HowWealthWorks.com

[Suresh]

Bust, Not Rust?
...
In my view, the deceleration in prices has been the product of two factors: Sinking housing affordability that undermined demand and builder exuberance that created an overhang of new supply and inventories of unsold homes. Because housing demand in the short run is relatively insensitive to price changes, a buildup in inventories can produce a sharp deceleration in prices. But that also implies that builders’ aggressive efforts to slash housing starts and cut back inventories will promote a better supply-demand balance and help to stabilize prices. And just as accelerating price changes eventually hobbled demand, I think a sharp deceleration in prices will help stabilize it, perhaps at levels 15% lower than today. Investors thus should not assume that a bust in housing activity will promote more than rusting home prices.
...
____________________________________________________________

Doesn't Dr. Berner's opinion assume that consumer demand for housing after the excess housing inventory is mopped up will be the same as (or greater than) it is now? But, why is this a fair assumption? Given the historically high rate of homeownership currently, are there that many people out there who want a house but don't have one? If so, how low must prices fall before home price-to-income ratios reach a point where such would-be home owners can afford a home? I'm going to guess that in most locales that have seen outsized price increases of late, prices will drop until the home price-to-income ratio is somewhere between 1 and 1.2.

Let's take a look at some home price-to-income ratios in various metropolitan areas.
____________________________________________________________

A Year Or Two?
...


In past 30 years, this ratio has never started to decline and then stopped a year later. Or even three years later. Nope, in our highly cyclical real estate market, declines in the home price-to-income ratio during this period have never lasted less than six years.

It should be noted that, due to very high inflation at the time, nominal (non-inflation-adjusted) home prices hardly fell at all during that first downturn in the 1980s. Instead, prices just flatlined for several years while inflation raged. So while home prices didn't drop in nominal terms, they did drop compared to everything else.
...
_____________________________________________________________



The San Diego area also took 6-7 years to go from peak price-to-income ratio to trough price-to-income ratio.



Los Angeles area took 5-8 years to go from peak price-to-income ratio to trough price-to-income ratio.



Santa Ana area took 4-8 years to go from peak price-to-income ratio to trough price-to-income ratio.



Riverside area took 5-6 years to go from peak price-to-income ratio to trough price-to-income ratio.

As to the metropolitan-D.C. area, consider Home Price Analysis for Washington-Arlington-Alexandria. See page 3.

Eyeballing the DC area, it looks like it took 6 years from the 1980 high in the home-price-to-income ratio to the subsequent low, and 9 years from 1991 high to the subsequent low.
_________________
Suresh

Please feel free to agree with or critique the article excerpts and our comments. Also, please post excerpts from current articles that you've read and which may help all of us get a more complete macroeconomic big picture.

[Suresh]

New Home Starts? Don't Make Me Laugh!
...
If you didn't know 3 factoids about New Home Sales, you might be tempted to believe sales are stabilizing, and that the worst is over for housing. Here's what you need to know anytime you see the New Home data:

- The data itself is reported not by a neutral observer, but by the Builders (an interested party) to the Commerce Department;
- The margin of error is typically greater than the reported number, rendering it statistically insignificant;
- Cancellations of New Home Sale contracts are omitted from both the inventory and sales data.
...


_________________
Suresh

Please feel free to agree with or critique the article excerpts and our comments. Also, please post excerpts from current articles that you've read and which may help all of us get a more complete macroeconomic big picture.

[Suresh]

Real Estate Will Underperform Inflation for Decades
...
Tables E135-E166 of the following link provides the source for this information:

Historical Statistics of the United States: Colonial Times to 1970

An interesting side note is that over the period of 1915 to 1965, housing costs appreciated in price by an average of only 1.32% per year, or negative 0.8% a year after inflation.

The Census data contradict the absurd fantasy often popularized in the media and culture that house prices are a wonderful investment and always provide consistent inflation-beating returns. In fact, in the last century they often underperformed inflation for many decades at a time. There are many legitimate reasons to buy real estate: stability of schools and neighbors, freedom from capricious landlords, certain tax advantages, and mortgage payments that save money every month by being less than the rental of the same unit. If the last 100 years are any indication of the future, expectations of future price appreciation are not a legitimate reason to buy real estate. A large percentage of the current buyers in the real estate boom of the 2000s are buying based on future price appreciation. Unfortunately, this means that the real estate boom of the 2000s is largely based on a myth. As real estate prices return to levels justified by the legitimate reasons, prices will fall in inflation-adjusted terms.

Combining the census data for 1914-1970 with data sets from Freddie Mac for the years 1970-2006, the following figure is obtained:



The chart indicates that housing prices in the mid-1990s were about 25% below prices in the mid-1920s.

The old adage of our grandparents that “housing is a depreciating asset” was true for a very long time.

