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Thursday, August 25, 2011 1:22 AM

Reader Seeks Help/Advice on US Housing/Economy; How Far to THE Bottom?

Mish Moved to MishTalk.Com Click to Visit.

Reader "Chris" is seeking advice on the state of the economy and the US housing market. Chris asks.

Hello Mish,

I have been reading your blog for a number of months now and I really appreciate your insights on the global economy. I have a more specific question for you in regards to housing.

We are recently married, 25 years old. My wife and I both have fairly solid jobs and we have a small amount of student loan debt. We currently rent a small apartment and have slowly started looking at housing in the Saint Louis area. While we both would like to upgrade our current housing situation, I get very gun-shy about jumping into such a large purchase, especially with the teetering of the economy. Saint Louis didn’t have the large run up in home prices like the coasts have, but there was still a mini-bubble throughout the area.

My concerns are when I read these doomsday scenarios where housing prices collapse and food shortages occur. While I don’t think this is the scenario that plays out, it’s enough to get me thinking about an event like this and I get extremely cautious.

What I’m trying to ask is for your advice/prediction on where the US is headed where housing is headed and what your vision is as the new normal for housing and living standards.

Thanks for your time, and I really enjoy the blog.

Has Housing bottomed? If not, when will it?

Barry Ritholtz at the Big Picture Blog chimed in on the housing bottom question back in April, and in response to Barry's post, Calculated Risk chimed in. I will chime in after taking a look at what Barry and Calculated Risk have to say.

Barry posted his projection in Case Shiller 100 Year Chart

click on chart for sharper image

Based on the Upward Slope of Real House Prices Calculated Risk does not think home prices will fall as Barry suggests.
I've argued that "In many areas - if the population is increasing - house prices increase slightly faster than inflation over time, so there is an upward slope for real prices."

Sure - house prices could overshoot to the downside. But the projection on the first graph of close to 25% in further real price declines is probably excessive. Right now the real CoreLogic HPI is less than 5% above the trend line (it could overshoot), and the Case-Shiller national index will probably decline sharply in Q1 too and not be far above the trend line.
Japan Nationwide Land Prices

Here is a recap of how I have called things.

Flashback March 26, 2005: It's a Totally New Paradigm

Here are some excerpts from that post.
  • Ron Shuffield, president of Esslinger-Wooten-Maxwell Realtors says that "South Florida is working off of a totally new economic model than any of us have ever experienced in the past." He predicts that a limited supply of land coupled with demand from baby boomers and foreigners will prolong the boom indefinitely.

  • "I just don't think we have what it takes to prick the bubble," said Diane C. Swonk, chief economist at Mesirow Financial in Chicago, who was an optimist during the 90's. "I don't think prices are going to fall, and I don't think they're even going to be flat."

  • Gregory J. Heym, the chief economist at Brown Harris Stevens, is not sold on the inevitability of a downturn. He bases his confidence in the market on things like continuing low mortgage rates, high Wall Street bonuses and the tax benefits of home ownership. "It is a new paradigm" he said.
I called the top of the housing bubble in summer of 2005 based on the Time Magazine Cover "Why We're Going Gaga Over Real Estate" and have been updating the chart ever since, in real time.

When was the US Housing Peak?

Case-Shiller has the peak in summer of 2006. I have it in summer of 2005.

Summer of 2005 is correct. Case-Shiller is a lagging indicator. It shows prices on a delayed basis a quarter old. More importantly, Case-Shiller does not look at condos or new home sales.

In summer of 2005 the condo market bit the dust in many places. Also home builders started discounting heavily. Those discounts did not show up in prices for six months or longer. Instead, we saw incentives such as "free" three-car garages, free granite counter-tops, free cars, etc.

In addition, there were massive fraudulent cash back schemes starting in 2005 that overstated home prices. Thus, contract prices did not reflect real costs to buyers for numerous reasons. Real costs were much lower because of incentives and discounts.

Case-Shiller only looks at resales, and those resales did not catch the action in condos, in cash back schemes, in huge incentives, and fraud.

Where Are We Now?

I think housing in some areas is very close to a bottom. Others areas have more to drop.

No Need for Buyers to Rush In

Even if housing is at the bottom, based on inventory, shadow inventory, and boomer demographics, home prices are not going up significantly for a long time yet, perhaps a decade.

There is certainly no reason for buyers to rush. Moreover, anyone with any uncertainties regarding their employment has no business even thinking about buying now.

The global economy, including the US is headed for recession.

