Friday, May 13, 2011

Housing Losses Are a Financial Disaster

Correspondent E.M. describes the true scope of the financial disaster that is housing.

Correspondent E.M. responded to $6.5 Trillion Lost, One House at a Time with this succinct account of housing's role in declining household wealth. E.M. is not a realtor or in a housing-related profession; his report on housing valuations in the Atlanta area is that of a knowledgeable observer and does not claim to be a complete statistical survey.

E.M.'s commentary is especially valuable as it examines the underlying assumption of real estate ownership in America--that it is a reliable "wealth building" investment for the average household. If this assumption is invalid, then that should change our perception of housing's value and place in the project of building household wealth.

The idea that "housing is not coming back" is filtering into the mainstream media: On Housing, There Will Be More Lean Years Ahead: Expect another 10 years before U.S. housing prices return to their 2006 highs. (

Here is E.M.'s commentary:

To say that housing losses are a financial disaster is a modest understatement. I do not think that most people really comprehend how true this is. The main reason this is so is first, leverage and second, the fact the US economy as a whole has over-CONSUMED housing for the time most people have been alive. They just do not know it because they have been duped into believing that housing is an "investment" when in actuality, it is a combination of a speculation (the land) and a long lived consumer durable (the structure).

Absent inflation, there is no reason whatsoever for most houses to "increase" in "value". Yet most people believed that there was something magical about housing because "they are not making any more land".

To illustrate, I will give you some examples on housing prices in the Atlanta (ATL) market from either areas I specifically know or people that I know who have bought homes that I know (for a fact) are worth much less than what they paid for them. I will also give you what I believe to be the "typical math" for the median household which shows anyone why, given the spending and savings habits of most Americans, it is essentially impossible for most people to accumulate wealth. I assume you know what I am describing but most others do not. Let me start with this first.

Today, the median household net worth is less than $100,000. The median income is about $50,000. The personal savings rate is less than 5%. If you buy the median priced home which I believe is about $160,000 and it loses even 2% in a year, then that essentially wipes out whatever you saved. This was not an issue at the peak of the housing bubble, but it is almost certainly is likely to be one, on and off, for years into the future.

CHS NOTE: E.M. is correct: median household income is $49,777 according to the Census Bureau data, and the national median home price was $166,000 in 2010, though with housing values continuing to decline that number is now $160,000 or less.

And there will be no stock market bubble to offset this either. If like the typical family, you own two cars that are "worth" about $30,000, you will lose $15,000 to $20,000 in only three years of depreciation if they are new and somewhat less if bought used.

Given how broke most people are in actuality, how are they going to improve their financial circumstances when "assets" representing 200% PERCENT of their net worth are subject to depreciation? The answer is that they will not for the most part.

And this does not even account for those who bought homes far above the median price or who "own" cars that cost a combined $80,000 (or even more) along with thousands of dollars of "techno gizmo" gadgets. I have been watching the HGTV channel a lot more lately and this is exactly what I see. Couples in their mid 20's to late 30's buying houses that are typically two times or more the median priced home. I do not know their specific financial circumstances but I doubt that any of them are "loaded' and most of them cannot actually afford to consume a house at these prices, regardless of whether they "qualify" and can make the payments.

In terms of housing prices, I have been actively looking at homes all over the Atlanta area because I might move back. I am not looking to buy now but later. Here are some examples of what I have seen.

The single family home I bought in Paulding County, GA with my mother for $138,000, I estimate is worth about $65,000 after commissions and closing costs in a sale. We bought it in April 2006 (at the peak of the Case Schiller index) not because I wanted to but because I had to bail her out. Currently, we are about $10,000 "underwater" but I would estimate that essentially every other home in our subdivision also has negative equity. (If not all, the vast majority.)

