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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