Expat

Latest Case-Schiller Report Shows the Sky is Falling

I don't think the estimates make much sense when they are given in a vacuum. "Down 28% from the peak" "Another 10% to go" Blah, blah, blah.

The reality is that the US housing market is massively overpriced as measured against the only thing that matters, affordability. Ignore the wealthy who rarely buy as much as they afford (otherwise, Bill Gates would live in a one hundred million square foot sold silver home).

Median house price is now at $201k (I don't know why this measurement is used, by the way). Median income is about $49k. The long-term affordability ratio for house prices is about 2.8 times income. Consequently, the median house price should revert to about $137k, implying another 30% drop.

What does this 2.8 times income ratio mean? It's not a fantasy number pulled out thin air. It represents the ability of the income to service the loan at typical interest rates and lending conditions. It means you pay one-third of your income on your housing (ALL costs included) in order to remain solvent and save for retirement. It also assumes typical wage growth.

This ratio does not take into account 100% mortgages or option ARMS with teaser rates. It does not take into account the lending backlash as prices collapse (what was loose and easy on the way up becomes tight and restricted on the way down). It is also likely to be a mean-reverting ratio which implies that it needs to go BELOW the long-term average in order to balance out with the insanity on the upside.

Given the insolvency of our major lending institutions, the eradication of irresponsible lending, negative savings rates, widespread debt, record housing inventory, and the recession, we are likely to see the affordability ratio head down towards and below 2.5 times income.

Look out below. The median home price needs to drop to about $120k to signal a bottom.

Housing Prices Expected to Bottom in 2010, 21% Off '06 Highs

Once again, another house appreciation number based on long-term historical increases. The facts are: house prices bubbled WAY above affordability, "owners" over-extended themselves massively, builders over-built, recession is here, real wages have NOT increased in ten years, banks are bankrupt and new loans will be very hard to get and very expensive.

All this means that house prices will need to hit historical lows (in P/E and income ratio terms). In order to revert to the long-term 2.8 times income ratio, we need to go seriously under the long-term average to compensate for being so far over it.

Owners will not be trading up for years to come as they work through the huge negative equity in their existing homes. New buyers will have a hard time buying as banks demand 20% down and limit price to income. How many under-30's have $40k lying around? How many over-30's have it?

Forget about inflation justifying a 5% rise per year. Take median income, multiply by two. That's your new target for house prices in 2009 and 2010.