Why a 50% Drop in Housing Is Not the Bottom

The psychology behind the idea that a 50% reduction in bubble-era housing prices constitutes a “bargain” is flawed for a number of reasons.

I recently saw a few minutes of a Nightly Business Report program on PBS in which a Florida broker was observing that homes which once commanded $350,000 at the bubble top were selling briskly now at $169,000 to investors from every part of the globe.

In other words: “These homes are half off! They’re screaming bargains! They can’t get any cheaper than this!”

The psychology behind this euphoria is accessible to us all. It’s easy to forget where housing prices were before the bubble and focus instead on how much they’ve dropped from the bubble peak. The same is true in any bubble, be it collectables, real estate, stocks, or tulip bulbs.

But valuation realities have no relation to bubble top pricing. Thus we should ground our analysis of housing valuations and what constitutes a “bottom” in metrics other than “it’s 50% off it’s top price.”

Let’s start by considering just how high the bubble took housing valuations:



This chart reveals that housing in California more than tripled at the bubble top. A fall of 50% from that peak (i.e. $275,000) is still 60% above the starting point.

Let’s consider a model of all bubbles, regardless of the asset or the era:



No model can predict the timing, highs or lows of any bubble, but bubbles tend to follow a pattern traced in human psychology:

1. As euphoria grabs hold, prices rise in a steep ascent to a point at which “everyone” believes there is no end to the trend.

2. The initial descent from the bubble peak is a “shock” which leaves the bubble mentality intact, i.e. the Bull Market in tulip bulbs, real estate, tech stocks, etc. is only suffering a standard retracement/indigestion; the trend higher is still in place.

3. In housing, this psychology is embedded in such chestnuts as “they’re not making any more land,” “real estate always rises over time,” “population growth means demand for housing will always rise,” “the house is the foundation of middle class wealth appreciation,” and so on.

4. At some point speculators who were left out of the initial explosive rise jump in because “prices are a real bargain now.”

5. still significantly cheaper than owning.



While this graph is a few years old, the trend to historic highs in property taxes is clearly illustrated. Yes, you can petition your county to lower your appraisal, but unless your state is protected from fast-rising property taxes via a Prop 13-type law, then brace yourself for local governments to make up their declinign tax revenues on the backs of property owners–plummeting prices be darned.



With reports of banks holding some 600,000 foreclosed or distressed properties on their books and off the market in the news, it is a foregone conclusion that any blip up in demand for homes will be met with a tide of new supply. After the current “bargain buying” dries up, inventory will exceed demand and prices will resume their fall.



And last but not least, let’s note that we’re dealing not just with the aftermath of one historically extreme bubble, but three: one in stocks (shown here), one in housing (shown above) and another in bonds which have skyrocketed as yields drop to near-zero.



The net result of declining asset values across all asset classes but gold is that there will be a global reduction in borrowing against assets. So add up the financial contexts which control real estagt; Array ( [0] =>gt; wpdb [1] =>gt; __construct [2] =>gt; __destruct [3] =>gt; set_prefix [4] =>gt; select [5] =>gt; escape [6] =>gt; escape_by_ref [7] =>gt; prepare [8] =>gt; print_error [9] =>gt; show_errors [10] =>gt; hide_errors [11] =>gt; suppress_errors [12] =>gt; flush [13] =>gt; query [14] =>gt; insert [15] =>gt; update [16] =>gt; get_var [17] =>gt; get_row [18] =>gt; get_col [19] =>gt; get_results [20] =>gt; get_col_info [21] =>gt; timer_start [22d is not limited to residential housing: How an economy foundering beneath stupendous debt can forcefeed housing prices higher via ever greater debt is unknown.



Just as a refresher on the extremes the housing bubble reached even when adjusted for inflation:



A significant percentage of this debt comes due in the years just ahead:



Another standard measure of valuation, the price-to-rent ratio, also reached historic highs. In some areas of the nation, this might have already returned to the mean, but with property taxes skyhigh and the cost of renting dropping, it may well be the cost of renting is still significantly cheaper than owning.



