Housing Market Interpretations: Revisit

Back in June 2008, I wrote about the housing market. The Dow was north of 11,000.

Since then, I’ve updated them to the latest data published by the Federal Reserve of St. Louis along with forecast data from California Association of Realtors.
What the data shows is an extraordinary turns of event that many calls deleveraging.
According to Investopedia, the plain English explanation is as follow:

Companies will often take on excessive amounts of debt to initiate growth. However, using leverage substantially increases the riskiness of the firm. If leverage does not further growth as planned, the risk can become too much for the company to bear. In these situations, all the firm can do is delever by paying off debt.

Although we hear such word often on TV, we don’t quite understand it so I highly recommend reading my previous post on it. For our purpose, we will substitute “companies” instead with “household” so that our definition will be:

Household will often take on excessive amounts of debt to initiate growth. However, using leverage substantially increases the riskiness of the household. If leverage does not further growth as planned, the risk can become too much for the household to bear. In these situations, all the individual can do is delever by paying off debt.

The process of leveraging up have driven property price through the roof. The party is over as we know and the median home price in California is expected to fall to $375,000 in 2008 and $358,000 in 2009, a decline of 32.8% and 4.5% respectively according to the California Association of Realtors. Let me remind you that their forecast hasn’t been the most accurate one.

Examine chart below and you shall see that typically, per capita income as a percentage of home price should remain above the level of the median home price. That trend reversed in 2003. I believe that the normal rate should return but not anytime soon. The two factors we have is income and home price. Either income will rise or home price fall. Last I checked, we are officially in a recession and thus I doubt the income side can rescue us. We are left with home price as a factor of affordability. Price has to fall or simply, the cost of purchasing has to come down via interest rate. We are at a historically low rate so we may see some incentives such as property tax cut, but I am just speculating. (see Figure 1)

Figure 2 shows the median home price compare to saving rate. The trend is clear.
Figure 1

Figure 2

Figure 3

Year	Personal Income ($)	Median Home Price ($)	Saving Rate	Household Debt
1984	15994	$ 114,260	10.8%	204.0
1985	16956	$ 119,860	9.0%	293.0
1986	17668	$ 113,640	8.2%	275.9
1987	18549	$ 142,060	7.0%	246.1
1988	19599	$ 168,200	7.3%	258.7
1989	20585	$ 196,120	7.2%	281.8
1990	21638	$ 193,770	7.0%	298.2
1991	21750	$ 200,660	7.3%	202.6
1992	22492	$ 197,030	7.7%	185.2
1993	22635	$ 188,240	5.8%	218.8
1994	23203	$ 185,010	4.8%	293.4
1995	24161	$ 178,160	4.7%	329.0
1996	25312	$ 177,270	4.0%	337.6
1997	26490	$ 186,490	3.7%	302.1
1998	28374	$ 200,100	4.3%	375.1
1999	29828	$ 217,510	2.4%	479.5
2000	32462	$ 241,350	2.4%	539.4
2001	32883	$ 262,350	1.8%	651.2
2002	32826	$ 316,130	2.4%	755.8
2003	33554	$ 371,520	2.1%	946.2
2004	35440	$ 450,990	2.1%	1017.8
2005	37311	$ 524,000	0.4%	1124.7
2006	39871	$ 556,600	0.7%	1261.1
2007	41580	$ 558,100	0.6%	969.0
2008		$ 375,000	1.4%	527.5
2009		$ 358,000

I can buy the argument that home price is bottoming because our government will do whatever it take to stabilize the price even if Ben Bernanke and Paulson has to attend open houses and purchase these properties!

What I don’t understand is why many are urging people to go out and buy as if home price will sky rocket back to where they were.
One formula that may be useful is from Richard Russell of the Dow Theory Letter which states the following:
“And he had a formula. No matter how you cut it, no matter how you finance it, when you buy a house it’s going to cost you an average of ten percent a year to hold that house. I’ve revealed this ten percent formula to a lot of people… Today you buy a house for say $400,000. How you finance it is your business. Can you rent that house for $40,000 a year? Are you kidding”

Side notes, given the type of liquidity the Federal Reserve is injecting, we are poised to see a major inflation sometime in the future. The hardest part is knowing when. Real estate along with commodities are one of the best place to be during an inflationary period.

Sources:
Federal Reserve of St. Louis
Realestate ABC
California Association of Realtors

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