Homes For The Holidays
Homes For The Holidays …Unfortunately,
yeah, and plenty of ‘em. It’s an understatement to
suggest residential real estate was either directly or
tangentially very important to both economic and financial market
outcomes in 2008. It has been the cornerstone of solvency,
or lack thereof, in so many quarters of the financial
sector. And as such, has had profound influence on the
character of the US and really global credit cycle. It’s
been a while since we’ve checked in and all of us know that
residential RE will continue to be a key macro economic health
watch point as we move into the New Year. The current
reconciliatory cycle drag that is residential real estate
affecting financial sector balance sheets, household balance
sheets (and P&L's for that matter), etc. is not about to
dissipate in importance to macro economic outcomes in 2009.
You’ve seen what has happened recently as the Fed has gone
into a good bit of hyper drive in terms of trying to financially
engineer at least some type of stabilization in what continues to
be a downhill journey for the asset class. They’ve
allocated $600 billion to essentially buy agency debt (Fannie and
Freddie paper) in the hopes of getting and keeping US conventional
mortgage rates down. And so far that has indeed happened as
post the establishment of this new Fed investment endeavor,
conventional 30 year fixed mortgage rates dropped a good 100 basis
points, plus or minus, in a matter of weeks. We’ll spare
you the graph, but in recent weeks we’ve seen new mortgage
applications and refi apps spike meaningfully higher.
Mission accomplished by the Fed? We’ll see, as we need
to remember that a lot of folks with rate-locked in-process loans
could only have taken advantage of these new lower mortgage rates
by canceling the prior loan and writing a new one, probably with
another mortgage vendor, which naturally would count as a “new”
mortgage or refi app in recent data. Hence, there may be a
bit of anomalistic higher counts in recent weeks due specifically
to getting around prior rate lock issue, so we’ll need to
continue watching the data in the months ahead. Lastly, and
you may know this already, China and a few foreign friends have
been big sellers of government agency paper since the summer of
this year. The $600 billion the Fed has already so
generously provided is in part simply offsetting current foreign
selling of US agency paper.
Additionally, the Fed followed up the $600 billion down
payment, if you will, in trying to spark housing price
stabilization/reacceleration with an announcement that they would
like to put a program together (through wonderful taxpayer
sponsored Fannie and Freddie) to provide 4.5% 30 year conventional
loans to new home buyers. After all, it is the season of
giving, no? Bottom line being, the Fed is starting to pull
out all the stops to arrest home price contraction. Upping
the ante in a big way relative to prior efforts. We expect
the Obama regime to likewise address this issue, and perhaps
forcefully. They’ve suggested rewriting existing
mortgages, but that enters into the very dangerous and cornerstone
area of contract law.
Key question for both our economic monitoring and investment
decision-making ahead then becomes, can the US government
decree/legislate/manipulate home prices higher, defying the
natural laws of asset class supply and demand, as well as
character and path of a generational credit cycle now in
reconciliation? Defy? We doubt it. Temporarily
arrest? The correct answer is, we’re going to find
out. Important in that, as we all know, the locus of initial
US credit cycle trauma was the mortgage securities markets.
Residential real estate was also the locus of consumer credit
creation this decade and a current key driver of household net
worth decline, certainly along with equities, influencing
household financial well-being. Lastly, we need to remember
the importance of investor psychology and bear markets as this
applies to housing. Any even temporary stabilization in
residential real estate would echo in positive psychological influence to
the financial markets. All part of the ebb and flow of
cycles in both financial markets and investor psychology.
A few macro overview observations about just where we are in
the cycle itself. Cutting to the bottom line, at least in
our minds, inventory and price remain the two largest cyclically
unresolved outstanding fundamental issues for residential real
estate at the moment. Once inventories at least get in line
with historical precedent and prices stabilize, then we can
begin to anticipate a better tone to mortgage credit markets, the
housing industry itself, consumer well being and hopefully the
macro economy. It’s when housing stabilizes that the
unprecedented stimulus being force fed into the system by the
Fed/Treasury/Administration may begin to bite and gain traction.
Let’s get right to a few simple and self-explanatory views of
life. The following is a four and one half decade view of
median family home prices relative to median family income.
To get back to the average level for this ratio since 1963 (the
red line in the chart), median home prices would need to drop
roughly another 12% from current levels. And of course this
assumes the cyclical correction stops at the historical
average. Let’s face it; we’ve already lived through a
lot of price correction. The problem clearly is that other
factors are weighing on residential real estate prices at the
current time. Weak labor and wage growth, a coordinated
global economic downturn of historical significance, and a credit
market contraction of very meaningful magnitude is colliding with
a housing reconciliation cycle, arguing the relationship above
being arrested at the average of the last four and one half
decades may be wishful thinking. Is the Fed essentially
trying to speed up the reconciliatory process implied by the above
relationship in manipulating the important plug factor in the real
estate equation that is financing costs? Of course this is
exactly what they are doing. Whether they will be successful
is the unanswered question. And in good part that depends on
the ability of inventory to clear as a result of the character of
both price and financing costs.