Flashback October 27, 2007: When Will Housing Bottom?
The following charts are from a friend who goes by the name "BC".

click on chart for a much sharper image

Housing Starts 1959 - Present

click on chart for a much sharper image

Those looking for a housing bottom anytime soon are likely to be disappointed.

Note that the current boom has lasted well over twice as long as any other. If the bust lasts twice as long as any other, 2012 just might be a rather optimist target for a bottom.
Please compare the above projections with recent charts by Calculated Risk.

New Home Sales

Housing Starts

Humorous Look at 2008 Bottom Calls

While searching for my housing bottom link from 2007, I stumbled across Rebuttal To SmartMoney Housing Bottom Call from May 2008.
Donald Luskin at SmartMoney is making a case that Housing Prices Near or at Bottom
Today home prices have fallen so much, mortgage rates are so low, and personal income is so high — that homes are more affordable today than at any other time, ever — with mortgage payments on the average home eating up about 40% of income.

With houses more affordable than ever before, why should we expect prices to fall much further from here?

Let's put it in concrete terms — jobs. Since the housing market started coming apart two years ago, jobs in the housing sector — broadly construed, to include everything from bricklayers to mortgage brokers — have already declined by over 1.5 million. That's about 1% of the whole national labor force, and it takes housing employment back to where it was in 2000 before the so-called "housing bubble" even got started. Which begs the question: How many more jobs are there to lose in this sector?
When I proposed 2012 as a possible bottom way back in 2007, many people thought the idea was absurd. Certainly Luskin must have thought so.

Well, here we are, less than six months away, prices still falling, and the economy likely headed for another recession.

2012 may still be an optimistic target for a bottom but we are certainly closer to the bottom now than we were than we were in 2007 or 2008.

Rentership Society

Reader Michael writes ...
Hi Mish

Thought you might be interested in this:

I had a neighbor over for dinner a few days ago. He's a solid homeowner, probably with reasonably high equity. Eventually the conversation turns to business health and the economy, housing, etc. His completely un-solicited comment was, "It's better to rent." I think my jaw hit the floor.
Signs Signs Everywhere a Sign

That is a sign we are far closer to the bottom than the top (look at my chart closely). Indeed some areas likely have bottomed.

Now let's return to reader "Chris".

I have no idea whether St. Louis is one of the areas that has bottomed or not. I can say we are back in conditions where it makes sense to assume in some locations there are reasonable values, perhaps even good values.

However, I repeat my caution: In general, housing prices will not go much of anywhere for a decade even though local conditions can vary widely. There is no need to rush to buy, even if the bottom is in.

My general advise stated last year still applies.

  • If you want a house and can afford a house
  • If you are fully prepared for the loss of a job
  • If you have six months (preferably a year) cash cushion of living expenses sitting in the bank
  • If you are prepared for reasonable losses (say 15-20% or so) .....

Then buy a house.

I am simply attempting to be realistic. I expect little to no "real" appreciation for a decade in most locations. Yet, residential real estate in good neighborhoods with good schools can easily outperform many other assets, especially the overvalued stock market.

As for food shortages and other hyperinflationist claptrap reader Chris asked about, I suggest people stop reading sites spewing such nonsense.

The irony is that if hyperinflationists are right, hard assets and housing should do splendidly.


Here are some common-sense thoughts from reader "Fedwatcher"
House prices will continue to decline in many high price areas. Some areas have already hit bottom. How do you tell? Well the fundamental value metrics are the cost to rent the house and the cost to build the house. Or rental equivalent and price per square foot. A two by four is a two by four and that cost will rise slowly. Rent is LOCAL and depends on employment. Then there is transaction cost - figure 10% to move from A to B.

Thus, if your attachments to the community are strong and you can see yourself in that house 10 years out, buy. If only 5 years out rent. In all cases you must factor in a long period of unemployment by one of the two incomes. Factor in 1 year at a minimum, that is take the bigger of the two salaries and assume it goes away for a full year. Finally since if you have to sell, it takes time and costs at least 6% to exit, can you afford that hit? You must assume that in today's market that price appreciation is negative in real terms. In some areas it is positive in nominal terms.

Owning has many "hidden costs" such as a new furnace or a new air conditioner or a new water heater or having your place put in a flood zone requiring you to buy flood insurance. Loans have covenants requiring that you have various forms of hazard insurance. If you do not buy it, your lender will and tack it onto the bill.

Realtors only show you an optimistic version of the costs. Realtors also show you houses that you qualify for, but not necessarily houses you can really afford.

An investment in a PC and learning how to use Excel is step number 1. You need to run the numbers.
Mike "Mish" Shedlock
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