Talk of a Real Estate Bottom Already Is a Waste of Breath

I was talking with my father yesterday about the meanings of the terms recession, depression, inflation, nominal and real prices. My dad (and my mom) are my heroes. They are hard working, God fearing, extremely loving working class folk. BTW, we had this discussion on the to talking the local Hyundai dealer to sell us their top-of-the-line, fully equipped Azera model for just over $23,000, brand spanking new. This car has 85% of the amenities as luxury cars literally costing four times as much, not to mention a 7 year warranty. This is the Edmunds pricing breakdown for that exact car.

2008 Hyundai Azera Limited 4dr Sedan (3.8L 6cyl 5A)					What Others Are Paying
		MSRP	Invoice
National Base Price		$28,550	$26,517		$27,306
Regional Adjustment for Zip Code Change		-	-		$175
Optional Equipment		$2,750	$2,538		$2,639
	06 Option Group 06 Ultimate Navigation Package	$2,750	$2,538		$2,639
Color Adjustment		-	-		$32
Sage Green
Destination Charge		$695	$695		$695
Total with Options		$31,995	$29,750		$30,847
Incentives & Rebates					-$2,500
Customer Cash Adjusted True Market Value					$28,347

Now, why would they sell us the car for $5k less than what "others" are allegedely paying? The truth of the matter is, as many have already surmised, that the car business is doing horrible. These dealers have inventory on a floor plan (credit line) and they are apparently losing enough money where they are willing to take deep losses in order to move it off the lot. This is a sign of a depressed economy. Hyundai are the "everyman's" car. If these can't move without discounting past the point of extreme pain, the debate about recession and hard landing is simly academic. Okay, I digress. On to the topic at hand.

If I hear another pundit (ex. Ara Hovnanian) query or comment on reaching a "bottom" in the real estate market anytime soon, I am going to scream. In the conversation I was having with my father, I explained the current housing like a ball that we usually play with at ground level. Ground level is the equilibrium point. Now, I said, imagine throwing that ball 50 feet into the sky, then expecting it to suddenly stop in mid-air or 5 feet down in its descent back to the ground - ex. finding the "bottom" that the CNBC crew are in search of and expecting to come sometime next year. Physically, and realistically, this expected stop (or bottom) for the ball just ain't gonna happen. The same can be said for real estate values. When things pop that far outside of historical mean, expect a reversal. The following graph makes this point crystal clear, congealing the entire conversation I had with my pops into one picture...

click to enlarge

Looking at the real (inflation adjusted) prices of homes over time and comparing them to the rates that tend to power them and the costs to build the home, that ball that was thrown up 50 feet into the air (the blue line) will have to drop at least 50% before it even comes close to hitting the ground again (the largest distance between the two lines, historically, excluding the 1997 spike, at at a realistic minimum). So all those guys who think the largest historical housing price spike since the US gold rush that lasted at least 7 years will be over after a year or two of relatively minor correction, study your history!

Now there is another way of looking at this. Many people ask me when I think the housing market prices will stabilize. I say the that houses will sell when people will be able to buy them. After the long run up, median prices have outstripped median incomes by so much that the (vast) majority of housing stock is out of reach of the everyday working couple. People like my mon and dad. It's as simple as this - houses won't start selling until people can buy them.

So taking the previous, and rather simplistic but highly informative theses into consideration, any one who believes that housing industry and financial industry that levered up on real assets and related securities at the very tippy top of that blue line in the first graph will stop writing down values by year end or even next year, I strongly suggest you start studying your history. It will be decades before we see those prices levels again. Where excessive leverage has come into play, it is quite possible that some of these assets may actually NEED to be written down to zero. Just look at the first chart and think of buying at that apex with 30x leverage, then having to suffer the trip down as the ball falls back to the ground.

Comments

[tcornelison]

Remove Arizona, California, Florida, Nevada and a few other coastal markets from your chart and you will find a different picture of those spreads. The biggest problem with all of the analysis out there is that it is generalized over the entire nation excluding adjustments for regional differences. See analysis performed by PMI for risk assessment (available at pmigroup.com). The majority of the nation is not expected to see the catastrophic plunges in market value that will be experienced in these markets where speculative purchases ruled the day. Reality is that most of the nation's markets will scarcely see a decline because they are still actually affordable. OK. Now you can go back to the sky is falling and your chicken little story.

