Wednesday, March 14, 2007

The Plankton Theory in Housing?

I'm quoting something Bill Gross originally wrote in 1980:  "...Without plankton almost every fish and mammal in the sea could not survive, since most species depend upon other fish for their existence and plankton are the initial building blocks of the entire process.  Logic would suggest, therefore, that in attempting to forecast the well being of the Great White Whale, Jaws, or even Jaws II, that one of the factors to consider would be the status and future outlook of the plankton..."

I've written several times before about how much I enjoy reading John Mauldin's weekly emails.  For those of you who aren't familiar with him, John Mauldin is an economist, money manager / hedge fund manager, and a terrific writer (he discusses extremely complex topics in relatively simple English that even I can understand!) - you can sign up for his free weekly email by visiting www.frontlinethoughts.com, or by emailing him at JohnMauldin@InvestorsInsight.com.

This week's email discussed the Plankton Theory as it relates to the demand side of our housing supply & demand equation.  "...In the case of real estate, the plankton would be the first-time buyer (perhaps a young married couple) with a desire to own their own home but with very little capital to carry it off.  When the time comes that they can't pull it off - either through an inability to come up with a down payment, or to service the monthly mortgage - then the 'plankton' would disappear and the rapid escalation in housing prices would ease as well.  For, unless the current homeowner has someone to sell his house to, he'll be unable to afford the house with ... the extra bedroom."

I wrote last week about how the homebuilders' inventory of spec homes is effecting our market (supply side), but this Plankton Theory brings up a very simple, yet excellent, point regarding the demand side.  Right now the average first-time homebuyer has been priced out of a lot of neighborhoods in the Greater Phoenix area, and this is with interest rates hovering near historic lows.  This helps to explain why some very nice neighborhoods are moving slower than their less-desireable counterparts - the majority of first-time homebuyers cannot afford to buy in the more expensive neighborhoods.  And the people who are moving up to their 2nd or 3rd home don't want the entry-level home in the upscale neighborhoods.

On a positive note, Phoenix is a little bit outside the norm compared with national averages.  We're a destination city, with many people moving here from other parts of the country every month.  So we won't have to wait for today's 17 year olds to grow up, get married, and start looking for a home to buy - we have lots of first-time buyers moving here.  I still think this year is going to be a bit rough on home sellers, but:  A) Home builders will get rid of their excess inventory at some point, which means more buyers will buy existing homes and cause a chain reaction of sales.  B) More new people moving to the Valley will help us move through the cycle faster, just due to having an inherant demand.  And C) Some of the new buyers (pankton) who bought in "lesser" neighborhoods last year & this year will want to upgrade their neighborhood next year, even if they can't afford extra square footage just yet.  All of this should help us to weather the storm and head into 2008 with a much more balanced residential real estate market.

-Chris