Is housing finally on the way down?

The CME housing futures contracts are now trading, and they predict a drop of about 5% over the next nine months in ten cities with hot markets. That expectation isn’t sustainable. The bubble could be about to pop rather explosively.

It’s sure starting to look that way.

The Chicago Mercantile Exchange now has housing futures contracts, one each for ten cities plus a national average. The May 2007 composite (the furthest-out contract) is 5% below the August 2006 composite. That’s right: projected appreciation in those ten cities over the next 9 months is -5%. Admittedly, the CME list is of especially “bubbly” cities: Boston, Chicago, Denver, Las Vegas, Los Angeles, Miami, New York, San Diego, San Francisco, and Washington.

If housing prices in those ten markets are really going to drop at an annual rate of almost 7%, then the effective price of homeownership &#8212 a 7% capital loss, plus the interest cost of the mortgage, the opportunity cost of the equity, and running expenses &#8212 is more than virtually any homeowner can really afford to pay; living in a million-dollar house will wind up costing more than $150,000 per year. (When I sold my house last year, it was because I’d done that calculation based on flat prices and decided that I couldn’t afford to keep owning.)

So a drop at the projected rate is unsustainable if people come to expect it, because almost no one is going to pay today’s hot-market housing prices, or anything near them, if prices are seen to be sliding. That’s how a bubble bursts.

More opinion on the subject:

Mark Trahant in the Seattle Post-Intelligencer

Bill Gross, managing director of PIMCO bond fund, writes in his August Outlook: “It’s not looking good, folks — housing that is. PIMCO’s on-the-ground analysts, who for nearly a year have roamed the country with random real estate agents in search of local housing trend information, report that prices in many areas are actually declining, which has significant implications for the economy, inflation and interest rate trends.”

Vikas Bajaj and David Leonhardt in the New York Times.

“It hasn’t slowed down a little bit — it has slowed down a lot,” said Doug McCraw, a developer who has scrapped his plans for a 205-unit condominium tower in a neighborhood just north of downtown Fort Lauderdale, Fla. “Anybody who did not have a shovel in the dirt has chosen to wait till the market settles.”

Rachel Beck in the Newark Star-Ledger

As if investors in home-building stocks need more to worry about. They’ve already watched their shares get hit by the slump in home sales and the weakening economy.

Now add this concern to the list: Companies writing down their land values because they aren’t worth what they paid for them.

Patrice Hill in the Washington Times

The housing slump reached a new milestone this spring as home prices that were soaring at double-digit rates only a year ago reached the break-even point and started to decline in many once-booming areas, recent reports show.

Footnote The guy who bought my place last June fixed it up and put it back on the market for a quick flip. No luck so far; it’s still sitting there, and the asking price has been reduced by half a million dollars. At the current asking price, he’d about break even after renovation expenses, commissions, and carrying costs. But that’s the asking price. It looks more and more as if I dodged a bullet.

Author: Mark Kleiman

Professor of Public Policy at the NYU Marron Institute for Urban Management and editor of the Journal of Drug Policy Analysis. Teaches about the methods of policy analysis about drug abuse control and crime control policy, working out the implications of two principles: that swift and certain sanctions don't have to be severe to be effective, and that well-designed threats usually don't have to be carried out. Books: Drugs and Drug Policy: What Everyone Needs to Know (with Jonathan Caulkins and Angela Hawken) When Brute Force Fails: How to Have Less Crime and Less Punishment (Princeton, 2009; named one of the "books of the year" by The Economist Against Excess: Drug Policy for Results (Basic, 1993) Marijuana: Costs of Abuse, Costs of Control (Greenwood, 1989) UCLA Homepage Curriculum Vitae Contact: Markarkleiman-at-gmail.com

18 thoughts on “Is housing finally on the way down?”

  1. On the bright side, a drop in market value doesn't actually cost you anything until you sell. It doesn't mean squat to us weird people who buy houses and then just sit there living in them.

