Wednesday, June 30, 2004

Housing Boom to Roll on for Years

By David S. Jones, Real Estate Center

Surely you’ve heard about the housing boom. It’s been in all the newspapers.

At the beginning of the 20th century, less than half of all Americans owned their own homes. Today, low interest rates have pushed homeownership rates to a record 68 percent, and that figure is still climbing. Experts say it will exceed 70 percent by 2013.

Millions more new homeowners are coming down the road. As many as 1.63 million new households could be formed every year for the next decade. That translates to 2.17 million new homes needed annually.

Most of the new homes — 72 percent — will be conventionally built, single-family dwellings. Multifamily units will account for nearly one-fifth, and manufactured homes will take up the slack.

These new waves of homebuyers will find homes cost more than they do today. No surprise there. Prices should appreciate an average of 5 percent per year from 2004 to 2013. And in those places where land-use restrictions and regulations reduce the amount of land available for new homes, homebuyers could rise an average of 6 percent annually.

In a new report, “America’s Home Forecast: The Next Decade for Housing and Mortgage Finance,” six noted economists look at housing in the years ahead. They paint a picture of a housing sector continuing to drive the economy, creating millions of jobs and generating billions of dollars in wages and tax revenues each year.

Ten years from now, experts say 24 million more homebuyers will be enjoying their first homes. In the coming decade, America’s families could need 125 million mortgage loans for home purchase or refinancing. That’s some $27 trillion in mortgage originations.

At the end of last year, America’s homes had a whopping market value of $15.2 trillion, the most ever. That’s one-third higher than it was just three years ago. At the same time, equity in American homes reached $8.4 trillion.

“The dramatic strength of the housing sector in recent years clearly was fueled by historically low interest rates, strong increases in house values and very positive demographic trends,” notes the report. “In the spring of 2004, the overall economic expansion appears to be gaining more strength and better balance, and interest rates are bound to move up to some degree as the U.S. economy grows at an above-trend rate and as slack in labor markets is reduced in the process.”

The authors of the report do, however, see some challenges that need prompt attention. They see increasingly stringent land-use controls pushing up house prices, impairing affordability in some areas. Also, increasing strains on the long-term federal budget may threaten programs that provide affordable rental housing for low-income households.

Some worry that proposed regulations could impair the secondary mortgage market. Also, an increasingly diverse population will challenge homebuilders, real estate professionals and the housing finance sector to meet differing expectations and needs of a growing number of foreign-born households.

Lastly, the report’s authors are concerned about the “glaring and persistent gap” between homeownership rates for non-Hispanic white households and racial and ethnic minorities.

Thursday, June 24, 2004

The Ever More Graspable, and Risky, American Dream

New York Times

NAHEIM, Calif. - For years, Ray and Shahrazad Daneshi sought to buy a home, only to be told that they did not earn enough to qualify for a mortgage. But they recently managed to buy a small house in the shadow of Disneyland for $360,000 - six times their annual income - thanks to a lender who allowed them to borrow the entire value of the home, with no down payment.

"We will not be going to any movies or eating out at restaurants," said Mr. Daneshi, a self-employed wedding photographer who came here from Iran in 1988. "But in two years, the house will be worth a lot more and we will have something to show for it."

The Daneshis' purchase underscores the new, ever-optimistic economics of home buying. A kaleidoscopic array of mortgages for people with little cash or overstretched budgets has enabled families of modest income to take on debt that once would have been beyond their reach. As long as new home buyers could count on rock-bottom interest rates and housing values were going nowhere but up, this seemed to be a virtuous circle.

But now, with the Federal Reserve expected to embark on a series of interest rate increases starting with its meeting on June 30, some experts worry that recent first-time buyers could find easy home ownership a lot harder on their wallets, possibly causing housing prices to wobble in some high-price markets.

With the Daneshis, for example, rising interest rates on the two adjustable-rate mortgages they took out to buy their house would mean that their monthly payment of $2,500 - already more half their monthly income - could go up substantially in two years. Mr. Daneshi realizes that, but is unconcerned.

"Why worry?" he said, adding that he believes rising home prices will help him obtain a better loan deal by then.

With interest rates going up, that may be wishful thinking. Most analysts agree that there is no nationwide housing bubble because housing prices have climbed only slowly in the Midwest and the South, even as they have soared on the East and West Coasts. Still, if rising interest rates cause housing prices to drop, even slightly, industry officials warn that some new buyers will have no equity in their homes and could choose to walk away from their loans if they run into trouble with payments.

"A lot of these loans are dangerous," said Allen Jackson, manager of Bristol Home Loan in Bellflower, Calif., a mortgage broker who specializes in so-called subprime loans, which charge higher interest rates to people unable to qualify for traditional mortgages. "If you have any dip in values, people can just say the heck with it because they don't have any of their own money in the house."

Lenders have aggressively encouraged home buyers to stretch in ways that would have been unimaginable a decade ago. In the new world of flexible mortgage lending, it is possible to buy a $600,000 house with no down payment, and to pay only interest and nothing on the principal for years.

"The financing has changed everything," said Humid Karat, a manager of Tarbell Realty's office in Anaheim. "Ten years ago, if I offered to buy your house with a 100 percent loan, you would have called it 'creative financing' and thought I was crooked. Today, everybody wants a 100 percent loan."

The volume of subprime mortgages, primarily for people with poor credit ratings, has risen sharply, as indicated by securities backed by the mortgages. Such securities soared to a total of $195 billion in 2003 from $17 billion in 1995, according to Inside Mortgage Finance, an industry research firm in Bethesda, Md. Securities backed by unconventional mortgages, like no-money-down loans, climbed to nearly $80 billion from less than $1 billion.

"Underwriting standards have loosened to almost historic levels," said Bill Dallas, a pioneer in no-money-down loans and a board member of the California Mortgage Bankers Association. "Nobody is heeding the yield signs."

Experts say these novel techniques have democratized the access to credit and home ownership. The overall rate of ownership climbed to nearly 69 percent in 2003 from 64 percent in 1994. Home ownership among blacks rose to 48 percent from 42.2 percent. Among Hispanics, it was up to 46.4 percent from 41.1 percent.

But the experts worry that problems may be just over the horizon, especially in markets where housing prices have risen far faster than personal income. Here in Orange County, one of the frothiest markets of all, the median price of a single-family home is $572,000, up 28 percent in the last year alone.

In the New York area, the median home price - half were less expensive, half more expensive - rose 88 percent from 1998 to 2003, to $353,000 from $188,100; in Miami, prices jumped to $226,800 from $121,500. The median home price for the Washington area increased to $286,200 from $172,100.

Signs that the frenzy has not yet reached a peak abound in Southern California. In Ladera Ranch, a planned community in the southern part of Orange County, more than 1,000 people are on a waiting list for the chance to buy one of 27 unbuilt three-bedroom houses at prices starting in "the low $400,000's." In San Bernardino County, where some commute as long as two hours a day to jobs in Los Angeles and elsewhere, a five-bedroom tract house that sold for $378,000 a year ago is on the market again for $609,000.

Mark Zandi, chief economist at the research firm, estimates that about a third of the nation's housing is now overpriced and poised for at least a mild drop in values as the Fed begins to push up rates.

And there is a risk that the situation could turn into something a lot worse. "If there is a fissure in the economic system, it's in housing," Mr. Zandi said. "This is a big, rapidly growing market that has not been tested by higher interest rates. Many people got into their houses by the skin of their teeth."

Southern California is at the leading edge. People with poor credit ratings or low incomes can take out subprime mortgages at high interest rates. Those with good credit but erratic earnings can get what are called no-document loans, in which they do not have to prove their incomes.

By any measure, such innovations have vastly expanded the availability of credit over the last decade, making it possible for people previously shut out of the market to share in the dream of home ownership.

"Thanks to God for finding me a mortgage program that let me buy my own house," Mr. Daneshi said.

He and his wife, a seamstress at Disneyland, had lived for years in a cramped apartment with their autistic son. They took out two mortgages this month, one for $280,000 at 6 percent and the second mortgage for $80,000 at 10.25 percent. Both are adjustable after two years, and the payments are virtually certain to rise, meaning that their budget will be further pinched unless their income rises, too.

And they are hardly alone in stretching.

Mark Christian, 33, a controller at a stock brokerage firm, is buying a four-bedroom house for $620,000. Mr. Christian, who earns $160,000 a year, is also borrowing the entire purchase price. To keep his monthly payments down to $3,700, he is taking out an interest-only loan.

Mr. Christian is already bracing for higher monthly payments. His mortgage will adjust to prevailing interest rates after three years, which he expects will be higher. "I'm figuring that my income will have climbed by then as well," he said.

House prices have climbed so rapidly in the last few months that banks are refusing to appraise some properties as high as their selling prices.

Jennifer Tracy, a graphic designer, recently agreed to buy a condominium in Los Angeles for $235,000. But the same property had exchanged hands less than a year before for $114,000, and no appraiser would value it at more than $195,000. Ms. Tracy bought the condo anyway, but only after coming up with the extra cash to bridge the gap.

The big question is whether prices will remain so high once the Fed begins raising interest rates.

Real estate agents and many homeowners here vividly remember that Southern California housing prices soared in the 1980's and then fell in the early 90's - the bubble ruptured by a combination of rising rates and a severe contraction in the region's aerospace and armaments industries.

