patrick.net

Troy,

I agree. Real wages will be under pressure, especially for J6P.

But our “government gone wild” is spending like drunken sailors, and the Fed printing press has been working overtime. This will lead to inflation. Nominal wages will rise, and investors will chase real assets to avoid the loss of purchasing power. Similar to the 1970s all over again…

the problem has not past yet. I ask again, what makes you think we are immune to further price drops if these "serious problems" have not taken affect yet?

Zephyr says

Similar to the 1970s all over again…

I think this may, and I mean may, prove to be totally naive.

The baby boomers were entering their 20s in the 1970s not their 60s as now.

The national debt was under a trillion and there was a modicum of fiscal restraint. State finances were also less unbalanced. Unions with real negotiating power still existed.

PCs, that wonderful productivity multiplier, were just getting started.

China was imploding under the Gang of Four. Working with India meant a $4000 plane ride or sketchy and expensive long distance communication over voice lines, but of course back then India didn't know a TRS-80 from trash.

We still made stuff and we only recently had gone into importing more manufactured stuff than we exported.

Japan has printed like crazy and what do they have? Lower wages and lower land values than 1985.

There could very well be raging inflation in global commodities like energy, food. Healthcare could double. Tax burdens could go up. None of these effects exert upward pressure on home prices. Quite the opposite, in fact, since housing -- rents -- is a household budget line that comes AFTER taxes, transportation to get to work, and essential food and other survival goods.

Zephyr says

Our growing population and demography does not suggest a decline in real demand

We may be growing by 2.5M people per year but 1M of those are immigrants and much of the rest are shall we say relatively unproductive mouths to feed. Looking for population growth to automatically stimulate the economy is a major broken window fallacy.

Population doesn't increase land values, after-tax household income does. And household income is primarily driven by wealth creation, something that may or may not grow as it has for the past 40 years.

" Our growing population and demography does not suggest a decline in real demand."

Plenty of land in CA central valley and even more in the South West.

thomas.wong87 says

Plenty of land in CA central valley and even more in the South West.

Unfortunately, there are ~no jobs~ in those locations. Plus every 20 people you add takes an acre-foot from ag.

There would be very little impact on Agriculture business.

Troy says

Unfortunately, there are ~no jobs~ in those locations.

Like to remind you of Ciscos 1999 plan to relocate its entire operations from Milpitas down to Gonzales.
So many are willing and able to relocate out of state as needed as did 3Com and Borland.

Troy,

I am not expecting an exact repeat of the 1970s. But, we are looking at inflationary pressures that will be greater than anything we have experienced in recent decades. Thus, I refer to the 1970s because that was a decade of rising inflation. The effects on asset prices will be similar. Classic cycle patterns suggest that the inflation will start with commodities and then work into real asset prices and the prices of goods. That will lead to nominal wage pressures. Real wages will probably be stagnant for most Americans, and actually decline for Joe Sixpack. This will mitigate the rise in real home prices.

“…what makes you think we are immune to further price drops if these “serious problems” have not taken affect yet?”

We are not immune, and I am expecting further price declines in the upper half of the market during 2010. But the bulk of the serious problems have taken effect already. And the results were dramatic – a financial panic, a collapse of the stock market and housing prices, and a major recession.

What remains to hit us will be much smaller than what has already hit. Financial markets are reflecting that. The stock market bottomed in March and has since recovered by about 60%. Housing is going through a rolling bottom. The problems are/were most significant for the lower part of the housing market and that segment has already bottomed, and prices are rising. The tide is turning.

“Looking for population growth to automatically stimulate the economy is a major broken window fallacy.

This has nothing to do with the broken window fallacy. That is a completely unrelated concept which pertains to the problem of things unseen. Cash for Clunkers is an example of the broken window fallacy. You cannot crate wealth by destroying what you have. You just create busy work to replace what you had.

Population growth does increase demand for housing, by increasing the number of households.

Home prices (like all goods) are moved by changes in supply and demand. Real price changes require real changes in supply and/or demand. Nominal price changes can occur without any real change in supply and demand if there is a change in the value of the currency. Inflation will raise nominal prices.

We are in the very early stages of a cyclical recovery in housing prices. Specific segments and locations will have strong movement while others stagnate, but overall I expect real housing prices to move slowly in the next few years. Rising inflation will begin to push nominal prices a bit faster.

Thomas.wong87,

You said: “Plenty of land in CA central valley and even more in the South West.”

