Housing Market Sinks Beneath the Waves

The markets gave no clear sign of their intentions yesterday. The Dow fell 30 points. Gold rose $8.

And this morning, stock markets in Asia dropped. Earnings are up, just as they are in America. But earnings have a “last waltz” sound to them. AP reports:

New figures from Japan offered a sobering reminder that the world’s No. 2 economy remains fragile: The jobless rate rose, deflation deepened, and factories made fewer cars and mobile phones.

There’s news from the housing market. This update from Bloomberg:

About 18.9 million homes in the US stood empty during the second quarter as surging foreclosures helped push ownership to the lowest level in a decade.

The number of vacant properties, including foreclosures, residences for sale and vacation homes, rose from 18.6 million in the year-earlier quarter, the US Census Bureau said in a report today. The ownership rate, meaning households that own their own residence, was 66.9 percent, the lowest since 1999.

Lenders are accelerating foreclosures as borrowers fall behind in mortgage payments after the worst housing crash since the Great Depression. A record 269,962 US homes were seized in the second quarter, according to RealtyTrac Inc. Foreclosures probably will top 1 million this year, the Irvine, California- based data company said in a July 15 report.

“There are a lot of people losing their homes and either moving in with family or renting places to live,” said Patrick Newport, an economist with IHS Global Insight in Lexington, Massachusetts. “Foreclosures are still going up.”

Foreclosure filings climbed in three-quarters of US metropolitan areas in the first half as high unemployment left many homeowners unable to pay their mortgages, according to RealtyTrac Inc.

The number of properties receiving a filing more than doubled from a year earlier in Baltimore, Oklahoma City and Albuquerque, New Mexico, the mortgage-data company said today in a report. Notices of default, auction or bank seizure rose more than 50 percent in areas including Salt Lake City; Savannah, Georgia; and Atlantic City, New Jersey.

“Foreclosures are spreading out from areas that had been hardest hit,” Rick Sharga, senior vice president for marketing at Irvine, California-based RealtyTrac, said in a telephone interview. “We’re dealing with underlying economic weakness as opposed to unsustainable home prices and bad loans.”

Okay…so the housing situation isn’t great. But housing is not a leading indicator. It’s a lagging indicator. It’s what happens after people have lost their jobs, for example.

But then, as more and more foreclosures happen, more and more houses are available for purchase – many in desperate circumstances. Prices tend to fall. And then, people who still have jobs and houses find that their net worth isn’t what it used to be.

Already, millions of people are underwater. As housing prices fall, millions more will slip beneath the waves. Some will go down with the ship. But many will take to the life boats – sending back the keys instead. This will add to the number of foreclosures and to the inventory of unsold and vacant houses.

When does it end? It ends when it comes to rest on the bottom.

Where’s that? No one knows. But just as houses tend to be priced at more than they’re really worth in a bubble, they tend to be priced at less than they are really worth in a bust.

You can get a rough idea where the bottom in housing might be by doing a little math. You should be able to buy a house at a price where, financially, the decision to buy or rent is relatively neutral. There’s no particular reason why a person should invest in a house rather than in stock or in other investments. His goal is to maximize his quality of life…and his wealth. So, if he can rent a house for less than he can buy it…he should rent, because that gives him the same quality of life at a lower cost, leaving him more money to put to work increasing his wealth. On the other hand, if he can buy more cheaply, he should buy…for the same reasons.

If houses are going up, he’ll pay more for a house – in anticipation of the capital gains. But if prices are flat or falling – he’ll look only to the stream of income he can get from the house (or the enjoyment he’ll get from it personally)…and put on an additional discount to protect himself from capital losses.

Three years ago, it cost much more to buy a place than it did to rent it. A house you might have rented for $1,500 a month might have sold for $300,000. There’s no way that was a good investment. A 6% mortgage alone would be $1,500 a month in interest. Once you’d paid upkeep and property taxes, you’d be in the hole.

Now, that house is down a bit…say, to $200,000 or $250,000. But it’s still a long way from the point where it makes sense to buy rather than rent. Figure you need about 10% per year to pay taxes and maintenance. Plus another 7% for the cost of money. So a house purchase makes sense when you can rent for 17% of the purchase price. Or, to look at it from the other direction, if a house will rent for $1,500 per month, you can pay $108,000 for it.

Now, assume that the price overshoots on the downside. You might expect to pick up the house at a price under $100,000…say $79,000 or $89,000. Most areas are far from yielding bargains like that.

Bill Bonner
for The Daily Reckoning