Today, interest rates are clearly heading up, but employment is climbing and economic growth appears strong. As a result, the Fed is widely expected to start raising rates at the end of this month, and some analysts worry that it may have to raise rates more sharply than originally planned to keep inflation under control.

Mr. Zandi, of, said that in overheated markets like Southern California, housing prices could easily drop at least 5 percent.

Mortgage brokers who help people qualify for bigger loans, acknowledge that they are nervous. But for the moment, they are pressing ahead.

"What can I do?" asked Mr. Jackson, the manager of Bristol Home Loan, the subprime loan specialist. "My job is to help people realize the American dream."

The Perfect Real Estate Storm

by Blanche Evans, Realty Times

Rising consumer debt, rising interest rates, inflation, low job and wage growth and many other factors are swirling together to form a housing slowdown. But there a few other factors that are adding to the winds that could create the perfect storm - the largest housing recession in modern history.

Take a look at the storm conditions.

Top economists from Alan Greenspan to the National Association of Realtors researchers are telling the public that housing will "flatten," either in sales or prices, respectively. Flat housing prices and sales means that buyers are more at risk in their housing investments because homes will cost more in a rising rate environment, and their liquidity is effected when they can't sell as quickly or for as high a profit.

To a buying market that is used to jumping in and out of properties like daytraders do stocks, this is unwelcome news and a good reason to sit on the sidelines and wait for better conditions. And that's exactly what's happening in many markets across the country, particularly in areas that overheated in the mid-90s like Atlanta, Seattle, Dallas, Austin, and other techno-centers. Which markets are vulnerable next? Las Vegas, San Diego and other multiple-offer capitals that have attracted jobs because of housing, not residents because of jobs.

According to The Harvard Joint Center For Housing Studies' "State of the Nation's Housing 2004 Report," housing has weathered such events as an international financial crisis in 1998, a recession in 2001, and the job depression of the new millennium. The economy and homebuyers benefitted from record low interest rates which helped offset rising prices. In 1989, when an average-priced home in the U.S. cost $211,900, the mortgage interest rate averaged 10.1 percent, notes the report, while in 2003, the average-priced home cost $243,400 and the interest rate averaged 5.7 percent.

But homebuyers in 2004 are facing a set of conditions that previous generations have never had before in the aggregate. National news, economic conditions, lending and borrowing conditions, and buyers' expectations, and much more are creating a perfect storm of conditions that separately and combined could flatten the existing housing market, and impact new homes as well.

On the positive side, the National Association of Realtors (NAR) predicts a record in 2004 for existing home sales of 6.17 million. Chief economist David Lereah predicts that growth in jobs will reach 3 million, dropping unemployment to 5.3 percent nationally. He also predicts that median home price appreciation will slow to 5.4 percent at $179,200, while median new home prices will grow by 7.9 percent to $210,400.

But some markets such as Dallas are reporting that since May, when interest rates rose in earnest, housing sales have fallen off a cliff. New home starts are slowing, and the National Association of Home Builders has already noted a drop of two points in the builder housing index, an index of builder sentiment that fewer people are looking at model homes. Normally, that indicates less interest in housing in general, and that could be bad for the existing housing market.

In other words, there is a calm before a perfect storm brewing in real estate that is being whipped by more wind than rising interest rates.

National and economic news

  • Jobs - Despite recent reports of hundreds of thousands of jobs gained, we have experienced the longest period of job loss since the Great Depression through the first half of 2004. Some housing experts are predicting that a slowing housing market will further hurt economic gains by hurting or eliminating employment related to housing such as mortgage lending, real estate sales, furniture sales, building, contracting, moving, and other jobs. A stagnant housing market means less spending in other areas, as interest rates rise and the cost of borrowing money means less discretionary spending.

    All this puts severe pressure on housing prices. UCLA economist Ed Leamer told the San Francisco Chronicle, that the most likely event is that "we have another recession in 2006, with significant problems in the housing sector."

  • Ongoing terror threats - The Presidential election, the Olympic Games, the rising stock market, the Iraqi prison scandal, and other events are tempting targets for terrorists. With interest rates their lowest in 30 years, the FED has nowhere to go (i.e.interest rate cuts) if another terrorist strike annihilates consumer confidence. The country could plunge back into deflation, where the cost of consumer goods goes down because no one is buying. A more familiar word for the same situation? Depression.
  • Alan Greenspan's housing-flattening comments - On Tuesday, June 15th, 2004, Federal Reserve Chairman Alan Greenspan testified to U.S. senators, "We perceive that the very strong expansion in new and existing home sales is now flattening out. And the really quite unexpected boom in home sales over the recent years is unlikely to be continued. Our forecast is generally flat, not in prices but in aggregate volumes. Where house prices go, I'm not sure, but I would be quite surprised if they showed continued acceleration on the upside."

    This is not music to the ears of homebuyers who don't intend to stay in their homes long enough to ride out the storm. Most prefer a daytrader environment for homebuying. If they can't flip homes quickly and easily for profit, then they'll sit out the home investment dance and put their money in the stock market instead.

  • Inflation: Typically, housing offers homeowners gains of only a point or two above inflation, but according to the U.S. House Price Index (HPI), housing has exceeded the overall inflation rate by more than 40 percentage points over the last eight years. Unfortunately, salaries haven't inflated at the same rate. At some point, buyers have to back away when low interest rates, easy credit and other favorable lending can't get them into the house of their dreams.

    Inflation is impacting other consumables. Milk has doubled in price and gas prices have reached new highs in the last two months. If you assume that all consumer goods and services will rise similarly, then it's easy to imagine that higher interest rates won't be the only thing to daunt homebuyers. They have to recalculate the basics in their budgets to a figure they can't predict. Good-bye inflation-free economy. Hello, more nasty surprises to come at the supermarket, pharmacy, gas station,and everywhere else people spend money.

  • Housing affordability: The Harvard Joint Center For Housing Studies, State of the Nation's Housing 2004 found that despite record home ownership of 68 percent and recent job creations, that most workers in America do not make enough income to afford "even the most modest housing."

    Nationally, the NAR's housing index for April, 2004, the latest month for which there is information, shows "the nation's typical household had 144.0 percent of the income needed to purchase a home at the first quarter median existing-home price, which was $161,500." This optimistic stat was taken before interest rates rose a full point.

    One in six homes in the U.S. are sold in California, so when housing affordability is an issue there, it impacts housing across the nation. A recent June report stated that less than 20 percent of households can afford the median-priced home in California. The minimum household income needed to purchase a median-priced home at $453,590 in California in April, said the report, was $102,550, based on a typical 30-year, fixed-rate mortgage at 5.42 percent and assuming a 20 percent downpayment.

  • Overburdened consumer: According to bond fund manager Bill Gross as interviewed for CNN Money, consumer spending accounts for two-thirds of gross domestic product, and we, the people, are already in too much debt. Interest rate increases could slow consumer spending, which could lead to further job loss. The nation and the world could also be overreliant on consumer spending to lead the nation's economic recovery because terrorism, inflation, and higher interest rates may sideline corporations from giving pay raises, adding jobs or spending to expand infrastructure, according to a recent Duke University study of over 200 CFOs.
  • Debt service: According to CBS Marketwatch chief economist Dr. Irwin Kellner in February 2004, consumer debt has reached a record $9,185 billion, or 110 percent of "people's take-home pay adjusted for inflation, also a record. "Ten years ago, household debt equaled 85 percent of disposable personal incomes; twenty years ago it was 65 percent." The reason debt service is so much higher now is floating interest rates, rates that can change, and make it much more difficult for households to service existing debt. As an example, he notes that the "Mortgage Bankers Association reports that the share of new mortgage applications to be financed by adjustable rate, or ARM, jumped from 13.5 percent in January 2003, to over 30 percent by yearend. Currently 40 percent of consumer debt is based on floating rates. What will happen when those favorable rates go away?

    Home loans and the equity picture

  • Easy loans: Lending products have burgeoned that allow buyers to get into homes with little money, poor credit, and other conditions that weren't present when most housing was built in the 50s and 70s. The gold standard 30-year-fixed loan is now being dissed by no less than Mr. Greenspan as a waste of money when other more appropriate loan products are available, such as ARMs, hybrid loans, and interest-only loans. The problem is that these are lower cost-higher risk loans that could snap back in the faces of homebuyers should a housing recession occur when the terms of these loans are due.

    This alone is impacting the older housing market. The older home seller, who perhaps had to save for years to make a down payment on a first home and spent years in the home before it generated even modest equity, is no match for today's buyer who can buy earlier in life, with little money down, with much more relaxed loan to debt ratios, while enjoying 40-year low interest rates. That makes buyers exposed to much more luxury than they otherwise would be able to afford, which is why they are a lot more picky about what they spend someone else's money on.

  • High tapped-equity asking prices: According to Dean Baker, an economist and co-director of the Center for Economic and Policy Research (CEPR) in Washington, DC, people are borrowing against their houses at a scary rate. "The fact that people are borrowing against their homes at a rapid rate (more than $750 billion in 2003) is more evidence of an unsustainable bubble," writes Baker in his column "Alan Greenspan's Second Bubble." "The ratio of mortgage debt to home equity is at record highs. This fact is especially scary given that equity values may be inflated by as much as 20 to 30 percent as a result of the housing bubble, and that the nation's demographics (with the baby boomers approaching retirement) suggest that many homeowners should have largely paid off their mortgages."

    If these homeowners have spent their equity on credit card debt, vacations, college tuitions and not improved their homes, that gives buyers all the more reason to punish asking prices by demanding more repairs, more improvements, or by ignoring unimproved homes on the market until they sink in price to investor-pleasing levels.

