Could house prices drop 20% from here?

I liked being a housing bear. If you don’t participate in a financial mania, you see the insanity for what it is, and although nobody likes a Cassandra, as the financial mania loses its grip on the masses, those lone voices of reason shine through.

Some of the most rewarding moments from the housing bust came when people thanked me for saving them hundreds of thousands of dollars and many sleepless nights. The memory of those thank yous keeps me going, and it reminds me that I have a unique way I can contribute and better people’s lives.

I am cautious by nature. I have a good bullshit detector, and I’m and not blinded by foolish optimism and wishful thinking. I am always willing to look at the bearish scenario and ask realistic questions about whether doomsday could come to pass. These days I really don’t qualify as a housing bear because try as I might, I don’t see a bearish scenario playing out in a compelling fashion. That being said, one of the few remaining housing bears left, Mark Hanson, does make a strong bearish case for a 20% decline from today’s levels.

A Lonely Housing Bear Predicts a Big Tumble

By Lewis Braham – Oct 7, 2013 8:18 AM PT

Talk to Mark Hanson about the housing market for five minutes and you may find yourself wanting to sell your home and park the cash in a suitcase.

The Menlo Park, California, real estate analyst, blogger and founder of consultancy Hanson Advisers predicts a decline of 20 percent in housing prices in the next 12 months. Half the gains since the latest housing bottom in 2011 could be erased in the hot areas — Florida, California, Nevada, Arizona and Georgia — by rising interest rates and a thinner herd of speculative private-equity buyers, he says.

Less bearish real estate experts such as Stan Humphries, chief economist at Zillow and a Hanson fan, also see signs of froth. Existing home sales jumped 6.5 percent to 5.39 million this July, their highest level in three years. In August those sales fell 1.6 percent despite a surge in 30-year mortgage rates — a move Humphries says was healthy because the market needed to cool off, and that relatively mild reaction showed there was still buying in the face of rising rates.

There’s a strong distinction between a normal slowdown and the wheels coming off the housing recovery,” says Humphries. “That’s where I depart from Mark’s take.”

I have to agree with Stan Humphries on this one. No matter how bad market conditions get, the only way I see prices going down is if must-sell inventory comes to market. We could see a dramatic drop in sales volumes as buyers and seller reach an impasse, but for prices to go down 20% in such a short time, it would require massive sales of distressed inventory. Further, it would require the private equity funds to remain on the sideline while this happened. I don’t believe either will occur. There is no source of must-sell inventory, and the hedge funds would likely pick up their buying if prices came down again.

Deeply Misleading

Hanson’s critical view of the housing market, which he shares with mutual fund and hedge fund clients, extends down to how those very statistics are generated. A reporting lag makes existing-home sales stats deeply misleading, he says. The statistics are calculated 30 to 60 days after sales contracts are signed. July’s positive data, for example, were mainly for homes sold before most of the rate increase.

Mark is right. The happy talk about Case-Shiller being up strongly doesn’t take into consideration the dramatic shift in the market when interest rates spiked.

Digging into the data does, however, reveal one reason why Hanson is so leery of housing now. Some 58 percent of existing-home sales in 2013 have been made by all-cash investors purchasing large swaths of distressed properties to lease to renters. Hanson says private-equity firms caused about 50 percent of the price appreciation in cities like Phoenix and Las Vegas, and generally overpaid by 10 percent to 20 percent, according to his calculations.

I’m not sure how Mark calculates that these markets are overvalued. My my calculations, Inland Empire housing markets are still extremely undervalued, but I could be wrong.


With gains of more than 35 percent since the crash for properties in Las Vegas, Phoenix and other of the hardest-hit regions, these vultures will begin to lose interest, he figures. With property prices and interest rates both higher, they may find better opportunities in Treasury and high-yield bonds than in houses. That’s because as house prices rise the yield you can get from renting the house declines. The loss of some of these buyers will remove what Hanson sees as an artificial support for prices.

This is one area where my assumptions might be wrong. I have rather glibly assumed that if prices fell that private equity investors would return to the market because rental returns would be attractive again. However, if those investors are finding better opportunities elsewhere, they may not return. And if Mark is right, and if those investors do not come back to the market, a significant portion of the buyer demand will disappear along with them.

Again, in my opinion, this does not mean prices will fall suddenly and dramatically. Without must-sell inventory, the reduction in buyer demand will cause sales volumes to plummet, but prices would only pull back modestly and slowly.

A lack of buyers for new homes is also part of Hanson’s downbeat outlook. He points to new-home sales as a better indicator of the health of the housing market than existing-home sales. They’re more current, reported as soon as sales contracts are signed, and 85 percent of sales are to traditional buyers with mortgages.

Such buyers have already begun to feel the sting of higher rates. “New-home sales fell 27.4 percent in July,” says Hanson. “The only other time they’ve ever fallen that much was when the home-buyer tax credit expired in May of 2010.” The adjusted Census Bureau numbers he tracks show new-home sales flat from July to August, but the number of new homes being sold is so low to begin with, he says, at 35,000, that they are “recession-level” sales numbers.