Yes. The same supply we have always had, during booms and busts. Nothing new. If the supply of land is not growing, and the demand for land is growing (population growth), then real prices must rise relative to other goods.

Real-estate inflation happened in the 1970s because of the massive influx of money into the aveage house-buying household. It came in the form of an additional paycheck with the woman's name on it. A nice, taxable representation of her economic power which previously skirted under the radar. Why raise your own chickens when you can pay taxes on the money you use to buy the eggs?

The problem I have with the 70s analogy is the fact that women today work to make money, whearas before they stayed home to make money. I'm not so sure how much of it was social stigma, and how much of it was the realization that a loaf of store-bought bread from the supermarket (not the grocery store, he went out of business) was just as cheap as making it yourself. No to mention that store-bought clothes/shoes/curtains/whatever were a heck of a lot cheaper to boot so why bother with it. My mother was the last generation to use a sewing machine, and even she hated it. If my taxes/interest rate were suddenly to double I wouldn't be able to turn to my wife and ask her to get a job, because her 40hr/week commitment to keeping us in the middle class is currently booked. Come to think of it, she already makes a lot more than I do!

No, I'm not getting another job.

The real estate explosion in the 1970s will not repeat itself because instead of going to work to buy the house/car they want they are already working too hard to try and keep it. There is no fall back plan this time. High interest rates will KILL the housing market, not make it better. But don't expect renters to make out, because rents will go up when housing becomes less affordable. Count on it!

Zephyr says

Nominal price changes can occur without any real change in supply and demand if there is a change in the value of the currency. Inflation will raise nominal prices.

This is basic economics, yes, but my argument is that the housing good is just one in a basket of goods.

I think we can agree that J6P's real, if not nominal, wages will be under pressure due to globalization and lack of bargaining power with employers.

I agree with you that commodity prices will respond to inflationary pressures, as will wages earned by professionals in gated job communities -- defense contractors, medical professionals, politicians and other higher-level gov't work.

My thesis, as mentioned above, is that even with wage inflation housing can still go DOWN in nominal terms, simply because the production cost of current construction, and all land, is approximately $0. As you well know, what we pay for land is its value as an income-producing asset, its rent. What happens to rents when wages are flat in real (and perhaps even nominal) terms, food goes up, gas is $10/gallon, taxes go up, health insurance goes up?

To make my argument explicitly clear, do you think landlords will have pricing power in this inflationary environment?

I don't. Rent is a surplus.

knewbetter says

Real-estate inflation happened in the 1970s because of the massive influx of money into the aveage house-buying household. It came in the form of an additional paycheck with the woman’s name on it.

yes, in the 1960s banks didn't even look at the wife's income for loan underwriting. They should do the same now (qualify on the greater income), LOL.

Zephyr says

Population growth does increase demand for housing, by increasing the number of households.

People can demand housing all they want, but they have to pay for it out of incomes.

Housing goods are still priced well above the cost of providing them. And there are ~20 million vacant homes in the US!

Granted, the rentiers may well be able to keep this excess inventory off the market and attempt to rack-rent their victims renters.

It's my thesis that housing rose this decade partially due to incorrect assumptions of income growth and also outright ponzi economics. Even now, we are only halfway down the correction curve.

This is not to say that general wage inflation isn't impossible. Perhaps the minimum wage will be $10 or $20 someday. Not sure how that works when weekly wages are that in China.

Correct me if I'm wrong but in the 1970's the leading edge of about 70 million baby boomers were starting to go into the housing market. In the 2010's they are starting to exit the market, looking to downsize (who the heck wants to live in a mcmansion at age 75), going to retirement homes, or dieing. Many have already bought their retirement home during the boom, providing they can hang on. Most of them are dramatically underfunded for retirement with their house being almost their only retirement asset, putting on even greater pressure to sell.

The median age for boomers is 53 with the average lifespan being about 75. For the next 20-30 years baby boomers will die much faster than immigration/births will replace them. This is almost 25% of the current population of the entire country that is simply going to disappear in the next 30 years. People in their most productive years. Do to our insane immigration policy which favors family in the country over all other factors, they will be replaced with people who are not only at the bottom of the chart, totally lacking in education or marketable skills, but many who are actually not capable of working at all.

These are irrefutable demographic facts. So exactly where are the buyers for this approaching tidal wave of homes for sale going to be coming from??

Something I have noticed while looking a houses to buy, people over 65 are selling (trying) at a record rate in the San Antonio, Texas area. I think they are hoping to get some money out of the sale.

