New vs. Existing Housing

"How's the Housing Market?" -- Vol. 27

"Where" (location) is certainly one of the key qualifiers for anyone seeking to divine the health and direction of the housing market.

But so is "what?" -- as in "what kind of housing?"

In the housing market, the key distinction is between existing and new housing.

Conflicting Signals

That distinction explains how, literally in the same paper (the Star Tribune, on July 30), the front page ran a story saying that new housing inventory was shrinking, and that new permit applications were up.

Conclusion: things are getting better.

Meanwhile, the lead article in the business section attested to the slow-down in sales of existing housing, and an uptick in foreclosures.

The takeaway?

Things are getting worse.

Relative Size

Certainly by size, what happens to existing housing matters much, more more: existing homes account for more than 90% of the market, or about 5 million units annually, vs. less than 500,000 units for new construction.

However, economically, new construction exerts an influence far greater than its 10% market share would suggest.

That's because each new home represents tens (if not hundreds of thousands) spent on labor, material, land, appliances, furniture, etc. -- expenditures that reverberate through the economy many times over due to what's called the multiplier effect.

Overlapping Demand

It's also true that new homes frequently compete with existing ones for Buyers, just as used (pre-owned) cars compete with new ones.

So, the supply (and therefore) price of new homes affects the supply (and price) of existing homes -- and vice versa.

However, at least in the Twin Cities, my experience is that the two markets -- existing and new -- overlap less than elsewhere.

I see two reasons for that: 1) the vast majority of new housing locally is put up in the outer suburbs ("exurbs"), where land is cheapest; and 2) the price difference between a new home in the 'burbs, vs. an existing one closer in, isn't as extreme in the Twin Cities as it is elsewhere -- for example, the Bay Area.

Going back to "location, location, location," most Buyers first settle on "where," before they get to "what" (kind of housing).

P.S.: is Jim Buchta back? The long-time real estate reporter for the Star Tribune -- switched to the travel section 2(?) years ago -- has has several housing article bylines in the last few weeks.

If true, that's very good news!

The Plight of the "Move-down Buyer"

Stuck in Place

A healthy housing market functions like a gigantic escalator.

The bottom rungs are occupied by first-time Buyers. As they purchase entry-level homes, the Sellers of those homes ("Move-up Buyers") typically buy larger homes, enabling Sellers of those homes to buy even bigger homes.

And so on, and so on.

One of the most remarked consequences of the housing bear market the last three(?) years is that falling real estate prices have clobbered the equity of move-up Buyers.

So, the money they need for a downpayment to buy a bigger home is either diminished -- or gone.

In the most distressed housing markets -- places like Florida and Las Vegas -- many people who bought at the peak are now "underwater" (they owe more than their home is worth) to the tune of tens (or hundreds) of thousands of dollars.

Voila! No more moving escalator.

Stranded at the "Top of the Food Chain"

All of the foregoing is now very-well documented.

Less remarked is the plight of the "move-down Buyer" -- the owner of a bigger home, typically close to retirement age, who is ready for a smaller dwelling, but is unable to sell (also known as a "down-sizer").

If move-down Buyers are lucky, they bought decades ago, and have so much equity that even a 30% drop in housing prices still leaves them able to sell (and they've been prudent enough -- and financially secure enough -- to leave that equity untapped through the years).

It's also true that financial products like reverse mortgages can help move-down Buyers (at least the ones over 62 years old) transition to a smaller home.

However, the flip side of buying a bigger home decades ago is that the same home today could easily require hundreds of thousands of dollars of updating and remodeling to appeal to today's (financially hamstrung) Buyers.

Even if those Buyers can still muster a six-figure downpayment and qualify for a jumbo mortgage, coming up with a couple hundred grand for remodeling, out-of-pocket is (often) the kiss of death.

So what happens?

Nothing.

Move-down Buyers can't sell, which means that the owners of homes at lower price rungs can't sell -- and so on, and so on.

Public Policy Implications

The foregoing dynamic suggests that the best way to unfreeze the housing market isn't to buttress first-time Buyers, as policymakers have done so far.

Rather, the smarter approach is to help move-down Buyers.

That could be done by making a pot of cheap money available to Buyers undertaking major remodeling (cheap purchase money, courtesy of the Fed, doesn't do it); by giving tax credits to Buyers who tackle such projects; or even by giving incentives to investors to buy and remodel such homes.

Such a strategy not only would unlock the housing market's frozen upper brackets, but it would have a huge ripple (multiplier) effect as billions of dollars spent on labor and materials coursed through the economy.

Which all makes eminent, common sense.

After all, as everyone knows, a working escalator needs to go down as well as up.

Housing Multiplier Effect

"Revenue-Positive" Fiscal Stimulus

Give a too-big-to-fail financial institution $1 of taxpayer money, and what do they do with it?

As best I can tell, one of two things: 1) lend it back to the government for (risk-free) interest; or 2) borrow $10 more against it, then bet all $11 in the credit derivatives market.

Of course, that's after paying themselves $3 in compensation.

(You'll notice that there is no third choice, i.e., lend it out to creditworthy businesses and individuals.)

Housing Multiplier

By contrast, give $1 in taxpayer subsidies to a prospective home Buyer, and what do they do?

Buy a home.

Then, often times . . . buy new carpet, furniture, and appliances; hire a painter; get new landscaping, etc.

Add up all the foregoing, and you get something like $6 in downstream spending for every $1 of housing subsidy. That's what economists and accountant-types call a "revenue-positive" fiscal stimulus -- and a whale of a multiplier effect.

No wonder Wall Street doesn't understand it . . .