Why Real Estate Cannot Climb For Years

Includes: XHB
by: Erik Gholtoghian

From the peak of the real estate bubble, we have had one of the largest falls in real estate prices in history. Some would think that what falls must someday go up, but that isn't necessarily true in this case.

For example, the unemployment rate at this time is extremely poor and recent college graduates are finding it nearly impossible to gain employment in work that offers a living wage. So that group has no way to buy a home. Additionally, the older Americans who are working in stable good paying jobs are almost all locked into underwater real estate which they cannot sell. Why?

If you bought a home in 2006 for $400,000, today it is probably worth around $200,000. If you purchased the home with 20% down, or $80,000, you now have zero equity in your home. In other words, your choice is to stay there and pay a fairly large mortgage payment forever or go bankrupt and lose your home and your $80,000 down payment. This will keep a constant supply of foreclosures hitting the market, not to mention illiquid under water homes, which cannot be sold, trapping homeowners for years.

The only solution is waiting for jobs to return to the US to support home prices. The dollar may need to weaken significantly before this can happen.

Below is a chart showing the Case-Shiller Home Price Index.

(Click chart to expand)

Homebuilders and real estate investment trusts (REITs) are the obvious choice to short if someone believes that real estate isn't coming back. The S&P Homebuilders ETF (NYSEARCA:XHB) is one such fund that can be easily shorted to hedge market risk against falling real estate prices.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.