The 1914 peak in inflation-adjusted terms was only exceeded for the first time in 2005.
...
____________________________________________________________

As Mr. Forshee noted, there are plenty of non-investment reasons to buy a house. But, if a house is purchased, at least in part, for investment reasons, then just like any other investment vehicle, the biggest factor in the real rate of return is the initial price paid.

It's easy to dismiss the above graph as being meaningless for local markets. But, regional housing charts such as those shown in our Berner: reduction in inventory will stabilize prices post appear to reflect of cyclicality of real rates of return. Once intial prices paid reach extreme heights, it takes years to reach troughs, from where real price appreciation in real estate is attained.
_________________
Suresh

Please feel free to agree with or critique the article excerpts and our comments. Also, please post excerpts from current articles that you've read and which may help all of us get a more complete macroeconomic big picture.

[Suresh]

RISMedia: House Prices Must Return to Trend Levels to Stabilize Market
...
[A] new report from the Center for Economic and Policy Research (CEPR) ..., “The Key to Stabilizing House Prices: Bring Them Down,” notes that prices are still hugely out of line with trend levels in bubble markets and calls for Fannie Mae and Freddie Mac to restrict the buying of mortgages in these areas. This would lead to fewer loans being issued in these markets and prices would quickly adjust to normal levels.
...
The report, which draws on data from the Case- Shiller Index, emphasizes that house prices used in mortgage appraisals should be based on rental values to avoid over-valuation. The fact that real house prices exploded by 80% from 1996 to 2006 while rents increased by only 4% over the same time period points to a degree of speculation and the fact that prices still have further to fall before the bubble deflates.

If Fannie and Freddie no longer supported the purchases of homes at bubble-inflated prices, there would be a quick price decline of 20 to 30% in the most over-valued markets. After this drop, homebuyers need be less fearful of further price declines, both boosting demand and reducing vacancy rates. At the same time, the consequent flow of loans into non-bubble markets would help prevent a downward price spiral in these areas and avert the risk of overshooting on the negative side.

“A rapid return to trend levels is significant for homeowners in that it gives them a sense of how their home equity figures into their real wealth and how they have to adjust their consumption and saving decisions,” said [CEPR Co-Director Dean] Baker.
_________________
Suresh

Please feel free to agree with or critique the article excerpts and our comments. Also, please post excerpts from current articles that you've read and which may help all of us get a more complete macroeconomic big picture.

[Suresh]

USA Today: Why home values may take decades to recover
...
So far, home values nationally have tumbled an average of 19% from their peak. As bad as that is, prices would need to fall as least 17% more to reach their traditional relationship to household income, according to a USA TODAY analysis of home prices since 1950.
...
When the housing bubble began to deflate in 2006, history had a sobering lesson to teach. Home values had closely tracked three common-sense measures for many years:

• Income —Home values floated at about three times average household income from 1950 to 2000. In 2006, the average household income was $66,500. Under the traditional model, home prices should have been about $200,000. Instead, the typical home sold for $301,000.

• Rent —Homes traditionally have sold for about 20 times what it would cost to rent them for a year. In 2006, houses were selling for 32 times annual rent.

• Appreciation —Existing homes grew in value by less than 0.5% per year, after adjusting for inflation, from 1950 to 2000. From 2000 to 2006, home prices rose at an average annualized rate of 8.2% above inflation and peaked with a 12.3% jump in 2005. Housing prices began to fall in the second quarter of 2006.

Inflation could help homes recapture their old prices, if not their value. But when inflation is factored in, home prices might not return to their 2006 peak for many years.
...
_________________
Suresh

Please feel free to agree with or critique the article excerpts and our comments. Also, please post excerpts from current articles that you've read and which may help all of us get a more complete macroeconomic big picture.

[Dave]

WSJ.com: Home Prices: Low, But Still No Bargain- Forget low mortgage rates and the buyer's market. Real-estate prices still have a long way to fall.

Homeowners are watching anxiously for any signs of housing market stabilization. So, too, are all those who believe the market may hold the key to the economy.

And yet the most recent data makes for more gloomy reading.

The closely watched Case-Shiller index, which tracks prices across twenty major cities, shows that through January the crash was getting worse, not better.

And yet, even after these declines, homes overall still may not be that cheap relative to wages. More on that later.

The headline numbers are grim enough. January's Case-Shiller index showed a 19% slump from a year earlier. The usual suspects fared very badly: Phoenix was down a remarkable 35%. Las Vegas fell 32% and Miami 29%.

Even today, prices overall have only reverted to levels seen in late 2003. Yet by that stage the bubble was already well inflated. You would expect a crash of this scale to retrace its steps much further. To find pre-bubble prices you have to go back to about 2000 – when values overall were about a third lower than they are today.

