08-30-2009 08:37 AM - edited 08-30-2009 08:52 AM
Falling House Prices Are The Solution, Not The Problem
By Patrick Killelea, last updated Wed 17 Jul 2009
- House prices will keep falling in most places because those prices are still dangerously high compared to incomes and rents. Banks say a safe mortgage is a maximum of 3 times the buyer's yearly income with 20% downpayment. Landlords say a safe price is a maximum of 15 times the tenant's yearly rent. Yet in coastal areas, both those safety rules are still being violated. Buyers are still borrowing 6 times their income and putting only 3% down, and sellers are still asking 30 times annual rent, even after recent price declines. Renting is a cash business that reflects what people can really pay based on their salary, not how much they can borrow. Salaries and rents prove that prices will keep falling for a long time. Anyone who bought a "bargain" this time last year is already sitting on a very painful loss.
- It's still much cheaper to rent than to own the same thing. On the coasts, yearly rents are less than 3% of purchase price and mortgage rates are 6%, so it costs twice as much to borrow money to buy a house than it does to borrow (rent) the house itself. Worse, total owner costs including taxes, maintenance, and insurance come to about 9% of purchase price, which is three times the cost of renting. Buying a house is still a very bad deal for the buyer on the coasts, but it does make sense to buy in Michigan and some other places where prices have fallen into line with salaries and rents. Check whether you should rent or buy in your own area with this NY Times calculator.
The bottom will be here when buying a house to rent out clearly makes money. At that point it will be justified to buy because rent can cover the mortgage and all expenses if necessary, eliminating much of the risk. For a rough indication of the wisdom of buying a house, look at the yearly-rent/purchase-price ratio for the model of house in question:
3% = do not buy 6% = borderline 9% = ok to buy
So for example, it's OK to pay $133,000 for a house that would cost you $1,000 per month to rent. That's $12,000 per year in rent, divided by $133,000, so about 9%. But it is foolish to pay $400,000 for that same house, because renting it would cost you only 3% of that per year. Renting in that case means getting the use of the house for free, paying only the property tax and maintenance (which are about 3%).
- It's a terrible time to buy when interest rates are low, like now. Realtors just lie without shame about this fundamental fact. Prices fall as interest rates rise, because a given monthly payment covers a smaller mortgage at a higher interest rate. Since interest rates have nowhere to go but up, prices have nowhere to go but down. The way to win the game is to have cash on hand to buy outright at a low price when others cannot borrow very much because of high interest rates. To buy at a time of very low interest rates is a mistake.
It is definitely far better to pay a low price with a high interest rate than a high price with a low interest rate, even if the mortgage payment is the same either way.
- First of all, your property taxes will be lower with a low purchase price.
- Second, a low price gives you the ability to pay it all off instead of being a debt-slave forever.
- Third, prices will definitely fall as interest rates rise -- so paying a high price may trap you "under water", meaning you'll have a mortgage larger than the value of the house. Then you will not be able to refinance, and won't be able to sell without a loss. Even if you get a long-term fixed rate mortgage, when rates inevitably go up the value of your property will go down. Paying a low price minimizes this possibility.
- The US economy will not recover until house prices are allowed to fall to prices buyers can easily pay on a normal salary. The primary evil in the economy is government "affordability" programs which encourage debt, making prices higher, not lower. True affordability is not more debt -- true affordability is lower prices. The government's false affordability programs have created more debt than can ever possibly be repaid. Credit rating agencies lied about the value of this debt, scaring off investors.
When house prices finally fall to affordable levels, and foolish lenders and foolish borrowers are finally allowed to fail, then the economy will work again: there will be investment based on real production instead of on financial speculation, jobs will be created, and money will be earned and spent. Currently, we have no investment because the government is punishing savers and investors with policies that waste their honestly earned money to cover the foolish gambling losses of others.
- Prices disconnected from Gross Domestic Product. The value of housing in the US depends a lot on the value of what the US actually produces. Not only is the GDP decreasing, jobs are being lost in large numbers. It does not make sense to buy when more jobs will be lost and the price people can pay will decrease. Unemployment drives housing prices down. It also does not make sense to buy when your own job is in danger.
