There is an old expression that comes to mind: "You can fool some of the people some of the time, but you can't fool ALL of the people ALL of the time!"
Regardless of what the National Association of Realtors (NAR), the government, the lending industry (or even economists who should know better) are saying, the current housing market is still artificially high.
If people could truly afford current home prices--on the basis of their actual incomes--the word "crisis" wouldn't appear in conjunction with the present housing market.
The reality is that in most parts of the country, households earning the median household income for their area cannotlegitimately afford to buy a median priced home where they live and work.
And there is no chance of rents or incomes increasing at a rapid pace in the near future--which means home pricesmust fall before the nation's affordability crisis can be solved. Home prices are way too high--and NEED to come down drastically!
If you believe the Wall Street Robber Barons, politicians, and others who argue otherwise, the time has come to step away from the Kool-Aid. As creative real estate investors, we need to come up with a healthier concoction, and it ain't Red Bull--nor any other "bull," for that matter!
Regardless of what the National Association of Realtors (NAR), the government, the lending industry (or even economists who should know better) are saying, the current housing market is still artificially high.
If people could truly afford current home prices--on the basis of their actual incomes--the word "crisis" wouldn't appear in conjunction with the present housing market.
The reality is that in most parts of the country, households earning the median household income for their area cannotlegitimately afford to buy a median priced home where they live and work.
And there is no chance of rents or incomes increasing at a rapid pace in the near future--which means home pricesmust fall before the nation's affordability crisis can be solved. Home prices are way too high--and NEED to come down drastically!
If you believe the Wall Street Robber Barons, politicians, and others who argue otherwise, the time has come to step away from the Kool-Aid. As creative real estate investors, we need to come up with a healthier concoction, and it ain't Red Bull--nor any other "bull," for that matter!
How far down?
Why must housing prices plunge deeply from here? House prices have been propped up for at least the past seven years, through a combination of low interest rates, unsound loan programs, and now, by nonsensical government bail out programs--which has led to a serious disconnect from the basic fundamentals of affordability.
Because the cost of buying has more than doubled in the last ten years, there is now a huge gap between rents and residential real estate prices. The Center for Responsible Lending projects that 2.2 million MORE homes are facing foreclosure by mid-2009--which works out to be about one in every 45 homes), further adding to supply.
And many people have lost the desire to buy until prices are lower. "A down market is getting baked into expectations," says Chris Flanagan, head of research in JP Morgan Chase's (JPM) asset-backed securities group. Flanagan predicts prices will fall about 25%, bottoming in 2010. Merrill Lynch forecasts U.S. home prices could decline 25% to 30% nationwide over the next three years.
Shocking though it might seem, a decline of 25% would merely reverse only partof the market's spectacular 130% appreciation during the boom. Interestingly, it would also put the national price level right back on its historical long-term growth trend line, a surprisingly modest 0.4% a year after inflation.
Because the cost of buying has more than doubled in the last ten years, there is now a huge gap between rents and residential real estate prices. The Center for Responsible Lending projects that 2.2 million MORE homes are facing foreclosure by mid-2009--which works out to be about one in every 45 homes), further adding to supply.
And many people have lost the desire to buy until prices are lower. "A down market is getting baked into expectations," says Chris Flanagan, head of research in JP Morgan Chase's (JPM) asset-backed securities group. Flanagan predicts prices will fall about 25%, bottoming in 2010. Merrill Lynch forecasts U.S. home prices could decline 25% to 30% nationwide over the next three years.
Shocking though it might seem, a decline of 25% would merely reverse only partof the market's spectacular 130% appreciation during the boom. Interestingly, it would also put the national price level right back on its historical long-term growth trend line, a surprisingly modest 0.4% a year after inflation.
Show me the money?
The historical ratio of median house pricing vs. median household income was consistently between 2.6 and 3.0 over the past 40 years. But, as homebuyers scrambled to avoid being left out of the "housing-mania," national median home prices jumped 130% (45% when adjusted for inflation) from 2000 to 2006.