Some of these conditions have existed before. Inflation was slowed by rising interest rates that capped at 19 percent in the 1980s, but homebuyers weren't facing higher costs along with on-our-own-turf terrorism, crushing consumer debt, and the worst job market in decades, along with all these other factors at the same time.

That's why it is conditions in the aggregate that point to a perfect real estate storm, not rising interest rates alone.

The conditions listed above are quantifiable and verifiable, but there are many other factors that also will impact real estate. Find out tomorrow what those are in the next edition of Realty Times, when 'Other Winds Building The Perfect Real Estate Storm' will be featured.

Published: June 24, 2004

Wednesday, June 23, 2004

Why Rising Interest Rates Will Hammer Housing

by Blanche Evans

For many areas around the country, buyers are way ahead of Alan Greenspan. Sales are already "flattening out" as the Fed chief predicts will happen, because buyers in many metros are beginning to assess their risk and deciding it's too high. Overheated housing markets such as San Diego are beginning to report mild rises in inventory and longer days on market, signals that the housing frenzy may be abating, while buyers' markets like Dallas are sinking further into apathy with every 1/8 point rise in interest rates as buyers decide that affordability is a bigger factor than opportunity.

New loan products and a relaxed lending environment, a lousy stock market, favorable tax laws and above average house sale returns, among other conditions have encouraged record homeownership to 68.6 percent last year. But many homeowners may get stuck in properties they can't sell if the nation sinks into a housing recession.

There are just as many factors on the negative side of the housing column to suggest that could well happen: rising interest rates, record consumer debt service, lack of real job creation, fears over terrorism and the coming election, to name only a few.

Every eighth of a point rise in interest rates impacts buyers' open-to-buy by adding as much as $25 or more per month to the monthly payment, depending on loan type. Consumer debt has reached 110 percent of disposable personal incomes. Despite a pace of three million new jobs created by year's end, unemployment figures are flat at 5.6 percent, if down from last year's peak of 6.3 percent. But, that figure is still 1. 6 million less than the number of jobs lost since 2001. Further, many new jobs don't pay what previous jobs did, according to the Economic Policy Institute. And, a 2.2 percent gain in earnings this year holds little comfort to those paying 35 percent more for a gallon of gas or double the price for a carton of milk, and eight percent more for housing nationally.

A primary but undocumented factor is the change in attitudes buyers have about homeownership. Homes, in the "new economy," are no longer a place to live, but an investment. Many homeowners have adopted a kind of daytrader mentality toward their abodes, flipping homes for hefty profits, using their bankers' money. Other homeowners have cashed out their equity to service other debts or to make improvements. Many have purchased their homes with so little down that they can't afford to sell except at an inflated price.

Never before has the home been such a crucial instrument of financial leverage.

The prevailing notion among sellers is somehow that buyers should pay them for having made such a clever investment. Further, sellers believe they are entitled to sell at a profit - they want to get paid for occupying the home, even if it was for a short amount of time and their largesse is due to bankers' goodwill. Making no sense, but a factor, nonetheless, is that many homeowners who were burned in the stock market meltdown of 2000 believe they should be able to make those gains back with their housing investments. This is particularly true of retirees and empty nesters.

Since 1980, according to the National Association of Home Builders, "home prices on average have increased around five percent annually and have never shown an annual loss." In fact, the housing market has been so good over the last eight years, that many homes have appreciated as much as 40 percent on average.

No wonder sellers have come to expect profits on their homes. And that's the key word here - expectation.

But buyers have expectations, too. They expect to realize equity, too, and now they are being told by the nation's most powerful economists that housing appreciation is slowing, interest rates are set to rise, and that job growth will offset rising housing prices.

But for many the reality is different from the national statistics. Nationally, markets differ. California may be in a housing boom, but Texas is not. And booms turn into busts sooner or later.

With interest rates rising, home appreciation is expected to slow, according to National Association of Realtors' economists. Buyers will want to be rewarded for buying in markets where slowing or flat home appreciation means more risk to equity-building.

They not only don't want to pay the seller for occupying the home, they want some of that unrealized equity for themselves. They aren't as swayed by arguments that lending rates are at 30-year-lows as they have been, because interest rates have hovered at low levels for over six years. All they know is that they are paying a point more in interest than today than four months ago, and that alone should slow housing sales in many markets. Another point, and housing will come to a halt. Not only will housing become too expensive, but so will debt service on other debts.

If buyers are going to become homesellers one day, they want the same thing current homesellers have received for the last eight years - instant equity. But equity can only be built with rising home values over time, because all loan products pay interest to the lender with little or no reduction in principle for years to come. If housing values go flat, it takes more time to build equity, and with the average homeowner staying only four to seven years, that isn't enough time to step over a flat or declining market. And there is the risk that a future selling environment could call for homeowners to bring money to closing, as happened to many homeowners in the late 80s and early 90s.

Buyers may recognize the signs that, suddenly, the conditions that favored homebuying are beginning to lose their underpinnings. Rising interest rates, a rising stock market, advancing inflation, sluggish job growth are all present. The high hopes of many economists who say that housing won't be significantly hurt by rising interest rates and slowing housing appreciation, are gambling that job growth will outpace inflation, and so far there's no indication that is happening.

And then there's human nature. No one wants to buy high and sell low. To get buyers to buy in that kind of a market, they have to be convinced that their risk will be rewarded, and there are only a few ways to do that since the simple joy of homeownership is no longer enough to get investment-conscious buyers to take the plunge.

What rewards them are incentives to buy - discounts, concessions, and upgrades.

The best way to reduce risk, they may come to believe, is to do what worked for them in the stock market - sit on the sidelines to get a better deal. Deals may seem few and far between while interest rates rise, reducing affordability and the range of qualifying loans, and while sellers hold on to high prices.

That leaves buyers no choice but to pressure sellers to give up some of the inflationary increases in their home values over the last few years. Buyers will put more pressure on sellers to reduce the price of their homes and to accept contracts with contingencies, along with ordering more repairs, and demanding more improvements.

The inability to build equity in a home means there is risk in liquidity, and that is the biggest factor to hurt housing sales. Housing and the stock market will change places as the stock market moves back in favor, and rising interest rates makes housing look less favorable. Just as stock buyers did in the stock market, housing buyers can afford to wait on the sidelines and buy on the dip.

Published: June 23, 2004

Monday, June 21, 2004

Strategies for Survival After the Housing Boom


June 21, 2004 -- It's been a great run.

In the past five years, home prices nationwide have climbed an average of more than 40%, according to one popular measure -- and more than 75% in some areas, including Boston, suburban New York and San Diego. Homeowners have tapped that equity to take vacations, buy second homes and build up their nest eggs. They have counted on rising home prices to bolster their future -- and shore up their present.

But now homeowners have to face a new reality: The party can't last forever.

Over the next five or 10 years, analysts say, home prices are likely to yield a less-impressive return, while the market slows to catch its breath.

For home buyers, that prospect presents a new set of challenges. In the recent past, diving into real estate was a no-brainer: Interest rates were low, and there were precious few other ways to safely invest money. It was hard to go wrong -- no matter where you bought a home.

Now, some of the forces that made housing so attractive have faded. The stock market has improved, and home-price appreciation has slowed across the country.

The good news is that few economists believe the housing market is about to crater. On the contrary, the available evidence suggests that home prices will continue to appreciate in most cities, although at a slower pace than before. Michael Sklarz, a widely followed home-price analyst in Honolulu, says that over the long haul, home prices on a national basis invariably rise at a pace slightly faster than inflation. Even so, with home values having run well ahead of inflation in recent years, he predicts that prices will rise only half as much in the next decade as they did in the past one.

That doesn't mean it will be impossible to make a good investment in real estate. It just means it will take a lot more work to do so. Here's a look at some of the economic and demographic forces that will drive the housing market in coming years, and how you can navigate them to your advantage.

Income Growth

From 1980 to 2001, median incomes in the U.S. rose 138%. Home prices rose almost exactly the same amount: 136%. A coincidence? Hardly. Over time, home prices move in lockstep with incomes, because incomes help determine how much a consumer can spend on a home. The relationship isn't always so clear in the short term, as builders add more supply if demand rises, and hold back if demand falls. But in general, if home prices grow faster than incomes, houses will then become unaffordable, and that will force a slowdown in price appreciation until the market balances out.

That's what homeowners could face in the next several years. From 1996 to 2003, incomes rose 22%, while home prices climbed 47%. In some cities, the gap was even wider. In Boston, for example, incomes rose 40%, while home prices shot up 120%. In San Diego, incomes rose just 31%, compared with a 142% run-up in home values.

Low interest rates have helped mask the problem by lowering home buyers' monthly mortgage payments. But sooner or later, incomes will have to catch up, especially if interest rates rise.

What should home buyers do in the face of an income gap? If you're a short-term investor with plans to buy a home and sell it again in a year or two, you should steer away from cities where the gap between incomes and prices is widest. That includes many cities in the Northeast and in California, which could face more harsh corrections in the short run.

But if you're looking to hold onto a house for many years, the Northeast and California often are smart places to buy. Even though their price-to-income ratios are out of whack now, many cities in those areas tend to have fast income growth over the long haul. The same is also true of many Sunbelt cities, like Atlanta. That means their prices will have more room to rise over a long stretch of time.