Let’s move right on to the also important issue of
inventories. In the past we’ve shown you a lot of raw
numbers when looking at this data. Time to stop that.
Below is a look at the number of homes listed strictly as “for
sale” properties (in other words this does not include second
homes, rentals homes, etc.) at the current time. This go
around we compare these per unit of inventory for sale numbers to
the total US population to get a sense of historical
perspective. We’ve heard “everybody’s gotta live
somewhere” a million times by those trying to bull up the
residential real estate markets over prior years. And since
the population is ever growing, comparing current nominal
inventories to past cycles is misleading because of the dynamic of
population growth. Oh yeah? Well now we’re looking
at the number of homes for sale relative to “everybody”. Any questions?
As the chart tells us, when looking at per unit for sale
residential homes on what is essentially a per capita basis, we’re
looking at a current level that is just shy of twice the
historical average of the last four-plus decades. Yes
indeed, everybody needs a place to live. It’s just a good
thing there are so many places to choose from at the moment
relative to historical precedent, no?
The last chart characterizing current residential real estate
inventories very much mirrors the directional pattern of what you
see above. It’s very simply the number of vacant
single-family homes relative to all single-family homes.
Bottom line? We’ve never seen anything like current
levels. Residential real estate as an asset class cannot
begin to fundamentally recover until inventory clears, and this is
far from an “all clear” view of life. Seems a matter of
relatively basic common sense, no?
House That Again?…Before concluding, a few last housing
related anecdotes we hope are of interest. As per the
comments above, we know that fundamentally housing prices and
current residential real estate inventories remain open question
mark issues. And the home building industry is more than
aware. This is a very good thing in terms of cycle
reconciliation. As of the latest data, housing starts rest
near half century lows in nominal terms. Residential real
estate construction has essentially collapsed. Existing
inventories and price have been very strong drivers of this
collapse in new activity. Years of demand were more than
satiated in the prior mortgage credit cycle. The view of per
unit starts is seen in the top clip of the following chart.
In the bottom half we look at starts again as a percentage of the
total US population. A new record historical low at recent
levels. Clearly existing inventory remains the issue for
real estate, not new inventory. As existing inventory
clears, the asset class will heal. That process is well
underway. The Fed just wants to speed things up a little
with a big bit of financial engineering. Of course financial
engineering has worked so well for them in the past, right?
Finally a very simple update of macro US homeowner equity as a
percentage of the market value of real estate. You already
know this ratio has been plunging for multiple decades now,
plumbing new lows at an accelerating rate with each passing
quarter over the last two to three years. The Fed has been
quite kind to recently manipulate credit market mortgage costs
downward, but only the real economy and real world residential
real estate cycle can change the trajectory of what you see
below. And this is the key to credit market collateral
values, a sense of household financial well being, access to real
estate based consumer credit, etc. Important? Yeah,
we'd say so.
As we look at the chart above and contemplate what may be to
come ahead, we again come back to the macro issue of deleveraging,
running through the domestic and global economy. How do
homeowners act to turn the trajectory of the relationship you see
above upward in an otherwise very tough pricing environment?
Deleveraging. Paying down mortgage debt. We're pretty
convinced US financial sector deleveraging is well underway and
more than discounted by the markets. Alternatively, we'd
suggest household deleveraging is more just getting started in
comparison and we believe has a long way to run. We expect
this will be a major macro theme for 2009. Have the markets
completely discounted this thought? We're simply not sure at
this point. Residential real estate was incredibly important
to economic and financial market outcomes in 2008. We expect
exactly the same in 2009.
The message of the data above is clear, price and inventory
cycle reconciliation is not yet finished. What is also clear
is that the Fed/Treasury/Administration are stepping up their
efforts as we walk into 2009 to truncate unfinished cycle
reconciliation at almost all costs. Although we'll save this
for a future discussion, we're not only focused on the importance
of residential real estate in our current economic and financial
market circumstances and how it will influence the financial
sector, credit cycle dynamics and the real economy, but place
incredible weight on the assured unintended consequences of
Fed/Treasury/Administration efforts to truncate the natural
cycle. The markets know what the Fed/Treasury/Administration
are doing and are discounting these actions known actions in
financial market prices. But it's the "at almost all
costs" unintended consequences of this truncation attempt
that may indeed be most important to 2009 investment decision
making.
Contrary Investor
www.contraryinvestor.com
January 1, 2008
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