Stock advice in actual English.
Joined Sep 2, 2009
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A Quick Survey Of Housing

Pundits are largely cheering a Case-Shiller release that shows housing prices pushed higher ~13% year over year. However, this celebration is largely premature and in hindsight.

I’ve been keeping a fairly close eye on housing and land in my own home state of Michigan, and have been listening attentively to any mortgage generators I come across. The story that I’ve been getting is not one of imminent growth and prosperity, but rather a tale of disguised rot.

Why just last week, a banker in a mortgage unit happened to sit next to me in one of my favorite water spots. Striking up a conversation, I asked this individual, upon learning his profession, if housing was set to begin a long price appreciation, in his opinion.

His sharp laughter rang out for a spell of almost a minute and a half…

As this is likely to depend greatly on where you live, you’ll forgive me if your own real estate markets are much better off and the content I am presenting does not apply to you.

But, if your market looks anything like ours, then this is likely what you are seeing:

1) realized prices on homes and land are indeed higher. But that’s because very few sales are actually being finalized (only ones that match the storyline get settled)
2) mortgage generation remains soft and loan approval remains scarce, mostly to the upper echelon of credit worthiness
3) large amount of land and home assets that were seized by banks are flooding the market, at prices that are, frankly, ridiculous and unrealistic

The other day, I inquired on a 33 acre parcel about 50 miles north of Detroit. This land was a foreclosure, which is now being offered by some miniscule, no name bank. The asking price amounted to almost $20,000 an acre.

This was just vacant land – no house.

Tell me, who in their right minds would buy that?? It’s not local to any job opportunities, its only saving grace is nearby highway access, and you’d need another $100,000-200,000 just to put a “decent” home on it.

This is probably my most egregious example, but other things I’ve seen include houses that frankly, need to be demolished to the foundation, with $200,000 sticker prices. Or two bedroom starter homes that look like they need total renovations with $120,000 requests.

This is madness.

People are still retaining this forlorn hope that they will somehow break even on their excesses from 2005-2006. But it won’t happen.

I want you to consider what a normal, “well functioning” housing market looks like. There are two key criteria I want to bring up:

1) local rents to housing prices need to be sufficient that an entity could pay off all mortgage servicing and expenses and still generate reasonable profits AND
2) there exists a natural progression from starter homes for young adults with two or three “trade ups” to the American “dream home” – until age and retirement when a scaling down and cashing out process are supposed to occur

These two general characteristics I think are sufficient to make my point. Now, as to rents, at this point the income generated from a lease is more than sufficient to cover all costs of a home plus mortgage for a prospective buyer. However, it is worth stating; rents are really quite high right now. The renter nation we’ve become is putting big pressure on rents (which is why I happen to really like multifamily units). So point 1, while important, I think is on shaky footing because if the housing market is to really recover, gross income from renting (rents multiplied by occupancy) will necessarily need to diminish.

Which takes us to point 2. You cannot argue with me successfully that we are anywhere near a healthy functioning housing market. The baby boomer generation is built from a 76 million birth boondoggle; and I think we all know, they liked themselves some housing.

And at the same time that this generation is trying to unload $500,000, 4,000 square foot homes to safely enter retirement, the new base generation, the 20 and 30 year olds as of 2010, are still living in their parents basements with no savings, barely making ends meet.

This is a serious wrench in the cogs of the long term housing market. Consider, that in many respects, the ability of a baby boomer to unload their house is in fact dependent on the ability of a 20 or 30 year old to purchase that first, smaller starter house.

The baby boomer needs the 40 year old to sell their eight bedroom, four bath palace to. But the 40 year old still has a mortgage and needs the 20 or 30 year old to monetize the remaining loan, taking over the three bedroom, two bath house with the nice yard. The 20 or 30 year old maybe has a starter home they’re trying to unload, or maybe is just trying to push straight into the $150,000-200,000 price range. But in any respect, the financial well being of those on the bottom is imperative to and essential for the turnover all the way up the ladder to the top.

Looking at the financial state of the younger Americans, this bodes ill for a strong housing recovery.

The old rule of thumb was that a man or woman could afford a mortgage equal to about three times their annual income, minus any other debts. Seeing all the families in this country with $50,000-60,000 household incomes, that would suggest an upper range of $150,000-180,000 for a modest, middle income home. Until you figure in the $30,000 in student loans and $10,000 in credit card debt…

The only reason banks, at this point in time, are seriously getting away with offering these properties at these prices is because there’s very little pressure on their bottom lines. The Fed is making sure of that. But the same low interest rates that are giving banks the freedom to offer these properties at stupid prices, pretending that the market will break even to its excesses any time in the next two decades, is also doing a number on retiree budgets.

