US Real Estate Markets

Look Out Below
By N.A. 1elttek@gmail.com

Pundits ranging from the well known CNBC host Jim Cramer to Smart Money’s Donald Luskin to Alan Greenspan have called a bottom to the housing collapse and appear to have neglected readily available public information that would suggest that they are all very wrong. "the drop in U.S. home prices will probably end well before' early next year as the number of houses on the market diminishes, aiding an economic rebound." -Alan Greenspan, April 8 2008 “I'm not here to tell you that home prices are at absolute bottom this very moment. But I can argue pretty persuasively that they might be. Or that they are close.” -Donald Luskin May 2, 2008 “I am indeed sticking my neck out right here, right now,” Cramer continued, “declaring emphatically that I believe the market will not revisit the panicked lows it hit on July 15.” -Jim Cramer July 30, 2008 Between the US Census, Federal Reserve, and Case-Shiller data, one can put together a picture which suggest that the majority of main stream prognosticators continue to make call after call that ignores historical trends and the current fiscal condition of the US and its citizens. Looking at the 90’s housing bubble gives some perspective to the current bubble. The 90’s bubble rapidly overshot the historical median for that period, peaked and then rapidly dropped below the median. This was followed by a long slow climb back towards the median value as seen in the Case-Shiller data in Figure 1. This demonstrates a classic reversion to mean type pattern that has been seen in many markets and in many nations, including Britain and Japan in the late 80’s and early 90’s. The current data for the US as a whole represented using the Case-Shiller Composite 10 data set (Figure 2) suggest that the current bubble began to form in 1998-1999. A sudden rise in the index can be seen in the composite and in the NY area data set (Figure 3). The growth of the housing bubble continued for about seven years, peaking both locally and nationally around 2006. What amount of the growth seen in the last seven years has been sustainable and what might have driven it? If we look at the median income, both nationally and regionally, we see that income has remained essentially flat. Since income did not appreciable increase, then home buyers were left with two choices. They could either borrow more money from the banks or the prices of homes had to decrease. It is well known that numerous types of exotic financing have been used for the duration of the growth phase of the current housing bubble. The effect of the housing debt expansion should be obvious in the home loan to household income ratio.

Using data from the US Census, two versions of the household income to home loan ratio were created. The first version (Figure 5) shows the ratio assuming a 20% down payment on the home, or an LTV of 80%. The second version (Figure 6) shows a ratio assuming a 0% down payment on the home, or and LTV of 100%. While an LTV of 100% was probably less then 50% of home buyers, it is still useful to see what sort of risks a significant portion of buyers were putting themselves in. “The survey covered people who bought and sold homes from August 2004 through July 2005. The association (NAR) said 43 percent of first-time buyers surveyed financed 100 percent of their homes, up from 28 percent two years ago when the trade group began tracking such figures” - Washington Post Jan 20, 2006 By 2001 a clear trend of an increase in the household income to purchase price ratio is visible (Figure 5). Given that there was an increasing rate of buyers using exotic financing to purchase homes and that LTV was generally increasing throughout the growth phase of the housing bubble, it may be helpful to look at (Figure 6) to get an idea of what sort of financial situation a non-trivial portion of home owners may now be in. The data used to generate the income to purchase price charts was the median purchase price data. So a home owner that purchased a home in the northeast with a traditional LTV of about 80% would be taking out a home loan about four times their annual household income. By the peak of the bubble the data shows the loan to income ratio peaking between 6.5 and 7 times household income. History shows that during the last US housing bubble in the 90’s, people who were underwater were generally able to continue paying the house note and as such there was not a significant spike in foreclosure. Such a trend would suggest that in the Northeast region, the income to loan ratio of 4X is sustainable. The Peak value of 6.5 – 7 times household income is clearly unsustainable as we are now reading about the growing “foreclosure crisis”. People bought homes substantially outside their ability to financially support in the long term while counting on short term gains created from bubble driven growth to make up the difference. An additional view of the real estate bubble can be seen in home ownership rates. The historical rate of home ownership tends to be between 64% and 65%. The current bubble has pushed home ownership to 69% while the nest closest high was 66% in 1983. This is a significant difference in historical terms as can be seen in Figure 7. This collection of data alone is capable of putting forth a very strong argument for a brutal reversion to mean in the housing market. Virtually any argument that the bottom is near in national or even regional terms is specious at best. The recent housing bubble appears to be the greatest housing bubble in the last 100 years. The only growth that has kept pace with housing is the indebtedness of the US as a people and as a nation (Figure 8). The question at hand is how far we have to fall. The chart in (Figure 9) shows the current Case-Shiller values for each of the twenty urban areas that are represented by the data set.

