Now’s NEVER a great time to buy!
In part 2 of our series on the housing crisis, we tackle the latest favorite mantra of the real estate industry: “Now’s a great time to buy.” Everyone knows real estate prices have fallen. Some markets have seen a complete collapse. Even in 2007, you could find houses in Detroit for less than $30,000. Now, you can find homes in America’s urban wasteland for under $6,000. That’s an 80% drop in just over 2 years! Now’s a great time to buy, right?
Well, (thankfully) not all of us live in Detroit. In fact, Detroit has been slowly disappearing since 1950 (when it’s population was 1.85 million) to 2008 (912 thousand). If not for the flood of immigrants from the middle east and eastern Europe, the city may have already disappeared. If only Detroit’s citizenry had rented over the past 50 years. They could have just walked away from a depreciating asset.
Unless you live in a similarly ravaged part of the country or you want to move to one of America’s many ghost towns in California’s central valley, Florida, Nevada, or Arizona, you can save money by waiting to buy. Real estate markets in the bay area, San Diego, Seattle, and Manhattan are still dramatically deflating.
Bubbles of every asset class have a very similar anatomy. Once you hear the word bubble, you can draw the path yourself. The only thing that’s unknown is the amplitude (peak price), interval (time between peaks and valleys), and Tau (the time from peak to bottom). Here’s an idealized diagram of an asset bubble:
Now compare for yourself this idealized bubble with graphs of some famous and evolving bubbles:
Nasdaq bubble – 1990s
US Stock market bubble – 1920s
Chinese Stock market bubble (Shanghai index) – 2000s
Japanese bubble (Nikkei) – 1980s
Now consider the housing bubble. As a rule, bubbly assets give up their entire bubble gains before finally increasing in value. The exact reasons for this price depreciation are complex, but are fundamentally related to the empty hype that drove up prices in the first place. The story never changes. With housing, we heard: “We’re running out of land,” “housing prices have only gone up,” “we’ve never seen a nation-wide decline in home prices,” “America’s population is rapidly increasing,” “don’t miss the peak,” until finally we learned that “we’ve reached a new plateau.” That’s when prices finally collapsed.
Why are consumer’s so confused? Consider this 100 year chart of the Case-Shiller index. People projected prices falling straight to the ground. Instead, prices oscillate slowly until they finally reach their pre-bubble levels.
So when should you buy a house? Look at the Case-Shiller index for your metropolitan area. If the index rose only 10% during the bubble, it could take a decade for you to see prices fall back to pre-bubble levels. Home prices may have already fallen 5%. You may not care if your home drops in value a few extra percent. It may even be worth buying if you plan on living there for your entire lifetime. Just don’t expect your home to be a good financial investment for at least a couple of decades.
But, if you’re looking to move to one of those neighborhoods which witnessed bidding wars, 300% – 1000% property appreciation in 5 years, and rampant overbuilding, the smart money is to wait on the sidelines. One thing’s for sure – housing prices will not run away from you anytime soon. The bubble already popped. Now, we’re just waiting for 1999 prices to come again.
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It may be a good time to buy a house if you think that inflation
is about to shoot up. Forget gold, – the best inflation hedge in the world is a fixed rate mortgage on your house.
That said, house prices overshoot on both the upside and on the downside. We are now in the process of going from ridicously high prices to ridicously low prices. I remember how in the mid to late 1990’s,houses in my Brooklyn neighborhood were selling for 1/2 of their replacement costs. Nobody wanted to buy them anyway. Then they went on their 20 percent a year run for the next 10 years and at the peak of the bubble in 2006, these same houses were selling for over twice their replacement costs.
Real estate cycles are very long and real house prices will be falling for years. Remember 2004-2005 when people fought over spots in developer’s pre-construction buying lines? The bottom of the cycle will be equally absurd but it will characterized by, say,
you buying a 2 family house and living in it and your tenant’s rent paying your entire monthly mortgage. At that time people will hate housing as an asset class and will overpay to rent.
My guess for the bottom in housing and the ridicously low prices mentioned above is that it will happen after the end of the next Fed tightening cycle, probably a few years away.