"There is no greater folly in the world than for a man to despair."
Up until lately many pundits, including Paulson himself, have stated that the housing market had finally reached a turning point and that it was time to buy. Each time these pundits made these claims we stated that this simply was not true. Certain criteria need to be satisfied before this sector can put in a sustainable bottom.
The most important of which is jobs; if it is hard to land a new job, then it is not very likely that anyone is going to want to run out and buy a new house. When the job market is terrible and the economy is far from healthy, than in all likelihood the real estate sector is going to remain in the doldrums potentially for years to come.
The following factors also are not helping:
- Banks are extremely stringent when it comes to lending money. From giving almost anyone that could scratch X on the signature line a loan they have reached the point where they want to know everything about you before they will even consider lending you money.
- There are too many homes on the market; at present it is estimated that there is almost a 4 years supply of homes on the market. And the situation is not going to get better anytime soon. There are lot of homes in pre foreclosure which make up part of what is called the “shadow inventory”. If we add this to the number of homes already on the market, the supply of homes could surge past the 5 year mark.
- Sales of new homes have fallen 18% in the past 2 years.
- The median price of new and used homes continues to fall. The median price of a new home is now $220,000, down another 6%.
The following developments also indicate/suggest that the housing sector is far from putting in a long term bottom:
- Building permits have continued to drop in most months since real estate peaked towards the end of 2006 and they show no sign of letting up. For the first 6 months of this year only 300,000 permits were issued. Contrast this to the more than 1 million permits that were issued in the first 6 months of 2005.
- The number of delinquent mortgages is set to rise again; the latest report states that individuals who have missed at least one payment rose during the 2nd quarter. The rate of delinquency rose to 8.44%, according to the Mortgage Bankers Association.
In addition to the huge inventory of unsold homes on the market we have what is now referred to as the “shadow inventory”. Lenders do not want to overload an already saturated market with additional inventory. According to a Standard and Poor’s report there are roughly 1.7 million homes that are owned by the banks or in some stage of foreclosure. At the current rate these homes are selling, it would take almost 4 years to get rid of these homes.
Standard and Poor’s does not count home loans backed by Fannie Mae or Freddie Mac, thus the number is probably much larger. In many cases banks are delaying on foreclosing. Once they foreclose they have to write off these losses; the longer they wait the better it is especially in light of the fact that the market is saturated with inventory.
You also have a large number of individuals who are in pre foreclosure living in their homes; they have no reason to sell as it’s just a matter of time before they are foreclosed on. However, in the mean time these properties lurk in the shadows and are not counted.
Shadow inventory has surged in many cities. In Las Vegas it went up to 48% (30 month supply), In Minneapolis it at 61% (35 months supply), and in Portland it rose to 47% (45 month supply). New York appears to be okay and this is because many of the homes in foreclosure are stuck in the pipeline. Due to this it is estimated that NY has 10 years worth of homes which would make it one of the longest shadow inventory lists in the country. In comparison the hard hit Miami area has a shadow inventory list of roughly 5 years.
There is one more group that falls under the “shadow inventory” category. These are home owners who have tried to sell their property in the last year but have been unable to do so. We have seen a lot of this in New York and Florida. A 7 family unit in NYC was put up for sale last year and the asking price was close to $1.4 million; it was just recently listed for 1 million and the price is negotiable and still there are no takers. Given the number of homeowners that have tried to unsuccessfully sell their homes over the past few years, the number of individuals in this group could be quite large.
The number of individuals who decided to purchase new homes has fallen for 3 months in a row. If this pace is maintained it would mark the worst year for sales on record for almost 50 years. Interestingly enough last year was the worst year on record and it looks like we are either going to match that record or set a new one this year.
Sales of new homes have fallen for 3 months in a row. Economists state that in a healthy housing market roughly 700,000 new homes need to be sold annually. At the current pace only 300,000 new homes will be sold this year; this is more than 50% below what is considered healthy. Sales of new homes fell nearly 1% for the month of July indicating that this trend is not going to end anytime soon.
In a healthy economy individuals purchase roughly 6-6.5 million used homes annually; this year we are on track to beat last years dismal record of 4.91 million units.
Adding fuel to the fire is a new report that states a large number of new home sales were cancelled at the last minute. This illustrates that buyers suddenly got cold feet and this is probably due to their expectation that that the economy is weakening. You don’t agree to buy a home and then suddenly cancel it at the last minute, unless something has really rattled you. The report estimates that at least 16% of home sales were cancelled just before closing last month; a surge of 400% over May’s readings.
Prior to the recession housing contributed roughly 19-21% to US economic growth, today it barely hits the 4% mark. If that is not telling enough, then consider this; it has been estimated that on a percentage basis the price drop since the beginning of the great recession is greater than what was experienced during the great depression. It took almost 2 decades for the housing market to recover after the great depression. Assuming that things are only half as bad now, that means it could take 10 years in total. If that’s the case than 2017-2018 is the earliest one can expect this sector to put in a meaningful bottom.
Year over year US home prices have dropped 5%, the largest drop since 2009, according to the FHA. Foreclosures continue to boost the supply of properties on the market, which in turn adversely impacts the price a property commands. June also experienced a 4.3% (year over year) drop. According to Lender Processing Services Inc. based in Florida, 6.5 million U.S. homes were late on payments or in some form of foreclosure for the month of June. And as we all know by now, the main driver behind this surge in foreclosures is the unemployment rate which sadly shows no signs of improving.
The mortgage banker’s association latest weekly survey reveals that mortgage purchase applications have dropped to a 15 year low illustrating that the housing sector is still in the dumps.
The great American dream has now become the never ending American nightmare. Despite what anyone might state over the next few years, owning a home is not a good idea. The unemployment rate has to level off and the excess inventory of both new and used homes needs to drop considerably before there is any hope of a long term bottom taking hold.
For the past 4 years we have constantly stated that traders should stay out of the real estate market even when so called experts made claims to the contrary. Even the so called great Paulson got it wrong when he started to claim it was time to buy not only 1 but several homes not too long ago. Now he has changed his tune again. We did however make the claim that owning farmland was a great investment when prices were depressed (2006 to early 2009) but this is no longer the case.
Real estate will make for a great investment one day; however that day is not yet here. In the meantime the wisest thing is to stay away from this sector, unless you stumble upon a screaming buy.
"Too much sanity may be madness and the maddest of all, to see life as it is and not as it should be."
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.