Should you buy a home, or should you wait?

People read this blog for a variety of reasons. Some like the in-depth coverage of housing issues unfettered by bias and bullshit. Some like the entertaining cartoons and HELOC abuse stories of woe. Some like the market information and cogent analysis of current trends in the OC market. This last group usually has one question in mind: is it a good time to buy a house?

The answer to that question is an unequivocal maybe.

There is no perfect time to buy a house. For those who want to buy at the absolute bottom of the market, unfortunately, there is no definitive sign as to when that will be. Further, to actually time the bottom of the market, one must enter escrow while prices are still falling. Most people overlook that fact. By the time the bottom is obvious in retrospect, it is also obvious to everyone else, and many sidelined buyers come to the market to compete for available inventory. In short, timing the bottom is very difficult. It takes much courage and even more luck.

Buying too early means suffering through a period of declining values. This can be quite stressful, particularly if the decline is deeper than anticipated. Because of this likelihood of declines and the potential loss of equity if a sale is necessary, Shevy and I have consistently advised people not to buy unless they plan to hold the property for quite a while to give sufficient time for prices to recover. Further, we recommend people obtain properties where the cost of ownership is at or below rental parity. That way, if they had to move to take a job or for whatever reason, they could rent the house and not be drained by persistent monthly losses. This is the advice we still give today and likely will continue to give for the next several years.

Is Now the Time to Buy Your First House?

May 14, 2012 — Wall Street Journal

It’s been a scary few years for the housing market. But at some point, the nightmare has to end (please?). Is now the time? Should first-time home buyers consider jumping into the market?

After all, home prices have fallen 34% from their 2006 peak and mortgage rates are hovering at or near record lows.

On one side are those who argue that homes are more affordable than they have been in decades, based on how much monthly income a mortgage consumes and whether owning is less costly than renting.

This is true. Houses are trading below rental parity in many markets. This is a precursor to housing finding a bottom. Prices below rental parity are required to motivate new buyers, both owner occupants and investors, to come to the market and absorb the overhanging inventory. The remaining question is how long it will take to absorb this overhead supply?

An uptick in home buying by investors already is under way, they say—an indication that those who wait may miss out on a good buying opportunity.

It infuriates me whenever I read the “buy now or be priced out forever” bullshit. This buying opportunity will be with us for quite some time because liquidating the overhead supply will not happen quickly.

On the other side, pessimists insist that the housing slump is far from over, and that prices will continue falling—perhaps as much as 20% or more.

Excess inventories, they say, are the problem, and some estimate it could be four years before the market absorbs all of that extra supply.

This is also true. Liquidation of excess inventory is the determining factor on when the housing market will bottom.

Eric Lascelles, the chief economist at money-management firm RBC Global Asset Management Inc., says this is a remarkable time to be a first-time home buyer. A. Gary Shilling, president of A. Gary Shilling & Co., an economic consulting firm in Springfield, N.J., says buying now is a terrible idea.

Yes: It’s a Rare Opportunity

By Eric Lascelles

This could be the best time in a generation to be a first-time home buyer.

It is certainly the best time in the last decade or more on a payment affordability basis: O.C. house payments at 10-year low.

Cheery views such as this are out of vogue and easy enough to dismiss as the ravings of a serial optimist. And yet this opinion isn’t based on any heroic economic assumptions. To the contrary, it is constructed upon a more curmudgeonly foundation: In my estimation, the stock market probably underestimates Europe’s woes, U.S. economic growth may fall short of expectations, and—of greatest relevance—the overall housing market is likely still several years from normality.

All of this means even if today is the bottom, significant appreciation is years away. Even the Pollyanna’s aren’t touting rapid appreciation… although I expect realtors will start spouting that nonsense soon enough.

Nevertheless, this is still a remarkable time to be a first-time home buyer. Affordability is the best it has been in 30 years, thanks to the combination of a 34% decline in prices since the 2006 peak and a historically low 4% average rate for a 30-year, fixed-rate mortgage.

