A Bumpy Road Ahead for Real Estate
Despite all that has happened over the past four years, many real estate “experts”, economists, and politicians continue to believe that property values will soon start climbing. My opinion is that the opposite will happen — a slow decline over several years with occasional steeper drops. Very few markets will avoid this direct hit.
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Why am I so convinced about this trend? Among several reasons, the biggest one by far is that household incomes cannot sustain the current price levels, especially in high-priced areas like California and part of the Northeast. The official unemployment rate is just over 9%. However, truer gauges of unemployment that include the long-term unemployed, part-timers wanting to work full-time, etc. show that the real rate is more than double that amount. This doesn’t even address the fact that, compared to a couple of decades ago, a larger percentage of those who are employed work in the lower-paying service sector. This has driven down average incomes across the nation.
Even if Wall Street creates new types of loans to replace such horrible programs as option ARMs, more wage earners won’t be able to afford a house. Over time, less demand with a still high supply of properties will mean lower prices. The price-to-income ratios will have to come back down.
Piling on to this income weakness is the level of household debt in our country. The debt carried by the average household is 119% of annual after-tax income. This is better than the 135% level reached in the third quarter of 2007, but much worse than the 89% level during the 1990’s (all three figures are from the Wall Street Journal).
Besides low household incomes and too much debt, a third factor is the most frustrating and unpredictable – the U.S. government, and to a lesser extent, state and local governments. The U.S. government is facing a $1.6 trillion official deficit, though the number is actually closer to $5 trillion if one accounts for Social Security and Medicare from this year alone. Our politicians are nowhere close to solving this debt problem. My expectation is that the current debt ceiling arguments will be resolved by small spending cuts that will hardly make a dent in the deficit. Even if they do agree to cut the deficit by $4 trillion over ten years, that averages to $400 billion per year – about a quarter of this year’s deficit.
Of course, the debt problems haven’t stopped the bureaucrats from launching useless programs like HAMP and homebuyer tax credits. After all, they feel like they need to do something other than just let the markets self-correct. More harmful programs are on the way.
While there will be some bright spots – rental properties in certain markets, for instance – the next five years look bleak. Be careful with your cash until we see how this all plays out. It took the country many years (decades actually) to get into this mess, so it’s a safe bet that any journey of recovery won’t start for a few years and will even then be flat or show very gradual growth.