THE #1 THREAT TO YOUR HOMES IN 2006
November 15, 2005
Which interests you more: Making money in real estate or not losing money in real estate?
You're in real estate if you own your home, i.e., if you and the mortgage lender own it.
You own any equity in your home. But if you have re- financed the home at any time, and the equity disappears, the mortgage lender owns you. You are not allowed to walk away free of charge.
One way to make money in real estate is the same as the way you make it in other markets: don't fight the inverted yield curve. If you do, you will lose your shirt.
For those of you who want to understand what this is and how it works, read the December 3, 2001 issue of "Gary North's Reality Check."
snipurl.com
We do not yet have an inverted curve, but short-term rates are headed in that direction. The Federal Reserve System has systematically increased the short-term federal funds rate over the last year. It has announced a .25 percentage point increase every few weeks. This has been coupled with monetary policy to enforce these announcements. The result: the markets are steadily heading toward yield inversion.
If you don't want to be blind-sided by a recession, you had better monitor long-term and short-term interest rates. That's why I have posted links to the major interest rate charts. They are easy to use. If you are even vaguely interested in not losing money, you should monitor these charts at least once a month.
snipurl.com
Back in the 1960s, huckster Bernard Cornfeld became a multimillionaire by selling mutual fund shares in Europe.
His slogan: "Do you sincerely want to be rich?" He ignored the inverted yield curve in 1969. His company went bust.
I would suggest this slogan: "Do you sincerely want to avoid losing your shirt?" But it's a tougher sell than "Do you sincerely want to be rich?" I'm "selling" prevention.
Prevention rarely sells.
Back to real estate. The housing market accelerated in 2001 because Greenspan's FED acted fast to drive down short-term rates when they saw the inverted yield curve in November, 2000, just five years ago. Therefore, the real estate boom that appeared after 1995 did not pop in 2001.
In grew bigger.
Now the FED is raising short-term rates. There is no doubt in my mind that FED policy-makers see what this is going to do to housing prices in boom areas: drop them. I think the FED not only knows, it is actively pursuing this as a policy goal.
IS THERE A REAL ESTATE BUBBLE?
There is a great debate going on: Is the American housing market a bubble?
The question basically is this: Will Americans be willing and able to continue to bid up prices in 2006 in the way they have since 2000 or even 1995?
My answer is clear: not where the markets have been hottest. We are at the top or beyond it.
But is it fair to call this market a bubble? First, it is either a bubble or else it represents a permanent shift in American home-ownership patterns that is historically unprecedented. If it is a permanent shift, then it is not based on demographics, which move slowly, or on Federal Reserve monetary policy, which has been expansionary since 1995 and especially since late 2000. In other words, is today's housing market part of an unprecedented turning point rather than a response to temporary monetary conditions that are now being reversed?
To see the answer, view the following chart. I know of no other chart that makes the point any more clearly.
It is a chart that compares American home prices with rents for houses, 1953-2005. A significant divergence began in 1999. It accelerated in 2003.
snipurl.com
Normally, the two lines move together, though with a
delay: the move in purchase prices precedes the move for rents, up or down.
The price buying a home shot upward in 1995. It continues upward today. In contrast, rents have not moved up sharply, and in 2003, they stabilized.
The extent of the disparity is obvious. What we have seen since 1999 is an anomaly: a seller's market like no other, going back to the early Eisenhower Administration.
There is no doubt that someone buying with 5% down in 1999 has made a killing.
If this chart's underlying relationships reassert themselves, there is no doubt that those who continue to own will suffer losses, compared with selling their homes now and either renting or buying in heartland America or the South, where housing prices, have moved up less spectacularly.
The price of renting has stabilized nationally. This means that first-time buying families will turn to rentals rather than buying, where they are increasingly locked out of the traditional 30-year fixed-interest mortgage market.
It also means that families that bought after 2000 by using ARMs (adjustable rate mortgages) will find themselves locked into mortgages that require them to pay rising monthly payments. Renters will not face this problem to the same degree. So, as these late-buying families are forced to sell because of repossession, they will leave the housing market for the rental market, probably with their credit impaired.
THE HOME CONSTRUCTION INDUSTRY
The familiar victims of recession are members of the home construction industry. They always over-build at the tail end of a boom. They are the lemmings of the business cycle. They avoided the usual crunch in 2001 because the Federal Reserve lowered rates from 6.25% to 1.25%. Now that process is being reversed.
Another chart that is stunning in its impact is the chart of the Pulte company. It is a nationally based home- building firm. The ten-year chart shows what happened. You could buy a share for under $5 in early 1997 and again as recently as mid-2001. It hit $48 in July, 2005. Then it sank sharply to $35. It has gyrated since then, and is now in the high $30s. The market indicates weakening, though not a collapse.
snipurl.com
There is a very useful website that lets you check the charts of dozens of home-builders and related companies, such as Lowes. Click on any daily chart. This will take you to a large chart. You can then clock on 1-year, 5- year, or 15-year charts.
snipurl.com
I clicked chart after chart. Most of them reveal the same pattern: amazing growth after 1995 and especially 2000. Then either a stabilization or a decline this year.
