Of Mice and Molecules...
Evidence the Housing Bubble's Gonna Pop
I rarely make financial predictions. And when I do, they're never bold. I believe stuff like, "the market always goes up over time" and "timing the market is for dummies" and not much else.
That said, I do think that home ownership is due for a pretty decent correction. I believe this so much that Susan and I are holding off on buying a home. And I thought I'd share my reasons for hesitating. It might not help if you just threw in on a new place, but if you're wavering or entering the market, I'd urge you to wait a little longer.
As always, I could be wrong. There could be fundamental changes happening with regard to housing patterns, population changes, or a thousand other things that could turn my argument on its head. But, if business as usual holds on, there are portents that housing will slow and prices may reverse themselves, possibly significantly.
Arguments for a real estate correction
- Implications of the new tax law. (1) Doubling the standard deduction will eliminate the tax write-off for many individuals with modestly-priced homes. This is "extra" money that will no longer be coming back to the homeowner, making home ownership less attractive, less demand for homes, yada yada, yada. (2) For people with more expensive homes (like here in SoCal), there is a new maximum for mortgage interest deductions. End result: a check on home prices. Not a huge one, necessarily, but a brake.
- The economy is white hot right now. We are at just about the minimum unemployment rate right now. Furthermore, we have been a VERY LONG cycle of economic expansion. This doesn't mean anything, other than the fact that these cycles can't last forever. Also note: when unemployment rates increase, that shit happens FAST. Recovery, on the other hand, is always slower. No money, no market.
- The Great Moderation could end. That's what we've called the last twenty or so years, where home prices have outpaced inflation. This period has been an aberrancy; whether it's the new normal is, at best, questionable.
- Reversion to 2006-era lending practices. When I bought in 2010, I basically had to give to the bank the financial equivalent of a colonoscopy. And I was a good borrower with low-risk and a healthy down payment. When I sold the same unit in 2017, I got a look at the purchase terms of our unit's buyers. 3.5% down, plus an extra $30K of principal to do renovation work. That's a lot of leverage, too much for a bank to take on. Additionally, I got a strong sense that our price-to-income ratio was a lot higher than our buyers'. Applying this anecdotal observation to the larger economy, these loosening loan terms are filling units with owners on shaky footing. This is likely not a problem unless (a) the economy cools, and/or (b) people who have variable rate loans experience rising interest rates. Speaking of interest rates...
- Rising interest rates. This is by far the biggest factor in home prices of late. Folks are used to ultra-low interest rates, but this is a HIGHLY UNUSUAL period in which to borrow. I've noticed the prime interest rate has been steadily ticking higher, with the Federal Reserve signaling a number of rate increases in the coming year. When the cost to borrow increases for banks, the rates will go up for homeowners as well.
I cannot overstate the impact interest rates have on the average home price. In my condo farm, the unit next to ours sold (instantly, I might add) for $600K. With 20% down, you need a loan of $480K. At current rates (4.5%), that's $2,432 for principal and interest, maybe closer to $3,000 a month all-in. Judging from the Toyotas and Kias in our parking lot, I'd assume that this is just about the maximum a family could afford to spend on housing.
You may think about these facts and come to the opposite conclusion - since money is historically cheap to borrow, now is the BEST TIME to buy. People have already tapped into low rates to buy, and this has driven housing prices up. To further illustrate why this is big fucking problem, let's do a thought experiment: what happens when rates increase, as they are almost certainly going to? Imagine that rates go up to 6.5% (I'll note that this is less than average for the last forty years). This adds $600 a month to the monthly payment. $3,600 a month ain't gonna happen for this crowd. Demand at $600K is going to fade until prices approach that sweet spot of $3,000 a month that people can afford.
So prices are going to drop. But how cheap does a house have to be to get to that $3,000 payment? About $475,000. That is $125,000 LESS that current asking. Imagine you're the guy who bought the unit next to mine at $600K and interest rates approach "normal" levels. You are now underwater; even with appreciation, it'll take years to get back to break even. This is a little different from the most recent housing crash, where poor lending practices fueled a false demand for housing, but the result may be similar in the end.
This is why I'd advise anyone thinking about buying to wait. Keep your money in an index fund, let it grow, and wait to swoop in on the heels of a holy-shitballs! recession. A lot of people got rich doing this in 2010.
Last thing: As a buyer, high interest rates are your friend when buying. As I mentioned, home prices deflate to compensate for the increases. Yes, you pay a lot of interest, but you gain two advantages: a higher-than-normal rate environment is likely to go back down towards average than increase further. When that happens you can (a) refinance to a lower rate, or (b) take advantage of the increasing purchase price (remember the teeter-totter of interest rates vs. home prices) by selling for a profit. My parents bought a house in 1982 (approximately) and sold it a few years later for a ton more than they paid. While appreciation may have played a role, I think the cooling interest rates (which were super high - 16% or so - in 1982) played a big role in that.
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Noah's Inner Monologue
Scribblings of a man who can barely operate an idiotproof website.