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Bottom in Home Prices, a Decade Away

Bottom in Home Prices, a Decade Away

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Published by MKC Global
A researched view into the residential real estate market and the factors that directly affect a bottom and rise or a continuation in the decline of real estate values.
A researched view into the residential real estate market and the factors that directly affect a bottom and rise or a continuation in the decline of real estate values.

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Published by: MKC Global on Jan 29, 2010
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01/29/2010

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 info@mkcglobal.com www.mkcglobal.com 206.920.4788
MKC G
LOBAL
 
I
NVESTMENTS, LLC
JANUARY 2010
Andrew McCormick Managing MemberBottom in Home Prices, a Decade AwayHumans are an optimistic breed by nature. There are some pessimists (or “realists” as they prefer to be called) among us;but on balance humans believe in a better future. This ensures that investment professionals will continue to track investorpsychology for many years to come. When the naturally optimistic demographic becomes a group of Doom and Gloomers(or vice versa), we take notice. The same is true for participants in the real estate as well as stock markets.The general public seems to believe the bottom in housing has arrived; however, I believe no one will make any money ontheir real estate investments for the next decade. There may be an exception or two with a fixer-upper or a foreclosure, butbuying a home for your primary residence under typical circumstances will be a net loser. The real estate market hasabsolutely no sustainable drivers for a price floor, let alone price appreciation. With taxes, interest, maintenance andinsurance, you are guaranteed to lose money, especially when compared to what you could be paying in rent forcomparable property.In addition to the typical rosy outlook for the future, humans have a consistent tendency to only remember the recent past-consistently forgetting important lessons from history. Home owners and real estate investors alike were all tooaccustomed to consistently rising real estate prices until 2006, when the subprime mortgage issues and real estate bubblebegan to take hold.Few people realize that home prices in the United States have only risen in a sustained manner
twice
in the last 116 years.Edward Kim, hedge fund manager of 2GTT, LLC, brought this fact to my attention and I know very few other people whoare aware of this reality. This data can be found below in the American House Price Index created by Robert Shiller.Other than the two aforementioned periods, all others have either seen declining home values or periods of stagnant orvolatile prices with a net zero change. In 116 years, only twice have home values appreciated in any rolling 8-year period,adjusted for inflation. The chart below shows data to 2006, the index now stands at about 146 for Oct. 2009.In determining what the next decade will bring in terms of real estate prices, one must look at a number of fundamentalfactors to determine when a major bottom will occur. In addition to watching the price levels of real estate, we should also
 
 info@mkcglobal.com www.mkcglobal.com 206.920.4788
observe the mortgage markets, interest rates, home affordability, housing inventory, new construction, mortgageapplications and the rate of home sales. Also, following the stock prices of home building companies may shed furtherlight into the state of the industry, as the stock market proves to be an effective tool at discounting news and can be aleading indicator of major industry turns. Determining an accurate view of these aspects should clarify the future of theresidential real estate market.Home Builder Stocks: The stocks of home builders have been weak and declining since August of 2009 while the broadstock market has rallied substantially. When these stocks cannot keep up with the broader market, there could potentiallybe a problem for that stock’s immediate future.Mortgages: The issues now lay with prime mortgages, as standard 30-year fixed loans are being defaulted on as peoplelose their jobs. Home values continue to decline putting more home owners “underwater”, owing more than the home’svalue. Also, adjustable rate mortgages have just begun to hit their reset dates, forcing the owner’s monthly mortgagepayment higher. This number of adjustable rate mortgage resets will increase each month until they peak in mid-2011.Rate of Home Sales: Moderation in the rate of decline in home sales has occurred, slowing down into Feb. 2009, but hassince picked up. 2008 marked the lowest number of home sales since 1999; but due to stimulus packages, optimisticthoughts of a housing bottom and home buyer tax credits, this important factor has reversed for the worse.Mortgage Applications: Mortgage purchase applications are declining rapidly; “cliff dive” was the comment of oneanalyst. As of January 2010, the MBA Purchase Applications Index is at the lowest rate since 1997.Interest Rates: Mortgage rates are currently very low, and it is a great time to acquire debt; unfortunately the drivers forhigher interest rates in the future are quite strong. Nobody knows when long-term interest rates will rise, because interestrates move in very long-term cycles. We will have to wait years for rates to raise, peak and
then
decline to meet thiscomponent of the real estate bottom model.Home Affordability: With all other criteria being equal, declining home prices mean affordability is rising. The importantquestion to ask is
how
affordable are homes and will they get even more reasonably priced? All the other criteria heresuggest they will. The National Association of Realtors releases its NAR Affordability Index every month. According tothis index (the data is available from 1988); we currently have homes that are the
most 
affordable on record. This indexonly once, for one month, dipped below 100 (over 100 means affordable and under 100 means unaffordable). It now sitsadjusted at 145 and unadjusted at 176, the highest levels on record. Only once before has the index ever showed thathomes were unaffordable! Barry Ritholtz of The Big Picture points out, if the index can’t indicate when homes areovervalued, how can we conceivable use it to determine when homes are affordable?Inventory: Currently real estate inventories are high. In early 2009, Credit Suisse estimated that inventories would rally to11 months worth of supply placing them at the highest level since at least 1988. This is insignificant compared to the“shadow inventory”. The shadow inventory is comprised of all properties/units that will be on the market, but are not yetlisted. This number is estimated to be extremely high and is comprised of several items: bank owned properties (includingFannie Mae and Freddie Mac) that have not been put on the market yet and the number is rumored to still be growing,foreclosures in process, new condos in high-rise towers not yet listed and current property owners waiting for a rebound inprices to sell. Amherst Securities Group, LP estimates there are 7 million units in shadow inventory or 135% of a full yearof existing home sales.Housing Starts: Since 1959 (with some exceptions), whenever the number of housing starts dropped below 1,000,000 itsignaled at least a temporary low in housing prices. As of March 2009 housing starts dipped to 510,000.Observing the rental market will be necessary as well. Currently, rental vacancies are at 30-year highs, depressing rents. If the real estate market cannot make a bottom due to the consumer wanting to own their own home, it could make a bottom

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