The declines have not been spectacular. This indicates that investors sense that the boom is over or stalled, but that it will not be followed by a bust. In other words, "this time it's different" for this industry.
The anomaly of rising home prices and stable rents will continue. Renters are renters, owners are owners, and the two markets for living space are no longer related.
WHY NOT SELL YOUR RENT HOME?
The question arises, why not sell your rent home if you own one? Rents are stable. So, why not sell now and invest in something else?
It appears that rent home owners are convinced that housing prices will not fall enough to let them make a profit after taxes. There are so many tax advantages from owning rental property that existing owners are not going to sell.
This does not explain why existing renters are not going to buy. Why should anyone rent when he can own? The answer is probably this: the renters qualify for loans in today's slowly tightening mortgage market. Renters constitute about 30% of American households. As interest rates rise, it becomes more difficult for them to buy, unless home prices fall.
Unless home prices fall. Unless home prices fall.
This may take repetition to get it into your consciousness.
The problem is, as adjustable rate mortgage rates and property taxes rise, what happens to recent renters who finally bought? How do they make their monthly payments?
A recession will produce problems for the owners of expensive homes.
Will there never be another recession? With short- term interest rates rising faster than long rates, the conditions of a recession -- the inverted yield curve, where short rates are higher than long rates -- are getting closer.
GO EAST, YOUNG MAN
The "New York Times" (Nov. 7) ran a story on a couple that sold their home in California and moved to a suburb of Kansas City, Missouri.
Today, Mrs. Fischer and her family live in this
suburb of Kansas City, in a five-bedroom house
nearly twice the size of their former home near
San Bernardino, with a huge yard and a lake view
from the hot tub on their deck. Still, Mrs.
Fischer, 28, and her husband, Nathan, 30, had
enough money left after their move to pay off the
debt on their two cars and buy a 21-foot
motorboat.
Many of their new neighbors cannot fathom why the
Fischers left sunny California for, of all
places, Missouri. "You have to give up things,"
Mrs. Fischer said, "to get things."
These people got the picture. I used to live in Riverside, California, within 20 minutes of San Bernardino.
There was no smog in 1960. There was in 1970. There were
orange groves in 1960. There weren't in 1970. Home
prices are high. It's hot. It's dusty. It's the desert.
Now the region is filled with traffic. People commute 90 minutes each way to work in Los Angeles.
In Kansas City, you can eat Bryant's bar-b-que. That alone is worth the move.
Commit this to memory: "You have to give up things to get things." The couple will now suffer from a phenomenon known around the world but not in San Bernardino. It's called winter. Other than that, they are ahead of the game. Word is getting out.
Last year, a half million people left California
for other parts of the United States, while fewer
than 400,000 Americans moved there. The net
outflow has risen fivefold, to more than 100,000,
since 2001, an analysis by Economy.com, a
research company, shows, although immigration
from other countries and births have kept the
state's population growing.
The number of people leaving Boston, New York and
Washington is also rising, and skyrocketing house
prices appear to be a major reason, said Mark
Zandi, chief economist at Economy.com. From New
York, the net migration to Philadelphia more than
doubled between 2001 and 2004, with 11,500 more
people leaving New York for Philadelphia last
year than vice versa. The number of New Yorkers
who have moved to Albany, Charlotte, N.C., and
Allentown, Pa., among other places, has also
increased sharply.
I think this interview indicates what is happening.
Here is a couple that understood that it is important to buy the lifestyle they wanted at a price they could afford.
Heather and John Franklin were renting a
one-bedroom apartment in San Diego when they
married last year. On Ms. Franklin's income as a
real estate agent and Mr. Franklin's pay as a
mechanic, they could not afford a house in San
Diego, where the median home price is almost
$605,000.
In Kansas City, where Mr. Franklin, 22, grew up,
the couple, who have a seven-month-old daughter,
bought a house for $134,000. Ms. Franklin, 24,
who was raised in San Diego, never imagined she
would leave California. Since moving to Kansas
City, she has had to get used to tornado warnings
and the concept of wind chill.
snipurl.com
There are trade-offs in life. Only a few people at the margin of any market make dramatic changes like this.
If everyone did, then the price of housing regionally would shift dramatically. But most people will not change. This leaves opportunities on the table for those few who are willing to change.
CONCLUSION
I think the party is about to shut down. Federal Reserve policy today is borderline rational: slowing the rate of monetary inflation. The FED, as always, wants a soft landing: a mild recession. The last time the FED attempted this was in late 2000. It produced a recession beginning in March, 2001. But even before then, the FED panicked and began lowering the federal funds rate through monetary expansion.
Greenspan's response to recession was the same in 1987 and 1991: monetary expansion. We will see if the new Federal Reserve Chairman next year is willing to bite the bullet and get tarred and feathered with a recession in 2006, his first year as Chairman. Greenspan wasn't wiling, ever.
FED monetary policy today indicates that a recession may be preferable in the FED's collective eyes than a runaway housing bubble. The FED wants to buy a less bubbly housing market by letting the public pay with a recession.
As we have read, "You have to give up things to get things."
Recessions, except in 2001, are bad for sellers of single-family houses but a great opportunity for buyers.
Stay tuned.
Gary North's REALITY CHECK
garynorth@garynorth.com |