Interest rates will have to rise or we’re going to edge tens of millions of retirees into poverty, destroying great swaths of savings/investment principal they have.

It’s a catch 22, and either path you take ends up looking bad for housing after too long. For the moment, we’re in the eye of the storm, as no one else is desperate to sell. But lots of people could be desperate, if the numbers change against them just a little bit.

Give retirees too long in a zero interest rate (or God forbid negative interest rate) environment, and suddenly they need to liquidate the real estate to preserve their retirement nest egg and standard of living. Or, if you prefer, help the retirees out by raising interest rates, and suddenly some of these small fry banks get toasted alive and the need to get those non-performing foreclosure assets off the books becomes a lot more urgent.

I am being assured by some of the mortgage guys I know that the foreclosure backlog is as long and demoralizing as ever. We were hit with the crisis of a generation and you don’t just jump up and walk away from that.

It’s not enough to go from the losses of 2008-2009 to neutral. Too many people are still holding out hope that they can “break even”. But there isn’t enough room for everyone to call it a wash. Based on what happened, there needs to be more than that – there will be losers.

For the moment, we are avoiding admitting that truth by creating a temporary, unsustainable oasis of higher perceived prices, built up on virtually no sales. But prices are not all that matters; rather what is truly important is the product of sales quantities are prices, together. Through this lens, the housing market remains in a steep depression.

It is my remaining suspicion that this mirage will eventually break to two or more decades of housing slump that largely disappoints everyone. This is not unprecedented when considering the magnitude of this financial crisis, next to the time it has taken other crises to work their way out of the economy.

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  1. matt_bear

    the one thing you’ve left out is the foreign cash buyer. though it might be included in your disclaimer of certain markets being different. Certainly the case in south FL. Bottom line, America is for sale (a fire sale almost) and foreigners are coming in and paying cash. The Russians have taken over North Miami. Venezuelans and Columbians are all over the nice parts of Weston.

    We have one of the largest toyota dealerships in the country, that’s making their numbers by the Venezuelans buying up cars, full price cash, and exporting them for 3x profit in south america.

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  2. Martin

    I expect a sizable home price drop after BX and others decide that they don’t want to be landlords anymore. If/when interest rates jump, there will be easier ways to get a yield than managing tenants.

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  3. Toronto Trader

    You Americans are lucky to at least have had a price correction in 2007-2008. There has not been a break here in Canada. Bidding wars on every property, young people can’t afford million dollar houses in the city. And let’s be clear…the lowest you can go in the city for a normal sized home is $500000-600000. Insanity.

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    • muktukchuk

      Mr. CT – you seem to have drawn general conclusions from your local experience, in what is now the economic backwater of Ahmarahka – Michigan, and more specifically anywhere within 100 miles of Ditroyt. The conditions found in Michigan may or may not apply elsewhere.

      Mr. TT – debt service on a $400,000 mortgage at 4.5% = $22,500/yr – less than $2,000/month.Or 33% of gross income of $72,000/yr. Compare that % to the rest of the world. All of you haters of Baby Boomers (typically, the spawn of said Boomers) can most certainly afford housing (think 2 income households), but perhaps you can’t afford it along with your $200 jeans, your BMW’s, etc. in which you just HAVE to been seen and noticed at the trendiest of bars/restaurants at least 3 nights a week. You can blame the Boomer’s for giving you the jeans, etc. in the first place when you were/are sucking off the Boomer’s teats, as youths — the definition of which now seems to be anyone under 35.

      Let me be clear, I am not saying that someone without gainful employment can afford to own a home, but when has that ever been the case?

      There’s connectivity between what you DO and what you GET. Unfortunately the generation that was spawned and spoiled rotten by the Boomers just wants to GET, without the DOING.

      So now you can bring on the “Boomers screwed us over comments” — give me shelter. (no homeless guy)

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      • Mr. Cain Thaler

        (laughter) proud boomer, hear Muk roar. I am not going trash the baby boomer generation. However, the turnover between generations is critical and should not be summed up to “insensitive generational warfare”.

        I was also pretty clear that the conclusions being drawn were local to me, I feel. If you are not seeing the same, please do tell me where you are and what the difference is. It will aid the discussion.

        But the last word I would add is this – just because something is affordable doesn’t mean it is good value. Most people could “afford” to buy a $100,000 yacht, if they subject themselves to the correct amount of pain and waste.

        The issue is not “can I make the payments?”, it’s “what’s the net cost?”