By contrast, according to reports out of the World Economic Forum on Jan 23-25, 2008, weekly earnings for full-time American workers last year were unchanged from their 2000 levels, even though productivity grew by 18% in the same period!
According to the Economic Policy Institute, the news is even bleaker. Their research indicates that the median income for working-age households actually declined 4% since 2000.
The Census Bureau indicates that the median U.S. household income is $48,201. Multiplied by 3.0 = $144,600. This is what the maximum U.S. median home price should be right now, given historically low interest rates. But the actual median home price ($218,900) is about 34% higher than that (or approximately 4.5 times the price-to-income ratio).at
Though prices have always been slightly elevated in the Golden State, California's median home price ($402,000), at 7.10 times California's median household income of $56,645--is 58% higher than it should be ($169,935). In parts of the state, median home prices have inflated to more than 11 times the median household income.
But forget "local bubbles." Median home prices are inflated in every region of the U.S. In the overall West, where the median household income is $52,249, the median home price of $309,800 is nearly double what it should be, using a maximum price-to-income ratio of 3.0 ($156,747).
The situation is similar in the Northeast, where the median home price of $258,600 is approximately 5 times the median household income of $52,057--or 40% higher than what it should be when compared to a 3.0 price-to-income ratio ($156,171).
Median home prices are not quite as high in the South ($173,400 vs. median household income of $43,884) and the Midwest ($159,800 vs. median household income of $47,836), respectively. Even so, prices are still 24% higher than what they should be in the South ($131,652), and least 10% higher than what they should be in the Midwest ($143,508).
Surprisingly, a number of folks question the validity of the price-to-income metric, including several of my successful students. But the 40 years' history behind it holds up well when evaluated in sync with several other important fundamental metrics, including back-end DTI, interest rates, and rent vs. own costs.
By contrast, according to reports out of the World Economic Forum on Jan 23-25, 2008, weekly earnings for full-time American workers last year were unchanged from their 2000 levels, even though productivity grew by 18% in the same period!
According to the Economic Policy Institute, the news is even bleaker. Their research indicates that the median income for working-age households actually declined 4% since 2000.
The Census Bureau indicates that the median U.S. household income is $48,201. Multiplied by 3.0 = $144,600. This is what the maximum U.S. median home price should be right now, given historically low interest rates. But the actual median home price ($218,900) is about 34% higher than that (or approximately 4.5 times the price-to-income ratio).at
Though prices have always been slightly elevated in the Golden State, California's median home price ($402,000), at 7.10 times California's median household income of $56,645--is 58% higher than it should be ($169,935). In parts of the state, median home prices have inflated to more than 11 times the median household income.
But forget "local bubbles." Median home prices are inflated in every region of the U.S. In the overall West, where the median household income is $52,249, the median home price of $309,800 is nearly double what it should be, using a maximum price-to-income ratio of 3.0 ($156,747).
The situation is similar in the Northeast, where the median home price of $258,600 is approximately 5 times the median household income of $52,057--or 40% higher than what it should be when compared to a 3.0 price-to-income ratio ($156,171).
Median home prices are not quite as high in the South ($173,400 vs. median household income of $43,884) and the Midwest ($159,800 vs. median household income of $47,836), respectively. Even so, prices are still 24% higher than what they should be in the South ($131,652), and least 10% higher than what they should be in the Midwest ($143,508).
Surprisingly, a number of folks question the validity of the price-to-income metric, including several of my successful students. But the 40 years' history behind it holds up well when evaluated in sync with several other important fundamental metrics, including back-end DTI, interest rates, and rent vs. own costs.
Other metrics
Back-End DTI (housing cost as percentage of monthly income). Traditionally restricted to 25% of gross monthly income, increased to a "soft" 28% by FNMA/FHLMA over past 15 years; FHA allows 31%; and as high as 41% allowed by subprime lenders.
Interest Rates Though presently at 5.47% (2/8/08) the FHLMA average for 30-year fixed mortgages over the past 440 months (4/01/71--12/31/07) was 9.18%. Eliminating the 72 months (11/01/79-10/31/85) of rates 12% and higher, drops the historical average to 8.17%.