It's true that mortgage rates, now at 4.5% to 5%, are currently very low. But relying just on that is far too simplistic. Rates were also low from 2003 through 2005 – as many pointed out, disastrously, at the time.

Is there a bullish scenario for house prices? Sure. If all the government spending to turn around the economy reignites inflation in a year or two—as some predict—house prices could begin climbing again. But if the current price deflation continues, look for house prices to keep dropping.

I looked at Case-Shiller's index back to 1987 and compared it to federal data on average earnings. The result, rebased to 100 in January 1987, can be seen here. And it's alarming. By this (admittedly very simple) measure, today's home prices are actually more expensive, in relation to average earnings, than at the peak of the 1989 property bubble.

Equally noteworthy is that when the last property bubble burst, it took about eight years before the market showed really strong signs of revival. This bubble was far, far bigger.
_________________
Dave

Please feel free to agree with or critique the article excerpts and our comments. Alan Greenspan: Gold and Economic Freedom

[Dave]

"Home has morphed from piggy-bank to albatross." That's a great line. Here's another article alluding to the vicious downward spiral of deflation. It's said that "all inflations end in deflation." We definitely had a great inflation worldwide in the real estate market, and now we're experiencing a great deflation.

Many seem to be of the opinion that the housing market has stopped falling. We do not agree.

Reuters: About half of U.S. mortgages seen underwater by 2011

The percentage of U.S. homeowners who owe more than their house is worth will nearly double to 48 percent in 2011 from 26 percent at the end of March, portending another blow to the housing market, Deutsche Bank said on Wednesday.

Home price declines will have their biggest impact on prime "conforming" loans that meet underwriting and size guidelines of Fannie Mae and Freddie Mac, the bank said in a report. Prime conforming loans make up two-thirds of mortgages, and are typically less risky because of stringent requirements.

Covering 100 U.S. metropolitan areas, Deutsche Bank in June forecast home prices would fall 14 percent through the first quarter of 2011, for a total drop of 41.7 percent.

The drop in home prices is fueling a vicious cycle of foreclosures as it eliminates homeowner equity and gives borrowers an incentive to walk away from their mortgages. The more severe the negative equity, the more likely are defaults, since many borrowers believe prices will not recover enough.

Regions suffering the worst negative equity are areas in California, Florida, Arizona, Nevada, Ohio, Michigan, Illinois, Wisconsin, Massachusetts and West Virginia. Las Vegas and parts of Florida and California will see 90 percent or more of their loans underwater by 2011, it added.

"For many, the home has morphed from piggy bank to albatross," the analysts said.
_________________
Dave

Please feel free to agree with or critique the article excerpts and our comments. Alan Greenspan: Gold and Economic Freedom

[Suresh]

In the current economic times, when a homeowner is underwater, he has all the power relative to the lender. A foreclosure will bring even less than market value to the lender. So, the lender will be amenable to a loan modification to keep some income stream coming on the mortgage.
_____________________________________________________________
Mish's Global Economic Trend Analysis: Brace for a Wave of Foreclosures, the Dam is About to Break
...
A summary of Second Quarter 2009 Negative Equity Data from First American CoreLogic shows that Nearly One-Third Of All Mortgages Are Underwater.

[Dave]

Long before the real estate bubble burst, we described the vicious cycle of deflation that would take hold as home values fell and homeowners were unable to refinance. Just as mainstream media and Joe 6-pack are the last to catch on to a bull market, so they are the last to catch on to a bear market.

SafeHaven.com: The 800,000 Pound Deflationary Gorilla

The housing market is rapidly deteriorating under the surface. A housing price collapse is a highly deflationary event because it affects so many banks and individuals. We are not close to a bottom in the real estate market and it is essentially almost impossible for it to come before the 2011-2012 time frame. If our government insists on continuing to subvert what's left of the free market system in real estate, it may take another decade to find the bottom.

Here's a recent headline for you: "Nine years worth of condos flood uptown Charlotte." This is Charlotte, North Carolina folks. We're not talking about an obvious place like southern Florida, California, or Las Vegas. We're talking about a fairly typical non-coastal American city (I mean no offense to those in Charlotte who believe they are above or below average). Nine years supply at the current sales pace while credit continues to get tighter and unemployment is still rising?!

Banks are now hiding foreclosures and refusing to list foreclosed homes on the market! Even worse, banks are allowing people who stop paying their mortgage to stay in their homes for 2 YEARS OR MORE without taking back the house.

