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Monday, October 15, 2007

Why the housing slump isn't over yet

For years, I bored my friends with talk that housing was in for a downturn. No one believed me, and people urged me to buy in before I was shut out of the market.

Despite the obvious slowdown in housing, I continue to sing the same tune. I've been doing a lot of reading this weekend about the housing market, and I've concluded that we still have a long way to go before housing reaches bottom.

Why? The main reason is that in spite of all the whining and moaning about the housing slowdown, prices haven't come down that much (maybe 10%) and affordability is still very low by historical standards.

Here are some other reasons to be wary of housing:

- There is a ton supply out there (supply is at a record, and 2x its normal rate over the last several years). It has just skyrocketed and it is not going down.

- Affordability for new home buyers is still at lows.

- More people own houses than ever before (meaning fewer buyers out there).

- The Fed will have trouble lowering interest rates in the face of $85 oil and a Euro of 1.42.

- Credit standards are tightening, meaning fewer mortgages and therefore fewer buyers.

- A large amount of ARMs are still resetting, with a tremendous amount due to reset in the second half of 2008. ARM resets are leading to more foreclosures, and therefore even more supply.

- Homebuilders are under enormous pressure with debt coming due and therefore will be willing to dramatically lower their prices.

- The economy seems to be softening, with economists raising the chances of a recession.

- Cap Rates (the income from rents) are still very low, making housing an unattractive investment.

- All of the above is leading to a change in the mentality towards housing. It is going from something people want to own to something to be wary of. This change in attitude towards housing can take a long time to set in and have a tremendously negative effect on pricing.

Frankly, the only bright spot I see in housing is that the weak dollar is leading to more foreign buying of U.S. real estate (in places like New York), but the effect of this buying is minimal compared to the other negatives. I just don't see other positives.

I think owners are stubborn and resistant to lower prices. Therefore, the market is not correcting itself quickly. The slowdown is likely to last several years.

Until Cap Rates are higher than Mortgages Rates (meaning it actually pays to be a landlord), I think the market will continue to head down. Unfortunately, we're not even close to having attractive Cap Rates.

I wouldn't be surprised if a major homebuilder declares bankruptcy in the next 6-12 months. I also wouldn't be surprised if homebuilders and banks start to move to more aggressively clear inventory, which will lead to big price declines.


  • The cycle in Real Estate runs seven years. The top was in June of 2005 we have at least until 2012 before we values start rising. Five hundred billion is lost from the re-fi sector this has a major impact on economic growth and the wealth effect. Values will continue to decline until forty to fifty percent of home equity is lost same as in the early 80's in California. ONe maybe two major lenders and builder will go bust before we see the bottom.

    By Anonymous Anonymous, at 5:45 PM  

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