Wednesday, October 27, 2010

The Real Estate Dilemna

The Case-Shiller Home Price Index today confirmed what was corroborated by other indexes: home prices are on the decline. 15 out of 20 cities in the Case-Shiller index experienced price declines in August. While home prices are up 1.7% year-over-year, note that the Case-Shiller index is a lagging moving average of home prices, meaning recent issues with foreclosures have yet to be reflected in the index. I believe there is a very high likelihood that home prices will fall on a year-over-year basis.

Take a look at the chart of recent home prices and you will start to understand why real estate is so critical to the economy. Talks of a “green shoots” economic recovery came right when real estate started to rebound. Now that real estate is stalling, you are starting to hear talks about the coming double-dip. Home prices are directly correlated with household net worths since Americans were led to believe that real estate is an investment. Well in most cases it is not, and as I’ve said before, we are in a Depression. Depressions develop over time; there will always be temporary “recoveries” before the economy stalls again.

This is a subject matter that would take some time to really explain, but understand that real estate is more or less a reflection of private debt accumulation. We hear talks about the public debt all the time, but know that the big debt crises occur with explosions in both private and public debt.

Real Estate vs Gold

In my opinion, real estate is a better against inflation than gold. Before the dramatic rise in home values earlier this decade, home prices rose in line with inflation without the kind of volatility that you saw in gold. Remember, gold rose over 2000% in the 1970′s. This is just not the type of move that you will see in real estate on a national basis.

I know a lot of people are thinking about buying real estate at current levels. I’m hearing that home prices have already fallen dramatically and how mortgage rates are at record lows. I’m also hearing about how the population continues to grow. Well these are the same arguments I heard 2 years ago, yet home prices have gone nowhere since then. Furthermore, the trend in taxation is clearly taking a turn for the worse. Given all the variables, I am very confident in my forecast that home prices will go sideways on a national basis in the next decade.

Real estate used to be valued based on the productive capacity of the land. This whole notion that a non-productive piece of residential real estate is supposed to rise 10% year after year is just ludicrous. It’s a modern construct, and rapid appreciation of this kind depends largely on leveraged money. But who is going to leverage their money 5 times in such an uncertain environment? And even if investors were willing to leverage their money into uncertainty, who would grant them loans?

A lot is made about how gold doesn’t pay a dividend., but last time I checked, real estate doesn’t either. 2 years ago, the mainstream financial media was convinced that real estate had bottomed and that the gold bubble had popped. Well since then, real estate is flat while gold has risen nearly 100%. The mainstream continues to be on the wrong side of the trade. They will continue to recommend real estate although it provides mediocre returns even in normal environments.

A lot of what I have been saying is now coming to light. I have been hesitant to call a bottom in housing because I know banks are keeping properties off the market. I also know that the character of this decline in housing is totally different from those in the past. Think about it. The securitization market created a disconnect between loan issuer and home buyer. Not only that, but very basic considerations about who owns the debt are in dispute. Believe me, this is no 80′s style decline in real estate. People are starting to lose faith in a snapback recovery in home prices. Many have already stopped paying their mortgages and are just waiting for their banks to foreclose on them. There is already serious pressure on tax revenues; they will become worse when more homeowners become renters.

As real estate comes to the fore, many of the things I have talked about will start to make sense. Like I’ve said for the longest time, gold and stocks will rise while real estate struggles. This is not some simple inflation vs deflation issue- it has much more to do with trends in capital concentration in an uncertain economic and political environment.