US Real Estate Market Sits in the Waiting Room

Dead guys walking…

An article at the Zero Hedge website says Paul Krugman is either “an imbecile or a fraud.”

We wouldn’t go that far. He might be only mildly retarded…or the victim of higher education. He has learned so much about modern economic theory that there is no room left in his brain case for good, old common sense.

More on that later in the week….

In the meantime, the Dow closed up 46 points yesterday…not enough to get excited about one way or the other. Oil traded at $74 when they turned off the lights. And gold slipped a little, but still is close to a new record.

This time gold approaches its old high in silence. All eyes and ears are focused on the US Treasury market, which many analysts say is in a bubble. Few notice gold creeping up to an all-time high.

Neither gold nor Treasuries are really in bubbles – yet. Gold is about where it ought to be, it is about as valuable as it has usually been for the last 2,000 years. And Treasuries? Well, there the story is more complicated. But here’s something interesting: 30 years ago, 30 year US bonds gave you a double-digit yield. Now, they give you less than half that much. And short-term loans to the government give you a yield with almost no digits at all.

Thirty years ago, the fellow running the Fed – Paul Volcker – worked to lower inflation. The current occupant of that post – Ben Bernanke – labors to raise inflation.

Thirty years ago, a wise investor should have taken Volcker at his word and bought US Treasury bonds. What’s a wise investor to do now? Take Ben Bernanke at his word and sell them?

Maybe. We will leave the question dangling…and turn to real estate. Let’s imagine that Ben Bernanke succeeds. Let’s imagine that he nudges consumer price inflation upwards. What happens to mortgage rates? Well, they go up too. Then, what happens to the housing market?

Ooh la la… Housing would be a dead guy walking. There are millions of people who are not buying already – even with the lowest rates since the Eisenhower era. Imagine all those who will not be buying at higher rates!

But many people think real estate has bottomed out. One of our colleagues posed the issue yesterday:

“I think we’re seeing the bottom of the real estate market. There are deals out there. Now is the time to act.”

He was proposing to buy an office building in Baltimore. It had been offered to us for $2.2 million two years ago. We passed. Now it is available at $1.5 million. We will offer $1.1.

“Maybe the downturn is over and maybe it isn’t,” we replied, with our customary helpful assurance. “But why not wait? If prices are going up, they probably won’t go up by much…and not fast. There’s too much inventory coming onto the market.

“So why not wait and see? If the market steadies…or rises…you won’t give up much. If, on the other hand, it goes down…you could get a much better deal by waiting.”

As near as we can tell, the US real estate market is just waiting. It doesn’t know whether to go up or down. Some areas are cheap – Detroit, Las Vegas, California. And some areas have barely dropped at all – such as Washington, DC, where the zombies live.

Also, there can be a big difference depending on what kind of property you are looking for. There are buyers at the top and the bottom, but not at the middle.

At the bottom of the market are the bargain hunters – bidding on what they consider good deals. At the bottom and lower part of the middle of the market there are also people taking advantage of record low interest rates. They do the math – but only on a month-to-month basis. At today’s low rates they can buy a mortgaged house and make a reasonable monthly payment. What do they have to lose? They need a place to live.

There are buyers, too, for properties at the top end. Rich buyers still have money – though not as much as they had three years ago. They still buy the properties they want when they want – though they may pay less.

The problem, according to our sources, is in the middle. Couples with two incomes. People who need substantial mortgages, but are thoughtful about their money. People who see a house as a substantial part of their assets and the purchase as an investment decision as well as the choice of a place to live. They don’t want to make a mistake.

Is it a mistake to buy now? They’re not sure. So they play it cool. They don’t want to put down a big down payment and then find it wiped out as the market slouches again.

David Lionhardt in The New York Times:

At times, real estate seems to be in the early stages of a severe double dip. Home sales plunged in July, and some analysts are now predicting that the market will struggle for years, if not decades.

Others argue that the worst is over. As Karl Case, the eminent real estate economist (and the Case in the Case-Shiller price index), recently wrote, “Buying a house now can make a lot of sense.”

No one doubts that prices rose roughly with incomes from 1970 to 2000. The issue is whether that period was an exception. Housing bears like Barry Ritholtz, an investment researcher and popular blogger, say it was. The government was adding new tax breaks for homeownership, and interest rates were falling. These trends won’t repeat themselves, the bears say.

As evidence, they can point to a historical data series collected by Mr. Case’s longtime collaborator, Robert Shiller. It suggests that house prices rose no faster than inflation for much of the last century.

The pattern makes some intuitive sense, too. As people become richer, they spend a shrinking share of their income on the basics. Think of it this way: someone who gets a big raise doesn’t usually spend it on groceries. You can see how shelter seems as if it might also qualify as a staple and, like food, would account for a shrinking share of consumer spending over time. In that case, house prices should rise at about the same rate as general inflation and well below incomes.

Here’s the scary thing, at least for homeowners: if this view is correct, house prices may still be overvalued by something like 30 percent. That’s roughly the gap between average household income growth and inflation over the last generation.

It’s also the overvaluation suggested by Mr. Shiller’s historical index. Today, it is around 130, which is way down from the 2006 bubble peak of 203. But it’s still far above the 1890 to 1970 average of 94.

In effect, the bears are arguing that housing was in a multidecade bubble and has now entered a multidecade slump.

Bill Bonner
for The Daily Reckoning