Finding a Floor in Housing

“U.S. home prices rose in September for the sixth straight month, signaling that the housing market is in the midst of a recovery” screamed the headline in MarketWatch earlier this week.  Indeed, there has been positive news for housing lately.  Besides rising home sales and prices, foreclosures have been declining and stocks of homebuilders have done well this year.  Prices have risen significantly in Phoenix and some coastal areas in California and Florida, with numerous stories of bidding wars and sellers’ markets.

Consumer confidence has also reached up to levels not seen in the last few years, and housing is seen by most economists now as more of a help than a hindrance to the general economy.  One large financial institution is predicting that home prices will increase 4-5% annually for the next several years.  On the note buying side, some of my fellow mortgage note buyers are acting like we have returned to the glory days of 2005 and 2006.  Clearly, the media and many “experts” believe that the real estate recovery is well underway.

Is the housing recovery sustainable in the short (< 2 years) and medium-term (2-5 years out)?  In the short term, anything is possible, so I would not even hazard a guess unless I could read the minds of politicians (though I’m sure that I would not like what I would find if I could).  Over the medium-term, any recovery is susceptible to headwinds, including:

1. Falling household incomes and high household debt, in combination with a high unemployment rate, means that most families are in no position buy a house.  The banks are still being fairly tight with real estate loans too.
2. A large percentage of current home buyers are investors (27% in 2011) or foreigners (including Chinese looking for a safer place to park their cash).  These are groups that are more volatile than typical homeowners and are likelier to jump ship at the first sign of trouble.
3. Lots of mortgages are still in trouble.  There are 1.6 million homes in some form of foreclosure backlog (per RealtyTrac), 2 million foreclosures in progress, between 1.5 million and 4 million homes at least three months behind on payments (per Barclays Capital Research), and 10 million mortgages underwater.  There have been 5 million completed foreclosures since 2006, out of 50 million households carrying a mortgage (per Dr. Housing Bubble).
4. Interest rates, currently around 3.5% for a 30-year fixed loan, have been held unnaturally low by the Fed.   Those rates must and will go back up, making loan payments more difficult for many.
5. The federal government is involved in nearly every mortgage loan out there.  This is the same government with trillions of dollars in debt that it has no way of paying back, where the Federal Housing Administration will soon need a bailout, and where a change to the mortgage interest deduction is being considered (though I don’t think the deduction will change much).

When considering what will happen with the U.S. real estate market, we must also consider indirectly related factors and competing investments like the stock market, real estate trends in other countries, world economies, and similar characteristics.  When I look at the structural issues facing the U.S. and other major economies, along with the continued ineptness of politicians and bureaucrats, it is hard to be optimistic about most investment types.  I’ll go out on a limb to predict that any current recovery will be short-lived and that housing prices will be at least 10% lower in five years than they are now.  Feel free to call me at the end of 2017 to either congratulate or ridicule me for my prediction.

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