This doesn't mean you should necessarily target neighborhoods that have high average incomes. What matters is the rate at which the incomes are rising, not the amount of wealth that's already there. After all, income growth can easily stagnate in posh parts of town when an economy goes south. Often, the best investments are made in transitional neighborhoods that once were economically distressed but are now enjoying rapid income gains due to new investments -- and new jobs -- in the area.

Interest Rates

Perhaps no other factor has pushed home sales and home prices higher in the past decade than the long-term decline in interest rates. Consider: In 1981, the interest rate for a 30-year, fixed-rate loan averaged 16.63%. The monthly payment for a $200,000 mortgage at that rate was $2,800 a month. Today, the average rate is about 6.25%. For the same $200,000 loan, that translates into payments of less than $1,250 a month. It should hardly be a surprise, then, that Americans bought more than one million new homes last year, up from just 436,000 in 1981.

The problem now is that interest rates are more likely to rise than fall. The economy is rebounding, inflationary pressures are beginning to appear, and the federal budget deficit is growing. All of these forces suggest rates will climb over the next few years.

Of course, no one expects rates to return to anything remotely close to the levels seen in the 1980s. But even a slight rise in interest rates could knock some buyers out of the market. If rates go to 7%, that would add $1,000 or more annually in payments on a $200,000 loan.

Also, as interest rates rise, more Americans will likely choose to rent their homes rather than buy. Because so many people bought homes in recent years, there is a now a large surplus of apartment units, and their owners are eager to deal. As more families take advantage of those deals, housing could slow further.

Real-estate agents will tell you that a rise in interest rates will be offset by an improved economy, which should inspire more buyer confidence -- and more home sales. That may be true, but only to a point. As the recent business cycle proved, housing can rise to new heights during a downturn, and it needn't boom during an economic rebound. Prices were nearly flat during the first several years of the rebound in the 1990s.

For buyers, one way to mitigate the pain of higher rates is to apply for an adjustable-rate loan that starts with an unusually low rate, then adjusts higher later if interest rates keep climbing. But that increases your risk later. For investors, it's worth noting that properties in affluent neighborhoods tend to be less vulnerable to rate increases, since wealthier buyers can more easily afford higher interest costs.

Then again, if you're not set on owning a home right away, you might just want to wait -- and rent. True, you'll be missing out on the current low interest rates. But you'll probably get a good deal from your landlord, and save yourself the headaches of worrying about you home's value when rates rise. You can always buy later, and then refinance the mortgage once interest rates come down again.

An Aging Population

In 1970, the median age in the U.S. was 27.9. Today, it's 35.5.

Real-estate agents often say this is good news for housing. The older a person is, the thinking goes, the more likely he or she is to own a home. So as America ages, there should be more home sales.

Unfortunately, that's not necessarily the case. Older Americans are less likely to move than younger people, and they don't form new households that didn't exist before. In the 1970s, the number of new households formed each year -- a key indicator of housing demand -- soared to 1.67 million. In this decade, as America gets older, household formation is expected to sag to an annual average of 1.27 million.

The good news is that the potential drag from an aging population is probably less of a factor now than in previous generations. Indeed, some analysts even believe older Americans will be a net positive for housing in this decade. People in their 40s, 50s and 60s today are wealthier than their predecessors, and healthier. So they're more likely to buy second homes. They're also more likely to move to new, often smaller, homes when their children move out.

For investors, the best way to benefit from an aging population is to think about buying in areas that will benefit from baby boomers' migratory patterns. Popular locales for retirees, including Florida, Texas and Arizona, should all get boosts from retiring Americans. States that are less popular among seniors, including Rust Belt states like Ohio, could suffer. Meanwhile, certain houses -- even in the top retiree states -- could become harder to sell. The giant McMansions so popular today could become more difficult to unload a decade from now, as baby boomers downsize into smaller homes.

You might also consider buying a home in one of the growing number of "active adult" communities around the country that cater to older buyers. These include the well-known Sun City and similar developments in Arizona, Texas and elsewhere that offer golf courses, community centers and other amenities for young retirees.

Meanwhile, if you're planning to fix up your home, ask an architect for tips about ways to make the house more accessible for older buyers. Some architects specialize in "aging in place" designs that allow older owners to live in homes longer by reducing clutter, widening passageways and adding grab bars and railings. If you're trying to target an older buyer, some of these modifications can greatly increase your home's value.

Of course, a decade from now all of this might not matter: By then, the children of the baby boomers, known as the echo boomers, will be coming of age as home buyers. When that happens, household formation should pick up substantially.

Immigration Trends

One reason an aging population didn't hurt housing in the 1990s is that immigrant and minority home buyers barreled into the market as never before. In the 1990s, more than nine million people immigrated to the U.S., compared with an average of 3.3 million a decade in the 1950s, '60s and '70s. Many of those immigrants ultimately bought homes, offsetting the loss of demand from an aging population. Meanwhile, an ever-larger number of minority home buyers bought homes in the 1990s with the help of new mortgage programs created by quasigovernmental agencies Fannie Mae and Freddie Mac.

Can the boost from immigrant and minority buyers continue? Many analysts believe it will. For one thing, the homeownership rate for African-Americans is 49.3%, far lower than the 75.5% rate for non-Hispanic whites. That implies there's a lot of room for minority homeownership to grow.

Even if immigration slows in the coming years, the market should continue to get a boost from those who entered the U.S. in the 1980s and 1990s. Most immigrants don't buy their first homes until they've been in the U.S. at least five years, and often even longer, meaning that the full impact of the 1990s immigration surge hasn't even been felt yet.

Investors who want to benefit from rising immigration rates should target transitional neighborhoods with large immigrant populations. Often, this will require focusing on fixer-upper properties that can be bought at a reduced price and then rented out while the neighborhood's income levels rise. Such properties can be more difficult to manage, but they often provide a steady income stream and above-average appreciation.

It will also be necessary to familiarize yourself with the latest mortgage products for first-time buyers, as well as any mortgage brokers and real-estate agents nearby who specialize in working with immigrant buyers. They can be ambassadors of sorts to help you better understand the nuances of dealing with immigrant buyers, many of whom might not speak English or understand the ins and outs of the U.S. mortgage-finance system.

But investors should be wary of some risks. If interest rates climb significantly, first-time home buyers -- including many immigrant families -- would be among the hardest-hit. It's also possible that lenders could reduce the availability of credit to these borrowers if a recent rise in delinquencies for certain loans continues.

Availability of Credit

Dramatic changes in the mortgage market during the past 10 years made it easier for borrowers to get home loans. Using sophisticated risk models, lenders were able to offer credit to borrowers with lower down payments and higher debt levels. At the same time, advances in loan-processing technology made the loan-approval process easier, faster and less expensive.

One big question is whether these innovations will continue to fuel expansion of mortgage credit in the current decade. If they do, it will make it easier for banks to approve more minorities, immigrant families and lower-income Americans, creating a vastly larger pool of potential buyers.

But many economists worry that the mortgage-credit system may already be stretched to its limit. In addition to higher delinquencies for many first-time home buyers, debt burdens in the U.S. are now significantly higher than a decade ago. Household debt as a percentage of disposable personal income rose to 118.8% in 2003 from 86.8% in 1990.

Also, underwriting guidelines are very loose by historical standards. Banks these days often let home buyers get loans when their mortgage payments total as much as 50% of their monthly income, up from the more customary limit of about one-third in past cycles. Lenders probably won't be able to push the current limit much further, and they could reverse course if delinquencies rise, as some expect.

Investors should pay close attention to quarterly mortgage delinquency data from the Mortgage Bankers Association. Although delinquencies for some kinds of mortgages have improved over the past year, significant patches of bad credit remain, especially among first-time home buyers. If overall mortgage delinquencies creep up further, that could be a sign that more credit tightening is coming -- with negative consequences for housing investments.

Investors should also seek to avoid geographic areas with unusually high levels of defaults. Recently this has included places that were hit hard by the manufacturing recession, including parts of Ohio, Michigan and North Carolina. It also includes cities that were smacked by the technology and telecom bubbles, including parts of Dallas and Denver.

It's worth noting that even high-income neighborhoods can have high levels of defaults -- if there have been lots of layoffs in the area. Investors can learn more about the credit quality in their area by talking with a mortgage lender and tracking down data on recent layoffs in the region.

Housing Supply

In recent years it has become harder and harder for builders to develop large housing projects. In some places, like San Francisco, there simply isn't much land left. In other places, such as Portland, environmental concerns have spurred local leaders to create strict land-use restrictions that keep a lid on new supply.

Partly as a result, the U.S. currently has a tight 4.6-month supply of existing homes for sale, according to the National Association of Realtors. That means that if no houses are added to the market, and sales activity continues at its current pace, the U.S. would run out of existing homes for sale this fall. At the beginning of the last decade, the inventory of homes reached as high as 9.6 months.

Less supply tends to push prices higher over the long haul. Compare home prices in places like New York, San Francisco and Portland -- all of which face land constraints -- to cities like Houston, Atlanta and Phoenix -- where land is readily available and it's easier for builders to get new projects approved. The median price right now in New York is $369,700. The median price in Houston is $130,700.

Unfortunately, areas with tight supply also tend to have more volatile markets, meaning that prices can shoot up more rapidly during periods of high demand and slow or fall more during periods of weak activity. In areas like Phoenix, where new supply keeps prices from rising too fast, home values have less need to correct whenever the market slows.

