The Folly in Calling a Housing Market Bottom

Nearly every week I read an article proclaiming that the housing market bottom is just around the corner, X-months away, etc, etc. People who are trying to sell me real estate have been saying the same thing, coupled with: “that won’t happen here”. Unfortunately I’ve been reading and hearing these types of things since mid 2006, and I don’t see a lot of evidence to support their claims. The various “mortgage rescue” programs are unable to solve the issue of people who bought homes they can’t afford, and there are many instances of the programs simply delaying the inevitable. The latter situation is arguably an even bigger problem, as it simply pushes the housing market correction out to a later date.

Meaning: while there are things we can do to mute the magnitude of the housing crisis and mitigate the impact on individual families, we won’t see a recovery until the correction runs its course. Furthermore, recovery is a misnomer in the sense that we’re not going to return to ’03, ’04, etc, but rather the housing market will return to the pricing levels and rates of appreciation seen prior to the boom.

I think that a lot of the desire to call a “housing market bottom” is a combination of wishful thinking and self-interest clouding people’s ability to interpret the facts. Namely people want the housing market to go back to ’04 so the housing ATM can be re-opened, they can use refinancing to get out of the trouble they’re facing and corporate earnings can (again) be re-inflated by the housing market, etc. After all, isn’t that the implication of a housing market that goes back to ’04 as opposed to returning to its usual state prior to the recent boom?

However why would anyone want the housing market to return to the boom days, even if in a muted form? Is a lesser asset bubble, inflated earnings and overpriced housing really in anyone’s best interest? Wouldn’t a return to close to boom time levels mean future problems that are more painful than what we’re facing now?

All that being said: while the housing market will recover at some point when that happens is anyone’s guess, so home owners and investors need to key in on a strategy that isn’t dependent on an accurate prediction of a market bottom.

Homeowners: should focus on getting themselves into a housing situation they can afford, and avoiding using refinancing to avoid trouble and/or using their homes as an ATM. IF you’re in a house you can afford that’s all that matters in the end, enjoy your home and stop worrying about the month over month (or even YoY) change in value.

Investors: don’t place bets on a housing recovery being right around the corner and focus on investing in truly under-valued companies, meaning cheap relative to growth potential and financial health as opposed to cheap on a numerical basis.

At this point it’s a waste of time to put too much energy into calling a housing market bottom or even worrying about when it will happen, instead focus on maintaining stability in the present and positioning yourself to profit at some point in the future. If you can pay your mortgage and/or are invested in under-valued stocks, there is no need to worry about when the bottom happens as you’re well positioned for success regardless.

Comments

[liorio1]

Homeowners were fooled into believeing that their biggest asset was also their biggest wealth producer. Wrong! Look at the long term trend, housing is slightly ahead of real inflation as it should be and nothing more. It is not a stock nor a tradable asset as others have used it and now suffering for it. A lot of charletans have told a lot of empty heads to buy and flip. Well, looks like some have made loads of money and others are now holding a bag of poop!

[QualifiedBuyer]

In their effort to prop up home prices and slow the mortgage meltdown, the Government has ensure the price decline will continue for quite some time. With rising inventories, why in the world would anyone decide to buy a home in this climate, only to have that now required big down payment evaporate as the value of their home declines. I agree with this article. Invested in under-valued stocks. Then, sit back and what the fireworks.

[Julie]

Excellent analysis! You're right about the "wishful thinking". I'm in the real estate industry and it seems people need to tell themselves we've seen bottom to face getting out of bed in the morning. I understand that, but don't think it's truly helpful.

[TonyC-SA]

While I mostly agree with the author and first comment, and I have owned my home for twenty years, I think a prescription to just ignore the market is a little drastic. There are property tax consequences to value appreciation which can be challenged; refinancing to a fixed lower rate can save real dollars even after points; and the losses of desperation sellers of real estate present actually profitable opportunity for those that can buy-and-hold. I'm not ruthless enough to take everything a man has got and leave him a homeless street bum, but I am not opposed to making a profit and teaching a speculator a harsh lesson about risk assessment. It is a fact of life, we learn our financial lessons through financial pain and losses.

