Are we in a real estate bubble or is it merely a period of overheated prices that will soon cool off? Is it the right time to buy (or sell) a home? If there is a bubble, how do we spot it?
Thinking about the housing markets for the past few weeks has been somewhat more than an academic exercise. I sold my last home a little more than four years ago, for family reasons unrelated to valuations or markets (time to downsize). I decided to lease for a time. My thought was to wait until a recession created a drop in values in the type of homes I wanted, and accompanied with low rates, would buy that perfect home. We would get the deal of the century. I persuaded my wife to go along with such an idea.
Because home values have not really risen in my area (Fort Worth, Texas), I have lost no gain on a home. Renting, even after tax, has been relatively cheap. But now my wife is getting a desire to nest. She wants to turn her creative powers to work on her own home.
"How long," she wonders, "are we going to have to wait? So what if we can get a 15% better deal? Are we going to rent for another 2-3 years, waiting for your recession to come about? Further, if we buy, we are not going to sell for a long, long time. You tell me that a long, long time will cover that 15% and more. Why does everything have to be about a profit or making the most money? Homes are not over-valued in our town. I want a home now." Ouch.
Housing is strongly related to consumer confidence. It is part of the American psyche, warp and woof of our economic contentment. For every dollar of increase in U.S. home prices, consumer spending rises 15 cents, as compared to the influence offered by the stock market, where consumers spend 2 cents for every dollar rise in stock market capitalization.
Housing Price Weakness: Regional Price Disparity
Home prices for many areas of the United States have barely kept up with inflation, while in other areas it has risen 100% in just the last five years. There is a strong correlation to outsized growth in home prices with high levels of regulation. That is because increased regulation artificially decreases the housing supply.
Overall, in terms of the last two decades, housing prices have not risen all that dramatically when compared to national incomes, especially as lower rates have reduced the cost of monthly payments. But in a few areas, especially on the coasts, median priced homes are simply no longer affordable for the average family. In some areas, less than 20% of the country can afford an average house. Further, housing prices have risen by 30% more than inflation in the last five years, which is a cause for concern.
On the other hand, the demand for housing will be reasonably strong over the next decade due to an increase in the number of households primarily from immigration and from boomers buying second homes.
Data shows that national home prices have fluctuated from high to low, relative to average national income, over the past 40 years. Using this index, you can feel relatively "safe" in buying a home when the ratio is low. When comparing the average income-to-home average prices, we find that, today, the ratio is on the high end of the scale, implying that either home prices will drop relative to income or that income will rise relative to housing over the next few years. Given the recent lack of any real upward trajectory of income, the study points to housing price weakness.
Also from last week, "In 1950, the average new house was 983 square feet and cost $11,000. In 2000, the average new house was 2, 265 feet and cost $205,000. In 1950, there were 3.37 people per household, and now there is but 2.6. In 1950, only 6% of homes had a two-car garage. In 2000, 65% had two-car garages and 17% had three (or more) garage spaces.
"In 1950, the average cost per square foot was $11. Today it is $91. Much of that is inflation, as inflation alone would increase prices to $76. The actual value of a square foot today is far more however. I grew up in one of those 1950 homes. No air-conditioning (in hot-as-hell Texas summers!), one bathroom, rudimentary appliances, heating was a space heater in the main room. And three young kids and two bedrooms. I truly enjoyed my youth, but I am not nostalgic for the old homestead."
Housing Price Weakness: Homeowner Jump
A Harvard study showed us that owning a home was somewhat cheaper after-tax than renting. Not in all places, of course, as many readers noted. But we are speaking of national averages.
Almost 70% of US citizens own their homes, up sharply from 63% over the last 10 years, plus the population has grown. This is partially responsible for the increase in demand, but such growth in the percentages of those who own homes is unlikely to persist in the future.
After the recession and over time, the increased demand from a growing number of households and an economic recovery will serve to bring home prices back to the rising trend.
What does that mean in practical terms? Let’s say your area is not one where there is a bubble and home values in your neighborhood still drop 20% in the next recession. If you do not need to move or sell, while you will be uncomfortable in the interim, over time values will rise and you will pay down your mortgage. If you have to sell at the wrong time, you will lose money over what you could get today. If you know you are going to need to sell within the next few years, you might want to consider what your local market will look like during a recession.
If your area is somewhat immune to employment and demand fluctuations, then your decision will be different. Think of homes that appeal to retiring boomers in very desirable retirement areas. There are a lot of wealthy boomers looking for that perfect spot for the golden years.
Housing Price Weakness: Is There a Housing Bubble?
I would also expect that mortgage interest rates will drop during the next recession, which will help bolster sagging values.
