Friday, May 4, 2012

Housing prices: a rebuttal to Barry Ritholtz, part 4

  - by New Deal democrat

As I said in part 1 of this series, Barry Ritholtz' argument that house prices will decline further rests generally on three arguments:
     (2) there is a large overhang of "shadow inventory" most especially including but not limited to foreclosures, which are primed to put renewed downward pressure on prices; and
     (3) potential buyers, especially younger buyers, are fearful of the potential immobility that comes with owning a house vs. renting.

In part 2 I addressed the affordability issue.  In part 3 I looked at the issue of shadow inventory.

Barry Ritholtz's last argument that we are not at or near a bottom in house prices is the fear of young, potential first time buyers. He asserts four points:
   1. Owning an asset class that is still falling in price; the fear of a continuing price slide remains....
   2. Being stuck with a property you cannot sell; if you may need to sell your property ... less than 5 years after purchase – there is a possibility that the home will sell for less than the purchase price. ... Even worse than the dollar hit is the situation of not being able to sell the house at any price.
   3. Losing one’s job; If one were to lose one’s job, a home mortgage and sale becomes a burden. ...
   4. Impact of rising Interest Rates on prices; ...

 Let me take these out of order.

 Number 4 is the weakest point of Barry's whole arugment. If I fear rising mortgage rates in the future, I'm going to do everything I can to buy NOW -- as in now when we've just set yet another all time low in 30 year interest rates. Waiting till my prospective mortgage payment rises is the last thing I want to do.

 Numbers 1 and 2 are circular. If prices are falling, therefore potential buyers won't buy, therefore prices will continue to fall. Of course, that also means that if prices are stable, the two fears disappear, and so prices presumably remain stable -- like they have become in the last year by virtually all measures except repeat sales indexes. Just yesterday the Trulia list price index, which does adjust for type of houses for sale, turned positive YoY. What Barry's argument really means is that price stability won't come because young buyers decide to jump in -- and it hasn't. Stability in most house price indexes has come because of the large number of cash buyers at the low end, as Barry himself conceded in one part of his series, when he said:
  lower prices can bring out buyers. ... we can see signs of bargain hunters in the statistics. All-cash sales rose to 33% of transactions (NAR), with investors purchasing 23% of all homes. 
 With those prices becoming stable, expect more young buyers to take the plunge.

 That leaves us with number 3. It's a valid concern, but it is by no means universal that young buyers are fearful, especially those who are college graduates and are employed, for whom the unemployment rate is considerably less than others. 

To the contrary, I believe Barry has overlooked one crucial fact: demography is destiny.

As I pointed out a couple of years ago, there actually is pent up demographic demand. People usugally buy their first home at approximately age 30. According to records of births available in the Statistical Abstract of the United States, from the mid-1970's through the early 1990s' the wind was at housing's back, as Boomers, with over 3.9 million births a year from 1952 through 1964, entered that age group. From then until the peak of the housing bubble, the reverse was true, as the Baby Bust a/k/a Generation X, with less than 3.6 million births from 1967 through 1979 (including a low of 3.144 million births in 1975) entered the target age. By 1989 and ever since, there have been over 4 million births a year. What this means is that every year since the peak of the housing bubble, a larger and larger cohort has reached prime first time home buying age. 

 Not only are those larger cohorts of young adults going to buy houses, but the group which delayed household formation during the years of the housing bust and great recession will also ultimately heed the call of nature. All of that means a very significant upsurge in demand for housing.

Further, renting may make excellent financial sense -- until you get tired of listening to the marital quarrels on the other side of the wall, or the a**h**e upstains who insists on blasting music at 2 a.m. on a worknight.

As I said above, demography is destiny.  With home prices stabilizing due to cash buyers at the lower end, and a pent-up demographic surge in the age group of first time home buyers, psychology should favor rather than inhibit first time home buying.


 In this series I have shown than none of Barry Ritholtz's arguments against a housing bottom actually require house prices to fall further.

 As to long term ratios of house prices to household income, the broader indexes show that we have already declined to the median. Further declines in the ratio can occur via declines in inflation-adjusted prices even after the nominal bottom occurs. Further, mortgage rates at multi-decade lows, even adjusted for household income, make housing costs more affordable than it has been in at least 30 years.

 Shadow inventory has been predicted for at least two years to be on the verge of creating a redoubled downturn in housing. It hasn't happened yet, and if the increase in foreclosures following the mortgage settlement is sufficiantly drawn out in time, it can be expected to exert only an influence on the rate of any increase in house prices, rather than a change in direction to a renewed downturn.

 Finally, demographics argues strongly in favor of an increase in demand from young first-time home buyers, with stability caused by cash buyers alleviating any fear of a continuing decline in prices.

 As I said at the outset of this series, my general approach, like CR's, is inductive. I look at past business cycles in terms of what change in A led to a change in B. My default position is that this time it's NOT different. In order to overcome that default setting, you'd better have arguments that go way beyond the preponderance of evidence. They had better be extremely convincing and not subject to equal counter-arguments. I've seen way too many deductive rational arguments that read persuasively blow up completely in the light of subseqent data (as, for example, the "foreclosure tsunami" piece I cited from 2010). While Barry Ritholtz's arguments are intelligent, rational, and sensible, they are not so compelling as to cause me to believe that the counter-arguments won't ultimately be proven true.

 So I am sticking with my inductive reasoning. Of course, it could be that CR and Barry and I are all correct, if prices decline in real terms by another 10% after establishing a nominal bottom in the next few months. But this isn't personal. If CR and I are wrong, and Barry Ritholtz is right, than kudos to him!