- Buyers borrowed too much money and cannot pay the interest. Now there are mass foreclosures, and Congress is taking a trillion dollars of your money to pay the mortgage investment losses for banks. The plan is to overpay the banks for bad mortgages, claiming that this will support the housing market. It will not work, since bank profits have nothing to do with housing prices. But it has protected Goldman Sachs from losses on their gambles, and even given them record bonuses at taxpayer expense. It is now clear that if you can get your CEO appointed Treasury Secretary, you can easily fleece taxpayers with no public protests.
We also have legal contracts being modified to stop even well-justified foreclosures. No one was forced to borrow money. It was a choice -- a very bad choice, but completely voluntary. Grownups should be responsible for their own actions. To prevent a justified foreclosure is also to prevent a deserving family from buying that house at a low price, not to mention what this does to faith in contract law. No one in government or the press will even mention that everyone in foreclosure trouble got themselves into that spot by voluntarily borrowing too much money.
Should taxes be used to pay the debts of irresponsible borrowers, no matter how much they over-borrowed or overpaid for a house? Should savers be forced to pay the debts of other people who cannot afford "their homes" no matter what price they paid or how far it is beyond their actual financial means? If so, go buy the most expensive house you can right now! Borrow as much as you possibly can to buy a bigger house, and don't pay it back, knowing that Congress will force the real repayment obligation onto others, onto people who are living within their means, so that you can stay in "your home".
Banks happily loaned whatever amount borrowers wanted as long as the banks could then sell the loan, pushing the default risk onto Fannie Mae (taxpayers) or onto buyers of mortgage-backed bonds. Now that it has become clear that a trillion dollars in foolish mortgage loans will not be repaid, Fannie Mae is under pressure not to buy risky loans and investors do not want mortgage-backed bonds. This means that the money available for mortgages is falling, and house prices will keep falling, probably for another five years or more. This is not just a subprime problem. All mortgages will be harder to get.
A return to traditional lending standards means a return to traditional prices, which are far below current prices.
- Extreme use of leverage. Leverage means using debt to amplify gain. Most people forget that losses get amplified as well. If a buyer puts 10% down and the house goes down 10%, he has lost 100% of his money on paper. If he has to sell due to job loss or an interest rate hike, he's bankrupt in the real world.
It's worse than that. House prices do not even have to fall to cause big losses. The cost of selling a house is 6% because of the realtor lobby's corruption of US legislators. On a $300,000 house, that's $18,000 lost even if prices just stay flat. So a 4% decline in housing prices bankrupts all those with 10% equity or less.
- Shortage of first-time buyers. From The Herald: "We were all corrupted by the housing boom, to some extent. People talked endlessly about how their houses were earning more than they did, never asking where all this free money was coming from. Well the truth is that it was being stolen from the next generation. Houses price increases don't produce wealth, they merely transfer it from the young to the old - from the coming generation of families who have to burden themselves with colossal debts if they want to own, to the baby boomers who are about to retire and live on the cash they make when they downsize."
High house prices have been very unfair to new families, especially those with children. It is foolish for them to buy at current prices, yet government leaders never talk about how lower house prices are good for pretty much everyone except bankers, instead preferring to sacrifice American families to make sure bankers have plenty of debt to earn interest on. If you own a house and ever want to upgrade, you benefit from falling prices because you'll save more on your next house than you'll lose in selling your current house. Every "affordability" program drives prices higher by pushing buyers deeper into debt. To really help Americans, Fannie Mae and Freddie Mac should be completely eliminated, along with the mortgage-interest deduction. Canada has no mortgage-interest deduction at all, and has a more affordable and stable housing market because of that.
The government keeps house prices unaffordably high through programs that increase buyer debt, and then pretends to be interested in affordable housing. No one in government except Ron Paul ever talks about the obvious solution: less debt and lower house prices. The real result of every "affordability" program is to keep you in debt for the rest of your life so that you have to keep working. Lower house prices would liberate millions of people from decades of labor each. There is never anything in the press about the millions of people that were hurt and continue to be hurt by high house prices.