It pays to buy homes in areas where it's difficult to add new supply -- so long as you can stomach a more volatile market. If you're looking to buy a home for just a couple of years, you'll need to be more careful in cities like New York and San Francisco, where prices have risen so dramatically in recent years. But if you plan to hold on to a property for a long period of time, especially a decade or more, you're likely to do a lot better in cities with building constraints than in Atlanta, Phoenix or Houston.

It's worth checking with your local city planning department to learn more about the building constraints that exist in your area, including rules governing lot size and population density. You'll also want to inquire about any zoning rules that could attract other kinds of development to the neighborhood that could reduce your property's value, including industrial buildings or high-traffic retail outlets.

The Coming Housing Crash

by Bob Wallace

There are a lot of thing I don't know, but one thing I do know are houses. My father was a general contractor all his life, his father was a carpenter, all my relatives are contractors, and I built many a house starting when I was 12, and ending in my 20s when I finished college.

I know houses, and because I know them, I know there is a boom right now, one that will be followed by a bust. I wouldn't be surprised if houses in some areas dropped by 90% in value. I just don't know when.

Thirty-five years ago, when I was a kid, a nice middle-class house cost $25,000. Now they can cost up to $250,000, depending, of course, where you live (the three most important things for selling a house are "location, location, and location").

People have tried to tell me this increase in price is due to supply-and- demand. No, it's not. Under the free market, as demand goes up, so does the supply. As supply goes up, the price drops. Under a truly free market, you'd have stable prices that would last a century. If prices did anything, they'd drop slightly over several decades.

Those brand-new $25,000 houses of 35 years ago should still cost $25,000 today, not $250,000. What caused this increase?

Overwhelmingly, it's inflation-the Federal Reserve pumping billions of paper dollars into the economy. That extra money in people's hands has bid up the prices of houses. That causes a bubble. Bubbles, of course, are always followed by busts.

The same thing happened during the dot com boom-bust during the 90's. All that extra money pumped into the economy went into the dot coms. Then, bam, the bust. The same thing is happening right in the housing market in some areas. All the money Greenspan is pumping into the economy is going into those markets. Sooner or later, they will blow.

All the money flowing into the housing market has turned housing into a gamble. People are buying houses and hoping the value continues to go up, so they can sell and make a huge profit. This works just fine except for the last people to buy the house, when the bubble bursts and they're left with a house that is worth $200,000 less than what they paid for it.

Houses are what are called "durable consumer goods." Strictly speaking, they are not investments. You generally aren't supposed to make a profit off of them, no more than you would make a profit of off an old car, unless it became the kind people wanted and bid the price up. The main reason houses become profitable investments is when inflated money pours into the market. And then it's not so much "investing" as it is gambling. And gambling's a heck of a lousy thing to base an economy on. It's certainly never the basis for a solid, long-lasting economy that provides good, high-paying jobs for people.

This gambling is made worse by the Fed's dropping the interest rates to the lowest I've ever seen. People are quite rightly refinancing their houses, but if they're taking the extra money and getting deeper into debt they have no idea what they are doing. When the economy goes bad, it will all backfire on them. Pushing down the interest rates that low is a desperate attempt by the Fed to keep the economy going just a little big longer.

Imagine if many people bought brand-new cars and kept hoping the price went up so they could sell them used and make a huge profit. You'd think they were nuts. The same should apply to houses, except houses last a lot longer than cars (that's why they are durable consumer goods). Whereas cars depreciate rapidly in a few years, houses should depreciate very, very slowly over several decades.

Two of my friends who live in the San Franciso area-where there is a huge bubble-just sold their houses. Each probably made $100,000. I know that sounds great. It is, for them. But if you look at the long-run, it's doesn't look great at all. The housing market will blow, as will the economy in that area.

Some people will lose their jobs, lose their houses, and declare bankruptcy. That is the long-term effect of inflation. My two friends made $100,000 each, but down the line lot more than two people will lose just about everything. And most of them won't have a clue what happened.

What would I do if I owned a home in an area where the prices kept skyrocketing every year? I'll sell and get the heck out. I'd go someplace where prices are a lot more stable.

An inflationary boom-bust cycle is something you can bet on. It's such a sure thing it's not even gambling.

Saturday, June 19, 2004

Please Give Me a Housing Bubble

John Mauldin, Safe Haven

As I have written about and documented on many occasions, the economic health of the US consumer is hinged upon the housing market and housing values more than any other single factor. Since the entire economy, not to mention the world economy, is heavily leveraged to a healthy US consumer, the question of whether or not there is a bubble in the housing market is of paramount importance. Today, we begin a series on housing. I have found the research to be fascinating and often surprising and contradictory. I trust you will find it useful, and it is almost guaranteed to be debated, as I will depart from the Conventional Wisdom of both housing bull and bears.

Thoughts on the Money Supply

But first, I want to address the recent dramatic rise and now slowing of the growth in the money supply as measured by M-2 and M-3. Many commentators breathlessly see alternatively either doom or a new bull market based upon these monetary measures, or the sinister hand of the Federal Reserve manipulating the markets.

I think the Fed is only secondarily responsible (at most) for the recent moves in the money supply. Remember last week I talked about how the carry trade is unwinding? Greenspan gave his warning in March and the funds and corporations began to act. We are watching hedge funds and other institutions who were involved in the carry trade have a particularly rough time (on average), and in general hedge funds involved in the carry trade have lost money for the last two months (and so far this month), after a very good run over the last few years.

The Fed has ways to influence (much less than you might think) the money supply (M-2 and M-3), but not actually control it. There is no man behind the curtain pulling levers. Or, if he is pulling, I am not sure they are connected to anything.

I think the rapid growth in the money supply is yet more evidence of hedge funds and corporations unwinding their positions and going to cash. To the extent that the markets heeded Greenspan's warning, the Fed "influenced" the money supply. But it was nothing they have done directly. While the rapid rise in the money supply was funds and corporations repatriating cash from abroad and from the carry trade, the recent slowdown is a result of the funds and corporations deploying that cash they raised over the last few months into other investments.

This is corroborated by the movement in the Treasury bond markets, as rates went much higher (hedge funds and corporations were selling in size and in concert) and then as the selling is drying up, rates came back down.

Maybe I am like the man who fell off the Empire State Building, who noted as he passed the 48 the floor that "So far, so good." But I think that the carry trade seems to be unwinding far more smoothly than I would have imagined last year as we saw the trade being "put on." Frankly, I expected one or two hedge fund blow-ups (not a large percentage out of 8,000 funds, by the way), but I have not heard of any. They may still be out there, but for now it is just the usual expected losses which always accompany the end of a trend.

That is also why I now think that a raise of 25 basis points on the 30th is locked in. If the Fed raised 50 bips or did nothing, the markets would "throw up." "Measured" is the watchword of the Fed this week. They are telegraphing their moves as much as they can. Any manager who suffers a "surprise" loss because rates are raised 25 basis points should be fired.

The Daily Reckoning

Before we jump into the housing question, permit me a brief, yet hopefully educational, commercial. Fellow author and writer Addison Wiggin (co-author with Bill Bonner of Financial Reckoning Day) gave me a very kind review this week in the Daily Reckoning. Let me quote a few lines, not just because they are laudatory, but because I think they are instructive.

"Investors, Mauldin suggests, continually make [the] same mistake, substituting familiarity for value-based research and reason, basing their investments and their future on false confidence that, in the end, leads to disaster... Just because we know a lot about an investment does not mean it is a good one.

"But where then, does Mr. Mauldin find the right kind of confidence? In a true sense, that search is the unstated theme of his book... and it comes from several sources.

"First, it is the steady march of history. Mauldin sees the stock market, currencies, commodities, bonds, interest rates - in short, everything - as subject to historical, economic and fundamental forces. Finding these forces and investing with the trend - rather than against it - is the key to confidence. Where some might see the continued decline of the dollar as a reason to despair, John simply sees another trend from which to profit. If the economy grows slower than in the past - something Daily Reckoning readers will recognize as Mauldin's 'Muddle Through Economy' - again it is not a problem, but an opportunity.

"When the Fed wants to manipulate interest rates - they may theoretically be wrong - but astute investors recognize it as a gift of potential personal profit. Every chapter of Mauldin's book is grounded in history... yet he steps out on occasion and deigns to predict the future.

"If you're a regular reader of the Daily Reckoning, you know Mauldin believes that value is the driver of market cycles. In Bull's Eye Investing, he offers numerous ways that small investors - which he demonstrates have an inherent advantage over institutions in today's market - can invest with confidence in today's market. His chapters on value investing may be considered as essential reading for the individual investor. Mauldin's data mining on 'behavioral investing' is worth an entire book of its own.

"Bull's Eye Investing is a must-read roadmap if you want to avoid the pitfalls of the modern investing landscape..."

The book is again on this month's New York Times Business Best-seller list. You can find it at your local bookstores, or buy it at discount at And now on to housing.

What Housing Market?

Over the years, I have had more questions from readers on my views on housing than on any other topic (with the possible exception of gold). These questions are almost invariably impossible to answer, as I know nothing about the real estate market in Des Moines or White Plains or Portland.

Whether to buy or sell a house is an intensely personal as well as an intensely regional (if note very local) exercise. There are just too many factors in the equation. What I have been able to do on occasion is to cause the reader to ask a few questions in order to help him solve his own equation.

Are we in a bubble? Should I sell and rent? Should I buy today or wait until next year? And, if so, at what interest rates? Will I be able to use the value in my home for retirement? In this series on housing, we are going to look at these questions and more.

