Buying a home is something embedded in the American economic DNA. Purchasing a home is the biggest financial decision most households will make in their entire lives. In the past the act of buying a home was more of a ritualistic rite of passage; you scrimp and save for the down payment, you purchase a home where your family will set roots, and eventually you will aim for that mortgage burning party. The entire process was accelerated in the last decade to create a perpetual churn. A mortgage was merely a temporary tool in the non-stop property ladder progression to the top. The equation did not leave room for falling home prices or a weakened economy. So we are left with a battle for the soul of US housing. Do we go back to more tested ways of a boring housing market where banks actually verify financials or do we juice up the machine again? The only issue is that the market no longer believes in the new way of financing housing and the government now has to step in to soften the withdrawal with loans such as FHA insured products. Yogi Berra once said it’s tough to make predictions, especially about the future. But the past is set in granite stone. What will the future look like for the American housing market?
The future of American housing
There is little question that the trend to city centers is here to stay:
Source: US Census, Washington State DOT
Yet the entire mission of the suburb does not sit well with a growing population. It does not offer the economies of scale of higher density housing. I find it fascinating that people are willing to commute two horrid hours each way in Southern California traffic just so they can have a giant home out in what is essentially the desert. The fact that oil is getting more expensive is also likely to change the perception of how people view living in a suburb far from their source of employment. With stagnant wages and rising costs of other items like food and energy, people are starting to ask more important questions simply to maintain their current economic state.
The question is complex because even building high density does not guarantee success. What comes to mind are the condominium projects in Miami and Las Vegas. The growth has to be sustained and complicated local economies take years to grow and diversify. Relying on one industry or chasing hot money is destined to produce issues. We are facing this on a nationwide level. The suburb might have made sense with 130,000,000 Americans back in 1940, absurdly low fuel costs, a competitive advantage in global manufacturing, and good jobs for most even high school graduates (1952 unemployment rate of 3 percent). With 313,000,000 people today it might be different.
Low interest rates and a growing population do not guarantee higher home prices or more sales. This is critical to understanding where we may go forward with the housing market:
Data Quick provides a nice up to date trending of many of the biggest markets in the US. The chart above reflects a record low in nationwide home prices and home sales remaining relatively light:
The cycle low for home sales occurred in January of 2009. The cycle low in price occurred this month. I’m fascinated by data like this because it tells us something that goes beyond basic economics. You would assume that with lower prices, the Federal Reserve artificially keeping rates low, and a growing population that somehow sales would be increasing in a significant fashion. It is hard to have price increases when household incomes are stagnant. It is hard to increase home prices when a sizeable portion of jobs are coming from lower wage sectors. That is the danger of pushing rates that are below market levels. It is unsustainable and may not even result in a desired effect because of wider trends.
Mortgage settlement impact
The mortgage settlement may actually push prices even lower. Let us first put the mortgage settlement in perspective. Although $25 billion is a good chunk of change the amount of negative equity in the US currently stands at over $700 billion. The settlement does address some of the issues that caused the shadow inventory to build up over the years. I would like to address a few of the key sticking points in the settlement and my thoughts on what impact they will have on prices.
Point 1 – Reducing principal on loans for borrowers that are delinquent or at imminent risk of default and underwater on their loans. The obvious point here is that this will lock in lower prices but help some home owners stay in their home. The impact will be minimal in my opinion. Keep in mind that of the 2 million active foreclosures, over 40 percent have made no payments in over two years. Will a reduction of say 5, 10, or even 20 percent suddenly cause many of these people to become current on their mortgage? How will they remedy the payments in arrears? Many will not be helped and as we are seeing, banks are starting to move on foreclosure starts to clear out the shadow inventory (although at a very slow pace).
Point 2 – Refinancing loans for borrowers who are current on their mortgage but underwater. Again this will have a minimal impact. 11 million homeowners are underwater so this will free up some money to spend in the economy. But how far will that $25 billion go? As we mentioned, homeowners are underwater by $700 billion.
Point 3 – Short sales. By definition a short sale is a sale that happens when the home is being sold for a price lower than the original balance due. If we use a metric like the Case-Shiller Index that looks at same home repeat sales, this by default will lower prices. For example a home that sold for $500,000 at the peak with a $450,000 loan now sells for $350,000. Impact on prices is likely to push them lower.
Point 4 – Forbearance of principal for unemployed borrowers – reading the settlement it looks like the principal will simply be tacked onto the end of the loan in some form of a zero-interest balloon. This is basically a delaying the inevitable strategy. My guess is this is an attempt to slow down the flood ofshadow inventory that at some point will come to market.
These are some of the key sticking points in the settlement. How is this beneficial to pushing prices even higher? I just don’t see it and the current data with post-bubble price lows simply reflects this trend.
Another major factor is how financially stable young households are since this is the juice that keeps the market going:
This is a somewhat troubling trend. The overall nationwide homeownership rate is 66 percent, back to levels last seen in 1998. The rate of homeownership of those under 35 is 37.6 percent. The peak was 43.1 percent reached in 2006. This is a decline of 12 percent in a few years while the overall rate has fallen by 4 percent. So what is happening here? I think a few things are hitting for this cohort:
–Higher student debt
-Delaying marriage and starting families (for economic or personal reasons)
Overall I think we are going to witness a very different housing market going forward. It is hard to see why prices would be increasing in the next few years given all the above data. A white picket fence loses its luster when you are paying $100 each time to fill-up your gas tank. What the mortgage settlement looks like is a platform to begin moving and clearing out the shadow inventory. How some saw this as a method of boosting prices is hard to understand.