Our P&I (principal and interest) is $442 per month. It would not surprise me if many "homeowners" in our subdivision have P&I which is THREE TIMES or even more. The reason for this is that they would have bought at the peak or near it, borrowed the full amount and also only qualified for a much higher interest rate as a "subprime" borrower. I'm surprised there have been so few foreclosures in our subdivision because many people must be sinking with this "hit".

In Stone Mountain, GA, I saw homes that were selling for about $60,000 last month. These are homes near where I used to work in the 1980's and though I cannot say they are exactly the same ones, they are similar and selling for the same or LESS than the prices listed in 1985 in one of those free magazines you pick up in the grocery store.

One of my best friends bought her 3/2 home in Lithonia, GA for (I believe) $82,000 in September, 1997. There was a comparable home listed in her subdivision for about $60,000 as of last month.

The 3/2 townhome (with finished basement) my mother owned in Lithonia before we bought her current house, I estimate that it would sell for $50,000 to $60,000 now, at most. She bought it for $114,000 in March 2000 and sold it for $103,000 in January, 2006. I have also seen other condos (not nearly as nice and older) that were listed for between $20,000 and $40,000.

Another of my friends bought his 3/2 home in Conyers, GA for about $145,000 perhaps five years ago or maybe slightly before. There was a comparable home for sale in his subdivision for $90,000 as of last month.

In Snellville GA, the 3/2 house my mother bought in 1985 for $65,000 and sold for $95,000 in early 2000 is probably worth about what she paid for it. I have also seen 5-bedroom houses with about 2500+ sqf in newer subdivisions for $140,000. I do not know what these sold for at the paek, but they must have also lost substantial value.

Within the ATL city limits, there are a substantial number of 1BD and 2BD condos for sale in the $50,000 to $80,000 range. Some even less. I cannot say what they sold for before in all instances but there is one that I know well. The price per SQF for this one has fallen from about $160 five years ago to less than $100 now. Given how nice this place is, the others must have done no better. In another building, the listing claimed that the asking price was the lowest ever in that building, dating back to 1965. I'm not sure this is literally true but it is an indication of the price damage.

To summarize my observations, there are two things I see generally.One is that prices of homes removed from the ATL city limits or areas like it have lost a lot of value as I described, while those closer in (at least in the good neighborhoods) appear to have held their value better. I do not know what they were worth before but they are still expensive now by my standards.

For condos, there is a VAST price disparity between older and newer buildings. Yes, the newer ones are presumably better but some of these units are literally in buildings right next to each other and the area is no dump either. It is a desirable location.

I see both of these as an indication of what may continue to happen in the future. If the price of energy increases or continues to strain household budgets, people are not going to be able to afford to drive like they do now and therefore, will pay less for homes that are farther from their employment. As for condos, my observations indicate that in a major bear market, they will become rapidly depreciating "assets" as they age.

Thank you, E.M. for this report. Today the Labor Department issued a report on consumer inflation and wages:

The Labor Department CPI data showed that without rounding, consumer prices were up by 0.422% in April from March. Excluding food and energy items, consumer prices increased 0.185% without rounding.

Meanwhile, real average weekly earnings fell by 0.3% over the month in April. Since reaching a peak in October 2010, inflation-adjusted weekly earnings have dropped by 1.7%.

The report states that "On an annual basis, consumer prices rose by 3.2% last month," but 12 X .422 = 5%, not 3.2%, so we have to wonder what "magic rounding" dropped the annual rate by 36%.

If inflation cruises along at 3% a year, and wages decline by 1% a year, then if housing prices stay flat for 10 years in nominal terms, in real terms (purchasing power, or adjusted for inflation) then the value of the home will have declined by 33% even as potential buyers' earnings will have declined by 11% over the decade.

That does not paint a very positive picture for housing as a store of value unless it is generating a net yield (after paying debt, property taxes, maintenance and all other costs of ownership) of 3% or higher. Counting on property to gain 33% in value, which would be the minimum necessary just to retain its current value, is an assumption with significant risk factors.

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NOTE: Jim informs me that May's report was posted late last night. if you missed that report, please log in again today.

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