longer term point of view.
Examples are:
Issue #1: US Home Ownership Rate is Plunging – The problem with this graph isn’t one created by you, but the point here is that you didn’t explain the shortcoming of the graph. Obviously, the issue is the value at the origin point of the graph (what I call the 0,0 point). The origin point is 63, and the top point is 70. If people are to assume the origin point is zero, then of course, the graph shows a HUGE PLUNGE (granted, it is following a HUGE SPIKE). But it isn’t a huge plunge, its actually a relatively small one percentage-wise. It is also pretty much a correction from the upwards slope that began around 1995. Not something unexpected given the era.
Issue #2: Real Estate Affordability Is Plunging – Again, you aren’t necessarily using faulty data, but your choice of words is misleading. Indeed, the current data does make it look as though the rate is plunging when looking at the graph, but only when you look at period from about 2006 onwards. Prior to that, from about 1992, the index stayed between 120 and 140, for a pretty long period of time. So what the graph is really showing is a correction towards a rate that was far more stable. Another issue with this index is how it is calculated. Your post just shows this graph and calls the change a “plunge.” But how is this index calculated? I had to go to the St. Louis Fed site to find out. It states that this index “Measures the degree to which a typical family can afford the monthly mortgage payments on a typical home.
Value of 100 means that a family with the median income has exactly enough income to qualify for a mortgage on a median-priced home. An index above 100 signifies that family earning the median income has more than enough income to qualify for a mortgage loan on a median-priced home, assuming a 20 percent down payment.”
I think the keyword here is “qualify”. Incomes certainly did not increase enough between say 2007 to 2012 to create an increase in the index from 120 to 210. There must be another factor. This is where the “qualify” factor comes into play. You said it yourself, during that period anyone, living or dead, could qualify for a loan. I bought my house in late-2010. The people who did the mortgage flat out said that what I had to do to jump through hoops to get the loan was a complete 180 from just a couple of years prior.
So it is clear to me that the index isn’t so much showing “affordability” as it is showing changes in how mortgage lenders “qualify” people with a certain income. The issue here is that you again oversimplify by relying on a graph without ANY sort of explanation as to what the number means and factors that influence it.
Issue #3: Interest Rates are Going Up – You state the rate has doubled in the last 12 months. Which to most people might sound horrible. However, again, this is misleading, because you are looking at a relatively short period of time and you are ignoring the long term trend. Take a look at the graphs towards the bottom of this link:
http://mortgage-x.com/trends.htm
The bottom two graphs show the average rates starting with 1970 and 1963 respectively. The current “doubling” of rates is inconsequential when considering these graphs. In fact, one thing you point out is that, historically, home values have basically kept up with inflation. The inflation rate is currently very low (has been for quite a while), but what is more telling is the fact that mortgage rates almost seemed to dip below the rate of inflation. That means, in the longer term, such low low rates were effectively a losing proposition for the mortgage lender. It is understandable why this situation happened for a while, but it is also understandable why it can’t continue.
Lastly, Issue #5: Who Is Buying All Of These Properties For Cash Today? – you basically state “who cares”. You go on to state that your article is about the impact this has on the “Average American Family”. However, you focus on changes in various indices and rates in the short term, instead of focusing them on the long term, which leads me to believe that the true audience for your article is to tell those “cash” folks that the reason things will get tougher for them is that the time they can make anything from this unique situation is quickly ending.
Just my two cents.
Hi Jack,
Thank you very much for your thoughtful write up. Your points are very well taken and I do apologize for not having time to address them individually. Basically, you right on many of your points and historical analysis. However, what I am trying to do here is anticipate the future ……which is very hard to do. While most of the fundamental analysis in that article is correct, I am primary relying on my stock market timing work to come to such a conclusion. My timing work clearly shows the Dow declining into 2016 bear market low over the next few years. That of course leads to a significant economic slow down in the US. In such a scenario, “technical & timing” work confirm the fundamental analysis for the real estate market. I hope this help. Thanks again.
Alex, very good reply, and again, very interesting article, and thanks for taking the time to answer. It will be interesting to see if your analysis reflects what will happen; I’ll be sure to keep reading your articles and follow along.
Thanks again!
Jack
Thank you Jack. I appreciate it.
Hi !
Highly appreciate your efforts to make it simple enough to be shared and understood by average people.
Can you pls shed your views about how you view the DOW in about 2-4 years? Do you foresee a great crash in the stock markets which in effect you believe to have its repurcussions in the Realty mkt as well ?
Any thoughts about EM ( specifically India ) ?
Highly appreciate your kind response.. Once again I would stress that you’ve done a great job; but would need to understand how you are going to time this Crash that you predict, with any degree of accuracy. I’ve shared the same views, but don’t really know how one could time it to perfection.
Regards,
Ramesh Kumar.
Hi Ramesh,
Thank you for your comment. Please scroll through my blog, going back only about 2 weeks (when I started writing it). I do talk about India as well as where I expect India to be. To quickly summarize, my work shows 2016 bottom on the Dow in 8000-9000 range. The decline will not be fast and I believe has already started or will start in March on 2014. In terms of India, I also posted an article about it. To be honest with you, I am not following India’s market that much but I am aware of the recent decline and currency drop. If I had to guess, I would say that India is probably approaching a bottom, but I am not 100% certain. At the same time I would not expect a fast recovery…..there are a lot of structural problems in India.
I hope this helps. If you have any questions after you read everything, please do not hesitate to contact me.
Alex
All so true, put my personal equation that I think is over look in the statics is the underline fault to real estate downfall that is the valuation of properties based on market. We need to stop assuming unlimited growth of real estate appreciation the appraisal system if some fool whats to over pay for a piece of property it effects the valuation of the market in total. Overpriced home need to be disregard, lets set value at replacement values this would cap overvalued properties that fuel the system like a wild fire burning up any true values. keep housing affordable, if a location is hot and people want it they will pay the extra at all cost, what something is worth is what drive real estate in the old days was LOCATION, LOCATION, LOCATION that cost is really the only true value to your properties, home or investment. Cap value at what is cost to replace something will stop the market false values.
Thank you Eddie, great point. Thank you.
I am thinking about buying a house. The house I like was between 550k-650k in 2010-2011, but now there are 750-799k. The price in Harford county in Maryland goes up fast. Should I wait for the next housing bubble or should I buy it now? It seems to me the expensive for sale houses just stay on the market for months, the sellers don’t reduce the price and no buyers buy them either. What is your opinion?
Hi Lili,
Thank you for your question. Would you mind if I talk about your question in one of my podcasts this week?
It’s hard for me to answer this question as it falls more into “financial advice” category and is really based on your financial situation as well as you lifestyle, etc…. Please search my blog with “Real Estate” keyword and you will pull all posts and my views.
So, while I can’t answer directly, I can tell you what I would do. I wouldn’t buy. I would wait for the prices to come down over the next couple of years before making any sort of a buying decision. Can it go higher? Sure, but I am not interested in chasing overvalued markets or assets just because its going up. If history teaches us anything, prices always come down or crash. This will be the case with real estate as well. That would be my action, but sometimes personal situations outweigh financial management. That might be the case for you. I hope this helps.
Thank you for writing me back. I feel the same way you feel about the housing market. While the price was high in the past when everybody else was crazy about the housing market, I stayed out of it. I probably will not buying a house right away since I want to look and see how the market goes. I just have the feeling the high price will not last forever since it doesn’t make sense that the housing price goes up but our salary stays where it was. On top of that, we will buy a house with cash anyway. Each year we can have 50k dollars saving, so I am not eager to jump. I don’t mind you talking about my question in one of your podcasts at all.
Thanks a lot