So, there are lots of facts that should make us nervous and others that give us reason to be a housing bull. But that still does not answer the question, is there a housing bubble?
I believe the short answer is "no" for all but a few areas of the U.S. Over the long-term, I think most homeowners will see reasonable returns from their homes. But that does not mean you should rush out and buy an investment house or that housing prices cannot drop significantly from where they are today.
And what about my predictions for the future of home prices over the next 10-15-20 years? Except for bubble areas, I would think that average U.S. home prices ought to rise in line with inflation. Near-term, the recent rapid rise over inflation suggests a slowing of increases or even a retreat back to "trend."
for The Daily Reckoning
July 13, 2004
Editor’s Note: John Mauldin is the creative force behind the Millennium Wave investment theory and author of the weekly economic e- mail "Thoughts from the Frontline." As well as being a frequent contributor to The Daily Reckoning, Mr. Mauldin is the author of Bull’s Eye Investing (John Wiley & Sons, 2004 London NY), which is currently tracking on the NY Times business bestseller list.
In his easy-to-read, straightforward style, Mauldin spots the big market trends – and shows you how to profit from them. "Bull’s Eye Investing" is a must-read roadmap if you want to avoid the pitfalls of the modern investing landscape…
Eric Fry, from the largest stock market on the planet…
– The Nasdaq Composite slumped again yesterday, bringing its losses for the month of July to more than 5%! Suddenly, tech stocks have become even less popular than GM cars. After Merrill Lynch urged its clients to steer clear of semiconductor stocks yesterday morning, Intel shares tumbled about 3% and the entire Nasdaq Composite fell to new lows for the month. The high-tech index ended the trading day with a 9-point loss at 1,937. The Dow managed to eke out a 25-point gain to 10,238.
– After more than six months of trading – and trillions of dollars worth of transactions – the Nasdaq and Dow are both nursing small losses for the year, while the S&P 500 has delivered a smaller gain than a money market account. Wall Street assures us that stocks ALWAYS go up over the long haul, but richly priced stocks sometimes take their time doing what they’re supposed to…and occasionally they fall.
– We have no idea whether stocks will be rising or falling, but if forced to guess, the Daily Reckoning’s New York Bureau would wager that stocks will bounce a bit before resuming their decline. However, the prospective bounce interests us less than the prospective decline. It’s true that corporate profits are rising, but so are interest rates…and that’s not a good thing for the stock market.
– What’s more, consumer spending seemed to be screeching to a halt, even BEFORE the Fed raised short-term interest rates…and that’s not a good thing for the stock market either. Wal-Mart reports negligible sales growth while General Motors reports harrowing sales decline. The automaker’s sales plummeted more than 12% in June, despite a dazzling array "incentive" programs…could it be that the consumer is simply tapped out?
– "Fortunately for GM, July is a new month," Automotive News hopefully observes. Unfortunately, GM’s incentives have become so lavish that sales won’t necessarily mean profits. "This is getting good," a successful hedge fund manager told your New York editor yesterday. "GM will rebate you $250 if you DON’T buy one of their cars (but ‘test-drive’ it)! You can’t make this stuff up! Oh yeah, also, you get $5,000 back if you’re a returning customer. Sort of makes you wonder about the value of GM’s ‘brand.’"
– We also wonder why most of GM’s creativity seems to reside in its marketing department. Why not redeploy this talent into the automotive design department?
– "In the past few months, the fertile minds at GM have presented three never-before-used types of rebates to the buying public," Automotive News reports. "All three have been noteworthy; all three have been expensive. For example, if you test drive a GM vehicle but buy a competitor’s vehicle, GM pays you $250. It makes you wonder whether GM will run out of money before its marketing experts run out of ideas."
– Technically, the automotive behemoth is already out of money, at least if one includes its mega-billion dollar pension liability. But those are problems for another day. In the here and now, GM has enough cash sloshing around to fritter away billions at a time. But fear not, based on GM’s current rate of profit, the automaker will satisfy its pension liabilities a few years before the global oil supply runs out.
– Time will tell if GM’s groundbreaking incentive programs are also bank-breaking.
– "The first of GM’s current innovations was the payment of $250 to anyone who test drives a GM car or truck and then purchases a non-GM brand," Automotive News reports. "That sounds like an open invitation to steal from GM. Drive a GM model that you have no intention of buying and pick up $250 to help with the down payment on the Ford or Toyota or Chrysler of your choice. Paying rebates on the other guy’s merchandise is definitely a first in automotive marketing.
– "Next came a round of huge bonuses to owners of GM vehicles who buy another GM model," Automotive News continues. "OK, loyalty payments aren’t new, but $5,000 loyalty bonuses certainly are. That is the amount GM paid in June to buyers of 29 car and truck nameplates.