This means that there is an absolutely huge pent-up supply of homes that will need to be sold onto the market eventually. This supply will hit right as the psychology for "investing" in real estate turns seriously south. People will be looking to rent, not buy, and yet an absolute flood of homes will need to be brought to market in this environment. By the way, the ability of people to buy (due to worsening unemployment and and ever tightening lending standards) will have decreased further as this supply eventually makes its way to the market. Many of these homes will be rented, forcing rents to decline as well (which in turn lowers the value of a home for a potential investor looking to buy a rental property).
_________________
Dave

Please feel free to agree with or critique the article excerpts and our comments. Alan Greenspan: Gold and Economic Freedom

[Suresh]

Wall Street Journal: One in Four Borrowers Is Underwater

The proportion of U.S. homeowners who owe more on their mortgages than the properties are worth has swelled to about 23%, threatening prospects for a sustained housing recovery.

Nearly 10.7 million households had negative equity in their homes in the third quarter, according to First American CoreLogic, a real-estate information company based in Santa Ana, Calif.
...
Economists from J.P. Morgan Chase & Co. said Monday they didn't expect U.S. home prices to hit bottom until early 2011, citing the prospect of oversupply.
...
The latest First American data aren't comparable to previous estimates because the company revised its methodology. First American now accounts for payments made by homeowners that reduce principal, and it no longer assumes that home-equity lines of credit have been completely drawn down.

The changes reduced the total number of borrowers under water -- although both old and new methodology show increases from the previous quarter. Using the old methodology, the portion of underwater borrowers would have increased to 33.8% in the third quarter.
...
_________________
Suresh

Please feel free to agree with or critique the article excerpts and our comments. Also, please post excerpts from current articles that you've read and which may help all of us get a more complete macroeconomic big picture.

[Suresh]

Thoughts from the Frontline: The Age of Deleveraging
...
Frank Veneroso noticed something unusual in the latest Federal Reserve Flow of Funds report. They changed their methodology for analyzing housing prices to a model more like the Case-Shiller index, which most believe to be more accurate. That meant they deducted another $2 trillion from household net worth than in the previous quarter. They just caught up with reality, so no big news there. But there is some big news if you look closely.

About one-third of the homes in the US have no mortgages. Typically, these are nicer homes, as the "rich" have paid off their homes. So you can estimate that to be somewhere between 35-40% of the total value of US homes. Writes Frank:

"So now the flow of funds accounts tell us that the total value of residential real estate is $16.53 trillion. The share owned by households with a mortgage is probably $10 trillion to $11 trillion. Total mortgage household debt now stands at $10.3 trillion. In effect, for all households with a mortgage taken in the aggregate, their loan-to-value ratio is now close to 100% and perhaps close to half of them have a zero to negative equity."

The biggest single factor in foreclosures is negative equity coupled with unemployment. That makes sense, because if you could sell your house and get some equity, you would.

As I have written in past letters, we are going to see a significant increase in mortgage resets in 2010, which will result in even more foreclosures.
...
_________________
Suresh

Please feel free to agree with or critique the article excerpts and our comments. Also, please post excerpts from current articles that you've read and which may help all of us get a more complete macroeconomic big picture.

[Suresh]

New York University Prof. Ann Lee notes that U.S. population growth is most notable among lower income households. Because real wage growth has either flat-lined or trended downward over many years, the segment of the U.S. population that is experiencing growth will not be able to afford houses until they come down in price significantly. Further, because excess housing inventory won't be cleared by purchases by the segment of the U.S. population experiencing growth, a large number of available housing units will end up as rentals.
_____________________________________________________________
Credit Writedowns: Alpert: Two years until we see market-clearing prices in housing market
...
Ann Lee and Dan Alpert joined Bloomberg’s Pimm Fox today to talk about the housing market recovery. Lee, a professor of finance at New York University, was sceptical that population growth predicts any substantial increase in housing transactions and prices simply due to the continued pressure on wages and disposable income. and Dan Alpert, managing director at Westwood Capital LLC, said we are not looking at market-clearing prices in the near-term because home ownership percentages need to drop. This process will take two to two and a half years in his view.

[Click here for] Short clip....
_________________
Suresh

Please feel free to agree with or critique the article excerpts and our comments. Also, please post excerpts from current articles that you've read and which may help all of us get a more complete macroeconomic big picture.

[Suresh]

Pragmatic Capitalist: U.S. HOUSING PRICES STILL MORE EXPENSIVE THAN ANY POINT IN LAST 120 YEARS

Today’s chart of the day comes to us courtesy of Robert Shiller at Yale University. The following is Shiller’s famous inflation adjusted home price index. Interestingly, despite a 30%+ decline from peak to trough, housing prices are still more expensive than at any other point in the last 120 years when you exclude the recent bubble era .
...

...
_________________
Suresh

Please feel free to agree with or critique the article excerpts and our comments. Also, please post excerpts from current articles that you've read and which may help all of us get a more complete macroeconomic big picture.

[Suresh]

Calculated Risk: CoreLogic: 11 Million U.S. Properties with Negative Equity in Q2
...
First American CoreLogic released the Q2 2010 negative equity report today.