  2. Houses were the latest pot of borrowed money to live on. Now there's nothing left for average consumers to maintain deficit lifestyles. We'll be hurtin' soon. But sadly the corporate owners of America can still sell their hard assets and the government can still sell services (like toll ways and PORT DEALS). In the end, like a British aristocratic family selling the art off the castle walls before going bankrupt, or a rock/movie star blowing it all on blow, america is in for a serious take down.
    Do I take any pleasure in it? Hell now. My wife and I are savers, and our assets have grown in 18 years from literally $500 to a pretty good portfolio of cash and stocks and bonds and a good public pension–never bought the McMansion-on-the-lake I dreamed of–but those will all go to hell when the economy tanks. Makes me feel like a middle class German family in the 1920s. My brother has a 150,000 German mark note framed on his wall. That bought a loaf of bread back then. doubt it will get that bad but with Bushco, who knows?

  3. This Sunday on ABC's national morning show (not This Week) one of the segments was Now Is The Time To Buy A House, teeing off the fact that it's a buyer's market. Had an interview with a realtor who still said that "a house is the best investment you can make".
    And that's after a slowdown in sales, not prices (at least not much of a decline in prices).

  4. Had an interview with a realtor who still said that "a house is the best investment you can make".
    What else would a realtor say? Many of them believe it. The human animal is capable of amazing self-deception for the furtherance of its self interest…

  5. How can homeowners use the CME housing market to hedge against declining home values? After all, I just put in all these nice fluorescent bulbs.

  6. No, note that this is the land price, and it's in Yen / Square Meter (there are currently about 116 Yen / US Dollar, and there are about 10 square feet per square meter).
    There's a very interesting long time series of real estate data in Amsterdam which basically shows that over a 350 year period house prices basically went nowhere in real terms. This is discussed here:
    http://economistsview.typepad.com/economistsview/

  7. I agree that housing prices are dropping, but have some quibbles with the analysis.
    Even if prices drop 7% in the coming year – quite plausible – they are very unlikely to continue dropping at a 7% annual rate. It's really not accurate to lump this cost with the mortgage. And, ironically, once the prices drop, the opportunity cost of the equity drops also. A twenty percent price drop, or less in many cases, leaves you with no equity, hence no opportunity cost.
    Also, selling a house has large transaction costs, so unless you think there's going to be a crash, it's questionable whether selling for pure financial reasons makes sense.

  8. In proof that I'm selfish–I'm going to be able to buy a house for the first time in about 2 years (in San Diego). If housing prices stay level or go down without wrecking the overall economy, I'll be thrilled.

  9. I have to agree. Our host is a smart cookie, but he's outside his competence here. Like many, he tends to conflate futures prices with predicted prices. Futures markets do not predict price; they reflect the influences of arbitrage, hedging and speculation. Backwardation is usually explained via convenience yield. With something like residential housing, that actually makes intuitive sense. Mr. K., if you find the time, read the first several chapters of Hull. It's a classic text for a reason.
    When your premise is demonstrably false, you shouldn't be surprised that the calculations that result arouse reactions ranging from bemusement to disagreement from rational interlocutors.
    SP, you could use the CME to hedge your house, but I am not sure I recommend it. You could hedge out your $1.5M SF home by selling around 30 futures contracts and rolling them over, but if markets keep going up, you'll have to pay up cash on the futures losses while the gains on your home remain unrealized. While this might be a nice tax dodge in a few circumstances, in most I expect the pain of cash payments quickly would drive most retail clients out of the position. Options on futures are a thought, I suppose, but then you're long volatility instead of just hedged, which seems even worse.

  10. bernard:
    I agree that current owners would have to expect continued declines to make it rational for them to sell, given the transactions costs. But think about someone about to buy: is he really willing to take the additional 7% hit? Not if he's sane. He ought to keep renting, and maybe buy the futures as a hedge.
    wcw:
    So are you long the L.A. contract or the composite? If you're right that the futures price systematically underpredicts actual growth in housing values, that's money for jam. In the longer run, of course, if enough people take advantage of the time-arbitrage, the futures price will come into line with the expected value of cash prices in the future.

