According to the trend above baseline shown in the chart below, US real estate is running about 20% above long term baseline trend. The are a number of well-documented reasons for this. Some of the more popular ones are:
- Low interest rates
- Aggressive marketing by mortgage companies
- Dissatisfaction with stock market investments
- Momentum - i.e. the shortsighted belief that markets going up will continue to do so indefinitely.
As the chart illustrates, this is a cyclic effect and we can learn from the history. In order to develop a forecast, we can simply assume that this bubble will an average of the previous two, and this would indicate that the values will retreat to values of .889 current in 6 years and the next UP market will start in 2010 for a total cycle time of 14 years. It is these long waves in the cycle that make it so difficult for buyers to understand. Many first time buyers were in high school the last time the cycle happened.
| Market peaks: | 1979 | 1990 | 2004F |
| Peak values: | 111% | 115% | 145%F |
| Previous valley: | 1984 | 1997 | 2010F |
| Valley values: | 97% | 104% | 129%F |
| Decline length (years): | 5 | 7 | 6F |
| Ratio valley to peak: | .874, | .904 | .889F |
| Loss peak to valley: | 12.6%, | 9.6% | 11.1%F |
It is tough to get consesnus on this phenomenon when important guys like this make such outrageous claims:
In 2005, Ben S. Bernanke, then an adviser to President Bush and now the chairman of the Federal Reserve, said surging home prices were being driven by economic fundamentals. “We’ve never had a decline in housing prices on a nationwide basis,” Mr. Bernanke said.
Using these assumptions, the forecast might look like this:
Of course, other factors might make the return go below the trend line as it has in the two previous bubbles. Just guessing, it might get as low as 110% instead of 129%!
Naturally, individual regions will be different than these averages.
Taking another view that considers relative valuations, I have taken the historical data of John Krainer
in which he compares national house prices to the comparable rental values:
The rationale of this analysis is that rental rates act as a moderating effect on house prices. As the price gets way above the rental value, more people will choose rental and use their money for other investment with better risk/reward characteristic. So if this bubble repeats the pattern of the previous one, you can see from
the forecast that the values will begin to retreat in 2005, reaching parity in
2008 and beginning to turn up again in 2010. This is a very similar result to the previous analysis.
| Market peaks: | 1990 | 2005F |
| Peak values: | 1.32 | 1.43F |
| Previous valley: | 1995 | 2010F |
| Valley values: | 1.20 | 1.20F |
| Decline length (years): | 5 | 5F |
| Cycle time (years): | 15 | 15F |
| Ratio valley to peak: | .91 | .84F |
| Loss peak to valley: | 9% | 16%F |
Note that these are all relative to rental prices. One can assume that rental will at least keep pace with inflation. The forecast is mine, not John's.
Of course, other factors might make the return go below the trend line by an amount proportional to that of the previous bubble. Just guessing, it might get as low as 1.1 instead of 1.2!
As before, individual regions will be different than these national averages. Here is another view of the major regions highlighting their differences:
If you think this boom is fueled by economic growth, think again. This chart shows that much of the bubble is just sustained by higher debt and that debt can only be sustained by higher earnings.
Finally, if you think the people are just using low interest rates for leverage, the chart on the right is showing the decline of savings to prove that the increased debt is not backstopped by cash or equity.
For completeness, here is a chart that shows how the equity in US households has declined since the equity market bubble burst in 2000 reinforcing the need for cheap debt to finance growth:
PS The basic data for the Price-to-rental chart came out of William Sterling's report "Home Sweet Home" published by CI Funds. Sterling is Chief Investment Officer of Trilogy Advisors LLC.
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