        The historical long term ratio of housing prices to average household incomes is about 2-2.5X. And there was 1X available on the low end.

        Today, 2-2.5X is the low end. And 3-4X household income is probably more the norm. So put that in terms of years of your life.

        Why should someone sacrifice 3-4 years of their life, not counting interest, to own that 3 bedroom 2 bath home?

        The second problem is that “average household incomes” includes the baby boomer generation themselves, as the highest compensated generation. However, since the whole structure in many ways depends on the turnover to younger generations, we should really be comparing average available real estate prices to average incomes of 20-30 year olds.

        Again, to summarize, it’s not that the payments can be made successfully. It’s that the real, net cost is very high for some properties that just aren’t worth it.



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  4. kpricestox

    Great post. Agree with matt_bear about the significance number of cash buyers. I have read many articles highlighting this point. According to RealtyTrac, 49% of all home purchases in the month of September were all cash deals. As you have mentioned you cannot have a healthy housing market without middle class Americans buying… Yet XHB showed strength today on rising prices…rotation rotation rotation. Thanks again

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  5. from gorby

    Canada had their OH_OH moment
    1989-1993.Awful awful time.One day your house was worth $500,000 the next day$3 ish.Took five years from the end of the recession to break even.In
    poor areas more so.Fortunately prices
    doubled in the next 10 years.Canadian
    buyers did not have hedge funds competing with them.That would have made things impossible.Many families
    have taken some of those gains and
    helped their children with their down
    payments. America though is so much more dynamic than Canada and should recover much sooner.Renting out
    single family home is very expensive maintenance wise and the hedge funds will soon find that out. Profits are only in the capital gains .With any luck prices will remain stable for a while and they
    exit this business opening up some
    bargains for the average American.
    Good luck


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  6. MX2101

    Thoughtful post by Cain Thaler, and excellent comments as well.

    1. muktukchuk- you make good points.
    I have noticed that most mortgage to rent payment comparisons do not always account for property taxes, HOA fees, and buyers who did not make enough of a down payment to avoid additional insurance payments.

    2. btw- There are condos in a high rise near my office, these are 500 to 700 K units, and the condo maintenance fee is $800 a month. I understand that in some states HOA and condo fees can be linked to a lien on the real estate.

    3. Elsewhere, modest “non-estate” waterfront property can have $ 1,000 a month in property taxes, even though the market value of the house is still under the tax assessment basis.

    4. I am absolutely certain that politicians will not hesitate to jack up property taxes if it becomes necessary to save themselves and the government structure. Many folks will one day lose their homes because of massive property tax hikes.

    5. Flood insurance is the new scam. An agency can change the parameters and hundreds of thousands (in not several million) cannot afford to keep the house. This is about a ONE PERCENT change of something happening in a 100 year period. So debtors have to pay up for a one percent chance of a flood in a hundred years? What is the chance of a government calamity (martial law or social security collapse) in a 100 year period? And oh by the way- cash buyers need not worry as no loan is involved. I say bring on sea level rise, can we get six feet by 2025? I will have ocean access here. LOL
    And it is not just near the ocean, they can classify flood risk from runoff and minor creeks.

    About South Florida- As I recall there have been many times when foreign cash buyers were reportedly “snapping up property as cash buyers and laughing at the locals”. I remember the cocaine money stuff, and influx of buyers brought on by currency exchange rate changes and disruption in the home country. South Florida would not be much without capital and attention from those outside the USA. Silly Americans are lured instead to the Disney promotion in Orlando, conned by media. Not sure what to say or do about this, collectively many Americans act like idiots, they buy the con and fall for the crap nearly every time.

    Best regards.

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  7. MX2101

    Also- In an area about 2 feet above sea level, prices are weak on middle class homes, and the high end homes are holding up. This must be flood insurance reality setting in, on those who cannot afford it. God bless the wealthy (seriously). They can pay cash or mostly cash, and not sweat ongoing efforts to shake out weaker hands.

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  8. ironbird

    Never did understand why you went bullish on the real economy whatever that is. There are no jobs. Rich moving money is rich moving money no doubt.

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    • Mr. Cain Thaler

      It’s the energy boom and a number of businesses I’m seeing crop up in the urban areas around Michigan.

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  9. matt_bear

    be careful what you wish for muktukchuk-
    by what you’re suggesting, we should forego all other aspects of life and pour all of our capital into a house. All other sides of the economy would crumble from the cut backs though. You try to say that our generation is spoiled (which has some truth to it), but in reality you just want us to be the bagholders for the unrealistic property values.

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