If you also eliminate the 65 months (06/01/02-12/31/07) of rates 6.65% and lower, the overall average increases to 8.57%. I'll leave discussion as to why interest rates are sure to rise in the near future (2 to 5 years) for another time. But consider how it plays into the DTI scenario below.
Using the "soft" 28% FNMA/FHLMA DTI metric and applying that to median income (28% housing expense x $48,200 U.S. median income / 12) leaves $1,124.66; less Taxes/Insurance $167 leaves $957.66 available for monthly Principal & Interest payments. How much 30-year fixed rate loan will $957.66 per month pay for?
$957.66 @ 5.50% = $168,665
$957.66 @ 6.00% = $159,730
$957.66 @ 6.50% = $151,512
$957.66 @ 7.00% = $143,944
$957.66 @ 7.50% = $136,962
$957.66 @ 7.50% = $130,513
Many families will have to drastically change their spending habits to reach this 28% ratio in their budgets.
Numerous studies indicate the average American familyACTUALLY only has 23% to 25% of gross monthly income available for housing expense--and generally tend to run at negative cash flow in their household budget as a result of overborrowing!
What about interest rates? As creative real estate investors, we have to account for reasonable probabilities.
At today's low rates, a median buyer would need to have $50,235 down (23%), plus approx. $4,400 for closing costs, to purchase the $218,900 median priced home. If rates rise to 7%, they'll need to have $75,300 (34%) down.
Americans have averaged between 5%-12% down payments for the past 25 years. Now, in the face of declining incomes, their down payments will have to somehow increase drastically, unless home prices drop significantly. Forget lending requirements. Forget tax rebates too! These are the numbers.
Rental Rates Historically, monthly rental costs over the past 10 years have run approximately 92% of monthly costs to own, or about 5.5% of the house value, annually. Now, in many communities, rental costs are as low as 40% of ownership costs--and below 3% of house "value."
Here's an example of how disconnected the housing market is in relation to local affordability factors, that brings to life the data I shared in my December 2007 article: Beware The Blue Sky
As in many housing markets, a number of homes listed for sale in Bend, OR are also available for rent, as the sellers try to hang on to their property "until the market recovers."
To own this sample home, you would have to pay $544,900, 6.5% for a jumbo mortgage, plus tax and insurance (2.0% annual), plus maintenance (at least another 1%) for a total of at least 9%--more than three times the cost of the $15,000 yearly rent sought (which is only 2.75% of the asking price).
It would be financially insane to buy this house, given that the rent is so cheap by comparison.
The rental rate implies the property is worth about $235,600 (assuming $188,500 30-year fixed mortgage at 5.67% with 20% down). If you apply the current Global Insight valuation "metric" for Bend, the market value is $163,500 in today's current marketplace, based on true affordability for that area.
Admittedly, Bend is currently ranked as the most "overvalued" metro area housing market in the U.S... but many communities are in the same quandary, albeit to a lesser degree. There are millions of renters and potential homebuyers (including CREIs) who would benefit from lower, more reasonable home prices.
Most real estate investors want to turn a monthly profit from real estate ownership. Since we do not want to merely break even, the price must be low enough for the prevailing rental rate to exceed the cost of ownership by enough to provide a return on our invested capital.
Historically, GRMs from 100-120 are required to create the conditions necessary to attract a CREIs capital. Using the national median income housing expense figure from above ($1,124.66 rounded up to $1,200 to include maintenance reserves), we could pay a maximum of $144,000 for the national median property (rather than $218,900).
For those sellers (homeowners, builders, or REO holders) believing they can hang on "until the market recovers," be aware that the recovery is happening already--and its name is "correction." Unfortunately, it is going in the opposite direction, and it still has a very long way to go.
Real estate investors form a durable bottom. If prices drop low enough for this group to get into the market, the influx of investment capital can be extraordinary.
