Why the Real Housing Bust's Still Coming

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Economists have been calling for a turnaround in the housing market for years without any lasting success. Yet as recent news starts to point toward at least the possibility of housing hitting bottom, it's important to realize that there's one important reason why home prices have another threat looming over them -- and it's one that could take years to manifest itself.

Later in this article, I'll talk about the coming crisis that could throw housing for another loop. But first, let's take a closer look at why optimists are coming to the conclusion that we may finally be near the end of the housing bust.

Happy news all around
Lately, the news has gotten a lot more upbeat about housing. Consider these recent tidbits:

  • Hovnanian (NYSE: HOV  ) announced a fourth-quarter loss, but it was lower than the previous year's level. A big 26% boost in backlogs points to improving revenue in the coming quarters, and a slight reduction in cancellations bodes well for buyers' willingness to follow through on purchases.
  • Beazer Homes (NYSE: BZH  ) won't announce fourth-quarter results until Thursday. But in the third quarter, it saw new home orders jump 33%. Backlogs jumped at an even faster pace, with a rise of more than 80%.
  • Standard Pacific (NYSE: SPF  ) is in the same boat as Beazer, with a 38% rise in orders in the third quarter.
  • Pulte (NYSE: PHM  ) hasn't seen the backorder gains that investors had hoped to see. But losses are narrowing, while a few companies have actually started eking out profits again.

Put all that together, and you get a good beginning to 2012 from SPDR S&P Homebuilders ETF (NYSE: XHB  ) and other investments tracking housing.

More generally, we've seen a lot more positive news about the housing economy. The National Association of Home Builders recently released bullish estimates for 2012's housing activity, with new home sales pegged to rise almost 20% and housing starts jumping 17%, with further gains expected in 2013. And while you may doubt the NAHB's objectivity, Wall Street analysts come in with a range of predictions, many of which are quite optimistic as well.

What could pop the bubble -- again
Unfortunately, any assertion that the worst of the housing bust is behind us is premature. The coming problem has to do with the difference between raw home prices and true affordability of homes.

Right now, the cost of home ownership is extremely low compared to where it was during the housing boom. Fallen home prices and extremely low interest rates combine to give prospective homeowners the lowest monthly payments they can expect to see for the rest of their lives.

But low interest rates aren't going to last forever. As long as today's buyers haven't repeated the mistakes of their predecessors and instead have gotten fixed-rate financing that won't rise with interest rates, they'll already have locked in favorable financing. But when it comes time to sell those homes, new buyers could see much higher monthly mortgage payments even if home prices stay the same -- let alone if they rise.

When that happens, one of two things will result. New home buyers may once again overextend themselves to pay higher home prices, leading to another round of defaults. On the other hand, if buyers prudently refuse to pay more than they can afford for housing, then home prices could see another big leg down when rates rise.

Buyers, it's your market
If you're buying a home, fear of what the future may bring is actually your biggest asset. Sellers have already sat on properties longer than they wanted, and they might actually consider buyers' demands that they would have refused a year or two ago. Given the very real risk of further declines, use your willingness to take on that risk as a way to get more concessions from sellers.

As painful as the housing bust has been, it will only end once affordability becomes stable. With rates at unrealistically low levels, we haven't yet seen the other shoe fall. Until it does, there's more potential downside to the housing market.

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Fool contributor Dan Caplinger was early buying his house as with many of his investing decisions. You can follow him on Twitter here. He doesn't own shares of the companies mentioned in this article. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy helps put a roof over your head.

Read/Post Comments (7) | Recommend This Article (11)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 31, 2012, at 4:13 PM, Hawmps wrote:

    Can't disagree... home values are directly influenced by interest rates in a stable market, but we haven't had a stable market. People don't necessarily buy the "value of the home" they buy the "cost of the monthly payment" and that is one of the root problems of the housing market. You can trace the problems with the housing market back to when a house bacame more than a place to keep you out of the rain and raise a family and began to be sold as "the single greatest investment of your life" which is a bunch of BS. A primary residnece does not put cash in your pocket, it does exactly the opposite. I'm not saying it can't be an asset, and I'm not saying that you can't buy a house and come out ahead when you sell, but buying a house to live in simply becasue you think it's a good investment is purely speculative and a very bad idea; an idea that NAR, MBA, and NAHB has pushed for decades.

