If Housing Has Bottomed Should You Buy?

In recent months a lot of news stories and experts have claimed they have spotted a housing bottom. I disagree. I think there is still room for a slight additional decline in prices. What is more important than spotting the exact moment of the bottom is to forecast how much will the coming housing recovery be. The answer is that when housing recovers it will not be a V shaped bounce to the old highs, rather it will be stuck in a saucer shaped flat stagnant market.

An analogy to housing is the price of Cisco shares which crashed from $80 in 2000 to spend years trading between 10 to 33 with a recent price of 19 after announcing a large dividend increase. Yes, it bottomed, but it didn’t fully recover. In Japan some commercial real estate has dropped down to the price last seen in the early 1970’s. It is important to keep one’s mind open to bizarre possibilities of a deep, long term depression for housing.

Housing prices are ultimately based on consumers’ ability to pay. In the past consumers could get a “Liar’s Loan” and borrow more than they could afford, thus creating a false bidding war for homes, so past home price statistics are meaningless. In addition income and employment for the middle class has been hurt and may stay stagnant for a long time. Since employment income is they to qualifying for a home loan then stagnant income will equal stagnant prices. Add to that the inevitability of a return to normal interest rates means that future buyers will have to buy lower priced homes in order to handle higher interest rates.

The mistake housing bulls make is to assume that housing is like a tradable share of stock that can be bought with a no-qualifier interest-only margin loan. Instead houses are bought using tough underwriting loan standards and are not day traded by algorithms that use liquid margin loans. The bulls look at old sales price highs as benchmark; instead the benchmark should be income driven as judged by an underwriter's standards and not by the raw data of how much is someone's income.

Henry Ford used to tell his workers I’m simply the conduit for the person who is paying and that is the ultimate consumer. If the consumer can’t afford a car or doesn’t like the car then the conduit can’t pay good wages. By analogy housing is a conduit for consumers to spend their income; if consumers are stuck with stagnant wages then they can’t cavalierly participate in reigniting a new housing boom.

The concept of the employer as a conduit for consumer demand is also an analogy to the case of apartment landlords who are a conduit for demand for rental housing. If the consumer simply can’t afford higher rent then there will be less demand as people double up in housing units, move to smaller properties, move to trailer parks, or lengthen commutes to lower cost areas.

The shadow inventory of housing is still a threat to the formation of a bottom. When I was a loan officer in 1991 I met a buyer of a foreclosed home who said the bank seller had left it empty for two years before trying to sell it. A logical person would have sold or rented the property to clear out an unused asset instead of letting it sit empty for two years. I think banks' cultural nature is that they are bureaucratic and afraid to make mistakes so when faced with a massive amount of foreclosures instead of quickly selling off properties they procrastinate and drag their feet on liquidation. Eventually more supply will come on the market. Rumor is that officials have asked banks to delay foreclosures during the election season. So I expect an increase in the pace of foreclosures after the election.

I wrote an article “Home price to income metrics wrong” and Housing has not bottomed”.

My comments are about national average homes and do not apply to elite pockets of full employment areas like Silicon Valley, Manhattan, Washington, DC. etc.

About the author

Don Martin, CFP®

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