The national real estate market has now officially double dipped, yet the lies and irrational “feelings” about current market conditions continue. This comprehensive review will update many of the metrics from my February 1st article “Real Estate will Drag Economy in 2011.” I will attempt to lay bare the often twisted and maligned facts of past and present conditions with just a tad bit of humor and sarcasm.
It is a great time to buy!!
For how many decades have we all heard this proclamation? Was there ever a great time to buy or is this just a propaganda tool used to create sales no matter what the conditions? The average American generally evaluates this statement based on their “feelings.” Let’s look at the raw data and see if the rhetoric of sales people trying to incite you to action will hold up against the facts.
It is easy to erroneously believe that the, “it is a great time to buy” mantra started in the bubble run up of the 2000’s; however, this message is hardly new. Digging through old print, TV, and radio commercials reveals these dogmatic themes as far back as you care to look. In fact, I recently received an old newspaper clipping that just happened to have a real estate advertisement on it. The paper was from the 1980s and the advertisement was excitedly telling you that interest rates had dropped to the low 10% range making it “a great time to buy.”
Even after the largest asset bubble in history began to deflate, the message continued. Repeated advertisements touting low interest rates, real estate’s ability to build wealth, and “double in value every 10 years” were as far as the eye could see. Please click the following 2007 advertisement as just a taste of what I’m referring to:
Before you go any further, please also take a look at the specific claims in the following advertisement by the National Association of Realtors (NAR) in their 2008 ad.
The advertisement above claims that according to the NAR’s statistics, home prices nearly double every 10 years. For that to be true, real estate would have to appreciate at an annual rate of about 7%. Really? Seven percent per year? Does that make sense to you? Wage increases over the decades averaged 3% per year. After many decades, how were we all not priced out of the market if that was really true? This simple fact alone should already tell you that 7% gains over the long haul is a laughable claim.
The Case-Shiller National Home Price Index is the most widely used and respected real estate price index. Looking at the Case-Shiller National index since 1987, when their data begins, real estate has appreciated at about 3% per year. Ouch! The NAR’s numbers are more than double that! Three percent, hmmm, that number rings a bell for some weird reason…
“Wait, wait Mike! The NAR has data going back further than 1987 and that is why they are so far off – right?” Not so fast with the touchy-feely factless theories dear reader. Take a look at Robert Shiller’s data that extrapolates home prices all the way back to 1890.
Source: http://www.econ.yale.edu/~shiller/data.htm
In fact, according to Shiller, home prices over time when adjusted for inflation have not appreciated over the long-term. The lie about home price value appreciation has been repeated so many times that I doubt many of my readers will even believe the data now staring them in the face. Remember; do not confuse “inflation” with “investment return” or increases in tangible value.
The fact remains that home prices have tracked wage growth with near perfect correlation for more than one hundred years. Your great great grandparents paid about the same as a factor of their wages as your great grandparents, your grandparents, and your parents did. The only thing that affected nominal pricing was the devaluing of the dollar through inflation. Inflation does not increase the value of your assets; it just requires more paper dollars to represent the same value.
Granted there were ups and downs along the way (buying opportunities and overpriced periods), but historically, housing does not appreciate above the rate of wage growth over the long-term. How could it? How can Americans pay increasingly more (7% annually) when they don’t have the wage growth to fund it? It is a mathematic impossibility, but if the lie is repeated often enough it becomes the truth in the American psyche.
Half truths to sell the dogma
The NAR repeated throughout the bubble and its collapse that the reason this was the greatest time to buy was that 1) Owning a home is the number one way Americans build wealth, 2) Interest rates are low, and 3) there is an abundance of inventory. Before I take these statements apart one by one, please watch the following interview with the President of the National Association of Realtors on CNBC in February of 2008. Here he insists that 2008, after two years of declines, and soon to be the year of the biggest pop in real estate history, is the best time to buy. Take a look:
Please try not to vomit on your computer screen as there is a tremendous amount of data forthcoming and I don’t want your computer to short-out before we get to it. Please put that disgraceful video out of your head for now.
