Housing prices aren’t going anywhere. Not for a long, long time.
This is not information that I am excited to be admitting to, as I am a homeowner and am currently in the process of buying another. Unfortunately, I have had way too many cold buckets of reality dumped on me over the years to ignore such a simple truth.
Now’s the time to buy – if you can
Generally, interest rates and housing prices have a negative correlation. That is, one goes up and the other goes down. Due to the fact that Americans, spend-happy as they tend to be, paradoxically would ideally like to budget their spending, a guaranteed monthly payment is attractive. To this end, mortgages are designed to provide a predictable, steady monthly payment that is based on the home price and, just as importantly, the interest rate.
When most prudent homebuyers go shopping, they more than likely are going into the operation with the knowledge of their maximum affordable payment per month rather than selecting a random home value to chase after. After all, there’s deals out there on multi-million dollar properties, but just because it’s a deal doesn’t mean that you can afford $42,000 per month.
Currently, interest rates are low and housing prices are also relatively low. This is not a common occurrence in general, and usually occurs only in these recessions that we find ourselves in (you can call it a “recovery” if you want… but just because my Nissan goes 160mph doesn’t make it a Ferrari). This means it is an ideal time to buy if you happen to be looking and able. The problem is that most Americans are in one of two situations:
Number one: They cannot afford to buy a new house – period.
Number two: They already own a home, and in order to purchase a new one, they must sell their current residence. However, the “deal” they may have found elsewhere is often offset by the fact that the home they are selling has depreciated as well.
Therefore, we have a stagnant market that is having a difficult time creating demand, even with ridiculous government stimuli.
Interest rate issues
Even if demand begins to creep in over the next year, interest rate increases are on the horizon. This will begin to stifle prices from rising significantly.
For example, someone who has a 30-year fixed 5% mortgage with a balance of $250,000 is paying $1,342.05 per month. If, one year later, someone comes along and is able to afford the same $1,342.05 per month, but is dealing with a 5.5% rate, this would only allow them to borrow $236,364.93.
Assuming no improvements have been done to the house and demand has remained steady, the real value of this home has dropped by more than $13,000. This is a matter of arithmetic, not opinion.
You may be thinking, “what if the Fed doesn’t touch interest rates?” Well, this is a fair statement, and they may very well leave rates alone. However, if we are in a position 12-18 months from now where we cannot raise interest rates, then that would imply that the economy, particularly the stock markets and labor markets, have not improved. We then see a whole new set of problems with the same result – low (or at best unchanged) housing prices.
Homebuilder sentiment is declining
Recently, U.S. homebuilder sentiment was expected to come in at 18 (a number less than 50 implies that builders have an unfavorable outlook on sales). The numbers came in below that already basement-level number to a 16.
NAHB’s chief economist David Crowe pointed to the same reasons outlined earlier in this article, namely the highest unemployment rate in more than a quarter-century. Accurate analysis.
To buy or not to buy – or rent
Another issue is the comparison of alternatives.
When you’re looking for a place to live, you have two basic choices: buy or rent.
In the long run, generally it is a better financial decision to buy property than to rent it, because some value is retained. Also, mortgage payments tend to be lower than the rent of a comparably sized home.
For the same reason that prospective home seekers are worried about their income (hesitant to buy or lock into a high rental lease), those who own rental properties are more likely to lower rent in order to ensure their units are generating maximum profits. Particularly if they are upside down on their rental property mortgage. Round and round we go.
Conclusions and market action
To top this all off, any demand that we have seen in the housing market has come mostly because of government intervention. A huge first-time buyer tax credit coupled with government purchases of mortgage-backed securities and mortgage modification programs has masked how poor the housing market actually is, as well as the extent of the real declines in value many homeowners are experiencing.
All of these programs will have to come to an end. When this happens, many experts are estimating that broad market housing prices will decline by another 10%.
For these reasons, I’m staying away from homebuilding stocks for a while. There are plenty of other opportunities out there, and there’s no reason to throw your money into something that has extremely limited upside potential.
For the record, if you’re in the market for an actual home (at least one that you plan to keep for more than a few years), you have a much better chance at earning money on your investment.