Friday, September 24, 2010

Housing Prediction: Bottom in 2014, Then a Decade of Stagnation

The housing bottom many see in 2014 will not usher in a new boom; rather, it will merely mark the transition to a decade (or more) of stagnation.


Take a wild stab at when housing will bottom, and you can find an analyst's opinion to support your guess: one respected housing expert sees a bottom in six months, while equally experienced observers see a bottom in 2013, followed by a decade of slow improvement.


If history echoes, as it tends to do, then the last mini-bubble, bust and aftermath offers us an instructional model of how housing bubbles play out.


Why is this so? For two reasons: human psychology reliably swings between euphoria and caution in the marketplace, and the business cycle of rising debt and over-expansion followed by contraction of credit and retrenching is a feature of free markets.


One standard way of assessing the underlying valuation of housing is to compare it with income. When homes are soaring in value, they rise above the historical average of 4 times median household income. When houses fall in value, they dip to 3.5 times median household income.


Ned Davis Research and CNBC recently published a chart of this ratio, housing prices to median household income, which I have annotated in italics.



The ratio accurately reflects peaks and valleys in residential real estate: housing prices rose to a peak in the late 1970s, and then fell sharply in the deep 1981-83 recession. The resurgent economy boosted prices for seven years, leading to another peak in valuations in 1990.


For various macroeconomic reasons, housing then stagnated for about a decade, drifting below the historic mean of 4 times income. These factors included the relative balance of supply and demand between homebuyers and sellers, and the greater attractiveness of stocks and bonds to investors in the 1990s.


We all know the story of the Great Housing Bubble: low interest rates, disavowal of risk management, subprime loans to unqualified buyers and investor wariness after the dot-com stock market crash all led to a massive sustained surge in home buying.


In the early 1990s, home sales averaged about 4 million a year. By the mid-2000s, that number had nearly doubled to 7 million sales a year.


This imbalance between supply (limited) and demand (rising due to the influx of marginally qualified buyers and investors) and ubiquitous mortgage-lender/investment bank fraud led to seven years of skyrocketing valuations.


No bubble expands forever, and the global financial crisis ended the housing mania's seemingly unstoppable ascent.


Once the Federal Reserve and Federal government finally acknowledged that housing prices were in a recessionary free-fall, the Fed stepped in to maintain super-low mortgage rates by purchasing $1 trillion in mortgages, and government agencies offered a slew of programs aimed at stabilizing the housing market and home prices.


As the chart reveals, these unprecedented efforts have provided a modest stabilization in valuations. But the limits of government intervention are painfully clear: according to the Treasury Department, bout half of the modifications done in 2009 were behind in payments by the first quarter of 2010.


The fundamental headwinds to any sustained rise in home values are substantial.Foreclosures have risen for the 9th month in a row, even as housing inventory continues to rise.


I first reported on the bulging foreclosure pipeline back in August of 2009.


More recently, I reported on the staggering numbers of underwater homeowners.


Other commentators have also noted the fundamental drag presented by the excess supply of existing housing units and the huge number of homeowners with negative equity(i.e. the mortgage exceeds the market value of the house).


Indeed, many analysts see a second leg down in housing prices as inevitable. There's nothing fancy or complicated about the reason: when supply exceeds demand, prices fall until there is a new equilibrium.


At this point, the guessing game moves from "when will housing bottom?" to "how much further will housing decline?" Some analysts are staking out future drops in the neighborhood of 5 to 8 percent, but bubbles tend to fully retrace to their starting point, and then dip another 10% just for good measure. "This time it's different"--yes, we heard that in 2000 as well, and the dot-com NASDAQ not only retraced all of its gains but then some. Why would housing perform any differently?


The answer is that yes, this time it is different: it's worse, because the Baby Boomers will be selling relentlessly for the next two decades. Demographics are against another housing mania as Boomers will be selling their real estate holdings to fund their hip replacements, retirement living, etc. Buyers from the smaller follow-on generations will simply not be numerous enough or wealthy enough to buy these millions of homes and vacation properties at anything close to today's prices.


There are three interesting features in the chart which suggest targets for both the housing bottom and the eventual bottom in valuations. Bubbles tend to rise and fall in symmetry, meaning that a bubble which took seven years to reach its apex typically takes about the same period to time to retrace to its starting point.


By that reckoning, the housing bubble which took off in 2001 and ended in 2007 will need about seven years to complete the retracement to historical valuations. That would put the bottom in the 2014 timeframe.


As for valuations, market watchers have long noted that "it's different this time" is a remarkably inaccurate basis for valuing anything. Thus we can look to the last deep recession in 1981-83 for some clues about where housing valuations may be heading: to about 3.5 times median household income.


This ratio of income to home prices is useful because it follows regional variations: higher income areas will have higher home prices, but the ratio will likely be about the same across the nation.


The last interesting feature is the decade of stagnation which followed the bust.


Bubbles do not arise again in the same asset class; they tend to bubble up elsewhere. Thus we can look for mania-led bubblicious valuations not in real estate but in some other asset class: silver, gold, the dollar (gasp! Sacrilege!), iridium, water, dirt, bat quano, the new gold-backed currency, the quatloo, etc.


"It's different this time" has a close and equally inaccurate cousin: "it can't happen here." Those counting on a timely resurgence in home valuations ignore the fundamentals of supply and demand at their own peril.



I am slowly catching up on correspondence after several weeks away from my desk --your patience is appreciated.



If you would like to post a comment where others can read it, please go toDailyJava.net, (registering only takes a moment), select Of Two Minds-Charles Smith, and then go to The daily topic. To see other readers recent comments, go to New Posts.





Order Survival+: Structuring Prosperity for Yourself and the Nation and/or Survival+ The Primer from your local bookseller or from amazon.com or in ebook and Kindle formats.A 20% discount is available from the publisher.


Of Two Minds is now available via Kindle: Of Two Minds blog-Kindle


Thank you, Spike T. ($100), for your outrageously generous support of this site-- I am honored by your continuing support and readership.


Terms of Service

All content on this blog is provided by Trewe LLC for informational purposes only. The owner of this blog makes no representations as to the accuracy or completeness of any information on this site or found by following any link on this site. The owner will not be liable for any errors or omissions in this information nor for the availability of this information. The owner will not be liable for any losses, injuries, or damages from the display or use of this information. These terms and conditions of use are subject to change at anytime and without notice.


Our Privacy Policy:
Correspondents' email is strictly confidential. The third-party advertising placed by Adsense, Investing Channel and/or other ad networks may collect information for ad targeting. Links for commercial sites are paid advertisements. Blog links on the site are posted at my discretion.


Our Commission Policy:
Though I earn a small commission on Amazon.com books and gift certificates purchased via links on my site, I receive no fees or compensation for any other non-advertising links or content posted on my site.

  © Blogger templates Newspaper III by Ourblogtemplates.com 2008

Back to TOP