The housing gamble: What if home prices remained stagnant until 2020?


The housing gamble: What if home prices remained stagnant until 2020? 6 charts laying out the argument for stagnant or declining home prices for another 10 years. Peak in dual income households, home prices still inflated relative to incomes, Federal Reserve unable to hold mortgage rates low forever.

What would happen if home prices remain stagnant for another decade?  It is hard to imagine that the cornerstone of the American dream would somehow become a bad investment for the next decade.  For decades every generation was conditioned into believing that housing was the best investment a family could make.  For many it provided a stable home for retirement once the mortgage was paid off.  One third of all homes in the United States that are owner occupied have no mortgage.  Yet this mindset of buying and paying off a mortgage has largely been lost.  No mortgage burning parties in the digital age.  It may be making a comeback not because people want this but because there is no other financial choice.  Given the current domestic and global trends, it is likely that housing will be suffering another troubled decade from 2011 to 2020 just like it experienced from 2001 to 2010.  I want to lay out six charts as to why I believe housing will have difficulty moving up in price in the next ten years.

Chart #1 – Dual income households peaking


One of the big reasons many families did not feel the deep pinch from 1970 to 2000 was because of the rise of the dual income household becoming the standard.  It should be obvious that with more incomes under one roof purchasing power would increase.  Yet this is really where we start seeing the loss of the middle class.  What used to be a path accomplished with one blue collar income now required two incomes.  Yet as the chart above highlights we may have hit a plateau in terms of dual income households as a percentage.  In the late 1960s 47 percent of households had both spouses working.  In the early 2000s it was up to 67 percent.

The biggest line item for a family is housing.  Household income growth has peaked and over the last decade it has gone stagnant.  It is hard to envision where the boost in income will come from.  Short of having your kids work and also live with you this does not seem like a likely option.  The market really shifted in 2000 and the only way the growth in housing prices continued was by the introduction of exotic mortgages that allowed incredible leverage and created the fertile ground for a bubble.  Now that incomes are being verified and the only game in town is government backed mortgages, the only way home prices on a national level will increase is simply if real income growth is generated.

Chart #2 – Case-Shiller 20 City Index

case shiller 20 city index

As measured by the Case-Shiller Index home prices are now back to levels last seen in 2003.  We are seeing a lost decade in many areas.  The bubble is rather clear in the chart above.  But with no household income growth why would home prices go up?  The Federal Reserve is trying to keep mortgage rates low via artificial means by buying up mortgage backed securities but how long can this go on?  At some point a market equilibrium is needed and the above chart shows that home prices are still inflated if we look at incomes.

Markets in Nevada and Arizona are seeing big sales jumps because prices have fallen 50, 60, and even 70 percent in some cities.  People will buy if the price moves low enough.  Can you imagine the above chart moving sideways for another 10 years?  In the short run, prices are still going lower.

Chart #3 – Case-Shiller last 12 months

case shiller last 12 months

Home prices over the last 12 months have fallen by 3 percent.  This may not sound like a lot to you but this is an asset that typically never moves lower even by a fraction of a percent.  The reason for this movement is the pressure of the large number of distressed properties out in the market.  You have to ask yourself why would a property become distressed?  It is likely, and the most common case, that many people simply cannot pay their mortgage with the household income that is coming in.  The middle class is shrinking and this is measurable by looking at household income and buying power.  As this power decreases, why would the biggest purchase of households keep moving up in price?  It simply cannot and that is why we still see home values moving lower.

Chart #4 – Federal Reserve holding prices high

fed funds rate

Expensive home prices simply to have prices inflated is not a good strategy.  It seems counterintuitive but home prices should reflect actual buying power by American households, not an artificial floor set by the Federal Reserve.  The Federal Reserve has purchased trillions of dollars in mortgage backed securities simply to keep the 30 year fixed mortgage rate low.  The reason it does this is because a lower interest rate increases buying power since most households only focus on their monthly net payment for housing.  Yet this is the wrong side of the equation.  When we had more prosperous times in the nation home prices went up because household incomes went up, not the other way around.

This strategy isn’t new and was tried by Japan.  They lived through a real estate bubble and quantitative easing and what happened to the Japanese economy?

Chart #5 – Japanese real estate bubble lessons

japan gdp

Japan has had two lost decades in their economy because of the real estate bubble that burst but also the large banking bailouts that were conducted by their central bank. What this did is that it kept the market price of housing from being realized and served as an albatross for the rest of the nation.  With an aging population problems are creeping in their system even with low interest rates.  This real world example serves as a lesson for the United States if we wish to hear it.

So far we have gone down the path of ignoring reality.  Yet you can only pretend so long and ultimately home prices have to reflect what local area families can afford without massive subsidies.  This redirects investments from more productive sectors and that is why it is dragging our economy down just like it did to Japan.

Chart #6 – Housing starts

housing starts

Finally those who actually build homes have not felt the need to add more housing units onto the market.  Why?  We probably have enough housing supply to last us a decade at the current pace.  Keep in mind you have many baby boomers that will want to sell and move into smaller homes.  This will add supply for younger families.  You also have many new homes that were built to over capacity and this too has added to supply.  Another factor is the large rental units on the market.  Ultimately there is a lot of housing to work through.  We have millions of homes that will be foreclosed on in the next few years.  More units of housing.  The above chart shows how devastating this bubble was.

Will home prices remain stagnant until 2020?  I would change my mind if we saw real household income growth for middle class families.  This I hope is the actual case here.  Yet there is little indication that this is happening.  Hard to imagine the American Dream icon being a drag for another 10 years but there you go.

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