The government pretends to be interested in affordable housing, but now that housing is becoming affordable, they want to stop it? Their actions speak louder than their words.
- Surplus of speculators. Nationally, 25% of houses bought the last few years were pure speculation, not houses to live in, and the speculators are going into foreclosure in large numbers now. Even the National Association of House Builders admits that "Investor-driven price appreciation looms over some housing markets."
- Deflation. There is fear of inflation, but it's not likely in the next few years. The actual amount of money created by the Fed lately is a trillion dollars, which sounds huge, but is small compared to the $10 trillion drop in housing "values" and another $10 trillion drop in stock market capitalization. The US government will not print extreme amounts of cash like Zimbabwe did, because significant inflation would mean that foreigners would no longer lend money to the US government unless interest rates were much higher to compensate them for inflation losses. Higher interest rates would push more people with adjustable mortgages over the edge. The most likely scenario is like Japan: low inflation and low interest rates, with falling house prices for years to come.
- Fraud. It was common for speculators take out a loan for up to 50% more than the price of the house. The appraiser went along with the inflated price, or he did not ever get called back to do another appraisal. The speculator then paid the seller his asking price (much less than the loan amount), and used the extra money to make mortgage payments on the unreasonably large mortgage until he could find a buyer to take the house off his hands for more than he paid. Worked great during the boom. Now it doesn't work at all, unless the speculator simply skips town with the extra money.
- Baby boomers retiring. There are 77 million Americans born between 1946-1964. One-third have zero retirement savings. The oldest are 62. The only money they have is equity in a house, so they must sell.
- Huge glut of empty housing. Builders are being forced to drop prices even faster than owners. Builders have huge excess inventory that they cannot sell, and more houses are completed each day, making the housing slump worse.
- Failure to re-regulate finance. The Graham, Leach, Bliley Act did away with the depression-era safety constraints placed on banks. This paved the way for record profits in the finance industry and an effective takeover of the US government by large banks, which has not yet been reversed.
- The best summary explanation, from Business Week: "Today's housing prices are predicated on an impossible combination: the strong growth in income and asset values of a strong economy, plus the ultra-low interest rates of a weak economy. Either the economy's long-term prospects will get worse or rates will rise. In either scenario, housing will weaken."
08-31-2009 07:51 AM
Wow! No flaming opposition form the lurking listing agents?
Come on lurkers!
Step #1: Copy and paste all posts from http://patrick.net/housing/crash.html or stop_bailouts.
Step #2: Call anything who doesn't declare 100% agreement to be a realtor.
Step #3: Revel in the self-satisfaction.
08-31-2009 08:08 AM
I list the source right there at the top of each article!
Just trying to shed light on what the shady agents and bankers are up to while prospective buyers are toiling away, laboring continously, participating in multiple bidding wars to throw their life savings at some crappy property when something far better could be just around the corner if they stop participating, be patient and wait a few months!
Let the temporary, summer-time uptick and the rush to take advantage of the $8k tax benefit die down. Don't spend $50k by overbidding just to save $8k on some stupid tax benefit.
Wait it out and force the banks to release their shadow inventory!
08-31-2009 09:40 AM
Here's a post that someone named 2250 made in the San Diego forum. It looks like it was originally written in 2008 but edited in March, 2009.
Here's my prediction algorithm -- it applies at the neighborhood level, not the National Level.
- Prices will drop to levels not seen since the year before.
- Qualified buyers that have been waiting will jump the gun and buy the first decent thing they can afford (they've been conditioned to the boom, remember).
- Prices will be steady for a couple months (maybe even increase!)
- That pool of buyers will be exhausted, foreclosures will continue, prices will drop.
- Repeat 1-4, until it is just a little more expensive to buy than to rent (i.e. affordable).
So we've seen steps 1-3 although in my neck of the woods that is only applying to the under $600,000 properties. A substantial number of properties in the $600,000+ amount are just sitting on the market. Sellers won't lower prices because they believe the market is turning around and buyers probably can't qualify for the higher loans even if they wanted to jump in.
