Residential Investment

In the comments of a prior post, a reader (Sailorman) asks: if housing is having heartburn while the general economy is still relatively strong, what will happen to housing if the general economy has a hard landing?

That’s a fair question worth further exploring:

Housing activity is a function of several factors: Rates, the overall economy, supply, population growth, rental prices. These are the primary drivers of sales and pricing. Like all asset classes, other elements will impact end demand: sentiment, speculation, liquidity (easy financing terms, I/O loans, no doc mortages), etc. 

Over the past 5 years, rates dropped, supply expanded, population expanded, prices rose. That’s fairly normal. Then something a bit unusual happened: rates plummeted even further, prices rose more quickly as former stock market investors discovered Real Estate Speculation.

This group is notorious for being late to the party. Just as they bought right into the top in 2000, I suspect many did the same in the Summer of 2005.

Fast forward a year or so: Equity price shave dropped — and not just the 2% you may have heard in the official data.

Most of the time, Real Estate is a function of the overall economy: Job creation, GDP, Rates. As we discussed extensively, this go round has seen the roles reversed: its the prime mover of the economy. 

Which leads us to this chart:   

Historical chart of Residential Investment Cycles, 60 Years



Does this look like the downturn in Residential Investment is over? Except for 1995, most private RE investment contractions are much longer lived . . .


"Carry" Trade in U.S. Housing Looks to be Over

December 01, 2006

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What's been said:

Discussions found on the web:
  1. Teddy commented on Jan 4

    Barry, I see you listed rates 1st tho on a relative basis I don’t know what your thoughts were. Albert Einstein found the power of compound interest mind boggling. If you couple debt with leverage up to the sky, it can alter the course of history. It’s greater than the power of wages. And adjustments and secular trends can change the economic landscape drastically. But I’m with Warren Buffet, changes in debt changes the terms of endearment.

  2. Howie Copywriter commented on Jan 4

    I write about real estate and I have a lot of pictures of New York City on my blog. But isn’t everything crashing? If you want to see my blogs, they are real crash and real estate crash. Of course, a lot of historical stores and sites are being destroyed in NYC today, too.

  3. alexd commented on Jan 4

    Let’s talk about the power of compounding.

    In any highly leveraged situation, if you are right compounding is wonderfull. If you are wrong it will eat your heart out of your chest while it still beats.

    The above is written with the proviso that you bet like a reasonable person. That means the greater the possible bi directional volatility is, the better prepared you will be for that volatility by adjusting the size of your bets. As long as housing was creeping up faster than the inflation rate ( lets keep the value of the dollar out of here for now) then you did well in your bet on real estate. So betting on real estate after a crash can be good. At the top is bad. Simple.

    Anyone here notice how home depot and loews are reacting? Look to the suppliers stocks.
    Home sales will lag due to the nature of the transaction that takes longer. But suppliers tend to have non perishable inventory. And it moves before housing.

    But the incredible thing that no one is talking about because we are scared to, is healthcare. How come no one is going nuts on this? I know, I know a river in Egypt.

    We no longer have the top medical care in the world. Perhaps we should be concerned with this trend? We have medical care that is accelerating in cost at very high rates beyond inflation and wages.If you are paying 20% of your earnings for healthcare (or what ever % is correct as an average for Americans) and it goes up 11% you are then paying 22.2%. Then it continues. Nothing new here. But many people in the USA are getting older. (Okay you got me there, everyone is getting older, even the dead.) Now the young and the aforementioned dead do not tend to need too much medical care. As a group, yes for the young there are unfortunate exceptions and for the dead we do not throw to much money into their medical care becasue frankly it is so ineffective that even congress does not try to earmark money for it. Although if the dead could vote they would.

    So people who ae middle aged and older tend to make greater demands on medical care. So demand is likely to go up. So no relief on price pressures based on demand.

    So what percentage of income or draw on this countrys resources is the level where the crap hits the fan? We have suffered with those who have a lack of imagination or a resistance to change the status quo but at some point we will be impoverished by this. So things will change.