– Coming soon: Cash rebates on tech stock purchases?
Bill Bonner, back in Boston…
*** At an atheist’s funeral…
We were only in Florida long enough to get a bad impression of the place. We had gone neither for the sun nor the sand nor the ubiquitous vulgarity. No, we came not in joy but in sorrow. We came not to witness and guffaw…but to bear witness and shed a tear.
But it was a sweet sorrow…for it brought together old friends and reminded us all that while ars may be longa, vita is brevis. And there’s nothing like a brush with the eternal to make the here-and-now seem a little less sordid, tedious and hot. After the memorial service, even Florida seemed like a nice place to be…as long as you still have a pulse.
"Bob didn’t believe in God," said one speaker. "I had a long argument with him on the subject. He kept trying to prove to me that God did not exist. Of course, I kept arguing with him. And at one point I told him, ‘I’m just trying to save your soul.’ To which he replied, ‘and I’m just trying to save your mind.’"
Of course, the argument was futile from the get-go. Galileo and his successors have shown us more and more of how the world works, but none of them has any idea of why it works that way. God could perfectly well create the world with a Big Bang if He wanted to. Elaborating the species by a process that looks like evolution would have been a cinch.
Yet after Galileo, many men got so enthusiastic about reason, they got entirely carried away by it…coming to believe that anything that their own reason could not grasp and explain simply couldn’t exist. The idea is so breathtakingly arrogant that we, here at the Daily Reckoning mobile headquarters, have to reject it out of hand. Humility is our creed. We don’t necessarily believe in God, but we are far too humble not to believe. And we see no reason why God, in creating Heaven and Earth, should be constrained to put them together in such a way as your dumbbell neighbor could understand it all.
In the upcoming election, about half the voters are expected to cast their ballots for George W. Bush. The other half will pull the Kerry-Edwards lever. Is it really possible that God would create a universe so simple minded that either candidate could figure it out? We don’t know. But we are glad we don’t live in such a world.
"It’s a slave’s religion," remarked a friend, another atheist, upon leaving the service. "Christianity is perfect for slaves…and that’s why slaves in Rome took to it so readily. It teaches people to accept their fate. They are supposed to be meek. It even tells them to act like sheep."
Our atheist friends do not like the idea of acting like sheep. They tend to be freethinkers, with faith only in their own ability to think things through and arrive at the correct answer, by reason alone. And yet every time we look at what humans – especially large groups of humans – actually think and do, our mouths drop open. We stop in our tracks and gasp for breath, for there is nothing at all reasonable about it.
Last night, on an airplane, we read a book about America’s role in WWI. Once again, we were entertained by the pure madness of it all. You could go from one end of the country to the other asking historians why America decided to enter the war…or why they entered on the side of England and France rather than on the side of Germany and Austria. You would get plenty of answers, but not a single reason that makes any sense or comes close to justifying the deaths of nearly half a million Americans. You would not, because they don’t exist. In the book we were reading, historian Thomas Fleming concludes that Wilson merely wanted to get America into the war so he could preside over the peace settlement and create the New World Order he had dreamed of.
(In a curious coincidence, WWI had its origins right in the library at our Baltimore HQ…where Wilson met with Theodore Marburg, U.S. ambassador to Belgium. It was here that the two dreamers were said to have come up with the idea for a League of Nations.)
Wilson, says Fleming, thought the war was almost over. He did not really expect to have to raise an army and send men to die. But the great mass of men does not react to the appeal of war with the calm reserve of a Princeton professor. Instead, their passions get pumped up into a bubble of war rage. Soon, they are eager to kick someone’s butt and are not too troubled by whose butt it is or why they are kicking it.
In Tulsa, Oklahoma, for example, a crowd of men who called themselves Christians hauled a Bulgarian immigrant out of a bar and lynched him. They took him for a German. All over the country, people declared they hated Germans, though none knew why. People changed their names to avoid sounding too Teutonic. A former mayor of Annapolis, Maryland, a man of German heritage, shot himself after the mob turned against him.
Even after the war, the hatred continued. The British continued their blockade of German ports…and tightened it…after the Armistice was declared. Thousands of Germans – especially children – starved to death. One British journalist visited a maternity hospital in Cologne. He found "rows of babies feverish from want of food, exhausted by privation to the point where their little limbs were like slender wands, their expressions hopeless, and their faces full of pain."
"But so what," said Clemenceau. There were 20 million too many Germans anyway, reasoned the French premier.
Back at our atheist friend’s funeral…
"Bob did not believe in God," continued a rememberer. "He believed in the power of reason and in his own mind. Of course…we don’t know what he believes now."