Tuesday, October 16, 2012

Another 20% Drop in Home Prices?

Another 20% Drop in Home Prices?

I read an article this weekend which I thought was worth sharing.

To set it up properly, I'll introduce some names. John Mauldin is an economist, writer, and founder of Mauldin Economics. He publishes a couple different free economic newsletters which I highly recommend. One of his newsletters, "Outside the Box", features a different guest writer each week. The guest writers are always very successful economists and financiers who may or may not agree with Mauldin's opinions, but who provide a different take on the topic at hand. This weekend's Outside the Box newsletter was titled "A Little Chronic Deflation", and featured guest author Dr. A. Gary Shilling.

In the article, Shilling writes about housing prices (excerpt below - click above link for the full article):

Housing Woes
House prices have been deflating for six years, with more to go (Chart 10). The earlier housing boom was driven by ample loans and low interest rates, loose and almost non-existent lending standards, securitization of mortgages which passed seemingly creditworthy but in reality toxic assets on to often unsuspecting buyers, and most of all, by the conviction that house prices never decline. 

I expect another 20% decline in single-family median house prices and, consequently, big problems in residential mortgages and related construction loans. In making the case for continuing housing weakness, I've persistently hammered home the ongoing negative effect of excess inventories on house sales, prices, new construction and just about every other aspect of residential real estate.
That further drop would have devastating effects. The average homeowner with a mortgage has already seen his equity drop from almost 50% in the early 1980s to 20.5% due to home equity withdrawal and falling prices. Another 20% price decline would push homeowner equity into single digits with few mortgagors having any appreciable equity left. It also would boost the percentage of mortgages that are under water, i.e., with mortgage principals that exceed the house's value, from the current 24% to 40%, according to my calculations. The negative effects on consumer spending would be substantial. So would the negative effects on household net worth, which already, in relation to after-tax income, is lower than in the 1950s.

What I find interesting is whether Phoenix will face the same declines as what he predicts nationally.
  • We're seeing bidding wars at today's already-appreciated prices.
  • Investors have proven they can rent homes out for a profit, even at today's already-appreciated prices. (this is why there are bidding wars.)
  • A downward trend in rental rates will scare investors away from the market, which would cause prices to fall.
  • Downward rental rates would be caused by fewer renters (less demand), which probably means these renters are buying homes.
  • This would simply trade one set of buyers (investors) for another (former renters), which seems like a net-neutral effect on prices.
Mauldin and Shilling are a lot smarter than me, so I tend to listen to their forecasts with great respect. However, I don't see how the Phoenix prices can fall another 20% from where they are today..

-Chris Butterworth