The answers will not be what you expect. There may indeed be "bubbles" in housing values, but not always where you suspect. Price is not always the determining factor in housing bubbles. Many are moaning about the fact that ARMs (adjustable rate mortgages) are on a dramatic rise, portending doom in our future as rates rise. Well, some studies and line of thought suggest maybe not. They may in fact be a very smart thing to do. Average housing sizes have doubled over the years. Should we look at historical homes prices on a per square foot comparison? We demand more quality in our homes. What effect does this have on housing prices?

As I mentioned, to analyze your own housing buy or sell equation is intensely personal. My premise is that the equation is based on a number of variables, both personal and economic. The values for the variables change from person to person and market to market. For instance, higher rates may mean lower prices in some markets and not in others. What we are going to do is look at a number of studies, statistics and reports and hopefully a few new insights along the way to give you the knowledge you need to do your own equation. My aim is to help you think outside of the box.

Bubble? Please Give Me a Housing Bubble

Let's first look at the actual statistics for housing prices. What we find is that a national number is meaningless to an individual.

For instance, average U.S. home prices increased 7.71% from the first quarter of 2003 through the first quarter of 2004. Appreciation for the most recent quarter was 0.96% or an annualized rate of 3.84. These and the next few statistics are from the friendly folks at the Office of Federal Housing Enterprise Oversight (OFHEO), which uses the databases of Freddie Mac and Fannie Mae to create their Housing Price Index. This index tracks average house price changes in repeat sales or refinancings of the same single-family properties.

Housing far out-paced the price for goods and services in the CPI, as goods and services only grew at 1.59%.

But what does 7.71% mean? If you are in Rhode Island or Texas, it means nothing. Rhode Islanders saw their housing prices jump 14.8%. Texas saw a decidedly modest 2.34%.

Home prices may be softening in some areas. There are 220 Metropolitan Statistical Areas (MSAs) in the US. Almost 20%, or 39 of those MSAs, saw home values drop on the first quarter of 2004, compared with only 3 in the fourth quarter and 4 in the second quarter of 2003.

OFHEO Chief Economist Patrick Lawler notes, "Last year's rise in borrowing rates may have stimulated fears of further rate increases, causing some prospective purchasers to move more quickly to buy than they might have otherwise last Fall. That sense of urgency apparently diminished last quarter after rates stabilized. It will be interesting to see what the effects of more recent interest rate increases are in the future."

Interesting indeed.

Let's see if we can put housing prices in some inflation-adjusted perspective. If you bought a $100,000 home in 1980, if it merely kept up with inflation, the home would sell for approximately $240,000 today. The average US home bought in 1980 now sells for $309,000. Thus, roughly 70% of the average rise in housing values is simply from inflation.

However, if you lived in New York, your $100,000 bungalow is now $499,000. Rhode Island is not far behind at $461,000. California home values have risen to $414,000, although in such a vast state, there is quite a difference in price increase in San Diego beach front and the desert, I am sure.

But the leader in terms of rising home values is Massachusetts. Your $100,000 1980 cottage is now a staggering $616,000. I find 8 states which have seen their values increase at more than double the rate of inflation. Massachusetts is almost 3 times the rate of inflation.

But it is not all sweetness and wealth. If you lived in Texas, as I do, a small bubble might be a thing to be desired. Housing values in Texas have not kept pace with inflation. Our $100,000 home is now only $188,000. Of, course, we can look to the north to Oklahoma, the state with the smallest rise in the US, whose homes have risen to only $174,000. That means their home values only rose about half the rate of inflation. I count 15 states which have seen home values rise less than inflation over the past 24 years.

But the bubble, if there is one, is something of recent vintage. What about the past five years? Utah has seen home values rise less than 10% in the last five years. While then average home has risen 41% in the US in the past five years, 23 states have seen rises of less than 25%.

Of the 220 SMAs, over the last year the top 20 come from California (10), Florida (6) New England (3) and (oddly) Las Vegas. Among the bottom 20, I find my own region of Fort Worth-Arlington (Texas) at #213 and Austin coming in dead last.

The OFHEO study looks at price rises state by state since 1985. If you bought a home almost anywhere in New England, unless it was over some environmental disaster, it has been a no-brainer for the last 24 years. You saw your equity do nothing but soar, assuming you did not borrow against your home. Some place called Barnstable, Massachusetts has seen their values rise 100% in the last five years alone.

But if you bought a home in 1985 in Texas, you had to wait for 12 years to see your home rise a mere 10% in value. If you live in Texas or Utah or any of scores of areas in the United States, you simply do not understand home prices in DC or New York or California. Far from being a bubble, much of US home values have not even kept up with inflation.

(I remember recently showing my friend, Constantin Felder from Geneva, Switzerland around my home town. He would look at some of the rather large homes in the area and marvel at the low prices. A $400,000 home here would cost millions in Geneva, or Boston or La Jolla, for that matter.)

You can read the 56 page study and tables for yourself at It is interesting to compare the various parts of the country and play "what if." As in, what if I had taken that job in DC 25 years ago?

Housing and "Intrinsic Value"

There does not have to be a bubble for prices to fall, and fall dramatically. In a theme we are going to return to again and again in this series, there is no such thing as "intrinsic value" in a home. It is a function of several factors, including demand and economic conditions.

Home values in Houston, Texas were already relatively cheap in the 80's when first oil prices and then the savings and loan banks collapsed. Lending for everything dried up as the as the banking system, based on oil and land values, simply imploded.

Already inexpensive homes became cheaper as employment in Houston dropped dramatically. Homes were selling at auction for one or two year's rental value. People literally bought them with credit cards. As the government flooded the markets with re-possessed homes, values dropped even more. People could buy homes in some areas for much less than replacement costs.

Forget about equity back then. In 1991, I wrote a large check just to get someone to buy my home which I had owned for 8 years. That was not untypical in Texas. Of course, I turned around and bought a home from the government agency overseeing the bankruptcy of the savings and loan banks in Texas, for about 35% of what it listed for less than three years earlier, and about half the value of the actual loan which had been made by the bank for the home.

You could not have built that home for anywhere close to what I paid for it. Over the next ten years, it proved to be a reasonable purchase. However, the 50% rise in price did not come close to what we see in other parts of the country.

The point? Home prices are tied to local economic events. Please note that ten of the top 20 MSAs for the last year were in California. But that is small comfort if you lived in San Jose, where your home prices have dropped over the past few years as Silicon Valley is still reeling from the bursting of the tech bubble.

If a factory closes and 10% of a region is out of a job, sooner or later housing values take a hit, unless the town fathers can attract another employer. It does not make a difference whether housing values had been rising 10% a year for ten years, or were already below replacement costs. The economic factors of local employment drive demand and thus housing prices. (Other economic factors, which we will review later, will also affect demand.)

Still, over time, home ownership is a compelling investment. Let's take the (almost) worst case over the past 24 years, buying a home in Texas. In 1980, you buy a home for $100,000, with 20% down. You were paying 12.5% in interest.

Over the next 24 years, you refinanced several times as interest rates and your payments went down. If you have not already paid off your mortgage by now, you are close to it. Your home is now worth $188,000. You have seen your investment of $20,000 grow 9 times, plus you have deducted the interest rate costs from your taxes. Not a bad return. Better than the stock market, actually. And you had a roof over your head, which an index fund does not provide.

But what if you bought an average home in Massachusetts? Your $20,000 is now $616,000! Are you smart or what? Simply for putting up with Ted Kennedy and the Red Sox (hey, this could be the year!), you are one of the richest guys in the country.

If you were lucky and had some coastal property or other prime location, then your wealth is off the charts, assuming you held through the years. Of course, if you bought a home in Massachusetts in 1989, it was 1997 before you saw a profit. Tough sledding in those years.

In fact, if you look at the tables in the report, you find that every state had rather lengthy tough periods in the 80's and 90's in which home values fell or were at best stagnant. That includes California, which had some very flat or negative years. The experience of the last five years which have seen such a dramatic rise in price in many areas has happened before, but it is almost always followed by a slowdown in price, which happen for a variety of local reasons, which we will look into in the coming weeks.

Let's end with story from one of my favorite perma-bear writers, Gary North. I love his wit and fluid style. And this section is typical.

"I watched 'Sunday Morning' a few weeks ago. They ran a segment on the Los Angeles residential real estate market, which is blisteringly hot. Some couple was hoping to buy a home for $600,000. They had been locked out by other buyers recently. Their offer of $500,000 had not been sufficient. The real estate sales lady commented that houses that were $600,000 last year are selling for $1.2 million this year. Anyone who didn't get in last year is locked out today.

"I shuddered. If they could have heard me, I would have yelled at that 30-something couple: 'Run for your lives! Rent. Move to Wisconsin. Anything. Don't sign that contract!' Of course, I would have yelled to the sellers, 'Way to go! You've got 'em. Take the money and run. Move.'

"Think of a couple that owe, say, $200,000 on a $1.2 million home. If they moved out and rented for a few months, they would establish their house as an investment property. Then they could sell it, pay off the $200,000, move to Northwest Arkansas, invest $1,000,000 by buying ten homes and renting them for $800 to $1,000 a month. They would enjoy income of $8,000 to $10,000 a month, and they would see their investment double in the next ten years.

"They could even hire a local rental agency to handle it for 10% of rent, and they could stay in L.A. and rent for $2,000 a month, pocketing maybe $4,000 after taxes.