Note that the Case-Shiller data for Dallas TX does not begin until 2000 and there for does not reflect pre-bubble trends. The percentage data for the reversion to mean is located in (Table 1). While the percentage drops just to reach historical median values seem drastic, reversion to mea usual entails an overshoot. If history is any indicator, then the actual drop as represented by the Case-Shiller index could very well hit 80% from peak in a hand full of regions. If the 90’s housing bubble is any guide then there is the potential for the overshoot to be almost as large as the undershoot. The timing of this event is really anyone’s guess. The last bubble bottomed out approximately as quickly as it overshot the median value at the time. However, Japans house bubble in the 80’s is a demonstration that once the government gets involved in attempting to control and artificially support prices that most educated guesses are out the window. Japans housing market declined for 20 years. As the US government continues to encroach further into market manipulation the question is quickly becoming will we stabilize quicker then Japan did?

Table 1
AZ-Phoenix CA-Los Angeles CA-San Diego CA-San Francisco CO-Denver DC-Washington FL-Miami FL-Tampa GA-Atlanta IL-Chicago MA-Boston MI-Detroit MN-Minneapolis NC-Charlotte NV-Las Vegas NY-New York OH-Cleveland OR-Portland TX-Dallas WA-Seattle Composite 10 Northeast South Midwest West % Drop Peak to Median 60% 65% 66% 65% 43% 63% 68% 62% 27% 47% 57% 26% 48% 32% 60% 61% 27% 50% 8% 49% 64% 59% 25% 32% 55% % Drop Current to Median 29% 45% 45% 44% 37% 49% 47% 44% 14% 37% 49% -12% 33% 27% 33% 55% 16% 42% 2% 42% 50% 53% 0% 14% 36%

Figure 1
90's Real Estate Bubble In Perspective
CS Composite 10 and Northeast Composite
Medians calculated from data range 87-99

100
Composite-10

95 90 85 80 75 70 65 60 1987

Composite 10 median Northeast Composite Northeast Median

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

Figure 2
Cas-Shiller Composite 10/20
250 225 200 175 150 125 100 75 50 25 0 1987
Composite-10 Composite-20 Comp-10 Median

Composite 10 median Value = 82 Median for 87-08

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

Figure 3

New York Area Case-Shiller
220 210 200 190 180 170 160 150 140 130 120 110 100 90 80 70 60 1987 1988 1989 NY-New York Median

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

Figure 4
Data Source: US Census

Median Income (Inflation Adjusted to 08 $)
1975 - 2007 For Total US and Each Region

$60,000 $50,000 $40,000 $30,000 $20,000 $10,000 $0 1975
United States

1980

1985
Northeast

1990
Midwest South

1995
West

2000
US Median

2009

2005

Figure 5
Home Price As a Multiple of Household Income
(assum ing 20% dow n paym ent)

6.0 5.5 5.0 4.5 4.0 3.5 3.0 2.5 2.0
1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 United States Northeast

Figure 6
Home Price As a Multiple of Household Income
(assum ing 0% dow n paym ent) 7.0 6.5 6.0 5.5 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 United States Northeast