Let’s take the claims one by one.
1) “Owning a home is the number one way Americans build wealth.” A fascinating half truth worthy of study by propaganda experts from Joseph Goebbels to Nancy Pelosi. America has one of the lowest savings rates in the world. In fact, for brief periods of time our savings rate has actually gone into negative territory. “WE” don’t save. Call us spend thrifts, irresponsible, or just plain idiots, but Americans don’t save much money “on average.”
Now with that firmly planted in your mind, imagine you buy a home and start paying off the principle by making loan payments. Stealthily and without your knowledge you’ve been duped into saving! Eventually the house is paid off and since it still has value, you now can add the value of the home to your net worth. This unwitting savings plan created the “wealth” in your home. As is clear from Shiller’s extensive research, this wealth did not come from investment return above inflation. It came by you sacking away your wages. Nothing more, nothing less.
So the President of NAR is right! If only it weren’t being presented to suggest that the “wealth building” was coming from an investment return, it wouldn’t be so underhanded. You simply built wealth by saving your money – not by investing it in your home. Remember, we are talking averages and historic trends, not your friends, cousin’s, son’s, brother, that bought a house in an area that as a fluke rapidly turned into a tourist trap making him millions. In statistics, we like to call these “exceptions.” Quoting exceptions when presented with facts you refuse to believe is the surest way to admit you are losing an argument.
Americans “intentionally” save next to nothing, so amazingly enough their home is the number one area where unspent wages accumulate. The NAR president’s claim doesn’t sound so impressive anymore – does it?
2) “Interest Rates are low.” If low interest rates were the sole determining factor in knowing when to buy, then 2006 was a great time to buy, and so was 2007, 2008, etc. Who still agrees with this premise? My newspaper ad from the 1980s said it was a great time to buy while interest rates were 10% – huh?
No case can be made to buy now based on imminent interest rate hikes. Who in this stuttering economy, a little more than a year before a presidential election, thinks the Federal Reserve is about to jack up interest rates? If you raised your hand, please seek professional help.
3) “Abundance of inventory” If the President of NAR thought inventory levels in 2008 were good, he must of thought 2009, 2010, and today’s inventory levels are outstanding! Perhaps he missed the supply and demand chapter in his Econ-101 class. Currently there is a huge housing inventory, huge bank shadow inventory, and even more homes that are in the foreclosure pipeline. The effect has been to drive up supply during a time of historically weak demand and prices are continuing to fall. Why do you think it is a good idea to buy today when houses will be cheaper next year, and your future loan will have the same interest rate as today? Wouldn’t next year be the “better time to buy?”
At no time should you even consider the foolish thought – “What if I miss the bottom?” Home prices will not suddenly spiral upwards without you getting plenty of warning. I’m talking YEARS not months. If you want to buy, keep an eye on home prices. When they stop declining for a protracted period (without government manipulation), start looking. If you are interest rate sensitive, you will also want to keep an eye on rate changes. Be patient.
It is not a great time to buy
Let’s look at some real estate metrics to better understand the current market and its affect on the economy. Last time around I started with sales volume. I explained in the prior article why sales volume is by far the least useful real estate metric but the one the press is obsessed with. The main thing that can be gleaned from sales volume is current demand.
Take a look at the following graph of new home sales.
Source: U.S. Census Bureau
The graph shows our precipitous fall from the peak in October 2005. We are now moving sideways. Do not be fooled by tiny movements from month-to-month. The “best time to buy” crowd abuses and misuses this metric every time it ticks up. The number is so abysmally low, that any movement creates a seemingly significant percentage shift. If you look at the very last dip in the line at the far right and calculate the percentage increase from that point until the last point in April this year, you’d calculate more than a 16% improvement! That makes for a great headline, sound bite, and propaganda piece for NAR, but when taken in context, you can see from the graph it is mere statistical noise. In fact, the 12 month moving average (white line) is still declining.
