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Housing Prices: Why Greenspan Is Right About Real Estate Investments
by Alexander Green, Chairman, Investment U
Investment Director, The Oxford Club
Monday, August 04, 2008: Issue # 832
I’ve disagreed with some of the things that former Fed Chairman Alan Greenspan has said and done over the years.
But what he said last week – that falling housing prices in America are “nowhere near the bottom” – you can take to the bank.
This may surprise some, especially since the national media just reported the single largest year-over-year drop in U.S. housing prices, May’s record 15.8% plunge.
But over the past several months, I’ve spent time looking at residential housing prices in cities large and small. I’ve been to areas that have held up relatively well, like Dallas, TX and Asheville, NC. And visited places that have been crushed, like Orlando, Las Vegas and Miami.
I’ve talked to realtors, appraisers, homebuilders and mortgage brokers. And I’ve come away with one overriding impression: Home sellers still don’t get it.
The Biggest Housing Boom in U.S. History
From 1999 to 2006, we experienced the wildest housing boom in U.S. history. The housing market skyrocketed relative to building costs, personal income, population growth and inflation.
In other words, housing prices didn’t soar for any sound fundamental reason. They soared because of:
- Low interest rates.
- Easy credit.
- And a $500,000 capital gains tax exemption. (Animal spirits, in other words.)
While there have been exceptions in some high-growth areas of the country (like Manhattan and Southern California), homes are ordinarily steady but unspectacular long-term investments. According to Freddie Mac, U.S. housing prices have climbed 6.2% a year over the past 30 years.
To see just how unusual recent price activity has been, take a look at Yale economist Robert Shiller’s inflation-adjusted housing prices chart, going back more than a century.
As you can see, no one alive today has ever seen anything like the run-up of the past few years. But now the bloom is off the rose.
- For starters, the economy is in the tank. That puts fewer consumers in the mood to make a big-ticket purchase. And homes are the biggest of them all.
- Then there is the state of the housing market itself. Foreclosures are at record levels. And we will see new records in the months ahead as variable mortgages reset higher and prices drift lower.
- Inventory keeps piling up. Nationally, lackluster sales have created an 11-month supply of unsold homes.
- Mortgage rates are rising. Two weeks ago, the national average for a 30-year mortgage surpassed 6%, a 52-week high.
- Banks and other mortgage lenders have raised their standards, too. In recent years, even borrowers with spotty payment histories were able to choose among a juicy selection of no-money-down, interest only, adjustable rate, negative amortization, “pick-your-payment” mortgages.
But now credit is tight. My brother, a homebuilder, says that even if you can find a buyer, good luck getting to closing. Many buyers either can’t come up with the down payment or fail to qualify for a mortgage under new guidelines. That means homes under contract are routinely coming back onto the market.
In short, it really is ugly out there.
Home Sellers Aren’t Facing the ”Housing Prices” Music
Put all these factors together – a weak economy, declining home prices, higher mortgage rates, tougher lending standards, the credit crunch and rising home inventory – and you’d think that home sellers would slash their housing prices.
But they haven’t. At least, not enough. Not yet.
Realtors keep telling me the same story. They are increasingly frustrated with sellers who simply refuse to face the music. (And every week a new batch of listings shows up at “you-must-be-joking” prices.)
No one likes to take a loss, of course, or to realize a smaller gain than anticipated. But understand that potential buyers do not care what we paid for our homes or how much they were “worth at the top.”
- The bubble is over.
- Magical buyers are not going to appear and pay us what we could have gotten three years ago.
- Nor, I’ll lay long odds, is the housing market going to “bounce back” anytime soon. (If you think so, please refer back to the Shiller chart.)
I’m not gloating, incidentally. I own two houses myself and they are mired in the same quicksand as yours.
I’m only pointing out that it’s too early to speculate on a rebound. And smart sellers are better off accepting a reasonable offer rather than waiting for a turnaround that is years away.
The U.S. housing market will bottom – and we’ll see the recovery that follows – when supply and demand come back into balance.
And as Greenspan pointed out last week, we’re nowhere near that now.
Good investing,
Alex
Today’s Investment U Crib Sheet
- Alex warned us of the pitfalls of speculating in real estate, and what to do if you’re trying to sell your home in today’s market, find out more in Investment U Issue #702, The U.S. Housing Market… Land of The Home Seller “Delusion.”
- Successful investing boils down to combating uncertainty – whether it’s real estate or equities. And the only way to consistently beat uncertainty is by asset allocation. No other investment strategy can boast the same safety or return. That’s why it earned a Nobel Prize. And that’s why it’s the foundation of our investment philosophy. Real estate should account for no more than 5% of your overall investment portfolio under our asset allocation model. Take a look:
- There will always be asset classes that “zig” while others “zag.” Disciplined asset allocation and portfolio rebalancing lets you capitalize in both circumstances… and reduce your risk and improve your returns along the way.
- For investors looking to get into the real estate market right now, Louis Basenese recently gave us a low-risk, low-hassle, low-cost approach in Investment U Issue #822, The Housing Market: How to Play the Real Estate Rebound…
- Why Housing Prices Will Keep Dropping in Value
- The Housing Market: Three Strikes Against Buyers
- The Housing Market: The Disappointment Of The Decade
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One Response to “Housing Prices: Why Greenspan Is Right About Real Estate Investments”
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Alexander Green is the Investment Director of The Oxford Club. A Wall Street veteran, he has over 20 years experience as a research analyst, investment advisor, financial writer and portfolio manager.
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February 4th, 2009 at 6:46 pm
Fix the capital gain tax’s hit for the investor in the housing market. If the fed’s make this fix we will see a flood gate of tax planning investors putting houses on the market instead of pushing potential gains forward in years to come. Prolonging the inevitable only pushes the deflated housing market that much further into the future, if the Fed’s think they are going to get blood out of a turnip; you know the rest. Investors are getting bad advice and the Fed’s think the fear the investor has of the capital gain they will see due to the loss created by selling lower than the principle amount that is owed is enough to either from happening is nuts. It is not if but when the sooner the Fed’s get it the sooner we will start to recover.
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