The two affordability metrics that truly matter are how much monthly income a mortgage consumes, and whether this is less costly than renting. …

Rock-Bottom Rates

Investors get this. While households dither, investors ramped up their home buying by 64% across 2011. They understand that this is the mother of all buyer’s markets, and won’t last forever. The prospect of making a profit by flipping these properties is still rather distant, so they lay in wait for an eventual rebound and in the meantime make money by renting out their properties for more than the monthly mortgage payment.

I can personally attest to the fact that investors both large and small are buying properties right now for their rental cashflow. It is the activity of these investors which will finally turn the tide of falling prices. It’s only a matter of when and at what price point.

… the situation for first-time home buyers is different. They largely skated through the past few years. They weren’t yet in the housing market, and so escaped that devastating hit. And with an average age of 30, they hadn’t yet accumulated sufficient assets to truly suffer when markets fell.

Unfortunately, this group is overloaded with student loan and credit card debt as a vestige of our loan ownership society of the 00s.

A significant part of this cohort’s savings has been generated in just the past five years, and while markets have been enormously volatile over that period, a monthly savings plan would have generated a 26% return in equities and 22% in bonds. First-time home buyers may not be so hard up for their down payment after all.

That’s just crazy bullshit. The 3.5% down payment requirement on an FHA loan is the biggest impediment to buying today. And with the default rates of low and no down payment loans, the down payment requirement is far more likely to go up than go down.

Heck of a Deal

But is it wise to take the plunge in this era of economic uncertainty? While the economy remains very fragile, it has become less so since the fall. Still, say the worst happens—you buy a home and then immediately lose your job: The foreclosure backlog provides breathing room ….

I am not proud to admit it, but when I bought my first property in Las Vegas, i felt a sense of relief knowing I had a place to crash.

Could home prices fall further? Yes they could. The home-inventory overhang is still quite large and credit availability remains poor. Home prices are unlikely to bloom in earnest for quite some time. …

Arguably, the bigger risk is rising interest rates, which could erode affordability and snuff out this buying opportunity.

Will rising interest rates cause house prices to crash? If interest rates go on a sustained rise, financing home purchases will become more expensive. That is the math. The real question then is whether or not these rising interest rates are compensated for by rising wages. If wages rise as fast as interest rates do, then borrowers will still be able to finance large sums, and house prices can remain stable or even rise. However, if wages do not rise as interest rates go up, then loan balances will decline, and house prices will fall again. Given the choice between inflation and falling house prices, which do you think Bernanke or a future central banker will chose? After the all-out effort they have made to prop up house prices over the last several years, I suspect they will chose inflation, a devalued currency, and steady house prices over a strong currency and falling house prices.

… Mr. Lascelles is the chief economist at money-management firm RBC Global Asset Management Inc. He can be reached at [email protected]

No: The Fall Isn’t Over

By A. Gary Shilling

Don’t buy your first house now unless you’re willing to lose 20% of its market value in the next several years. Maybe more.

It will take a 22% drop to return median single-family house prices to the trend identified by Robert Shiller of Yale University that stretches back to the 1890s and prevailed until the housing bubble began. (It adjusts for inflation and the tendency of houses to get bigger over time.) And corrections usually overshoot on the downside just as bubbles do on the upside.

This is a compelling argument. No trendline can be drawn which supports such high inflation-adjusted house prices. I explored this issue in depth in the post Real house prices will take 90 years to reach the peak absent another housing bubble.

There is only one reason house prices may bottom at such a high nominal price level. Interest rates declined from 6.5% in 2006 to 3.8% today. That’s an over 40% decline in borrowing costs. This may cause house prices to stabilize at current price points, but over the long term, such low interest rates will create inflation, and in inflation-adjusted terms, prices will revert to the long-term trend, but at today’s higher nominal price.

In short, low interest rates will prevent the 20% decline in aggregate pricing Mr. Shilling believes is coming.

The problem is excess inventories. They are the mortal enemy of prices, and we’ve calculated an excess of two million housing units, over and above normal working levels of inventories of new and existing homes. That is huge, considering that before the housing market collapsed, about 1.5 million new homes were being built annually, a figure that shrank to 568,000 in February. At current rates of housing starts and household formation, it will take four years to work off the excess inventory, plenty of time for those surplus houses to drag down prices.