    We will find a cheaper way to affect this, either by emulating others who do it better than us, healthcare will get worse and worse until it is THE politcal subject. Or we find some way to alleviate the cause of the problem through medical technology , genocide or neglect.

    This has reached a point of crisis. So how are we going to profit out of it? Sure some companies are going to rake in the money becaue the people who can pay, will pay to improve their lives. Some will come up with answers to solve the availabiltiy problems. Some will suffer when efficiences are demanded by the situation.

    Any one want to bet on when?

    Be well (poignent ain’t I?)

  4. Chad commented on Jan 4

    Speaking of reader comments, I was wondering what Barry thought about the WSJ redesign and the new online tools.

  5. Repoman commented on Jan 4

    From the looks of the chart, each move up was followed by an almost retracement on the way down, before basing and then making a new high.

    Since there has been no “normal pullback” since 1990 (looks like the average was about 40% after each move up), we could go back to the ’91 level before a bottom if the pattern of the chart hold true.

    Does that sound right?

  6. Jimcos commented on Jan 4

    OK, I did this really simplistic thing and calculated the trendline slope by eyeballing the late 1940’s and the early 1980’s data points, and extending the resulting “trendline” to the present. (Don’t take me for a technician here; it just seems like an intuitive thing to do.)

    The trendline works out to about an annualized 2.4%. (That seems to be less than the average inflation rate would be over that period, but that’s another topic.)

    In any event, the trendline currently passes through about 344 (my rough calculation) and therefore suggests an additional 42% drop in RPRI and places it on a par with the “corrections” of the mid-70’s and early 80’s.

    Of course, one could have posited similar assertions in the late 80’s and mid 90’s.

    Nonetheless my conclusion is that there’s plenty of downside potential here, and not much upside. Whether the downside manifests or not is the real question.

    Is it different this time? (Hee-hee) Perhaps. Inflation, for one, is nowhere near what it was in the late 70’s/early 80’s. However, the accompanying graphics in Kasriel’s original piece would support significant additional downside, with a concurrent recession to boot.

    By the way, a similar trendline building exercise on the DJIA suggests a downside potential to about 4000 in that index and that doesn’t seem like it’s gonna happen anytime soon either.

    So maybe we just waffle on through with all this and nobody gets hurt badly, sub-par asset returns notwithstanding.

  7. Fred commented on Jan 4

    “Except for 1995, most private RE investment contractions are much longer lived . . . ”

    Thanks for beating me to the punch on this observation. I believe that this will be a similar situation. Many similarities to 1995.

    BTW, notice that the Real Private Investment was the same level in 1995 as 1973!! So, that being said, has it really moved up that much over this 30 year period (peak to peak)?

  8. Mike_in_FL commented on Jan 4

    I would be very surprised if this summer turns out to be the “ultimate” bottom in the residential real estate market. The magnitude of the inventory overhang we’re dealing with is severe … the amount of “stuck” speculators is very large vs. history … and most importantly, lending standards appear to be tightening up at the margin. Witness the rolling failure of some of the subprime lenders who made the riskiest loans.

    I think we’re in for a lengthy period of weakness in sales, pricing, construction activity, housing-related employment, etc. (through 2007 at least). Indeed, if inventory shoots up again soon (due to post-holiday “re-lists”) and the nascent tightening in the lending market gets worse, I think we could be in for a real negative surprise this spring (the key buying/selling season). Anyway, more extensive thoughts are available at my blog.

  9. Ralph commented on Jan 4

    This is a very key discussion and an important one but I really feel that we are all missing a bigger point.

    Just cause the media keeps repeating that car sales and housing will be the determining factors in the economy does not mean that it is true.

    The economy is a big complex animal. It has many components. We can not ignore the effects of other economies around the world either. Many global factors have a very direct influence on our economy. (this was not as true say 40 years ago. )

    A list of things for you to also consider when trying to measure the economies strength.

    Certainly a biggie is Debt. Govt. based deficits and the trade imbalance are huge.

    Couple that with the fact that a major portion of all the other cash as I call it, liquidity as the press refers to it, is also from debt. No one is as yet making any inroads in reducing debt. The interest payments alone are hitting staggering proportions.

