Regarding the housing bubble, here's an interesting read from John Mauldin" "The time has come," the Walrus said, "to talk of many things." This
week we talk about whether we are in a housing bubble, look at stock
and bond market directions, the problems with the dollar and much
more. It is that semi-annual time when I make predictions (which is
the term for educated guess), and then watch to see what actually
occurs.
This week I begin with a look at the housing market. I probably get
more questions on housing and real estate than on any topic, other
than stocks. I am going to try and do a quick analysis, and then let
that be the jumping off point for my economic predictions.
There has been much written about the fact that we are in a
potential housing bubble. Typical of the concern is that voiced by
Business Week: "Call it the double bubble. A housing bubble may be
developing--right behind the Nasdaq bubble.....In fact, falling
equities have led many well-heeled investors to shift money into
residential real estate. Robert J. Shiller, author of Irrational
Exuberance, which predicted the Nasdaq crash a year before it
happened, now warns that a psychological frenzy not unlike tech
mania is gripping housing. It appears that the Federal Reserve's
dramatic rate-cutting campaign to revive the economy may be
overheating housing."
Let's set the stage: The total price for all homes in America was
$6.6 trillion dollars in 1990. The collective value of homes rose by
another trillion over the next five years, and since then has
exploded to $12 trillion. There has been a rise of 20.9% in just the
last two years. (EIR)
We are spending more and more of our income on housing. The ratio of
after tax income to the total real estate valuation is at its
highest level in 50 years. Total outstanding mortgage debt is $5.7
trillion, or about one-half of total home value. 60% of today's
families cannot afford/qualify to buy an average home. By some
measures, it takes roughly twice the income to buy a house today as
it did 40 years ago.
The strong housing market gave homeowners a safe-haven during the
recent economic storms. For instance, the national average price of
an existing single-family home is now $192,400. A year ago, the
average was $179,500. For new single-family homes, the national
average price is now $226,800, while a year ago, it was $205,500.
The increases have created a sense of economic security, the so-
called wealth effect. (ABC News)
A Ceiling on Housing Prices
Let's look at what has led to the recent run-up in housing prices
and see whether that is sustainable.
First, one primary driver is lower mortgage rates. A drop of 2% in
mortgage rates lowers the monthly payment of a median house by
almost $300. Conversely, if a family can afford to make $1500
monthly payments, they can now buy "more" home for their monthly
payments. Mortgage rates have been dropping for over ten years. This
increases demand, and thus prices rise.
As noted above, people see housing as a safe investment. Many buy
"too much home" as a "forced" way to save money. Since homes have
risen in value, especially of late, this seems reasonable to the
average home buyer. Since for much of America, the bulk of their net
worth and the greatest increase in their net worth is in their
homes, it only makes sense to them to keep doing more of the same.
Demographics have led to rising values. There are more people
wanting to buy homes, and even though home building has stayed at a
feverish pace throughout the last recession, the supply of homes
available is still historically low.
Two other factors contributed significantly. Mortgage banks created
new classes of loans available to first time buyers and those with
problem credit histories. The number of people who can now qualify
for home loans has exploded. These families buy smaller homes which
cost less, thus driving up prices at the lower end of the market and
allowing those home owners who sold and now have large equity to
move up to a higher priced home. This is not a bad thing, but it is
a real driver on prices. Secondly, low unemployment levels have
fueled demand.
I believe most of these growth factors have run their course. Rates,
while they could drop some more (and I think they will at some
point), are not likely to drop another 2%. There is not much fuel
left in that engine. Demographics, while still positive, do not
suggest that demand will be as big in the future. There are no new
classes of potential borrowers on the horizon. We have made loans
available to almost anyone who can demonstrate economic viability.
But does this mean that like the Nasdaq we will see a bubble burst?
I don't think so, and for the following reasons.
First, a home is an altogether different type of asset than
Amazon.com or Cisco. We can live without the latter, but we all
have to have a place to hang our hats. While the demand for
Amazon.com stock is very elastic, the demand for housing is
universal.
Further, Amazon.com stock can be created quite easily, and for very
little real value. Homes are not created easily, and there is an
intrinsic replacement value to a home.
As our population increases, the demand for housing will increase as
well.
This is not to say that homes cannot fall in value. When and if in
some future time interest rates rise by 2-3%, you can bet home
values will drop. It is not inconceivable that prices could drop 10-
15% or more, as they have in the past because of rising interest
rates. But they are not likely to drop 50% in all but the most
doomsday scenarios. I think doomsday is quite unlikely.
But we may have reached the top in terms of significantly
compounding home prices. If homes were to rise in value by just 7%
per year (forget about 10%), in ten years that means the value of
our homes would double. If incomes were to grow at 3% a year, the
portion that we allocate to housing would have to rise by 50% to be
able to buy the same house.
That is fine if you buy your home today, lock in your mortgage rate
and watch your income rise over time. But when you go to sell in ten
years, a person who makes the same as you do would have to be
willing to spend a great deal more of his income to buy your home.
If your home cost you 25% of your income, your prospective buyer
would have to be willing to spend 37% of his income, or he would
have to make a lot more than you do.
On the average, that is not going to happen. (I will mention
exceptions below.) We are at an all-time high in the percentage of
our incomes we spend on housing. How much more can it grow? We are
also at all-time debt personal debt levels. We have just about
reached the end of the road.
I think growth in average home prices is going to be limited to
inflation plus growth in real income over the next decade, at best.
The key factor in the future growth of housing prices is going to be
affordability.
The next recession could bring about an altogether different result
in the housing markets as opposed to this last recession. Normally,
recessions cause home prices to drop, as more homes come on the
market, and there are fewer buyers. Those of us who live in Texas
experienced the pain of being in a regional recession and watching
our housing values drop significantly. It was not fun to bring a
check to the closing table in order to get someone to buy your home.
So, when you write and ask me if you should buy a home in (your
town), what do I say? I never answer that question. It all depends
upon local situations, and I don't know your local conditions. How
stable is the local employment? How well will your local economy
weather the next recession? Are people wanting to move to your town,
or is there a net drain of buyers? Is there reason to think local
businesses are likely to expand employment? How long do you want to
own your home? The longer you will stay in your home, assuming your
income is stable, the less problem you will have.
Plus, how desirable is the home you want to buy? If it is one of a
kind Maine beach front property, as long as there are rich people,
there will be a demand. (Hint: there will always be rich people.
Like the poor, they are always with us.) If it is a home in the
suburbs, where there are 50,000 homes just like it, then you have to
carefully consider the future economic stability of your area.
But you can no longer buy a home and expect it to grow by 7-10% a
year in value just because it is a home. While there will be places
where this happens, they are going to be the exception. We are
bumping up against our income limits. Buying a home and hoping to
flip it in 2-3 years is going to become a dicey proposition.
That is not to say you should not buy a home. I sold my home a few
years ago, and now lease. I intend to buy another in a few years. I
am waiting, because the home I need in two years will be much
different than the home I need today. When I buy, I want to be in
that next home for some time. I do think homes are reasonable
purchases. But I am not expecting to see it double in ten years, nor
do I intend to sell soon.
One final thought. In just a few years, the Baby Boom generation
starts to hit retirement age. We will not all be able to sell our
homes and move to Florida. The amount of used homes on the market is
likely to increase over the next decade, and this will put a further
ceiling on rising prices. It does not mean that prices will drop,
but it will limit price increases for used homes. |