Excess inventories, of course, were spawned by the earlier housing boom, which was driven by a host of factors—including low interest rates, almost nonexistent lending standards and government attempts to put even those who couldn’t afford chicken coops into four-bedroom houses. But most of all, the housing bubble was driven by the conviction that home prices never fall—they hadn’t on a nationwide basis since the 1930s—so any bad purchase would eventually be reversed.

As such, the homeownership rate expanded to 69.3% by late 2004, from the earlier norm of 64%. But now, homeownership has retreated to 66% as foreclosures mount, lending standards stay tight and many worry about their jobs and/or the responsibilities of homeownership. Everyone knows that house prices can and do fall.

Every point he makes above is accurate, and those will make for substantial market headwinds.

Pushing Up Inventories

The optimists will tell you that home inventories have stabilized, but their thinking is flawed.

The recent decline in MLS inventories of REO are completely artificial manipulations caused by lenders witholding inventory.

Our estimate of two million excess homes takes into account those on the market as well as hidden inventories, such as foreclosed homes not yet listed for sale and those withdrawn from the market because owners couldn’t stomach the bids they received. A U.S. Census Bureau category that measures such hidden inventories has leapt by one million units since 2006.

Additionally, our inventory estimate doesn’t even include future foreclosures, some five million of which are waiting in the wings. …

8.7 years to clear Orange County distressed inventory at stable liquidation rate. Housing bulls largely dismiss the realistically dire estimates of people like me or organizations like S&P who say it will take nearly four years to clear the backlog.

A Disastrous Investment?

Sure, the always optimistic National Association of Realtors tells you that based on mortgage rates, incomes and house prices, single-family houses have never been more affordable. But according to their index, that was also true in December 2008, and prices have fallen 9.2% since then. Ugh! Home prices may have dropped 34% since the peak in early 2006, but that doesn’t make them cheap if prices continue to decline. …

The NAr affordability index is a joke. It is bullshit and propaganda put out to convince people houses are affordable even when they are not. Unfortunately, like the boy who cried wolf, nobody believes them now when prices really are affordable on a monthly payment basis. The virtue of telling the truth escapes them because they are so caught up in spinning their own bullshit.

The homeownership dream of an appreciating asset and huge ATM has been replaced by the nightmare of a liability that is expensive to own and falling in value. Act accordingly.

Mr. Shilling is president of A. Gary Shilling & Co., an economic consulting firm in Springfield, N.J. He can be reached at [email protected]

That last sentence is the same sound advice Shevy and I have been giving for the last few years. The housing ATM is shut off for a generation. I wish we had smart politicians who would turn it off permanently, but now that our entire economy is dependant upon HELOC spending, the pressures to reflate the Ponzi scheme are too strong for policymakers to resist.

A tale of two bottoms

When thinking about the bottom of the housing market, it is important to keep in mind that there will be two distinct bottoms: a nominal price bottom, and a payment affordability bottom. These may not, probably will not, be at the same time. In all likelihood, the bottom of payment affordability will come first, and the bottom of nominal prices will come later once interest rates begin to rise.

For example, today’s featured property costs $425,000 in nominal dollars, but with 3.78% interest rates, it only costs $2,048 per month to own. We may be looking at the bottom in payment affordability for this property. What happens when interest rates rise?

Imagine two or three years from now, this same property is selling for $375,000, but interest rates are back up to 5%. In such a scenario, the nominal price is $50,000 less, but the monthly cost of ownership is $2,122, nearly 4% higher. As you can see, rising interest rates can make lower house prices have a higher cost of ownership. And since rising interest rates is eventually going to happen, it is also likely that payment affordability may bottom before nominal house prices do. (This is a topic I may revisit in depth in another post.)

So what is better? A lower monthly cost of ownership, or a lower purchase price? There is no clear answer. Personally, I would rather have the lower cost of ownership, particularly if I were looking to own the same property for a decade or more. However, not everyone has the same circumstances. For those who may want to sell and get a different property five years later with move-up equity, they are better off buying at a lower price point even if that means making larger payments to do so. There is no single right answer. It depends on your circumstances.