    Lousy government and industry data may also be creating a false sense of good times. It is widely talked about that inflation is probably grossly understated, unemployment rate is grossly undertated and going back to debt, Govt deficit numbers are grossly understated simply by leaving out key expense items like funding the Iraq war.

    Lastly at least for this post, housing is only one of many asset class bubbles that poor policies have created in the last five years. If any one of those bubbles deflates rapidly it could have a very serious effect.

  10. Jim D commented on Jan 4

    I’m curious about Fred’s comments – similar to 1995? In what way? Income to price and rent to price ratios are nothing like 1995.

  11. Fred commented on Jan 4

    Not real estate, but many other aspects of the economy….(eg soft landing!)

    But I like the fact that this would be an “outlier”. The constant real estate bashing (not news) serves the bulls well…keeping sentiment cautious, and the Fed towards easing.

  12. brion commented on Jan 4

    “this go round has seen the roles reversed: It’s (Housing) the prime mover of the economy.”

    I personally know of 2 acquaintances who took out 2nd mortgages to fund start-ups. I’ve wondered since then how slowing/falling prices have impacted their circadian rhythmns…

    If Kramer ever needs a new name for his show i’d suggest “MEW Money”

  13. SPXsurvivor commented on Jan 4

    Seems like one of the most surprising (if inadvertant) messages from the chart is the relative paucity of economic contractions over the past 22 years, especially given all that we’ve gone through in that period: Asia currency crisis, LTCM, meltdown, 9/11. It’s hard to refute that there is a unique resiliency about our economy over this time period. What causes it? Busted unions, infotech/supply chain management, deregulation, Soviets go TU…who knows, but something is different.

    Anyway, regarding real estate, I’m curious why so few people focus on the cap.gains tax changes in 1997, specifically the homeowners cap. gains exclusion. It seems this single act was transformative in that it created (or at least significantly stimulated) a new category of economic activity. The government is now subsidizing folks who buy old properties, renovate them, live in them 2 years, sell (hopefully) at a tax-free profit up to the cap gains exclusion. Home Depot obviously benefits, and we benefit overall with an upgraded housing stock (assuming these DIYers do it right)and the second order social benefits of increased homeownership, however,it seems like this is a significant distortion relative to other sorts of income. From the chart, and forgive my lack of technical acumen, it looks like this offset what would have been a typical cyclical contraction in the mid/late 90s. Thoughts, data?

  14. Ken Houghton commented on Jan 4

    SPXsurvivor – Taking a way a cap that was $250K per person ($500K for a couple) to begin with isn’t that much of an issue for most sellers/buyers–and certainly not in the “flip” market. (Not even NYC or Charlotte went up that fast; unless you’ve got the Truly Broken Building in a GREAT Neighborhood that you’re completely rebuilding, you’re not going to walk away with a spare $250K after expenses [including carrying costs] in two years.)

    What it motivated, if anything, was sales of olders homes in more expensive neighborhoods by people who were going to downsize anyway. (The likely result there is, paradoxically, that the extra availability slowed the growth; greater supply, even with liquidity and fungibility constraints.)

    I doubt there would have been a contraction in the late 1990s anyway; it was the first time a lot of people were making decent real wages, and the U.S. stock market was soaring. Lots of paper gains, and lots of people locking in profits, real or imagined.

  15. Larry Nusbaum commented on Jan 4

    Fred: “Thanks for beating me to the punch on this observation. I believe that this will be a similar situation. Many similarities to 1995.”

    Fred, 1995 saw a stabilization in housing, starting with huge rental demand/rent increases and two years later the start of the greatest hosuing boom ever. Is that what you mean?

    And, Ken, I am hearing from realtors who sell million houses that business is incredible here in Scottsdale. Business owners / entrepreneurs, flush with cash and making a lot in their buisnesses.
    That’s a sign that our economy is strong. When a recession comes, it will be the starter homes that will do well as people stop trading up and some try to trade down.

  16. theroxylandr commented on Jan 4

    This chart is already inflation-adjusted. The growth you see is because population grows.