Interest Rates Though presently at 5.47% (2/8/08) the FHLMA average for 30-year fixed mortgages over the past 440 months (4/01/71--12/31/07) was 9.18%. Eliminating the 72 months (11/01/79-10/31/85) of rates 12% and higher, drops the historical average to 8.17%.
If you also eliminate the 65 months (06/01/02-12/31/07) of rates 6.65% and lower, the overall average increases to 8.57%. I'll leave discussion as to why interest rates are sure to rise in the near future (2 to 5 years) for another time. But consider how it plays into the DTI scenario below.
Using the "soft" 28% FNMA/FHLMA DTI metric and applying that to median income (28% housing expense x $48,200 U.S. median income / 12) leaves $1,124.66; less Taxes/Insurance $167 leaves $957.66 available for monthly Principal & Interest payments. How much 30-year fixed rate loan will $957.66 per month pay for?
$957.66 @ 5.50% = $168,665
$957.66 @ 6.00% = $159,730
$957.66 @ 6.50% = $151,512
$957.66 @ 7.00% = $143,944
$957.66 @ 7.50% = $136,962
$957.66 @ 7.50% = $130,513
Many families will have to drastically change their spending habits to reach this 28% ratio in their budgets.
Numerous studies indicate the average American familyACTUALLY only has 23% to 25% of gross monthly income available for housing expense--and generally tend to run at negative cash flow in their household budget as a result of overborrowing!
What about interest rates? As creative real estate investors, we have to account for reasonable probabilities.
At today's low rates, a median buyer would need to have $50,235 down (23%), plus approx. $4,400 for closing costs, to purchase the $218,900 median priced home. If rates rise to 7%, they'll need to have $75,300 (34%) down.
Americans have averaged between 5%-12% down payments for the past 25 years. Now, in the face of declining incomes, their down payments will have to somehow increase drastically, unless home prices drop significantly. Forget lending requirements. Forget tax rebates too! These are the numbers.
Rental Rates Historically, monthly rental costs over the past 10 years have run approximately 92% of monthly costs to own, or about 5.5% of the house value, annually. Now, in many communities, rental costs are as low as 40% of ownership costs--and below 3% of house "value."
Here's an example of how disconnected the housing market is in relation to local affordability factors, that brings to life the data I shared in my December 2007 article: Beware The Blue Sky
As in many housing markets, a number of homes listed for sale in Bend, OR are also available for rent, as the sellers try to hang on to their property "until the market recovers."
To own this sample home, you would have to pay $544,900, 6.5% for a jumbo mortgage, plus tax and insurance (2.0% annual), plus maintenance (at least another 1%) for a total of at least 9%--more than three times the cost of the $15,000 yearly rent sought (which is only 2.75% of the asking price).
It would be financially insane to buy this house, given that the rent is so cheap by comparison.
The rental rate implies the property is worth about $235,600 (assuming $188,500 30-year fixed mortgage at 5.67% with 20% down). If you apply the current Global Insight valuation "metric" for Bend, the market value is $163,500 in today's current marketplace, based on true affordability for that area.
Admittedly, Bend is currently ranked as the most "overvalued" metro area housing market in the U.S... but many communities are in the same quandary, albeit to a lesser degree. There are millions of renters and potential homebuyers (including CREIs) who would benefit from lower, more reasonable home prices.
Most real estate investors want to turn a monthly profit from real estate ownership. Since we do not want to merely break even, the price must be low enough for the prevailing rental rate to exceed the cost of ownership by enough to provide a return on our invested capital.
Historically, GRMs from 100-120 are required to create the conditions necessary to attract a CREIs capital. Using the national median income housing expense figure from above ($1,124.66 rounded up to $1,200 to include maintenance reserves), we could pay a maximum of $144,000 for the national median property (rather than $218,900).
For those sellers (homeowners, builders, or REO holders) believing they can hang on "until the market recovers," be aware that the recovery is happening already--and its name is "correction." Unfortunately, it is going in the opposite direction, and it still has a very long way to go.
Real estate investors form a durable bottom. If prices drop low enough for this group to get into the market, the influx of investment capital can be extraordinary.