Will they do this? Of course not. They will buy a $1.4 million home.

"A housing mania makes fools of buyers and sellers. Buyers don't know how to say no and rent in peace (RIP). Sellers never know when to quit. Their ship has come in, and they're at the bus station."

Is that $1.2 million home necessarily a bad investment for that couple? Maybe and maybe not. If they expect to flip it in 2-3 years, they are taking a significant risk. They are buying after a large run-up in home values. Looking through the OFHEO tables suggest that run-ups are followed by softer periods.

But if it is their dream home - the place where they want to live for the next 20 years - and if they have the ability to make the payments in that time, then inflation and the long-term affect of paying down the mortgage (especially if they lock in historically low long-term rates) should overcome the ups and downs, assuming they do not have to sell during the next recession. If California is where they want to live, if it is where they make their living, then housing is part of the cost of doing business in California. (Not to mention high state income taxes and other government nonsense.)

Housing is not simply an investment decision. There are emotional and psychological parts of the equation that must be factored in.

My business partner, Jon Sundt of Altegris Investments, has a truly magnificent home overlooking Black's Beach in La Jolla, California. There is no good reason he could not move his business to Texas, buy a similarly truly magnificent home and pocket more than few million. His business overhead would drop dramatically. He would get an immediate 10% raise in income as there is no state income tax. I have pointed this out to him on a few occasions. But it is not just a business, dollars and sense, equation.

"Where," he asks, "do I go to surf? Where are the sunsets on the beach in Fort Worth? How do I get my wife to come to Texas in 100 degree weather in August? Or freezing in January?"

Jon is married to the beach, the weather and the lifestyle in coastal southern California. He and millions of people like him. Over the long term, that is good for property values there. It is no guarantee of anything, as over the next 20-30 years, values will rise and fall, as they always do. But if you are not selling, the price of your home is simply a number. Perhaps it makes you feel good, or perhaps not.

If you did not have to sell your home in Houston in the 80's, made your payments and simply kept on going on, you saw your home values come back and your equity increase. It took some time. If you needed to sell at the wrong time, you got hosed big-time (note to non-Texans: that is slang for beaten up).

What have we learned so far? Parts of the housing equation are the desirability of your local market, the length of time you intend to live in your home and your own ability to stay the course, local economic conditions and your own psychology.

Next week, we look at a Harvard study which says housing is not over-priced. Then we find some apple and oranges flaws in their arguments. We delve more into the psychology of housing and how it affects the national consumer sentiment, and a few other thoughts. I should note I now lease a home, but plan to buy, and we will look at the personal equation from my own decision making process.

Howard Ruff Writes Again

Before I sign off and go and see my twins who have finally come home from college, I want to mention a rather special book by one of the grand old names (and a good friend) in the investment writing business, Howard Ruff.

For younger readers, Howard built the first large investment newsletter (The Ruff Times) in the country, with hundreds of thousands of subscribers over the years. His book in the late 70's, How to Survive and Prosper in the Coming Bad Years, sold almost 3,000,000 copies. He was a political mover and shaker, meeting presidents and politicians and kings. He roamed the world and was a magnet for crowds wherever he went. He had his own syndicated TV and radio shows, and appeared on Oprah and every big TV show there was at the time. He could move stocks on a mention. He was a certifiable Big Deal.

He also made and lost two fortunes. And therein lies the tale worth the telling.

His new book, "Safely Prosperous or Really Rich: Choosing Your Personal Financial Heaven" is worth reading on two levels. First, Howard shows that there are really two ways to retirement prosperity in the world. You can either live modestly and save and watch your nest egg grow over time. Or, you can take certain risks and start your own business. It's not how much money the really rich have or how smart they are, it's their attitude toward risk and fear, their understanding of when to break the rules that the Safely Prosperous follow, and their knowledge of a few simple capitalistic principles that allows them to accumulate serious wealth. It is full of lots of solid wisdom that Howard has gathered over the years.

Howard is a great writer and the book is an easy, even fun, read. Old fans of his will enjoy their reunion and he will gather new ones, I am sure.

But the book is more than a "how to get rich" book. It is Howard's tale of his personal business rise and fall and rise and fall, and he does it with no holds barred. It is emotionally jarring in its brutal honesty. We all like to brag about our success. Howard has had more than a few. But it is his mistakes that he holds up to inspection that make the book special, at least to me. It is a cautionary tale full of wisdom that only comes from a few bruises and broken bones. If you are in a business, there are a few chapters that are simply must reading. I am serious. Every business owner, and especially those in the investment publishing and writing world, should read them and weep and rejoice along with Howard and learn.

Howard at 70 is one of the most optimistic guys I know. He fought cancer had survived. He faced crisis on more than one occasion and kept his wits and his optimism about him. With something like 18 kids and 60 or so grand-kids, he stays young. He is still writing the Ruff Times, and plans to make it a major letter once again.

The book is a mere $16.97 at I just looked and noticed (entirely coincidentally, I assure you) that his book on Amazon is linked with mine and you can buy both of them for $34.

Father's Day

I am a piker compared to Ruff. I merely have seven kids and no grand-kids. But Father's Day is still a special time. Daughter #1 is in Poland, but sent me an email which more than warmed this Dad's heart. I still read it when I need a psychological boost. The rest of the gang will be there Sunday, with lots of noise and shouting and fighting and fun. I will pick up the check for lunch, but it is worth every penny.

There are those who think someone with seven kids must be crazy. How can I afford it? With three (and hopefully four, if she will go back) kids currently in college, I often ask the same question. But the answer comes to me when I go back and look at a website my kids gave to me a few years ago, Just as some pay the extra costs for living in California, the "extra" costs for my kids seems like a good investment. And the dividends, like that letter, or a sunset on the beach, come in different ways, but they are valuable, if not priceless, all the same.

To all Father's everywhere, I wish you the joy I have.

Your missing his own less-than-sainted Dad analyst,

Friday, June 18, 2004

Harvard Study Should Boost Stock In Housing Market

by Broderick Perkins

Ken Browne initially balked at buying a second home investment property in Manhattan, concerned that a repeat of the 1980s downturn in Hartford, CT would put him in another overpriced market ready to go bust.

After input from real estate market experts and conceding "there is no crystal ball" he felt comfortable that market conditions are in his favor and decided to go for the deal.

One expert, Kathy Braddock a partner with residential real estate consultants Braddock+Purcell in New York thinks he made the right decision.

"History tells us that New York City real estate, if held long enough, has proven to be a great investment. Why? We are an Island. Quite simply, there is a limited amount of new building that can occur. Additionally, we are the financial capital of the world, even 911 did not affect the overall residential real estate momentum here," she said.

"New York City continues to attract more and more people who want to live and work in the most exciting city in the world. There will always be people who would rather buy than rent. America makes it very desirable for us to own property," Braddock added.

While local markets can rise and fall independent of the national trend, New York City may be a microcosm, generally, of today's national real estate market and Browne is typical of many buyers concerned about the past.

Both should find some comfort in the fact that today's housing market, spawned by the nation's longest economic expansion on record, isn't what it used to be. Going beyond just surviving the last recession, unlike the market of the 1980s, today's housing market remained robust throughout the downturn and emerged as an economic cornerstone generating a level of wealth and consumer expenditures sufficient to help lead the nation out of recession.

Given it's recent track record, it's difficult not to bank on housing.

Further deflating bubble market forecasts, a major annual academic study says the housing industry is poised for yet more growth -- 10 more years worth, at least.

Citing greater roles among women, minorities and immigrants, Harvard's Joint Center For Housing Studies' "2004 State of the Nation's Housing Report" says, while fast appreciating home rates have made it more difficult for some to buy, shifting demographics will increase the pressure on the low-end starter home and rental markets as well as move-up and second home markets.

The study is hot on the heels of a similar 10-year forecast offered by Homeownership Alliance, an association of 18 national housing organizations.

From the independent, academic Joint Center come new projections that suggest household growth between 2005 and 2015 will be at least 10 percent higher than previously projected -- bringing the total increase to more than 13 million households.

"As strong as housing construction has been in the recent past, demographic factors will propel housing production even higher over the next 10 years," says explains Eric Belsky, executive director of the Joint Center.

"Given higher household formations, demand for second homes, and replacement of units lost from the stock, production should reach at least 18.5 million and could top 19.5 million if immigration remains at current levels," he added.

Important to repelling bubble market arguments is the fact that even with fast appreciating home prices, incomes have kept pace as low interest rates helped stretch household dollars.

All the news isn't all good. Affordability issues haven't waned and rising interest rates could make matters worse.

"The run-up in home prices, however, is contributing to housing affordability pressures and fueling concerns that at least some markets may be overheated. While two-thirds of Americans are well-housed, the remaining third have significant housing problems and many struggle to meet other basic needs while still managing to keep a roof over their heads," said Joint Center director Nicolas P. Retsinas.

Published: June 18, 2004

Wednesday, June 16, 2004

Down Under May Hint At U.S. Housing's Future


The Wall Street Journal

June 16, 2004 -- Economists looking for clues about the future of the U.S. housing boom might want to take a look at Australia.

Like the U.S., Australia has enjoyed a spectacular run-up in home values over the past few years, with prices more than doubling in some parts of the country. The reasons for the boom are similar, too: low interest rates, relatively easy credit and buyers seeking to offset stock-market losses.