    Next, the period 1982-now IS different, because we lived in a huge secular bull period. It was a long 18-year bull with two recessions inside that did not break the trend.

    Now we are 5 year into the down leg, which will probably also take 15-20 years. Another 10-15 years to go, folks.

  17. seamus commented on Jan 4

    Larry, there’s a lot of anecdotal evidence that high-end homes are still in demand in markets across America. It’s not really evidence that the economy (output) is strong, as much as profits, which as a % of the economy are astonishingly high.

    But the majority of consumers and potential home-buyers don’t earn much directly from profits. They earn wages. And while the economy is still relatively good for most wage-earners, they’re still already becoming less willing to stretch themselves financially to buy a home that might be worth less in five years. This is what the recent stats tell us (albeit understated). And every chart shows us that no matter what real estate agents tell us, there’s a lot of downside to come.

  18. Larry Nusbaum commented on Jan 4

    seamus: my professional acting friends in NYC used to be able to predict recessions 6 months ahead of everyone else. Calls for print and media commercials auditions decreased dramatically.

    “It’s not really evidence that the economy (output) is strong,” – your are right, but, I was just a bit surpried at the strength in the upper end. On the other hand, businesses are doing well (here) and commercial vacancies have come way down while rents have increased.

  19. Fred commented on Jan 4

    Larry (and Jim D):

    I mentioned the 1995 instance, not for its similarties in real estate, but the economy as a whole. The Fed engineered a soft landing in 1995 (despite all the nay sayers) just as they are doing today.

    BTW, did you see Pimco’s prediction today of 4 rate cuts and a 4.5% ten year?

    Lovely!…and hugely bullish for tech, growth and financial equities!

    Fade the recession talk imho.

  20. Larry Nusbaum commented on Jan 4

    “BTW, did you see Pimco’s prediction today of 4 rate cuts and a 4.5% ten year?”


  21. Fred commented on Jan 4

    Actually it’s called a positively sloped yield curve. (contrarian call)

    Yes, SOME of the idiots that bought RE at the top using stupid leverage might get bailed out.

    This economy has WAY more than real estate going for it. Look past the trees.

  22. Larry Nusbaum commented on Jan 4

    “This economy has WAY more than real estate going for it. Look past the trees.”

  23. Chief Tomahawk commented on Jan 4

    For the Bill Gross/PIMCO watchers, the ITulip link I posted above has some quotes from the man himself. A worthy read, imo.

  24. Norman commented on Jan 4

    Looking at the 60 year chart of Real Private Residential Investment does anyone have an explanation as to why there has been so few and so shallow downward retracements since 1991, fully 15 years ago, whereas from 1945-1990 there were 8 serious declines or one every 5.5 years that averaged -30%?

  25. Zephyr commented on Jan 5

    The sources of mortgage financing have changed significantly over time, and is a major factor in the changed nature of the real estate cycle.

    The securitization of mortgages made the availability of mortgage money much more stable than before. This largely evolved prior to 1990. In previous cycles mortgage money would become very scarce at times, leading to exagerated declines in buying.

  26. DavidB commented on Jan 5

    Looking at the 60 year chart of Real Private Residential Investment does anyone have an explanation as to why there has been so few and so shallow downward retracements since 1991, fully 15 years ago, whereas from 1945-1990 there were 8 serious declines or one every 5.5 years that averaged -30%?

    Some would argue the fed has perfected it’s game. They have learned to perfectly manipulate the money supply and pick winners every time.

    That, ethical arguments aside, remains to be seen.

  27. RP commented on Jan 5

    alexd – look around:

    first world heath care -> up.
    first world housing (reliable electricity, water, …) -> up.
    first world wages -> no longer defined by the nation you live in,
    increasingly defined by your ability to extract
    income from the global pie.
    wages will increasingly define which world (first, third) you
    live in, instead of being defined largely by the nation you call
    home. Either we will raise all living standards enough that
    the losers don’t revolt, or at some point there is going to
    be a developed country voter backlash.

    but what do I know…

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