The sudden decline in builder sales is a canary in the coal mine. In fact, I knew exactly when the housing bubble burst in June of 2006 because I was working with KB Home at the time, and sales volumes declined nearly 65% in one month during the prime selling season. This was a clear sign of a parabolic blowoff at the top of a bubble.

This time around, it didn’t signal the top of a bubble, but it certainly sent a strong message to the federal reserve. I believe this was one of the big indicators that prompted Bernanke not to taper at the last FOMC meeting.

Rate Impact

Whether homes become unaffordable as a result of rising rates is a key question for the housing market. Zillow’s Humphries points out that in markets such as Phoenix it costs only 13 percent of the average family’s household income to cover its 30-year monthly mortgage payments despite the rate increase. That compares with the 20 percent of income it used to cost in the years leading up to the housing bubble. So, in his view, houses in Phoenix are still very affordable.

That method of measuring affordability is similar to mine, and it leads to the same conclusions. Based on historic levels of payment affordability, many markets are still undervalued.

Hanson says apples-to-apples comparisons of affordability for pre- and post-crisis periods are problematic. While home prices were higher and 30-year mortgage rates were typically above 6 percent prior to the 2008 crash, houses were actually more affordable back then because of the types of loans people had, he says — such as loans with zero-interest teaser rates and adjustable-rate mortgages with lower rates than today’s fixed ones.

While that is true for the 2004-2007 peak of the mania, if you go back to the 1990s like I do, those products did not dominate the financial landscape. Comparing those conditions to today’s is comparing apples to apples.

Hanson’s track record as a forecaster is mixed. He’s made numerous good calls, including predicting the 2007 housing crash. Where he says he went wrong in recent years was in 2012, when he turned from bull to bear, not realizing the extent of the private-equity and all-cash buying that he says is propping up the market.

I don’t think that was the reason he was wrong. I was also wrong about the sudden market bottom and rally in 2012, but not because of investor demand. I knew that would be there as I was talking with large private equity funds myself. What I didn’t see coming was the dramatic reduction of supply brought about by changes in lender policies. If I had known lenders were going to completely stop foreclosures and opt for loan modifications instead — and be successful at implementing those policies throughout the lending cartel — I would have become bullish much earlier. Calculated Risk got it right because he focused totally on inventory levels, and when he saw them drop dramatically, he made the correct call.

Bears often aren’t popular with their peers, and Hanson is no exception. “I give him zero credibility,” says John Burns of John Burns Real Estate Consulting. “For there to be a 20 percent decline we’d have to have a massive U.S. recession.

Those are pretty harsh words from John Burns, particularly since he completely missed the housing bubble.

Absolutely not, says Hanson: “You’re going to have a cooling on the investor side and the buy-to-rent crowd, and that will be the catalyst for the downturn.”

In one of Hanson’s latest blog posts he remarks that perhaps he is the only housing bear left. But as anyone familiar with financial history knows, it’s when there are no more bears left that the bear market begins.

Is the fact that Mark Hanson and Keith Jurow are among the few bears left a contrarian indicator? Perhaps, but I’m going with the herd on this one. Without must-sell inventory, house prices will not decline significantly, and I see no indications that this inventory is coming to market any time soon.

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14521 ALDER Ln Tustin, CA 92780

$570,000 …….. Asking Price
$412,000 ………. Purchase Price
3/28/2002 ………. Purchase Date

$158,000 ………. Gross Gain (Loss)
($45,600) ………… Commissions and Costs at 8%
$112,400 ………. Net Gain (Loss)
38.3% ………. Gross Percent Change
27.3% ………. Net Percent Change
2.8% ………… Annual Appreciation

Cost of Home Ownership
$570,000 …….. Asking Price
$114,000 ………… 20% Down Conventional
4.25% …………. Mortgage Interest Rate
30 ……………… Number of Years
$456,000 …….. Mortgage
$110,555 ………. Income Requirement

$2,243 ………… Monthly Mortgage Payment
$494 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$119 ………… Homeowners Insurance at 0.25%
$0 ………… Private Mortgage Insurance
$0 ………… Homeowners Association Fees
$2,856 ………. Monthly Cash Outlays

($410) ………. Tax Savings
($628) ………. Principal Amortization
$174 ………….. Opportunity Cost of Down Payment
$163 ………….. Maintenance and Replacement Reserves
$2,155 ………. Monthly Cost of Ownership

Cash Acquisition Demands
$7,200 ………… Furnishing and Move-In Costs at 1% + $1,500
$7,200 ………… Closing Costs at 1% + $1,500
$4,560 ………… Interest Points at 1%
$114,000 ………… Down Payment
$132,960 ………. Total Cash Costs
$33,000 ………. Emergency Cash Reserves
$165,960 ………. Total Savings Needed
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