Recs
By Morgan Housel | More Articles June 30, 2011 | Comments (10)
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The housing market is a mess. Prices might look cheap, but probably aren't finished falling. They've basically fallen back to historic averages. The washing out process that happens after bubbles burst usually takes assets far below average. Euphoria doesn't just end. It turns to hatred. Fool me once ... you know.
Still, housing is going to recover. It might be years from now, but it's going to happen. You can guarantee it. Those are strong words, but the force that will drive recovery is even stronger.
A driver behind the housing bubble was that we built too many homes. For most of the last decade, new home construction grew far faster than population growth or household formation. This wasn't surprising. It didn't even matter that there weren't enough new households to fill all the new homes. Investors would happily purchase a new home -- or 10 -- and let it sit empty. The sole point was to let it appreciate and sell it at a profit.
But today we're in the exact opposite position. New home construction is comatose. It doesn't make any sense for contractors to keep building. "The construction industry is dead right now," Yale economist Robert Shiller said last month. "They don't see any profit in building homes at these prices." That's the strongest force you could ask for to keep new home construction glued to the floor, and it means homebuilding in relation to the size of the economy is nowhere near normal levels.
Here's a good way to visualize this:
Source: Federal Reserve.
The higher the line on this chart, the higher the odds are that we'll need to build more homes in the future. Obviously, we're in uncharted waters right now.
Some more figures to throw at you: In 2005, about 1 million new households were formed while more than 2 million new homes were built. That created an inventory glut. Today, about 1 million new households are still being formed, yet housing starts (new home construction) are running at about 560,000 per year. That's eating up excess inventory -- quickly.
That trend should stand, too, thanks to the U.S.' strong demographic and immigration trends. Household formation over the next decade should average nearly 1.5 million per year, according to the Joint Center for Housing Studies at Harvard University.
Simply put, the number of homes being built today cannot, and will not, support population growth. Excess from the housing bubble is being removed, and will likely be mostly cleared out in another year or two. After that, one of two things (or a combination of both) has to happen.
The first is home prices will rise. It's simple. At the rate we're going today, demand will not only catch up with, but surpass, supply in the future. And that's a fairly safe forecast to make. Unlike demand for stocks, gold, or bonds, a minimum level of demand for housing can be projected rather safely based off household formation -- itself a relatively safe forecast being based on demographics.
Once prices start rising after new households clear out excess inventory, homebuilders will regain the incentive to build. They'll have the demand to do it. I think that's the most important point to consider when looking at companies like Pulte (NYSE: PHM ) , NVR (NYSE: NVR ) , and KB Homes (NYSE: KBH ) . If these companies can stick it out another two years or so, business is practically guaranteed to improve. Quite substantially, too. A lot of these companies are being priced based solely off of today's derelict housing market without respect for the inevitable construction rebound. Could be an interesting sector if you've got the patience. Most investors don't, and that's why these companies trade where they do.
More importantly, no modern U.S. recession has ever fully recovered without the help of housing. Even in non-bubble times, housing is one of biggest economy drivers for the simple reason that it's the largest investment most people ever make. Its downfall is a major reason our economy is still in a funk. And we'll probably stay there for a while. But if there's light at the end of the tunnel, it's from the chart above. The inevitable rebound in construction is one of the most positive future indicators we have today -- even if that future is a full two years away.
Again, the housing market is a mess and will probably get worse. Count on it. But everything is in place for a recovery. All markets are cyclical, and when you look at the numbers it's hard not to think we're near the bottom of this cycle.
Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Follow him on Twitter @TMFHousel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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So with interest rates at a low, would now be the time to invest in income properties? If one can put enough down (say 20-50%), take out a 15-20-30 yr mortgage, make the payments from rentals, looks like a nice dividend once home is paid off.
Hmmmm. Perhaps I'll roll a bit of my IRA into a real estate IRA.
Where is the flaw in my thinking?
Estrogen
Estrogen
Only flaw I see is that you have to figure out the (probably high) interest rate you would pay for 2+ years vs how fast the property increases in value. My guess is that you would have to hold the rental properties for at least 4-5 years and that would be assuming that after 2 years property values begin climbing at a nice 5-7% per year. Then you would also get the write-offs on the rental properties while you held them. I guess the interest would be a write off too? This could get confusing. Good luck! I'll just stick to stocks, they are easier to evict when they don't pay the rent.