As much as I believe that prices are coming down in the next couple of years, I can't blame people who jump in because they can finally afford a house. Many of these people have intelligently been waiting for years and no one would argue that a decision to buy now is much smarter than a decision to buy three years ago. That said, I hope people will consider waiting a little while longer. I have not seen one credible argument that prices will go up at any time in the near future so waiting for next year should not result in anyone being "priced out of the market" as in times past. My only request is that if any of us do find ourselves "underwater" on our mortgages that we honorably pay our debt. I am very saddened and resentful that so many of us who have tried to do things the right way are still here feeling like we're pulling the arm of a slot machine when we go to purchase a house. I believe that anyone who understands economics understands that the government (both Dems. and Reps.) used the taxpayers' money with a lot of help from the banks and the Federal Reserve and freed up credit and caused this bubble. It is anybody's guess how long the government will continue to use our money to support the bubble and what action will be next- $15,000 tax credit, programs to rent properties back to "homeowners", etc., continuing to keep interest rates low... I tend to believe that these are just "finger in the dikes" and the real question is if the gov't, banks and many real estate industry people can convince people that the economic crisis is over and that huge unemployment rates, trillion dollars of debt and our country's lack of a manufacturing base don't matter. If however you do believe these inconsequential things might matter, it could be prudent to wait.
08-31-2009 10:07 AM
.....I have not seen one credible argument that prices will go up at any time in the near future so waiting for next year should not result in anyone being "priced out of the market" as in times past. ....
But the NAR says you should buy now! Haven't you heard housing prices are going up!
The only argument I have heard for housing prices going up has been based on emotion, not on fundamentals.
All the fundamentals say housing prices will continue to decline.
08-31-2009 10:09 AM - edited 08-31-2009 10:12 AM
I agree that house prices will trend toward a baseline where (1) homes are affordable, and (2) it costs slightly more to buy than to rent. However, we are almost there in many neighborhoods (each city is different).
In terms of affordability, we are at the point where the median household income in Southern California can afford the median sales price. The median household income in Los Angeles can afford the median sales price.
In terms of rent vs own, we are almost there in many neighborhoods. In fact, in many lower-end neighborhoods, it actually costs less to buy than to rent. That is why we are seeing a lot of investors enter into the market. Investors can buy at the low-end and see immediate cash flow because their mortgage payments are less than the rental income. In the higher mid-range, a $600,000 house with 20% down and a 5% interest rate will cost about $2,575 in monthly payments. Most 3bd houses in good neighborhoods (at least where I live), are renting for at least $2,200 (notice that I am referring to houses and not townhomes/apartments). Those rent vs own numbers are not a horrible distance apart. In the ultra high end, it remains much cheaper to rent than to buy.
Do the math. Each neighborhood is different. Your neighborhood may be different from mine.
08-31-2009 10:24 AM
The fact is nobody knows what the future holds. Most of the fans of Patrick.net, Housing Doom, etc. are pretty sure we are in for a world of hurt; however, nobody knows how it will play out.
As terrible as the mortgage crisis has been for many people, there are a ton of people who can still make payments and will just hold on to their houses, instead of moving. I do not beleive pricing will immediately fall more than 10 - 15%.
I do know we have a Social Security, Medicare, Pension System, and possible future Obamacare, built on a Ponzi Scheme that cannot sustain itself.
The government has no choice but to make the unfunded liabilities devalued at somepoint, and I do not see any recourse other than massive inflation (bad), or some sort of settlement with the government creditors (good); settle with China, tell Americans they will not get as much social security, etc as originally promised).
I have never heard a logical way to solve these issues. It is way too much to solve by higher taxes, and all the war financing, porkbarrel spending, etc. is miniscule when compared to the mandated spending to provide for these large social programs. Politicians simply keep kicking the ever increasing bubble down the road.
There may be a window of 10 years before we have the real crash, or it may come as early as next year - pyschology will play a huge roll in it. I don't know that collectively we are up to the challenge, so as individuals we should best prepare ourselves. A massive change is comming.
Then again, I might be wrong.