Short of having your house paid for and willing to deal, they are not selling. I have seen properties on the market for a year plus and still no sale.

The seniors thought they were going to retire on the equity. Oh well.

people over 65 are selling (trying) at a record rate in the San Antonio
the Silent Gens final act is going to be hosing the Boomers. I'm guessing the seniors will be next to join the Coalition of the Willing in the Bay Area. Could get quite interesting if they all decide to head for the exits (the more sensible ones have their houses paid off, so any price will put cash in their pockets versus overleveraged Boomers.) Calling surfer-x...

I'm 38 y.o. and I can't tell you how many of my friends, especially in the Midwest, were telling me about the vast amount of equity in their homes and how it was going to be their retirement 'egg' just a few years back. I'm afraid to bring up the subject these days. I just hope they have a Plan B!

"Housing goods are still priced well above the cost of providing them."

If that were true, then homebuilders would still be building like crazy, undercutting the existing home sales. But they are not because they can't. Instead we have existing home sales in the millions (not far from previous precord levels), while new home sales have collapsed to under half of one million units.

"What happens to rents when wages are flat in real (and perhaps even nominal) terms, food goes up, gas is $10/gallon, taxes go up, health insurance goes up?"

I agree that housing budgets will be cut more than food budgets if real wages fall. Both will be cut. If wages decline in real terms then people will buy less of everything, as they did in the past, before real incomes rose. Fifty years ago people spent far less (in real terms) on everything - housing, food, clothes, etc. So people will cut out the less needed items - the luxury portion of their spending in each category. In housing they will downsize and forgo granite etc. This would lead to simpler smaller housing and reduced consumption of all luxury goods.

Leigh says

I’m 38 y.o. and I can’t tell you how many of my friends, especially in the Midwest, were telling me about the vast amount of equity in their homes and how it was going to be their retirement ‘egg’ just a few years back. I’m afraid to bring up the subject these days. I just hope they have a Plan B!

I had friends telling me the same. They all tried to convince us to buy too. Now we just avoid the housing topic.

Since the CS reset chart is headlining this post, it might be a good time to point out that Wells is getting religion with respect to their Wachovia portfolio. From the WSJ; also, Bloomberg did a recent piece on the phenomena.
The San Francisco company is issuing thousands of interest-only loans that will defer borrowers' balances for as long as six to 10 years... The move to shift Pick-A-Pay borrowers into interest-only loans helps Wells Fargo avoid hefty write-downs on Pick-A-Pay mortgages that would likely result from foreclosures.
The big question is whether they are doing enough to head off the ruthless defaulters (at this point, they appear to be splitting the difference with the mortgagors):
Danny Annan, an Orange County, Calif., engineer, said Wells Fargo recently offered to reduce his loan balance by $100,000 and transfer the remaining balance to a six-year interest-only loan with an initial interest rate of about 4.9%, Annan said. The offer will leave Annan more than $100,000 underwater on his home.

Zephyr says

“Housing goods are still priced well above the cost of providing them.”
If that were true, then homebuilders would still be building like crazy, undercutting the existing home sales.

Where there are jobs, there is no buildable land. Where there is buildable land, there are no jobs.

Note what I asserted:

“Housing goods are still priced well above the cost of providing them.”

What is the cost of production of an existing home? A coat of paint and new carpets, plus the annual property tax bill. The nation has 20 million vacant homes now. We have a housing glut of existing stock.

while new home sales have collapsed to under half of one million units.

New homes are far away from job centers and have to compete with existing stock, much of it good enough. $4 gas last year also put the fear of G-d into those contemplating being long-distance commuters.

So people will cut out the less needed items - the luxury portion of their spending in each category. In housing they will downsize and forgo granite etc. This would lead to simpler smaller housing and reduced consumption of all luxury goods.

And less jobs, less income, and less money to spend on housing. Anyhoo, it's not the luxury improvements that are "luxury", it's the site value component that is making housing unaffordable. Ground rents are TOTALLY out of the control of landlords, unless they possess monopoly pricing power (some do).

Edit: I realize I'm being rather dogmatic on this point and could be entirely wrong. Wage increases may come from J6P being pressured on all sides. It is a fight between J6P's employer and landlord as to who gets the most value from his labor.

