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Five Things You Need To Know About Real Estate: Orders Plunge, Affordability, Debt Fret, Plain Vanilla, Turning Japanese


I liked the front side of the bubble a whole lot more


Pinch hitting the daily "Five Things You Need To Know" for vacation-bound Pepe Depew is no small task., hence I will stick to close to "homies." I know the subject has been beaten at least as badly as the stocks themselves and except for the "cheerleader for a living" types, most have come to recognize that the housing market is slowing down more than just a bit. The next money-making question is whether the housing market is crashing, or just correcting. I'll try to remain as open minded as possible (it's crashing), not to influence your conclusion (it's crashing) and simply present you (it's worse than crashing) with some data that compares the current environment (crash) to past crashes:

1. Taking a Plunge

I keep a 1).xls">spreadsheet of new orders for five homebuilders: D.R. Horton (DHI), Beazer Homes (BZH), Toll Bros. (TOL), MDC Holdings (MDC) and Meritage Homes (MTH).

  • The bottom line is that the last four quarters y/y orders for the five companies combined reads as follows: +21.1%, +9.5%, +1.7%, (17.8%).
  • The 17.8% plunge took place during the 2Q "spring selling" season, the most important three months of the year. In the words of DHI's CEO, orders "fell off the Richter scale."

2. What About the Other 15%?

One of the most popular mantras is that demographic trends are strong and will support the housing market for years to come. Therefore there is little chance of a housing market collapse. I have yet to see any meaningful statistic behind the "demographics" argument.

  • What I do know is that according to Census data, 85% of households with income above the national median already own a home.
  • I also know that housing affordability for the remaining 15% of households is at the lowest level since late 1990, a time when the real estate market was at the depth of that particular collapse. Back then affordability began regaining its footing only after prices fell 20% from the 1989 peak to the 1992 bottom.
  • My sense is that, for now, the possibility that real estate values might "correct" 20% is still not taken seriously by anyone except those segregated to the perma-bear camp.

3. Droppin' Benjamins

Another serendipitous coincidence surrounding the 1989-1992 crash was the reckless accumulation of housing debt that occurred well before the collapse.

  • Between 1985 and 1990, the housing debt/asset ratio rose from 28% to 35%.
  • The elders in the 'Ville might recall that to avoid a systemic meltdown, Congress took over hundreds of failed S&L's, while at the same time the Fed lowered the effective rate of interest on mortgages by 200 bps.
  • Boom Boom might yet have his chance to drop Benjamins from his chopper, but for now the most recent parabolic rise in mortgage indebtedness (a cool double since 2000) is being met by rising interest rates. A very dangerous brew in my humble opinion.

4. Simple Math and the Long-Term Investment

Some in the past have commented that I look at real estate through the eyes of a trader, not as the long term investment that it is supposed to be, and the refrain is that the "long term" real estate values always go up. Therefore, down periods like '89-'92 are simply short term blips of no consequence to most homeowners. Perhaps that's true, but some facts get in the way.

  • First the average holding period of a home in the U.S. is about 7 years. Historical annual home appreciation is around 4% per year.
  • If home prices fall 20% over the next 3 years and then rise 4%/year for the next 4 years, simple math suggests that at year 7, most of the 2003-'05 buyers will be at break-even to down 8%, before the sacrosanct 6% sale commission.
  • That's just the plain vanilla gradual decline scenario. If you believe USA/CNN in the next decline average prices in America's top 40 cities will plunge 47%.

5. Turning Japanese I Really Think So

So, for those of you who have had it with listening to me and my fellow Professors' daily harping about impending doom, I will leave you with the following comments from the Chief economist for the National Association of Home Builders:

  • "If there is a sudden unloading by speculators, or if interest rates go up more than a few points, it could spark a quick reversal...Estimates suggest that as many as four out of every ten purchases in some places were by investors, some of whom...are depending solely on appreciation to float their boats and not even renting the units...The downside to the economy resides largely within the housing sector."
  • Did he say unloading by speculators (Months Supply of Existing Homes)? Interest rates going up? Appreciation floating the speculators boats? Could the back side of our bubble parallel Japan as much as the "good times" did?
  • We will all know for sure very very soon.
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