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According to the Case-Shiller Index, it appears to be double dipping in most areas of the country with further declines expected ahead. So you may ask, when is the bottom? When is the best time to buy a house?

There are two camps when it comes to calling out the housing bottom and best time to buy a house.

One side of the camp says the housing bottom is nowhere near, that it’ll take a decade to fix all the problems in the housing market and the economy in general before we can see any growth in housing. Reasons for this argument include persistently high unemployment and underemployment rates, record levels of foreclosure homes and shadow inventory, high price to income ratio, to name just a few. Therefore, the best time to buy a house is at least several years later after letting the house price decline further, 5 to 10 percent or even more. This seems like a logical conclusion based on facts.

However, the people on the other side of the camp says you need to buy a house now before the inflation hits. The record high levels of US debt and the billions of dollars the Fed has been spending on QEI and QEII will ultimately lead to high inflation. In fact, it’s already been happening in many parts of the world. The price of food, energy, and basic materials have gone up significantly in the past year, severely impacting the people in third-world countries. This inflation has been the catalyst for the widespread protests and violence happening throughout the world these days starting from Tunisia, Egypt to Libya and other nations in the Middle East and North Africa with no end in sight. The people living in these countries spend the majority of their income on basic needs such as food, so the impact of inflation is felt quite a bit there, and it will soon impact the lives of Americans in the near future especially with the rapidly rising price of oil. When the inflation in America hits a high single digit or even double digit, a house will be a good hedge against inflation especially if you buy one with a minimum down payment with a low fixed-rate mortgage because high inflation will essentially wipe out your debt since you can pay off the mortgage with cheaper dollar in the future. Even though the price of a house does not increase as much as other inflation-hedge assets like gold and silver, it will increase in dollar so it’s better to buy a house now when the rates are still low. This seems like a logical conclusion based on facts.

So, who’s right? To me, both are right. But how can it be? It seems oxymoron to say that it’s better to buy a house several years later when it bottoms out and at the same time say it’s better to buy now before inflation gets worse? Therein lies the great confusion and endless debate between the two camps. The reason both sides are right is because there will be two different housing bottoms. That’s right, two housing bottoms. One is the bottom of housing price in nominal terms, and the other one is the bottom of housing price in real, inflation-adjusted terms.

What does it mean? Here’s how I envision the housing market to play out in the next several years. In nominal term, the housing price will increase when inflation hits America hard. As stated, a house will not be the best hedge against inflation like gold or silver because of its illiquidity and undesirability during inflationary period when everyone is having hard time keeping up with basic needs such as food. Nonetheless, it is a physical asset and thus would retain the value of the house leading to the increase of the housing price in nominal terms. On the other hand, when inflation hits America, the housing price will decrease in real term when you adjust it for inflation because in addition to not being the best asset class for hedging against inflation, we still have a lot of other downward pressure on housing price like the ones stated before.

So when is the nominal bottom and when is the real bottom? The nominal bottom will be before the inflation gets much worse, and the real bottom will be at the peak of the inflation. So then, when is the best time to buy a house? At the nominal bottom, real bottom or post-inflationary period? I think for most Americans it would be the nominal bottom. The interest rate will go up significantly higher during inflationary period, and the housing price will also increase in nominal terms during the period. You would not be able to buy a house with a bigger mortgage with a higher interest rate in those times because your increase in wage will not have caught up with inflation. Thus you should not buy a house at the real bottom when the price and interest rate are both high. However, the people who have been anticipating and preparing for inflationary period with a lot of gold and silver will frantically buy houses at the real bottom because to them housing will be extremely cheap with their much-desired gold and silver physical asset. How about post-inflationary period? The housing price would come down and the interest rate would come down during the post-inflationary period. However, the housing price will probably not come down so much to the pre-inflationary level, so you’ll have to have a bigger down payment and take out a bigger mortgage. How about not buying at all? It’s not a good idea to weather high inflationary period without a house because you’ll have to pay higher rent which could have been well spent on paying off your mortgage. Therefore, the best time to buy a house for most Americans seems to be at the nominal bottom while the interest rate is still low. Yes, the house will lose its value during the inflationary period in real terms, but it’ll be much more difficult to get the same house with the same down payment and mortgage after inflation hits hard.

So then, the next question is, when is the nominal bottom? When is the inflation going to get much worse from here? We’ve been through a deflationary period during the financial crisis of 2008-2009 until mid-2010. However, we’re already seeing signs that inflation has picked up in most parts of the world, so it won’t be long before it hits America. In light of all this, I think the best time to buy a house is now before QE2 ends and before the interest rate rises further. You think the Fed will announce QE3 and keep the rates artificially low? That is a possibility but not guaranteed. Also, if the investors are sick of the Fed printing trillions of dollar and flee the bond market in fear of US defaulting on its ever-more increased debt, the market will dictate and the interest rate will rapidly rise regardless of what the Fed does.

What are your thoughts on my conclusion that there will be two separate bottoms, one in nominal term and another in real term, and that the best time to buy is now before the inflation gets worse which would lead to higher interest rate?

#housing