I am a staunch Democrat willing to provide some safety net to keep people from falling into abject poverty, but if we completely bail them out and make them whole we infantilize them and do them a disservice; we teach them a false lesson, namely that wild speculation has no real financial consequence.

Rather than ignoring the market, we should treat it like a MARKET: When supply vastly exceeds demand prices drop to the lowest the sellers can stand, and a prudent investor, looking 3-5 years down the road and assuming the housing market will return to its long term trend, can find value, be the buyer a seller needs immediately, and be rewarded for the ability to wait out the turmoil of the popping bubble.

[bowlmar]

Investors don't place "bets" on anything - traders do.

[Stillrenting]

The problem is that just as homeowners have adjusted their lifestyle to one supported by the Home Equity ATM, and are now having to adjust, local and state governments have done the same with the taxes that brought in.

I think THAT is where it is really gonna hit the fan.

Oh, and when a fairly significant of people are distressed by the effect this has on them and their family, expect more domestic violence and divorce and all the fallout that it brings.

Things could get a little dicey the next few years.

[bowlmar]

I like the attempt to predict increased DOMESTIC violence and divorce on Realtors, appraisers, mortgage brokers, banks and Wall Street. Ponzi schemes always work, because there is NEVER a shortage of greed, and the greater (greedier) fool is right behind you. Its the PEOPLE and their personalities who got themselves into this mess. My wife and I decided homes were overvalued in 2001, and bought a cheap, small marker home. We invested the rest, and pulled it out last July. Sold our market home in 28 days by August. We're doing fine, because we aren't ruled by naked greed. We have no need to keep up with the Joneses, and if we need more money, we EARN it.

Folks like us tend to have low incidences of domestic violence and divorce. The housing boom just provided another road for the greater fool to follow.

[evergreen16]

The author seems to be a little confused by the avalanche of available data.
Nobody wants to return to '03 or '04 and relive the past again. Time travel concept is dead. Sorry to break it to you like this.
The boom started few months into 2004 and the prices are expected to reach those levels of 2004 again, as that is considered the normal. Growing trend will most likely not occur for several years, however stabilization is already starting to appear here and there.
We are now back to basics - in areas, where there is work, prices will hold, whereas areas with vacation or investment properties are forgotten.

[Stillrenting]

Bowlmar. My wife and I are similar. We wanted to buy but saw what we had to compete against in other buyers attitudes and compared that to the value of rentals. We knew this was a bubble several years ago. The amount I can invest every month is actually quite staggering.

We may be looking to buy in a few years...

I'm dead serious about the domestic violence and divorce thing though. Money does not buy happyness, but serious financial problems put serious strain on a relationship. The ugliness will, strictly statistically speaking, increase. How much is anyones guess.

[BasicFinance]

"Sorry to break it to you like this. The boom started few months into 2004"

Evergreen16: Why do you think the boom started in 2004? Most graphs I have seen show a disconnect from fundamentals back in 2000. Hell, the PEAK of the boom was 2005. Was there really just a one year boom?

["Magazine-Cover-Indicator"Indicator....]

Evergreen: click the 2nd graphic on the left of this article labled "A slowdown ahead", and then examine the middle graph carefully, then see if you think 2004 is correct. Be aware the pink shaded part was a projection, which is already shown to be optimistic by now...

["Magazine-Cover-Indicator"Indicator....]

www.nytimes.com/2007/0...

[Avl Guy]

Great post, Lee.
The good thing that may come out of the on-going De-Leveraging is the market’s battle for equilibrium, i.e. new valuations of assets. Median home prices need to sink much further relative to median American incomes, and so far no one has figured out how to stop this sinking…though Homer at the WSJ is pushing for mass-bulldozing of excess housing inventory to rapidly speed-up the market’s search for a housing bottom (bulldoze excess supply to meet a very tepid demand).

