Real Estate's "Tectonic Plates"

Renting vs. Owning:
Shifting Consumer Preferences?

Before explaining the "tectonic plates" of the housing market, this preliminary question:

What was the biggest factor in the stock market's almost 12X(!) appreciation between 1982 and 2000?

A. Increased corporate earnings
B. Low interest rates
C. An increase in stocks' price-earnings multiple
D. Reduced taxes on capital gains

Answer: C

Although the other factors all contributed to the historic 1982-2000 bull market, the stark, simple fact is that the biggest driver of gains was that stocks went from being extremely unpopular in 1982, when the average P/E ratio was 7, to extremely popular in 2000, when the average P/E ratio had more than quadrupled to 30.

Change in Sentiment

The equivalent in the housing market is the percentage of consumers who own their own home (vs. rent).

Each percentage point change in the number of households owning their own home corresponds to 1.3 million households.

So, when the percentage of homeowners shrinks from 69% to 67.2% -- as it did from 2004 to 2010 -- the number of home buyers shrinks by 2.34 million.

That compares to about 5.5 million units of total housing (new and existing) sold annually.

Renter Nation?

A recent Barron's cover article, "Renter Nation" (July 26), extrapolates a further drop in the home ownership rate due to unfavorable demographic trends, tighter credit, and an assumed sluggish economy.

As a result, it predicts weaker prospective demand for housing -- which, of course, portends lower prices.

Is Barron's right?

Maybe.

However, even if Barron's' economic and demographic analyses are correct, the conclusions it draws may still be suspect.

Parsing Barron's Case

Least in dispute is the demographic case for weaker housing demand.

Thanks to the pattern of "Boomer - "Buster" - "Echo Buster," at least in the short run, there will be fewer people in the prime home-buying age ranges.

So if past is prologue, demand for homes will fall.

However, in today's uncertain economy, it's hardly a given that historical preferences will persist, unchanged.

For example, if inflation should appear with a vengeance, "financial planning 101" says to latch onto hard assets.

The most obvious way for most Americans to do that is to . . . . own their own home.

Assumption #2

Barron's second assumption is that the economy will remain weak, impairing household formation (or even causing household dissolution).

With fewer new households, demand for housing suffers accordingly.

While a continued, weak economy certainly seems like a safe bet now, as Yogi Berra liked to say, "predictions are tough . . . especially about the future. "

Given how few economists predicted today's economy five years ago, I think it's a mistake to assume that they now know what will happen with confidence the next five.

At the very least, simply extrapolating current economic conditions certainly seems like the safe, defensive call.

Drawing Conclusions

Which leaves Barron's' conclusion: weaker demand for housing, at least in the short run -- and therefore, presumably, lower home prices.

What Barron's omits is that all housing is owned by someone.

So, if fewer households own their own homes, by definition, more landlords (or investors) do.

It's certainly possible to conjure up a scenario in which rising investor demand for housing (more than) offsets falling consumer demand.

Investor demand, in turn, will depend on things like housing's price (a bit circular, I know), market rental rates, interest rates, taxes and the like.

Here's a radical thought: yield-starved investors may decide that even getting a modest 5% on a portfolio of rental properties is a safer, more remunerative investment than lending their money to the U.S. government -- or mega-corporations like IBM, Microsoft, and Johnson & Johnson* -- for a measly 1% or 2%.

Or trusting it to the vagaries of the stock market.

*All 3 corporations just took advantage of record-low bond rates to sell billions in bonds paying as little as 1% for five years or longer. Might as well put it in your mattress -- in a house you own!