    Interest rates have to go up at some point (I'm sure most of us agree on that), and that will reduce the cash equivalency value of a mortage which in turn will work against value appriciation. Come to think of it, we really don't have a housing crisis in the US, we have a debt crisis and a housing surplus. To me, a housing crisis is an imbalance in the other direction, big demand and no suply. I think that there is a good arguement for stagnent home prices as interest rates rise over time but not until the real bottom has been recognized and it will take probably two years after reaching bottom that we realize, yes, that was the bottom.

  • Report this Comment On January 31, 2012, at 7:42 PM, duuude1 wrote:

    When the following interview with Shiller was posted a couple weeks ago the comments debate was pretty intense:

    There was a lot of hate thrown at Shiller in those comments, so here is some data to back up his statement that real estate prices COULD continue to decline:

    One of the stronger markets in the US is the Boston area and here are Mass Association of Realtor (MAR) data:

    And here is data from the more respected Warren Group:

    A realtor friend of mine mentioned that Wells Fargo is predicting lower interest rates. Lower rates usually imply more demand and higher prices. But despite the lower rates, the MAR is predicting lower prices.

    I agree with Shiller and Caplinger that home prices are likely to continue to fall for a loooong time. It is clear from the data that since prices continue to FALL despite historically and artificially low interest rates, that homes are far far far too richly priced still.

    The question is - do we rip the band-aid off quickly, or do we let the pain continue for years or decades and pull off the band-aid a millimeter at a time? The failure to pull the collective heads out of the sand and immediately recognize lost asset values is the reason why Japan had their lost decade+. We are similarly refusing to admit that our homes are NOT worth anywhere near the hyper-inflated prices of the past decade. It is already 5 years after the peak of the housing crisis.

    Do we let this go on for another 5-10 years?

    My thoughts: The data clearly shows that homes are NOT worth what sellers are asking. Buyers - don't buy and be the fool in the transaction. Seller - don't anchor to the prices you saw your neighbors get a few years or months ago. Drop the prices and get rid of the albatross quickly.

    Rip the band-aid off quickly, reset prices down to where they need to be (median home price = 3x median income, and other homes scale accordingly) - and let's get this whole market buzzing again like it should be!!

  • Report this Comment On February 02, 2012, at 12:51 AM, ScottmFool wrote:

    While I agree that some of the NAR & wall street expectations are overly optimistic, I find the pessimism in this article and comments equally misplaced.

    Bottom line: If people can pay the same or less in mortgage than rent, have the down-payment and are likely to live there at least 5 years, it's a no-brainer to buy. Rents act as a floor for property values.

    There are already markets where the mortgage is less than the rent a property can pull in. Therefore, in those markets property values are more likely near/at their "floor."

  • Report this Comment On February 02, 2012, at 4:54 PM, Hawmps wrote:

    >>"Bottom line: If people can pay the same or less in mortgage than rent, have the down-payment and are likely to live there at least 5 years, it's a no-brainer to buy. Rents act as a floor for property values.

    There are already markets where the mortgage is less than the rent a property can pull in. Therefore, in those markets property values are more likely near/at their "floor.""<<

    The mortgage has to be less than rent or else it doesn't work. It doesn't cash flow. One important thing I think your missing is this-- inherent in the rent the landlord receives is a premium for risk, reserves for replacement, regular maintenance, profit, etc. The rent, over time, pays for that stuff above and beyond the mortgage. If it doesn't, you made a poor investement and good luck to you. The tenant will not pay for maintenance etc. therefore there has to be a margin between rent and mortgage. The tenant should EXPECT to pay more for rent than a monthly mortage payment because they have significantly less risk.