Figure 7
US Home Ownsership Rate
70.0 69.0 68.0 67.0 66.0 65.0 64.0 63.0 62.0 61.0 60.0
67 65 69 73 75 79 83 85 87 91 71 93 77 81 97 89 03 05 95 99 01 07
20,000 18,000 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0

United States

Median

+1 Stdev

-1 Stdev

Figure 8
Growth of American Indebtedness
$5,000 $4,500 $4,000 $3,500 $3,000
Total Consumer Credit (Billions) Consumer Debt / Person Total US Population (10's of thousands)

$ $2,500
$2,000 $1,500 $1,000 $500 $0 1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

Population

100.00

120.00

140.00

160.00

180.00

200.00

20.00

40.00

60.00

80.00

0.00

Current CS Value

Figure 9

Median CS Value

AZ -P ho C Aen Lo ix s An ge C le As Sa n C D Aie Sa go n Fr an ci sc o C O -D en N ve Vr La s Ve ga O s R -P or tla nd W ASe D at Ctle W as hi ng to n FL -M ia m i FL -T am pa G AAt la nt N a CC ha rlo tte TX -D al la s IL -C hi ca go M I-D M et N ro -M it in ne ap O ol H is -C le ve la nd M ABo st on N YNe w Yo rk

Home Price As a Multiple of Household Income
(assuming 0% down payment)
7.0 6.5 $50,000 6.0 5.5 5.0 $30,000 4.5 4.0 3.5 $10,000 3.0 2.5 1975 $0 2010 $20,000 $40,000 Median Income $60,000

Multiple of Income

1980

1985

1990

1995

2000

2005

United States Median US Income (inflationn Adjusted to 08)

Northeast Median NE Income (Inflation Adjusted to 08)

US and Regional Home Ownership rates 80.0 75.0 70.0 65.0 60.0 55.0 50.0
65 68 71 74 77 80 89 92 83 01 86 95 98 04 20 19 19 19 19 19 19 19 19 19 19 19 19 20 20
West

United States

Northeast

Midwest

South

07

North East Home Ownsership Rate
66.0 65.0 64.0 63.0 62.0 61.0 60.0 59.0 58.0 57.0 56.0

69

75

97

85

91

03

Northeast

Median

+1 Stdev

93

-1 Stdev

Midwest Home Ownsership Rate
75.0 74.0 73.0 72.0 71.0 70.0 69.0 68.0 67.0 66.0
75 81 89 95 01 65 67 69 71 73 77 79 87 91 93 83 85 97 99 03 05
05

Midwest

Median

+1 Stdev

-1 Stdev

South Home Ownsership Rate
72.0 71.0 70.0 69.0 68.0 67.0 66.0 65.0 64.0 63.0 62.0
93 97 91 85 79 75 67 65 69 71 73 77 81 83 87 89 95 99 01 03 07

South

Median

+1 Stdev

-1 Stdev

07

07

79

83

81

87

95

77

05

67

73

65

71

89

99

01

West Home Ownsership Rate
66.0 65.0 64.0 63.0 62.0 61.0 60.0 59.0 58.0 57.0 56.0
03 93 97 91 79 75 67 65 69 71 73 77 81 83 85 87 89 95 99 01 05 07

West

Median

+1 Stdev

-1 Stdev

Reigon Definitions:

Northeast: Connecticut, Maine, Massachusetts, New Hampshire, Rhode Island, Vermont, New Jersey, New York, Pennsylvania. Midwest: Illinois, Indiana, Michigan, Ohio, Wisconsin, Iowa, Kansas, Minnesota, Missouri, Nebraska, North Dakota, South Dakota. South: Delaware, District of Columbia, Florida, Georgia, Maryland, North Carolina, South Carolina, Virginia, West Virginia, Alabama, Kentucky, Mississippi, Tennessee, Arkansas, Louisiana, Oklahoma, Texas. West: Arizona, Colorado, Idaho, Montana, Nevada, New Mexico, Utah, Wyoming, Alaska, California, Hawaii, Oregon, Washington.