New homes are far away from job centers and have to compete with existing stock, much of it good enough. $4 gas last year also put the fear of G-d into those contemplating being long-distance commuters.
I caught this episode of Patchwork Nation on the News Hour last night. It really highlights some of the points your are making.
If you look at what Eagle's population does for a living, a large percentage are builders, there's no doubt about it, in the construction trade. They were doing the two-year flip, so, tax -- you know, save tax money. Someone else would move in. They would build another house, and continue that cycle. The people that have been really hurt were the ones that were in that cycle, did not -- next thing you know, they own two homes, a couple lots, can't afford the payments, can't sell the homes.
Eagle County's boom was built on recession-sensitive businesses, housing and the resort industry. It's unclear whether Eagle and towns like it have learned anything from this downturn and can grow other industries to avoid the boom-bust cycle in the future.

Troy,

You said: “Where there are jobs, there is no buildable land. Where there is buildable land, there are no jobs.”

Yes, that is generally true. This means that population growth will require longer commutes or more housing density. Both factors will raise the relative value of land and existing housing located closer to the jobs.

“What is the cost of production of an existing home? A coat of paint and new carpets, plus the annual property tax bill.”

I suppose you could claim that, just as you could claim the “production cost” of anything already produced is close to nothing. The relevant comparison is replacement cost. And that is local labor costs plus materials, plus the lot.

The replacement cost of a structure is largely a function of current local labor costs and material costs (plus a time preference value). It is the land that fluctuates most in real price over the cycle, and in the long run gains or loses real value as its environment becomes more or less desirable relative to other choices.

I agree that we have a glut of homes, because of overbuilding. It will take a few years to absorb the excess supply. And homes in the hinterlands are an inferior good, and will be the last to be absorbed.

“Anyhoo, it’s not the luxury improvements that are “luxury”, it’s the site value component that is making housing unaffordable.”

It is both. But the site value is very cyclical, and has dropped significantly to the current cyclical lows.
Housing has become very affordable in most places today. In most of the country housing is more affordable today than it has ever been. This condition will not last. A combination of rising prices and rising interest rates will soon make housing less affordable.

We are experiencing a cyclical low in the costs of many goods including housing. As the economy recovers prices for most goods and services will rise. So, everyone should enjoy the lower than normal prices while they last.

Zephyr says

Housing has become very affordable in most places today. In most of the country housing is more affordable today than it has ever been. This condition will not last. A combina

More affordable than ever? Most of the country? Are you sure? That's not the way I read the numbers at all. The ratios of prices to rent and income still doesn't even approach historical norms in most of the country.

Cyclical low prices following a bubble bust can last a very long time as proven time and time again in history. Housing may not recover for decades. Look at a chart of real estate in Japan for the last 25 years. Drops from 90% in residential to 99% commercial real estate in Tokyo alone where there is most certainly no new land available.

For anyone buying a house as shelter for the long term none of this matters. But people thinking of jumping in the market as an investment (other than insiders doing illegal deals who are already cleaning up) are going to get creamed.

bob2356

The boomers will not die faster than the new births and immigrants replace them. The population of the US is expected to increase by roughly 100 million people over the next 25 years. So, real demand will grow.

And those who replace the dying are always from the bottom of the ladder, and they work their way up. All the people in the middle move up slowly as the oldest retire, and then die.

The replacement demand is already walking among us.

Zephyr says

The sky has fallen as far as it is going to fall.
The bottom is behind us for the lower third of the market.
The middle market is bottoming now.
Higher end home prices will keep slipping during 2010.
With all the wild government spending and Fed printing of money, inflation is coming. The lower end market has been rising for a year now. We will never see those prices again. Ever.
There is more pain remaining for many. But, the end of the world has passed.

Huge generalizations. It all depends on where you are. In my neighborhood, the sky is still falling because it has hardly even started to fall. In Detroit, it can't be beaten down any more (I saw houses for less than $500 on BoA's REO web site).

It's very local. San Jose has four or so new high rises all at less than 20% occupancy. Were asking $500,000s and now $279,000 and still not selling. Houses that were $6-800,000 are now asking $4-500,000 (still too high for many n'hoods). Up the penninsula, $1 mil is now $800,000, which is still out of reach to most potential buyers withOUT the mortgages of the past. Investors don't buy these as rentals because rents won't support their costs (without 1/2 mil down). But it is creeping closer and closer to my neighborhood.

Most boomers are indeed under funded for retirement (as are all age groups).

The “plan B” will be working longer before retirement, and spending less in retirement. Unless, of course, if they can get the government to give them more (at everyone else’s expense).

Zephyr says

Most boomers are indeed under funded for retirement (as are all age groups).
The “plan B” will be working longer before retirement, and spending less in retirement. Unless, of course, if they can get the government to give them more (at everyone else’s expense).