Estrogen -
Owning rental properties is not like owning a dividend stock. There are many risks involved and you really have to look at the costs that you may incur when building a cash flow analysis. If you have a large amount to put down, then absurdly interest rates work against you, not for you. When rates rise, pricees will fall. That is when you will want to buy.
it's not as simple as that.
perhaps only 560,00 are being built but there a glut of houses that will be back on the market by way of foreclosures over the next few years.
combine stricter lending standards with higher interest rates which impact affordability and you have a significantly smaller base of people who can afford to buy a home.
that slows the pace at which the glut of inventory can be sopped up. i'd love to see the housing market humming again but we're still years away from getting to that point.
What do you mean by "recover"? As frogdog mentions, there's more to it than supply and demand. If mortgage rates jump 3-4%, affordability declines 30-40%. Some segments of the existing home market may start to look healthy again from a supply/demand perspective...home prices may start rising modestly, but they aren't going to "recover" pre-bust highs anytime soon...unless we see high inflation / wage inflation, it could be 20+ years. If mortgage rates rise and stay in that 7-8% range, and wages remain stagnant, I don't see a large segment of the boom market (3,500+ sq.ft. homes) "recovering"...with such a large oversupply and little demand, these large homes could continue selling below the cost of construction for decades. The building that I have been seeing recently are much smaller, more energy efficient homes that people can afford...that, and incomplete developments that were purchased from bankrupt private builders by large private builders at super low prices with units being sold close to existing home foreclosure prices.
The author equates household formation with housing demand and construction as supply. What is missing is the % of household formation which typically results in home ownership demand. That was as high as 66%, every 1 million new households formed resulted in demand for another 660k new homes. However that % has been falling. 20 somethings waiting a few more years, potential retiree's deciding they don't need to buy and hold that second eventual retirement home now, existing retiree's downsizing, people being foreclosed on, people not qualifying, etc. etc. Lets say demand declines to 60% homeownership rate. Then every 1 million new household formations only results in demand of 600k purchased units. More importantly if we already had existing stock of 100 million homes that drop to 60% homeownership also free's up 6 million homes of supply. In this scenario even with 0 new homes being built, there would be 6 years worth of supply available.
Change in homeownership rate (and the potential reasons that will happen) need to be factored into one's analysis.
And you cannot overlook the 14 % of the work force that are out of work, plus thousands of others that are working part-time jobs. (Some estimates are approaching 25% when one figures in the number of people that have given up looking for work.
Add to that the numbers of college grads that are now working for Starbucks, etc. and have huge education loans that they will have to spend many years paying off. Many of the recent grads are returning to the nest and living with their parents until they can find better opportunities.
Then there is the fact that many of the previous high-pay manufacturing jobs have moved off-shore resulting in a larger portion of the the jobs are in the lower paying services sector.
(Yeah I know that the "official unemployment rate" is about 9.1% but the government keeps changing the way they measure the rate).
Don't get your chart at all.
Brother Ben is going to keep rates low as long as he needs to in order to sustain a recovery. With QE3, 4, 5, 6 we'll eventually see inflation, which of course would impact housing on the positive side.
Of course, we are probably many years away from that. But America is historically quite resilient and the entrepreneurial spirit will continue to push this country and the world forward (IMHO).
Leveraged real estate (and equities) should do well.
Thanks all for your insight.
You cannot resilience your way out of debt or coming inflation. Do think we can keep printing money and not suffer the consequences of inflation? Add inflation to double or even triple the mortgage rate and see what happens to a housing recovery.
But then we have this ridiculous national debt that we cannot pay as a nation. Taxes could be raised on anyone remotely successful so our politicians can make more self serving decisions, and that too will put significant downward pressure on the housing market.
Don't ignore the fact that a large part of our economy is based on discretionary spending, and that will continue to put downward pressure on employment, which then puts more downward pressure on housing.
Let's not forget to add that real wages have been stagnant over the last couple of decades while housing prices have exploded. When do we expect real wages to catch up with the increase in housing prices? I personally think housing will continue to fall or be stagnant at best over the next decade.
In all there are so many looming factors that need to be addressed that this country is going to be in for a rough time over the next decade. This will show how resilient we are as a nation. I would even expect rioting by the government unions like we see in Greece as real changes are finally forced.
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