Existing home sales as reported by NAR for April 2011 came in at 5.05 million SAAR (seasonally adjusted annual rate). This rate is about the sales rate we experienced in 1998 and 1999. Clearly demand for housing remains at record low levels.
Forward looking metrics and construction jobs
While looking at the prior chart you may have wondered how I could possibly know that that 16% rise wasn’t the beginning of some massive upswing in new home sales. The quick and dirty answer is – building permits. Building permits are an excellent indicator of future new home sales and future construction spending. New construction creates jobs and jobs create new homeowners. Looking at the next graph of building permits through April 2011, we can see that absolutely nothing has changed since my last report.
Source: U.S. Census Bureau
Building permits are running about one third normal levels. In fact, annualized building permit counts have never been as low as they are now (last couple years) since they started keeping records in the 1960’s. How does this affect construction spending? Take a look at this construction spending graph from the Census Bureau:
Source: U.S. Census Bureau
This chart does not adjust the construction dollars being spent for inflation. In other words, the value of construction currently taking place, dollar-for-dollar, is much lower than past spending. Essentially the graph’s plot points for prior years should be adjusted upward, making the current level of spending look even more catastrophic.
Not only is construction spending at historically low levels, it is continuing to decline. As government stimulus programs end, the fake “shovel ready” economic activity in the construction sector goes with it. Since building permits come before construction spending and jobs, we can see no reason to believe new home sales are about to spike upward.
Residential home pricing
The latest Case-Shiller Index numbers have been all over the news lately because they recently double-dipped. Robert Shiller stated back in March that “my intuition rates the possibility of another 15, 20, or even 25% real home price decline as substantial.” Earlier this year when I told friends and relatives that home prices will fall a minimum of 5% this year alone, and they could pull back 20% or more before reaching a bottom, I got that, “you’re a weirdo” look in return.
Since “The Weirdo” started predicting declines, home prices as measured by the Case-Shiller National Home Price Index have pulled back 4.2% in the first quarter of 2011. With the current trajectory of declines, who will now tell me prices will not fall another 0.8% by year end? If you again raised your hand, there is an entire team somewhere in Vienna waiting to study you.
Take a look at the Case-Shiller National Home Price Index graph below:
Source: www.standardandpoors.com
You can clearly see the decline following the expiration of the government rebates last spring. Prices have declined every month since and have dropped at a rate of about 2.3% per quarter using S&P’s seasonally adjusted numbers or around 3.2% per quarter using their non-seasonally adjusted figures.
To return briefly to the question of, “is this a good time to buy” let’s create a simple example. You want to buy a $200,000 home. A mere three months from now that same home will cost $6,000 less and can be financed at the same rate as you can get today. Is now a good time to buy, or is it better to buy the home three months from now? What could possibly justify paying $6,000 more just to own the home three months earlier?
Vacancy Rates and Asking Rents
Pricing doesn’t look good, demand is down, and supply is moving ever upward. Home sellers are getting squeezed and home buyers can get better deals by letting the market continue to fall. What about the rental market? Is the situation improving for landlords? Take a look at this updated rental vacancy rate graph.
Source: U.S. Census Bureau
Nationwide rental vacancy rates ticked up from 9.4% in Q4 2010 to 9.7% in Q1 2011. Vacancy rates have certainly pulled back from the highs created during the financial crisis, but further improvements are proving elusive. Nationally, vacancy rates have averaged 7.3% since 1956 or 6.7% if you eliminate the last decade. With vacancy rates at levels never seen before the crisis, landlords will have a difficult time pushing rents higher.
Regionally, vacancy rates in the North East and West improved last quarter, while the Midwest and South deteriorated. See the following regional graph of rental vacancy rates:
Source: U.S. Census Bureau
Again, removing the last decade and calculating the average since 1956, the western region is the closest to its historical norm of 7.2% with a reading of 7.3% in Q1 2011. By contrast the North East, Midwest, and South are sitting at 6.8%, 10.2% and 12.5% in Q1 with historical averages of 4.8%, 6.6% and 8.1% respectively.