Forget about our generation having an opportunity to retire. We are in for a toughest 10-15 years of our lives. Pardon my pessimism but that seems to be a reality. We have to give back the last 20-30 years of artificially credit generated wealth.

Bob,

Affordability is a primarily a function of monthly cost. And at current interest rates and current housing prices, the monthly cost of buying an average house is lower than it has been in any year prior to 2009.

The simple ratio of price to income is too simplistic. It must be viewed in the context of prevailing interest rates. I remember buying properties in the 1980s when mortgage rates were double digits. The affordable price to income ratio was much lower with a 14% interest rate, compared to less than 6% today.

If you double the interest rate, then the average buyer can afford only about half the price. So the price to income ratio must change accordingly.

Dadab,

The problem is that people bought big screen tvs, big SUVs, fancy vacation trips, restaurant meals and bigger fancy houses with the money that they should have been saving for retirement.

Foolish is as foolish does.

Illness and disability will force many (most?) to retire before they expect to.
They will live a modest lifestyle in retirement.

If your home is paid for you can be comfortable on Social Security - if you are not an extravagant consumer. My 80 year old mother lives well spending only her Social Security income. She has plenty of other money, but never needs to use it.

Zephyr says

The sky has fallen as far as it is going to fall.
The bottom is behind us for the lower third of the market.

The middle market is bottoming now.

Higher end home prices will keep slipping during 2010.
With all the wild government spending and Fed printing of money, inflation is coming. The lower end market has been rising for a year now. We will never see those prices again. Ever.
There is more pain remaining for many. But, the end of the world has passed.

Great post and great follow~up posts, Zephyr.

I've purchased a few income properties in the past year and it seems as if more and more investors are coming into the market and the rock~bottom bargains are now a thing of the past (I'm speaking of low~end income properties). I'm an all~cash buyer but I'm not the only one out there. Seems as if quite a number of people were waiting on the sidelines to buy, or were able to sell off their portfolio prior to the collapse. I sold my investments a bit prematurely, 2004~~~but then I bought everything between '95 and '96 so I have lots of cash to play with.

It’s very local. San Jose has four or so new high rises all at less than 20% occupancy.
I saw on the news last night Alum Rock was closing schools. We having rising enrollments in our part of the East Bay, though. The Urbanization Shift appears to be picking winners and losers, although I still think even the winners will be facing a world of hurt.

compared to less than 6% today
Watch out for that deflation, though, real interest rates are higher than you might think. Well, at this point, I'm being somewhat hyperbolic as it appears CPI is headed back up (slowly).

WillyWanker,

Yes. You are on great path. Good luck to you.

I am also one of those all cash buyers.
And I have been waiting a loooong time for this market.

In 2003 I decided the prices were geting too high, as nothing looked good to me. In late 2005 I decided it was time to start selling. I did not sell everything (I wish I had). This year I started buying again (as I did in 1998 to 2003, after selling in 1989).

But I also play the market cycle in stocks. I sold almost everthing during 2007, mostly in the third quarter. One year ago I started buying stocks again, especially during the first quarter of this year. So far so good. I did the same thing in 2000, getting out before the market declined, and then buying back in during March of 2003. I like to follow and speculate on market cycles. And it has worked well for me for about 30 years now.

It is interesting to see so many people buy at the top, and then sell at the bottom.
During the bubble they think prices will never fall.
At the bottom they think that prices will never rise.
But it is cycle that keeps repeating itself.

"...as it appears CPI is headed back up (slowly)."

Always slowly at first.

Commodoties first, then goods, assets, and nominal wages.

The Fed has dramatically increased the money supply.
That will transform into inflation before long.

The Fed has dramatically increased the money supply.
The bubble vaporized a lot money. While I don't exactly sleep well with the Feds balance sheet hovering around $2.1 trillion, I'm not going to worry about the specter of Fed induced inflation until they hit $2.8 trillion. Commercial RE is the last to go, and, at least in my neighborhood, it's providing quite a spectacular show.

that graph looks like a double-dip recession. I hope TPTB have learned to "Just dip once and end it"

"The bubble vaporized a lot money."

Mostly it just transfered money from the buyers (and their lenders) to the sellers at the top of the market. Unfortunately many people lent money to the buyers so they were the real losers. But all of the "lost" money went to the sellers, and also to the people who sold other stuff to those borrowers who used home equity loans to buy stuff.

I agree that commercial RE has much pain yet to come.