By A. Gary Shilling
Don’t buy your first house now unless you’re willing to lose 20% of its market value in the next several years. Maybe more.
It will take a 22% drop to return median single-family house prices to the trend identified by Robert Shiller of Yale University that stretches back to the 1890s and prevailed until the housing bubble began. (It adjusts for inflation and the tendency of houses to get bigger over time.) And corrections usually overshoot on the downside just as bubbles do on the upside.
The problem is excess inventories. They are the mortal enemy of prices, and we’ve calculated an excess of two million housing units, over and above normal working levels of inventories of new and existing homes. That is huge, considering that before the housing market collapsed, about 1.5 million new homes were being built annually, a figure that shrank to 568,000 in February. At current rates of housing starts and household formation, it will take four years to work off the excess inventory, plenty of time for those surplus houses to drag down prices.
Excess inventories, of course, were spawned by the earlier housing boom, which was driven by a host of factors—including low interest rates, almost nonexistent lending standards and government attempts to put even those who couldn’t afford chicken coops into four-bedroom houses. But most of all, the housing bubble was driven by the conviction that home prices never fall—they hadn’t on a nationwide basis since the 1930s—so any bad purchase would eventually be reversed.
As such, the homeownership rate expanded to 69.3% by late 2004, from the earlier norm of 64%. But now, homeownership has retreated to 66% as foreclosures mount, lending standards stay tight and many worry about their jobs and/or the responsibilities of homeownership. Everyone knows that house prices can and do fall.
Pushing Up Inventories
The optimists will tell you that home inventories have stabilized, but their thinking is flawed.
Our estimate of two million excess homes takes into account those on the market as well as hidden inventories, such as foreclosed homes not yet listed for sale and those withdrawn from the market because owners couldn’t stomach the bids they received. A U.S. Census Bureau category that measures such hidden inventories has leapt by one million units since 2006.
Additionally, our inventory estimate doesn’t even include future foreclosures, some five million of which are waiting in the wings. The 49% drop in new foreclosures since the second quarter of 2009 is a mirage, and was partly due to the Obama administration pressuring mortgage lenders to try to modify troubled mortgages to keep people in their homes. (They were largely unsuccessful.) Then lenders refrained from foreclosing to avoid even more bad PR during the robo-signing flap that highlighted inadequate foreclosure procedures.
Now that mortgage servicers have reached a $25 billion settlement with Washington and state attorneys general, foreclosures are likely to roar back. That likely will trigger the additional price decline, since the National Association of Realtors says foreclosed houses sell at a 19% discount to other listings, and sizable sales of real estate owned by lenders drag down the entire market. The total peak-to-trough decline in single-family house prices then would be more than 50%.
If those foreclosed out of their abodes move to rentals, they’re occupying other housing units, so there is no change in overall inventories. But if they double up or move in with their parents—as statistics show they have been doing—even more excess inventory results.
A Disastrous Investment?
Sure, the always optimistic National Association of Realtors tells you that based on mortgage rates, incomes and house prices, single-family houses have never been more affordable. But according to their index, that was also true in December 2008, and prices have fallen 9.2% since then. Ugh! Home prices may have dropped 34% since the peak in early 2006, but that doesn’t make them cheap if prices continue to decline.
Many have realized that an abode and a great investment are no longer combined in a single-family house. Instead of straining to buy a house, young families should rent until their kids are old enough to really need a single-family home.
Yes, apartment rental rates are rising and vacancies are falling, but by past standards, house prices remain high relative to rents. But even if homeownership was cheaper than renting, as some claim, buying a house now would be a disastrous investment if prices fall another 20% or more.
The homeownership dream of an appreciating asset and huge ATM has been replaced by the nightmare of a liability that is expensive to own and falling in value. Act accordingly.
Mr. Shilling is president of A. Gary Shilling & Co., an economic consulting firm in Springfield, N.J. He can be reached at firstname.lastname@example.org.