As would be expected when vacancy rates are high, national asking rents declined for the second quarter in a row as can be seen in the following graph.
Source: U.S. Census Bureau
High vacancy rates and poor economic conditions appear to be pressuring landlords to lower rents. Regionally only the North East saw an increase in nominal rents.
Source: U.S. Census Bureau
I’m not going to bother adjusting rents for inflation as I did last time. If you remember from my prior article, landlords were not able to raise rents to keep up with inflation the last few years. Since average rents have declined since February’s article, it is safe to assume, that the spending power of landlords has declined further.
Homes in Limbo
I stumbled on another fascinating trend while studying Census Bureau data. The NAR and other sales groups love to quote how many months of inventory are on the market, all the while knowing damn well that many homeowners would love to sell if conditions improved (pent up sales demand). Many of these homeowners were clueless speculators that are now trying to rent a home they’d sell in a hot second if conditions improved. Banks are also withholding inventory to avoid depressing prices. How much of this is lurking beneath the phony numbers you hear reported? Take a look at the following chart I made from the Census data.
Source: U.S. Census Bureau
The Census Bureau tracks vacant homes and breaks this category into several subcategories. The broadest breakdown is seasonally vacant versus year round vacant. I subtracted the seasonally vacant homes and divided total housing units into what was left. This remainder contains homes that are for rent, for sale, being held off the market for other reasons, etc. As you can see, the number of homes in this category shot up during the housing bubble. Before 1990 the average ran around 7%, but as of 2010 we are sitting at 10.94%. With a nationwide count of 130,599,000 total housing units in 2010, we have over 14 million homes sitting vacant year round. That is over 5 million homes above historical norms and the number is still climbing. The percentage of vacant homes has never been this high since the Census Bureau’s records started. See Table 7 here http://www.census.gov/hhes/www/housing/hvs/historic/index.html for more details.
Homeownership Rates
Homeownership skewed outside the normal range due to rabid government manipulation during the formation of the bubble. Since nothing has fundamentally changed regarding the “character” of America, it is misguided to believe we can sustain these artificially high homeownership rates. The graph below, although updated, has barely changed since the prior article.
Source: U.S. Census Bureau
Currently there are approximately 6.3 million homes 30 days or more delinquent or in foreclosure according to Lender Processing Services (LPS). As these homeowners lose their homes, homeownership rates should continue to decline. In addition, as home prices decline, strategic defaults will increase. Unfortunately, the foreclosure process continues to get drawn out by legal delays. According to LPS, as of April, the average loan in foreclosure is 567 days past due. In addition, 33% of loans in foreclosure have not made a payment in two years! See http://www.lpsvcs.com/LPSCorporateInformation/NewsRoom/Pages/20110531.aspx for details.
Foreclosures
As was touched on above, foreclosures are currently having a substantial effect on the real estate and financial markets. A number of studies have been done to try to quantify the level of negative equity required before strategic defaults begin to increase. Although the topic is hotly debated, several studies have suggested that strategic defaults increase substantially when the homeowner owes 25% or more than the home’s current value, and a recent study by the Federal Reserve suggests that about half of homeowners will strategically default once 64% underwater. The same study also suggests that half of the defaults by homeowners 50% underwater were strategic defaults.
Exact numbers aside, more financially solvent homeowners will walk away from their homes the more underwater they become. The ongoing decline in home values therefore is a threat to financial institutions, home supply, and pricing. The worst case scenario would be a temporary feedback loop where lower prices create additional foreclosures, which lowers prices, which creates additional foreclosures… At the current rate of nearly 3% equity loss per quarter, should this trajectory continue, the banks and broader economy could take a significant hit.
Let me cover a few of the latest statistics regarding foreclosures published in Reality Trac’s May 25th Report.
- In Q1 2011 28% of homes sold were bank owned or in some stage of the foreclosure process.
- The average sales price of foreclosure properties was nearly 27 percent below the average sales price of properties not in foreclosure.
