Too Many Houses, Too Much House

Includes: ITB, PKB, XHB
by: Acting Man

by Ramsey Su

Good unmolested data are becoming harder and harder to get these days. Housing data are no exception. There is nothing that can determine the appropriate level of the housing supply. Household formation and employment growth have never shown any correlation to housing starts, even though it does theoretically sound logical that they should and they probably do influence housing demand in the long term. In this post, I am going to employ advanced concepts in statistics such as "many" or "much" instead of numbers.

Thinking about the past several decades, there are other factors that should be considered that may negate all the old unproven theories. The most significant factor are most likely the baby boomers. There are 10,000 of those turning 65 everyday, which will continue for the next 15 years. Once upon a time, the rather optimistic consensus prediction was for this group to enter its golden years ready to play golf, cruise the world and buy a couple of second homes. In reality, many are reaching 65 and are realizing their retirement savings are grossly underfunded and are either forced to keep working, or must substantially curtail their retirement plans.

Pertaining to housing, the boomers are not only not buying second homes en masse, many are struggling to stay in their homes. Many are struggling with large mortgages with long remaining terms. Many of these mortgages may even be higher than the property value. As more and more boomers reach their retirement decision point, I believe they are going to create negative demand for housing.

In addition to financial considerations, there is also the question of how much house one needs. At 65, current life expectancy gives the boomers about 20 more years to live. During this time, hips, knees, hearts and other body parts will start to deteriorate. Many boomers have already experienced what it takes to care for their parents, and staying on the subject of real estate, the housing decisions that they had to make on their parents behalf. It is safe to say that the demand is going to be for less and not more house.

If we roll back the clock 40 years, the same boomers that are reaching 65 today just turned 25, fresh out of college and ready to enter the productive years of their lives.

The Vietnam War was over. The US and the world entered a few decades of true economic growth, ending with the tech revolution. In comparison to today, housing was dirt cheap back then, even though the buyers at the time did not think so.

There were the FHA and the VA, but a 20% down payment was a common financing requirement. Southern California was already considered expensive, but the typical transaction used three times the annual household income as a yardstick. The front end (using only housing expense) debt-to-income ratio was similar to today's, in the low 30% range. However, there was a lot less other debt back then, fewer credit cards, fewer BMW leases, and definitely only very minimal student loans. Back end ratios (total debt vs income) in the >40% range were far less common.

The theories of housing demand in relationship to household formation and employment were probably accurate back then, as economic growth continued unabated with only minor interruptions for about 30 years. Times have changed.

Today, college graduates are burdened with $1 trillion of student loans, and many are already proving that they have no ability to repay. Saving enough for a down payment is far more difficult for them, that is assuming they graduated with a marketable degree. Unskilled college grads and uneducated youths are struggling to find employment. Due to the loopholes of the upcoming Obamacare program, full time employment may be even harder to find. By necessity, young people in the US are following in the footsteps of those in decaying countries such as Spain, Italy, Greece and Japan. They are forced to seek inexpensive shelter, whereby the cheapest option is moving back in with their parents. Housing bulls call this pent-up-demand. Yeah, right.

The 65 year old boomers are not adding to the demand for housing. Young people are struggling to find the starting line of their productive years. What about the group in the middle? Many are going to have to support their aging boomer parents. Many are going to have to house and feed adult kids that won't move out. All have to pay for growing government deficits plus the liabilities created by unfunded entitlements. Some have already dropped out and are living off social security, disability support, food stamps, unemployment benefits or whatever else society provides. This trend is not temporary. Look at Japan - we are heading down the same path.

Just like with stock picking, there are always winners, even though the overall market may tank. There are always different factors that influence demand in specific locations, such as the extremes of Silicon Valley versus Detroit, but in the aggregate, I believe we have too many houses. In addition to too many houses, I opine that we have too much house. Demand over the next decade is likely going to be for smaller and cheaper housing units for the young. These homes won't be different from the European look or maybe even the jam-packed necessities of overpopulated Asian countries. For the aging, I think the trend is going to be toward self sufficiency. In other words, their homes may be smaller, have no stairs, and have easy access to transportation, health care and other everyday conveniences. Back in the 1990s, investors that built assisted living housing were too early and lost their shirts. The timing for investing in that type of housing may be friendlier today.

In summary, there is no looking back in real estate. Past performance offers no predictive value for future trends. I believe the real estate winners of tomorrow are those who can find the right markets and deliver the right products. The funds that are buying blindly in Phoenix, Las Vegas or the armpits of California may be readying an unpleasant surprise for their investors.