While this graph is a few years old, the trend to historic highs in property taxes is clearly illustrated. Yes, you can petition your county to lower your appraisal, but unless your state is protected from fast-rising property taxes via a Prop 13-type law, then brace yourself for local governments to make up their declinign tax revenues on the backs of property owners–plummeting prices be darned.



With reports of banks holding some 600,000 foreclosed or distressed properties on their books and off the market in the news, it is a foregone conclusion that any blip up in demand for homes will be met with a tide of new supply. After the current “bargain buying” dries up, inventory will exceed demand and prices will resume their fall.

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And last but not least, let’s note that we’re dealing not just with the aftermath of one historically extreme bubble, but three: one in stocks (shown here), one in housing (shown above) and another in bonds which have skyrocketed as yields drop to near-zero.



The net result of declining asset values across all asset classes but gold is that there will be a global reduction in borrowing against assets. So add up the financial contexts which control real estate valuations:

1. Extreme bubble valuations must eventually retrace to the starting point, and in many cases they drop below the starting point.

2. Housing and real estate are based on the availability of cheap, plentiful debt. As economy-wide debt loads are at historic extremes, it is prudent to ask what conditions will enable trillions more in debt to be issued to buy inflated housing.

3. As the Federal government borrows trillions of dollars on the open market to fund its mega-stimulus-bailout debts (in the trillions and counting), then the government is competing with private borrowers for a dwindling pool of capital/savings. That will drive up rates, making mortgages more expensive. And since prices drop as rates rise, this global push on interest rates is a profound headwind for housing prices globally.

4. Paying a mortgage requires steady income, which for most citizens means a steady job. Rapidly rising unemployment reduces the pool of potential buyers and adds to the inventory as those losing their incomes also lose their homes.

In short: with the national and household balance sheets at historic extremes of indebtedness it is difficult to see what fundamental financial foundation exists for higher housing prices.

The only conclusion to be drawn from the above charts is that those currently buying “at bargain prices” will very likely be disappointed as prices renew their downtrend in the near future.

 The U.S. Credit Crisis Visualized

Credit Crisis Visualized - Part 1

The short and simple story of the U.S. credit crisis.





The U.S. Credit Crisis Visualized - Part 2

Fight Foreclosure: Produce the Note How-To

7 Ways to Save Money And Energy This Winter

Since money is tight this winter, homeowners need to become tightwads with their spending on energy and heat. Here's how:

Install programmable thermostats
They can save you up to $180 on annual energy bills, says the Environmental Protection Agency.

Use Energy Star rated appliances
They use between 10 and 50 percent less energy and water than standard models.

Change doors
Energy Star rated doors with built-in weather stripping offer five times the insulation value of solid wood doors.

Update windows
Save up to $465 yearly on energy costs by replacing windows.

Install dimmer switch and motion detector
Dim lights by 25 percent and save an average of 15 percent on energy costs — and extend incandescent bulb life by four times. Motion-sensor lights save energy since they activate only when motion is detected and cut off during the daytime.

Seal
Use caulk, sealants and weather stripping. Try DAP Side Winder Caulk on doors and windows to fill gaps and leaks, and save up to 20 percent on heating and cooling costs.

Insulate
Cut costs by up to 20 percent by adding insulation to attics, crawl spaces and basement rim joists.

Check out other ways to save on energy costs.

$7,500 Tax Break for First-Time Home Buyers

There's nothing that perks up interest in DIY projects more than owning a home. And a new, temporary $7,500 first-time home buyer tax credit is expected to help millions of Americans own their first home.

The National Association of Home Builders has a Web site to help people understand how this incentive works. Here are some key provisions:

• The tax credit is available for first-time home buyers; this includes people who have not owned a home that is their primary residence for at least three years.
• The credit depends on how much money the home buyer makes. To receive the full tax credit amount of $7,500, the income limits are $75,000 a year for single taxpayers and $150,000 for married taxpayers filing joint returns. For partial credit, the upper limit is $95,000 and $170,000, respectively.
• The home purchase must occur on or after April 9, 2008, and before July 1, 2009.
• The tax credit works as an interest-free loan with up to 15 years to repay. For example, a buyer claiming the full $7,500 credit would repay the loan at a rate of about $500 a year.

For more about the tax credit, click here.