The good thing about collapsing home prices is that it uses the market (not government) to distribute the pain (loss of paper wealth)…so everyone from Donald Trump to the Bush family to Wall Street Hedge Fund managers to the guy & gal on Main Street will potentially share in the collective loss of wealth…if given enough time. Hence, Homer’s call for a bull-dozing. Of course, the truly wealthier have other assets: massive stock portfolios, business ownerships, etc.

It’s an ugly process, no doubt.
The bad news is that all of the public policy and tax incentives remain in play to repeat trumpeting consumerism and center it around housing whenever a recovery starts. Those policies and incentives need to be changed.

Still, let’s face it..consumerism and greed have deep psycho-social underpinnings. Ever hear a 3-yr-old headstarter scream, “It’s Mine !!!”. All the time.
I see no programs to derail the re-metastasizing of this mind-set once the economy starts rebounding. Besides the fact that ‘acquisitiveness’ may be basic human trait, modern America genuinely fears economic systems not built upon individual acquisitiveness; US foreign policy has been to undermine non-capitalist systems wherever found.

Our best bet may lay in a perfect storm of opportunity posed by the intersection of the sustainable building / living movement, and a long “L”-shaped recession. The latter may provide the timeframe needed for the former to gain a stronger foothold in America.

[David in D]

Hello; I'm no economic genius and thus this is a real question not a rhetorical one. When experts on this site talk about a housing "recovery" I am a bit confused. Are people actually thinking that prices will return to 2005 levels within the near-term (5-10 years)? If I am not mistaken, the fueling of the housing bubble is tied directly to the fact that housing prices far outpaced real earnings growth; therefore how can there be any recovery without real earnings increasing. If the average family is far beyond 2.8 times salary (and say closer to 3.5 or 4.0) then what sort of "recovery" can be expected. I simply don't understand the logic of this and would appreciate some comments helping me "get" it.

[TonyC-SA]

David in Denver: I am no economic genius either; but in the near term I think experts I have read agree we can return to those levels within 10 years. The decline is expected to bottom out around a total of 10% in 2009, and then unless real estate has made a fundamental change (which I think is unlikely) it will gain a little over 1% per year PLUS the inflation rate so it could wipe out the paper loss by 2012 (i.e. reach the 2005 price unadjusted for inflation), and wipe out the real loss (i.e. adjusted for inflation, meaning reach the 2005 price in 2005 dollars) by 2020 or so.

But don't forget that these national averages do not reflect local conditions; the variation across the country is huge. As is often said, there is no such thing as the national real estate market! People are just not that mobile, even the young and single. They are tied to a locale by family, jobs and lifelong friends and business relationships.

So the California market is likely to be hit 2-3 times harder than the rural Texas market. In the former, prices began high and speculation was rife; in the latter, prices began low and speculation was either not necessary, or did not involve nearly as big a bet. It is not as if Calfornians were using ARMs to buy Oklahoman or Texan 1-acre country plots. They were buying overpriced condos and homes in California and as a percentage of true value (say, average for the locale under 1985-1990 valuation norms) their bubble was bigger than the bubble in rural Texas. So the "recovery" (meaning return to a normal +1% real dollar real estate market) will not overcome that bubble premium in real dollars for probably 20 or even 30 years.

[TonyC-SA]

Of course I should add that if the bottom is in 2009 or 2010, that presents an opportunity for new money to invest in real estate cheap; and for those people appreciation might be faster than the long term average would suggest because the prices will be artificially deflated compared to true value.

When markets crash (even local ones) they always crash further than rationality would dictate. Everybody sees lower pricing is imminent. Nobody wants to be left holding the bag so the supply increases disproportionately to the true value decline; people that need to sell in the next six months or whatever all rush to the exit now instead of waiting and taking a hit. In the meantime, demand dries up faster than the true value decline would dictate; buyers that were thinking of closing in the next few months but can wait it out for a better price will wait and see what happens. Knowing about a crash accelerates the crash on both the supply and demand fronts; this is why markets always crash much faster than they rise, and momentum carries them below their ideal setpoint. Fear of impending loss is a much stronger motivator than hope of eventual gain.