Wednesday, November 19, 2008

Real estate - stop holding your breath

It's not coming back any time soon. Trust me. If you own a house, you're screwed. If you're waiting to buy a house, wait longer. There has never been a housing bubble in history that has reached bottom within 5 years and many take 10-20 years to reach a true bottom. This bubble peaked in 2005-2006, so hoping it will bottom before 2010 is unrealistic.

There are a few charts you need to be aware of to help put things in perspective. The first, courtesy of the Japan Real Estate Institute, compares the Japanese real estate bubble to our own and doesn't show the early downturn that began for the U.S. (as well as the UK and Australia, among others) shortly after this chart's data ended in 2005.

Notice that Japan went down for 14 years after the peak and they are now almost starting to stabilize after 18 YEARS OF DECLINING REAL ESTATE PRICES. You think we're better/different? You think Japan doesn't have a lot less land to go around than we do? You think our government will fix the mess?

Next up, mortgage rate resets, courtesy of Credit Suisse:

That big peach-colored peak that starts ramping up next year and continues until early 2012 is "option adjustable rate" loan resets. These are predominantly the "pick a pay" loans, where the home debtor can pay the minimum payment (what 80% are actually doing) and get into negative amortization. Negative amortization means every month you owe more and more on the house because you are paying less than an interest only payment so you end up owing $410,000 on a house that you bought for $400,000 with 100% financing. The loans often "trigger" a demand for ASTRONOMICALLY HIGHER payments when you owe over a certain amount of the original loan value. Though the other 20% of people with these loans pay interest only or a full interest plus principal payment and should be fine for a while, the other 80% of this herd is stampeding over a cliff as we speak.

Additionally, these loans and the clustered peak of "Alt-A" loans (usually 3/1 or 5/1 adjustable rate mortgages [ARMs] with low documentation and high credit scores) are for higher amounts/larger homes than subprime and are usually low documentation or no documentation loans based on a high credit score alone. This means that those who think "ritzy"/high-priced areas are immune from the ongoing housing massacre are ignoring the reality that lies dead ahead. These loans are how so many seemingly low or average paid people kept up with the Jones's and moved into McMansions.

Next up, the transmission mechanism is broken because banks and their potential customers are both broke or about to become so because of job losses (chart stolen from Dr. Housing Bubble via U.S. Treasury and Freddie Mac):

This is important. If you want to know what mortgage rates are, you can generally follow the 10 year U.S. Treasury bond rate and get a good idea of the trend. But notice the lack of drop in mortgage rates with the recent drop in the 10 year bond yields in this chart. Translation: banker's want a much higher premium in the rate they charge relative to historical trends, which means mortgage interest rates are the same or more compared with last year despite the Federal Reserve cutting their short-term rates and doing everything they can to "stimulate" lending.

Second translation: The "Fed" is not all powerful like the Wizard of Oz, but the free market is. The Fed is now trying to bypass the banks and reduce people's loans for them, which means anyone who doesn't take advantage of it or who isn't a homeowner will have to pay for their share of it anyway. After all, the Fed, when it prints money out of thin air, just puts it on the U.S. Treasury's tab and the taxpayers are then liable, either through inflation (the invisible tax that screws us all) or through increased taxation. By the way, what happens in a few years when interest rates actually start going up again?

Lastly, and probably most importantly, is the devastating psychological shift that will slowly transform the way we all think about housing:

"Housing always goes up."
"If you buy a house and hold it for at least 5-10 years, you'll make money."
"They're not making any more land."
"The tax benefits alone make it cheaper to buy than rent."

I used to believe all this B.S., too, so don't think I didn't drink the Kool Aid myself before I got educated on market cycles and financial history. All of these statements are false and only apply until they don't. Well, they don't anymore.

"Why buy a house when you can rent."
"Renting is cheaper than buying."
"Why pay taxes and maintenance on a house and deal with repairs when you can rent."
"Housing prices will continue to go down."

These are the new mantras that apply until they don't and they're just getting started. Ask me in 2012 if I think we've hit bottom, because I'd bet your first child it won't be before then. If real estate does bottom before then, it will only be in nominal terms because we will have destroyed our currency. In this setting, your house will be worth $1 million dollars but gasoline will cost $50/gallon.

Priced in gold, the best "real" money out there (have you traded any of your monopoly money for some yet?), real estate has a long way to fall. What you think is a good deal now will be too pricey in a few years.

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