- At the first quarter’s foreclosure sales pace, it would take exactly three years to clear the current inventory of 1.9 million properties already on the bank’s books, or in foreclosure.
The full Reality Trac Report can be found by clicking this link. The report provides additional information and specifics for California, Nevada, Arizona, Ohio, Illinois and Kentucky.
I want to point out something very important in the Realty Trac statistics regarding clearing inventory. If you recall the data from LPS above, they show 6.3 million homes 30 days or more delinquent or in foreclosure. As home prices continue to fall, a substantial part, if not 6.3 million or more homes will eventually need to be cleared through sales channels. If it will take 3 years at the current sales rate to clear 1.9 million homes already foreclosed on, it will take nearly 10 years to clear the existing and coming foreclosures. Granted, no one can forecast the ongoing rate of sales over the next ten years; however, in the near term there are absolutely zero catalysts to jump start inventory liquidation.
With such a huge inventory overhang, and generally weak economic conditions, I believe home prices as measured by the Case-Shiller National Home Price Index will likely be down 10% or more from January to December 2011. The mere suggestion of this level of decline is want prompted the, “you are crazy” looks just four months ago. Does 10% still seem crazy and impossible to you after we declined 4.2% in just the first three months of the year? I guess we’ll all have to wait for December’s figures to be published in late February next year to get some to admit what is happening right before their eyes.
Commercial Real Estate Metrics
Our picture of real estate markets would not be complete without looking at commercial real estate and the business market. I know from the questions I’ve received and just flat out asking my readers, that nearly no one actually clicks on the extremely valuable links provided in my articles. With the following link, I ask you to make an exception as it is a waste of my time to reassemble the comprehensive data provided by CoStar’s commercial real estate report.
To state that commercial real estate pricing is continuing to tank would understate the 10.5% decline in CoStar’s Investment Grade index in the first quarter of this year. Please examine the trajectory of nearly every graph provided in the report linked above.
Office vacancy rates are still at dizzying heights (16.3%), but off their all time highs as I reported in February. Industrial vacancy rates sit around 13.9% and retail vacancy rates hover in the 13% range. According to the National Association of Realtors, rents will decline in both the Industrial and Retail markets this year. Rents in the office market will likely be flat and NAR’s chief economist Lawrence Yun suggests that job creation is key to improving commercial real estate metrics. Wow, what a genius! Jobs – why didn’t I think of that?
Considering that the most recent job reports have shown the job market has stalled, I’d take any positive upticks in rents, forecast by Mr. Yun, with a huge grain of salt. In fact, he projected a 3.4% gain in multifamily rents this year, which flies in the face of the Census Bureau’s Q1 numbers showing a decline.
Bank Failures
So far the FDIC’s failed bank list shows 45 bank failures from January 1st to June 3rd. That puts us on pace for more than 100 bank failures this year. I need not remind you that the continuing deterioration of the real estate market coupled with financial stresses coming from Europe can quickly change the pace of regional bank failures. Stressed banks are currently leaving the lion’s share of home lending to Freddie and Fanny. These two broke and insolvent institutions will eventually need to be dealt with no matter how politically incorrect it may be. Any substantive reform to these institutions will have a negative effect on the residential real estate markets.
Conclusions
Residential real estate metrics continue to weaken, record government support is slowly winding down, and the mounting State and Federal Deficits will soon add additional pressures. In the short-term, there is no reason to believe residential home prices will bottom soon, and the current trajectory of declines should serve as a large flashing stop sign to those considering a home purchase unless under the most exceptional and quantifiable of circumstances.
Commercial real estate prices are continuing to plummet and rents continue to deteriorate. With the latest slow down in the manufacturing sector, along with the recent collapse of jobs growth, conditions look weak for the remainder of 2011.
With the inflationary pressures of QE2 coming to an end, real estate, commodities and even stocks will have to find some new driver to try to stabilize or push prices higher. My hope is that they eventually find fundamental reasons to recover, rather than temporary government manipulation. Until that happens – renting good, buying bad…