September, 2008
Where is the economy headed?
The US consumer is completely tapped out…saving nothing…burdened with debt and suffering from falling home prices. Most folks are having difficulty maintaining their standard of living and have cut back on their purchases of almost everything…including cars…appliances and of course houses.
Housing is the most important sector of the economy in our economic downturns…as the housing sector goes so goes the economic recovery and therefore we may be in “recovery mode” for at least several more years.
What about housing prices?
The housing price decline is not anywhere near the bottom. We currently have an “inventory overhang” that will take at least a year…if not longer…to fully unwind. Housing prices are still falling and that is primarily due to tighter lending standards and the fact that incomes over the last decade have not kept pace with inflation. Not only have incomes not kept pace with inflation…but homes are still overpriced relative to current income. A home price/affordability rule of thumb is that the median home price in any given area should be 2.5-3 times median income. Do the math: if the median annual income in your area is $60,000 then the median house price should be around $180,000.
Housing prices will continue to decline until prices fall to a level where they are inexpensive enough for the rank and file to afford the mortgage payments. Watch the employment figures as job creation (or lack thereof) will be the key to any housing recovery.
What caused the real estate bubble and why did it pop?
Without getting into an exhaustive analysis of human behavior…the largest single factor behind the housing bubble was access to cheap credit and “relaxed” mortgage underwriting. As a result….a mortgage market was created that reached deeply into a pool of renters and home buyers with low incomes and dubious credit.
Simply…more people were buying because more people could qualify to buy and as more homes were bought…home prices skyrocketed…creating “irrational exuberance.”
As home prices were driven higher…homeowners began to tap home equity…extracting (borrowing) and spending billions of dollars thereby keeping the economy primed. As long as consumers could meet their ever increasing debt load…all was well. Ultimately…borrowing to spend wasn’t sustainable. Welcome to the great unwinding!
In the final analysis…lenders…investors and residential home buyers convinced (deluded) themselves that house prices could only keep going higher…and were all “speculating” on real estate appreciation as opposed to making decisions based on sound…fundamental financial principles. We’re now left with consumers and financial institutions over leveraged and without liquidity.
What should I consider if I want to buy a house?
We now have an entire generation of citizens that do not understand that housing is merely a place to live and that housing…over time…marginally outpaces inflation as an investment. If people would (re) learn to think of their houses primarily as homes as opposed to investments there would be greater antipathy toward borrowing heavily to acquire and maintain them. That said…
First…honestly assess whether or not buying a house makes more sense than renting. For many it doesn’t once they factor in the various costs of owning such as taxes…maintenance and insurance. Is it better to rent or buy?
Second…honestly access the strength of the local economy and your employment prospects. Will you have a job next year? Would you have enough savings to pay for the mortgage and other living expenses if you or your spouse/partner or both are out of work for 6 months or more?
Third…think in terms of long term financial “sustainability!” Get your financial house in order by paying off debt and repairing credit. Create savings equivalent to 6 -12 months income as an emergency fund…THEN save for a downpayment on a house. Be prudent…focus on a comfortable payment rather than on how much house you can qualify for. Remember that a house payment should represent no more that 25% of your gross monthly income.
