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!

"Rehab Novices"

Why Such a Big Discount For

Big Homes Needing Updating?

Want a novel -- but not at all far-fetched -- (additional) explanation for why so many nicer, bigger homes are facing significant discounts in today's market, especially ones that need significant updating?

Keep reading.

Far and away, there are three big reasons why such homes -- let's just say 4 or 5 Bedrooms, 3-4 Baths, with 3,500 to 4,500 finished square feet, in a nice part of town -- are proving tougher to sell. (Note: the price tag for such a home could be anywhere from $600k-$800k (or more) locally, depending on the particulars).

One. The economy. A rough economy shrinks the number of people who can swing a $5,000 monthly mortgage payment, $10k or so in annual property taxes, and the upkeep on a bigger home.

Oh, and since Buyers of such homes typically need a jumbo mortgage, they'll need to put down $50k or $100k instead of a fraction of that amount needed to buy a home under $500k.

Two. Demographics.

The Baby Boom generation now retiring/downsizing is being followed by a smaller generation with fewer, smaller families.

Ergo, demand is less than supply.

Three. Remodeling costs. You can finance a home purchase with a still-cheap 5%-plus mortgage.

Remodeling costs are typically straight out-of-pocket (remember that little Recession we were just in?).

Rehab Novices

That's probably all the explanation needed to explain why bigger, dated homes are taking longer to sell.

But I think there's actually a fourth reason that goes with the other three.

Namely, the resulting "market compression" makes rehab/updating projects especially daunting for the people who would naturally undertake them.

Here's the logic:

Because of the peculiarities of today's market, it's not unusual to see a completely updated, mint condition home with around 2,500 square feet fetch $500k or more, depending on where it's located.

Meanwhile, some 4,000 square foot-plus homes can be had -- especially if they need significant updating -- for $600k to $700k.

What happens when someone who's outgrown their (otherwise perfect) 2,500 square foot home looks at a 4,500 square foot home that needs "everything?"

It looks overwhelming.

That's especially the case if the biggest remodeling project they've tackled previously is a new bathroom.

Ironically, this "feedback loop" results in bigger homes sitting on the market, which results in discounting, which makes them affordable (at least on paper) to more Buyers moving up from smaller homes . . . who find a big project daunting.

No, I can't prove the foregoing -- but my gut (and my Buyer clients) tells me there's something to it . . .

Baby Boomers & Reverse Mortgages

Next Big Thing:
Reverse Mortgages

Take 80 million Baby Boomers fast closing in on retirement age, many of whom (still) have lots accumulated equity in their now too-big homes, and what do you get?

A vast potential market for something called a reverse mortgage.

Like its name suggests, in a reverse mortgage, the lender pays the borrower, instead of the other way around (it can either be a lump sum, or periodic payments).

The benefit to the borrower?

They get to tap their home equity without making payments -- and without qualifying for a new, conventionally amortizing loan (which could be difficult, given the now-retired borrower's lower income).

In fact, there are no income tests for reverse mortgages; to qualify, the borrow only has to: 1) be at least 62 years old; and 2) have sufficient equity in their home, as determined by an appraisal.

Reverse Mortgage Logistics

How big a reverse mortgage one qualifies for is then a(n actuarially determined) function of age: the younger you are, the less you can borrow.

Why no screening for pre-existing conditions, or other health issues that might affect the borrower's longevity?

Because someone in poor health is actually a better risk for the lender. If they die the day after taking out a reverse mortgage, the lender pockets the borrower's residual equity.

Conversely, it's the 62 year-old who's fit as a fiddle and lives to be 100 that causes lender losses (because the unpaid principal and interest keep accruing).

Fortunately for the reverse mortgagors, it's impossible to owe more than their home is worth (a condition called being "underwater").

For the 3% of (long-lived) borrowers where that would otherwise happen, insurance kicks in to cover the shortfall.

Not More Square Feet -- More Per Square Foot

Home Trends 2010: 'Don't Call it a Basement'

First, some background:

The big trends in housing at the moment are being driven by technology, demographics, and economics (primarily, the Recession, and secondarily, energy costs).

Demographics: lots of upper bracket Baby Boomers -- ages 50-65 and on the verge of becoming "empty nesters" -- are suddenly finding themselves with too much house. Not only don't they need 5,000 square foot-plus monster homes, but they don't want the upkeep and property taxes that go with (see, preceding post).

The "Gen X" and "Gen Y" homeowners following immediately behind them are taking the hint, and opting for relatively smaller homes -- say, around 3,500 square feet -- that they won't automatically have to downsize from.

More efficiently used space. The keys to getting by with a smaller house are making it feel bigger, and using all the space efficiently.

Towards that end, here's what I'm seeing in upper bracket homes (with bits and pieces popping up in more modest homes):

--Higher ceilings. The beauty of a 3,500 square foot home with 10 foot ceilings (vs. 8' or lower) is that it really is bigger -- but the property taxes are the same, because the home's "footprint" is unchanged.

--"Don't call it a basement." No, it's not a basement -- it's a "(well) finished lower level." Higher ceilings are showing up there, too, and make a huge difference in how the space looks and feels.

So do lower level heated floors; oversized, flat-panel TV's (now de rigueur for high-end lower levels); lots of recessed lighting; and egress windows (I recently saw a lower level Bedroom with not one but two egress windows; the effect was stunning).

In fact, the only thing you won't find in these deluxe lower levels is the laundry: that's moved upstairs, to the first floor (or even the 2nd).

--More and bigger windows. Beside higher ceilings, the other way to make a smaller home feel bigger are more windows. The higher end, new construction I've seen the last year or so seem to have large, custom windows everywhere (energy efficient, double-pane, low-e -- of course).

--"The Great Kitchen": as I've posted previously, the pendulum is swinging back from completely opened-up "Great Rooms" to a hybrid I like to call "the Great Kitchen": basically, a combination Kitchen - Family Room.

The (formal) Living Room and Dining Room are still there, just smaller.

Same Footprint, More Square Feet -- part 2.

Of course, the other way to squeeze more finished square feet under the same roof is to tackle the space . . . under the roof.

A homeowner in my neighborhood just added dormers to their third level, presumably adding another 1,000 square feet-plus of finished space (I haven't seen the inside).

Besides the extra space, the dormers give the home another great amenity: views of Cedar Lake!