There is one critical difference, however. Home prices are still climbing in the U.S., but not so in Australia. According to Australian Property Monitors, a widely followed Sydney-based research firm, Sydney home prices fell 7.5% in the first quarter of 2004 and could tumble by 20% by the end of the year. Other Aussie cities are seeing price drops as well.

The divergence, many analysts believe, is the result of Australian policy-maker moves to rein in the country's inflated property market, primarily by raising interest rates. The U.S., by contrast, has largely left the housing market to run its course. But with the U.S. economy seemingly back on track and inflation possibly on the horizon, many analysts believe the U.S. Federal Reserve will have to raise interest rates later this year.

Of course, there are some very important differences between U.S. and Australian real estate. Recent U.S. home-price gains, while striking, haven't been as dramatic as those in Australia. Also, some unique factors have contributed to the Australian slowdown, including a new tax on investment properties that cooled speculative demand.

Still, the recent retreat of the Aussie property sector serves as a potent reminder that no housing market -- even one insulated by relatively low interest rates and strong demand -- is trouble-free.

Like the U.S., Australian home sales really began to heat up in the late 1990s. They got a boost from a rise in the number of mortgage brokers who, as in the U.S., provided a variety of new financing alternatives to buyers, including low-documentation loans.

By 2002, home values were rising faster than incomes, pricing many first-time homebuyers out of the market. Debt levels were soaring, and houses were moving surprisingly fast at public auctions, one of the more popular ways of selling a home in Australia. In April 2002, auction "clearance" rates soared to a record 80%, meaning that four-fifths of the homes offered for auction sold by the end of public bidding.

But as the market raced ahead, worries mounted. Much of the concern focused on the role of investors, many of whom had been burned by stocks and were pouring money into real estate. A report by the Reserve Bank of Australia noted that more than 40% of new home loans were being made to investors, compared with slightly more than 10% in the early 1990s.

"There is a common belief that house prices cannot fall," the central bank warned.

The Reserve Bank raised its key interest rate twice in late 2003, to 5.25% from 4.75%. Although the increases weren't dramatic, they were enough to knock some first-time buyers out of the market. They also had a big psychological effect, spooking home shoppers who were already anxious about the market and were watching for any sign that Australia's business cycle was turning. Prices started to fall and clearance rates tumbled to as low as 32% -- about the same as in 1989, just before the last property bust.

A new wariness was evident among buyers at a recent auction in Sydney. The house for sale, a Victorian home with molded ceilings near Sydney's Centennial Park, was listed at about 1.1 million Australian dollars, or about US$765,000. About 20 or more people showed up, but many were onlookers who came simply to get a read on the uncertain market. One potential buyer, 53-year-old Brian Connell, put in a few bids but dropped out after the price rose. Despite the recent turn in the market, he said, many properties are still too expensive and prices could have more room to fall. The market "is like a game of musical chairs that everyone can play ... and now they're taking chairs away," said Mr. Connell, an auto-parts importer. "I'm a bit nervous."

The house eventually sold for roughly its asking price. But real-estate agents and the seller said the house probably would have nabbed a lot more, perhaps US$100,000 more, just a few months earlier.

Some Australian analysts are hopeful the market will soon stabilize. Interest rates remain low by historical standards. The prospect of massive foreclosures, a problem in the last housing slowdown, seems remote. "There's no sign of panic selling," says John McGrath, chief executive of McGrath Estate Agents, one of Sydney's most prominent property companies.

But others are less sanguine. For one thing, more supply is on the way. In Melbourne, construction is under way on an 88-story apartment tower that will be one of the biggest residential buildings in the world. In Sydney, some real-estate agents have begun refusing listings in downtown areas where there has been a lot of new apartment construction because they fear the units will be too hard to sell.

The property market is now "the biggest single economic vulnerability" in Australia, says Rory Robertson, an interest-rate strategist at Macquarie Bank in Sydney. Indeed, growth slowed significantly in the first quarter, and some economists worry that consumer spending will weaken due to cooler housing activity. Whatever happens, he says, "it's going to be quite a shock to some people that home prices actually can fall."

Wednesday, June 02, 2004

The Bubbles Mr. Greenspan has created!

AME Info fn
Dr. Faber continues to recommend staying out of markets, with lower bond prices and much higher interest rates on the horizon. In particular he is concerned about the US housing market. Asset inflation always comes to a bitter end.
Credit has to be given to Mr. Greenspan. By bailing out the S&L Associations in 1990 he contributed to the creation of the emerging market bubble of 1994, which led to the Mexican crisis.

Then, by bailing out Mexico - with the then acting Treasury Secretary Robert Rubin's help - he contributed to the emerging market debt excesses that led to the Russian crisis and the LTCM debacle of 1998.

Again he bailed out the system with an enormous liquidity injection and created in the process financial history's biggest bubble – the NASDAQ bubble of 1999/2000.

But until then, Mr. Greenspan was only a 'serial' bubble blower. He managed to create bubbles, but only one at the time and in different asset classes, at different times and in different parts of the world. But this time around, we have to give him far more credit for his monetary achievements and nominate him for a Nobel Price in bubble creation.

After all, he is the first central banker in the history of capitalism who has managed to not only create a credit bubble in the US, which has led to the entire mortgage refinancing scheme, excessive household borrowings, over-consumption, and a growing current account deficit, but he has also miraculously managed to create bubbles all over the world – in stocks and bonds of emerging economies, the currencies of Australia, New Zealand and South Africa, in housing, and lastly in Chinese capital spending, which is now growing by more than 40% per annum, as well as in commodity prices.

In addition, as a result of the growing US current account deficit, which is offset by current account surpluses in Asia, he has managed to create a bubble in foreign exchange reserves of Asian central banks. Japanese foreign exchange reserves have exploded on the upside since year 2000, whereby the same situation of soaring foreign exchange reserve growth can be found in China as well as in most other Asian countries.

So, what terrorists are to peace loving citizens – we must exclude from these Mr. Bush & Co – Mr. Greenspan is to sound money, which is not supposed to lose its purchasing power. In short, he is for the honest saver, who depends on the purchasing power of his money to be maintained for his retirement or for his children' sake, the world's most dangerous man!

In the meantime, US industrial production is hardly growing, as can be seen from the continuous decline in commercial and industrial loans.

So, all Mr. Greenspan has created is a huge financial and asset bubble everywhere in the world, but no real improvement in the US economy, which is like a drug addict and requires more and more credit to stay afloat. As someone once said, in order to avoid a hangover, you must keep on drinking…

The problem, however, is that the US requires an increasing amount of credit growth in order to keep real estate and stock prices up and to make them move higher, which in turn supports the US consumer's excessive consumption. But, at the same time, while asset prices in the US are soaring, output is not rising for the simple reason that the market has discounted this 'evil' Fed induced con game.

We all know from basic economics that the only way in which monetary policy can really affect output is if it comes as a surprise – and this only in the short-term. If, however, everybody knows that monetary policy will be easy, everybody will move prices instead of output, and the monetary expansion will be "neutral" at best.

But what is now suddenly happening is that the investment community, through the market mechanism, is beginning to catch on to the fact that there is much more credit growth out there than productive capacity, and therefore prices have risen in some cases, such as for commodities, very rapidly.

It would seem to me that the realization by the investment community that Greenspan's game cannot end well has begun to reverse expectations. Suddenly, out of the blue, the bond market has collapsed and brought down stock and commodity prices along with it.

As I have maintained before, this is not a time to play hero like the brain-damaged president of the US in Iraq. It is a time to stay of out of all assets and be patiently waiting for better buying opportunities. In particular, I am concerned about the US housing market.

In some areas of the US, housing prices have been rising at almost 30% per annum in recent years and overall prices have doubled since 1997. The question, therefore, arises when this housing boom, which was fueled by ultra low interest rates and allowed people to refinance their homes, will come to an end.

This is an important question because US consumption since year 2000 was not driven by capital spending and employment gains, but purely by asset inflation in the housing market, which allowed people to take out larger and larger mortgages and spend the additional funds (well understood, 'borrowed funds') on consumer durables such as cars and consumer non-durables.

Now, however, there is a problem with the housing market. If the US economy continues to strengthen, interest rates, which are negative in real terms, will have to rise considerably and this could lead - if not to a housing crash - so at least to a less buoyant market. In addition, the inventories of unsold homes are at a record.

Therefore, should higher interest rates, driven by a stronger economy, lead to less home purchases by individuals, home-builders who are holding these inventories could get hurt quite badly.

I would, therefore, recommend to all investors who believe that the US economy is expanding solidly to sell all homebuilding companies' stocks here or on any rebound.

Personally, however, I am not so sure about the strength of the US economy, since consumption is purely driven by additional borrowings and government spending, which leads to larger and larger budget deficits. In fact, I have just bought some US treasury bonds with the view that, in the next few weeks, investors' expectations about future growth could be somewhat disappointed.

After all, every asset-inflation, which drove consumption in the past, such as was the case in Japan in the late 1980s and in Hong Kong prior to 1997, came to a bitter end. Thus, with bond prices being near-term oversold, any disappointment about economic growth could lead to a modest or even strong rebound in bond prices.

If you look at the figure below, which shows the recent performance of 10 years US Treasury bonds, it would appear that there is some support around this level and that a modest rebound is probable.

Still, this short term rebound aside, bonds may shortly be completing a longer-term head-and-shoulders top, which would mean that in future we could see lower bond prices or much higher interest rates.

Such an outcome could spoil all other asset inflation parties and lead to lower home, commodity and stock prices. Therefore, once again, patience and staying aside from the markets may be the best option.