[DougPoretz]

The residential real estate market is a food chain. There are no buyers of luxury homes if there aren't sellers of first-move-up homes. Like all food chains, the last market to go away is the highend, and the part of the chain that has to start the food chain is the small fish, or the first time homebuyer. Want to get the residential real estate market moving very fast and make political points? Propose that the federal government immediately launch a first-time home buyers plan, with some help with down payments and/or bought-down interest rates provided by the federal government. Want to really make points? Give an even steeper benefit to people in certain jobs such as teachers, firemen, police, nurses, etc.

[jkmac]

Teachers,are already on a gravy train. Nurses and the like, I'll go along with.

[smallishinvestorish]

I bought a duplex in a very good area 10 years ago for $257,000. Over the 10 years the "market value" as judged by the local tax estimator went up to $478,000. I thought that was quite high since no major changes were made. I had them come out and reevaluate. They now put the "market value" at $390,000. My taxes will drop in 2009 (however the mill rate will probably go up so my dollar amout paid will not go down as much) but I will still pay the higher rate for 2008. This is a complaint about government and their ability to charge whatever.

[jimsep]

tcornelison is forgetting about Michigan, Ohio and Colorado for starters.

What does it matter, anyway if there is concentration? It is the magnitude of the problem that matters.

[Mallarde]

There are some factors that many neglect. First: immigration and population. Particularly in CA and FL, there is more demand for housing in good areas of cities. Second: double-income families. Families have engaged in an arms race and have been using women -- who used to stay out of the labor force -- for second incomes. Once enough families are double-income, the market adjusts up due to demand and more money that can flow to real estate.

This is not to say there is not more room for the market to fall. There is lots of room. I still hope all the air seeps out of this market over the next few years.

[squawk]

Your ball analogy illustrates a complete lack of understanding of the real estate market. First, as an early poster comments, real estate prices are driven by LOCAL economic factors. In markets like Ohio, Michigan, where there is little or no economic growth, your analogy might have a bit of merit. However, in continually proven high growth markets, your ball analogy comes crashing to the ground, as it should.

Granted, high growth markets, particularly markets like South Florida, Vegas, Phoenix, Inland Empire (San Bernardino-Riverside), where price appreciation has clearly outstripped economic growth, a correction was, & is, inevitable. However, in certain traditionally strong markets in California, such as Los Angeles, Bay Area, where there has been a LONG TERM shortage of "affordable" housing due to a CONTINUAL influx of population, you cannot expect prices to fall 50% as you postulate.

Yes, an "equilibrium"... will be reached. But to say that such equilibrium is a "ground level" after a period of years of significant price appreciation, shows a basic lack of understanding of real estate economics. Beyond the cost of capital, which is still at historically at low levels despite relative tight underwriting standards, look to the LOCAL economy for a better understanding of how supply and demand interact to determine real estate prices.

Local markets with historically growing economies and limited supply of housing will continue to appreciate, where your so called "ground" equilibrium is not flat, but "climbing" over time.

[VISION]

hey squawk,

What are you smoking?

[The Mayor]

Give teachers a break, NOT!! They only work 9 months of the year and make more than most people, plus in state's like Illinois their lucrative pensions paid for by taxpayers (do you get a pension at your job?) are bankrupting the system. Teachers have become the modern snake oil salesmen.

[Kunst]

Teachers are underappreciated and underpaid. They all have a masters degree or equivalent. They are worked like dogs for 9 months and then have to figure a way to make some extra during the summer. Half of all teachers drop out of the profession within 5 years. I made more money my entire career as a bachelors-degree engineer than the average Ph.D. professor. We have little respect for education in this country and the results show.

[ReggieMiddleton]

This is a very opinionated bunch. I'm glad to see I stimulated some conversation. It is quite interesting to see squawk tell me, a successful real estate investor for the past 8 years, that my missive "illustrates a complete lack of understanding of the real estate market". I guess I bettergo back and unravel all of those deals... Squawk, read carefully. Each market is different, I had one article to write. Come visit us on my blog and we can go over this in detail.

Tcorneilson: "Remove Arizona, California, Florida, Nevada and a few other coastal markets" and remove X and Y and Z and ... We only have 50 states...

There is a lot of negative criticism on Seeking Alpha, much of it ucalled for. I think many a pundit could use a hug:-)

[underbr00m]

Lots of information regarding real estate getbestofrealestatenow...