  11. Brett: "On the bright side, a drop in market value doesn't actually cost you anything until you sell. It doesn't mean squat to us weird people who buy houses and then just sit there living in them."
    Brett, for many of us, life occasionally forces (strongly encourages, for the econopedantics) us to move. I worked with a guy at Ford, in the 1990's, who spent three years renting out his CA house while working in Dearborn, MI, because he couldn't sell it for an acceptable price.

  12. During the last bad market in California in 1991, I put my home on the market at $795,000 based on my realtors advice. I purchased a house in Arizona thinking I could reduce my costs. Two years later the California house was listed at $559,000 and still unsold. I rented the house at a loss for 7 years until the market came back so I could sell at $719,000. I think this market could be worse.
    The banks are gearing up for a surge in forclosures. When these adjustable loans reset, recent buyers will walk away.

  13. MK:
    In the interest of full disclosure. Shorting homebuilders has been one of my big, big winning trades this calendar year. My targets had a little LA exposure, as well as SD, SF, DC and Miami. I covered most of these, but expect to fade rallies. Why didn't you short futures? You could have collected cash against your home's drop in value while continuing both to live in it and to book the governments generous mortgage interest tax deduction.
    Whatever your and my market stances, futures markets still do not make predictions. Futures sometimes offer a convenience yield. Some market participants indeed attempt to book it. I am not one. I am a little shocked that a tenured policy expert thinks misdirection is effective refutation, but perhaps I overestimate you.
    Kidding aside, buy Hull and read the first six chapters: http://www.rotman.utoronto.ca/%7Ehull/ofodout/

  14. Since we're in the business of noting what side of the market on now, I should note that I am long Toll Brothers, which is the homebuilder at the top of the market (the men who brought you the McMansion). I am with Mark that housing is on its way down (although it is interesting that we haven't actually seen that much of a move in prices, yet). It is possible to believe that housing prices could go down 15-20% in many overpriced markets, and still think that TOL is an incredible opportunity. TOL is selling at nine times the most pessimistic analyst estimate of 07 earnings and five times this year's earnings. There's an old adage that the time to buy is when the blood is running in the street. With TOL 60% off of its highs, I'd say that time was now. There is irrational exuberance, but there's also irrational pessimism. The former helps explain why some people can make money on the short end of the market, the latter why you can make a lot of money going long.

  15. I sold in Jan '05 using similar reasoning. Until we see the next significant price reductions I advise all to calc. costs using "Flat" pricing. Remember, the $500k price reduction is off of ASKING price. All that really means is the upward spiral has stopped, for this brief point in time. Understand, I'm with (& perhaps ahead of) Mark on this, but it's still to early to get puffed up.

  16. TOL has been one of the industry's more honest brokers. The market rewarded that by driving their stock down first. Cf <a href="http://bigcharts.marketwatch.com/charts/big.chart?symb=tol&comp=bhs+bzh&type=2&size=3&style=320&freq=1&startdate=6%2F30%2F05&quot; rel="nofollow"&gt <a href="http://;http://bigcharts.marketwatch.com/charts/big.chart?symb=tol&comp=bhs+bzh&type=2&size=3&style=320&freq=1&startdate=6%2F30%2F05” target=”_blank”>;http://bigcharts.marketwatch.com/charts/big.chart?symb=tol&comp=bhs+bzh&type=2&size=3&style=320&freq=1&startdate=6%2F30%2F05 and note how Toll leads the other names down.
    However, just because they're honest and know their business backwards and forwards doesn't mean I was buying them last week, even though along with the whole group they're up 5% today. You might be surprised at what happens to homebuilders in toto even if prices merely remain flat for a while, unless rates come back down as well. I might be even more surprised, of course. A group whose underlying market looks to be changing will have volatile earnings. If you want to be long, check out book multiple as well as earnings.

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