    This is completely contradictory to the status quo thinking that "if I can afford $2000 rent, I can afford a $2000 mortgage" and that is not true. People have been led to believe that it is a straight 1 to 1 comparison rent to mortgage, but the renter does not account for the landlord paying for maintenance etc. with a portion of their rent dollars. Hence, the new buyer (former renter) gets their $2000 mortgage only to learn the hard way that they have to replace the water heater with their own out-of-pocket and that just blew their monthly housing costs out of the water. As a good rule of thumb, your mortgage+taxes+insurance (PITI) should be about 75% of the equivalent market rent you would be paying for the same property and the cost of your new water heater (and all the other nickel and dime homeowner expenses) should ballance out over timeline of several years. Eventually your dream home will need a new roof.

    As far as the major builder's recent reports... I think it is more of a sign of gaining market share from the little guys that went belly up rather than actual market gains. The home building industry does not need gains in construction, it needs absorption of existing product.

  • Report this Comment On February 02, 2012, at 8:06 PM, ScottmFool wrote:

    @Hawmps: your point is well taken, but outside the scope of the point of this article, which addresses the downside potential of real estate.

    I contend that in many markets, due to mortgages being lower than the rent for a comparable property, the value of property in those areas is at/near their floor. I think the pessimism conveyed in this article is not grounded in much reality.

    Again, if people can pay the same or less in mortgage than rent, have the down-payment and are likely to live there at least 5 years, it's a no-brainer to buy. Rents act as a floor for property values.

  • Report this Comment On February 02, 2012, at 9:01 PM, duuude1 wrote:

    ScottmFool - in both your posts, you raised the mortgage/rent relationship as having some bearing on the direction of home prices. Hawmps addressed the flaw in that argument.

    I'm obviously in the camp that says home prices will continue down for a long time based on what the data is showing (and even more based on what Shiller says since he has a history of being correct - making calls that are clearly contrarian in nature - I love contrarians - it's also how I invest).

    And I agree with you that rents in many markets are probably rising higher than mortgages for a comparable home. Then why, ScottmFool, are prices still declining in 19 of 20 metro markets? The data is out there for you to see. Even the realtors, the world's most reality-denying species on earth, my good buddy included, have come to the conclusion that home prices will continue down - even despite predicted decreases in interest rates. Despite interest rates falling - still no one wants to buy.


    When we as Foolish investors buy a stock that is falling - what is the phrase that many Fools throw out - something about catching a falling knife...? And that is for an investment of, oh, maybe $500. Or $1k. Or $5k. Or $10k for big spenders? We ain't in the 1% in this club here, right?

    So why on earth would even the miserable financial fools out there who bought overpriced homes in 2006 with balloon interest and no money down, ever consider spending many $100k's on the biggest freaking falling guillotine ever?


    Instantly losing major capital, and for how many years, only to save a few $$ versus rent? Does that make any sense?

    So how many of us feel 100% certain about our jobs in today's environment? Are you sure that your job, your company, heck even your freaking industry - will be around next year, 5 years, 10 years from now?

    So if you lose your job next year - will you take a haircut on your home to move 1000 miles away? If homes continue to decline for 5 years, and your company is no longer viable, will you take a 20% cut on your home price to move? Do you think these minor considerations may be weighing as well for some who might consider buying a home?

    The mortgage/rent relationship has no weight against falling home prices combined with today's economy. Who want's to buy? Currently no one. And I feel that no one should buy until prices are MUCH lower, in order to provide a margin of safety in case you do lose your job. Renting is much safer. Oh, and that "throwing rent away" line - right now it's the buyers that are throwing their capital away.

    Buying will be a good idea again, just not right now.

  • Report this Comment On October 30, 2012, at 6:25 PM, ScottmFool wrote:

    > The mortgage/rent relationship has no weight against falling home prices combined with today's economy. Who want's to buy? Currently no one.

    I sold one of my rental properties (which I owned with no mortgage, and I wanted to free up the cash), just last month.

    I did receive some lowball offers, however I was able to sell at the price I asked.

    The market is not as bad as you think it is.

    I stand by my original statements. And the following months have so far proven me correct.

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