Thursday, September 07, 2006

State of the market

Stagnant or declining home prices?

There are two theories to how homes will hold up for the next few years. Some suggest homes will hold their value or possibly inflate along more traditional lines, others like myself believe prices will not only decline to fundamentals but over-shoot to the low side.

Let’s look at the drivers of home prices:

1. Wages. One has to pay for that home

2. Inventory How many homes are for sale?

3. Job/population growth If homes are selling fast, sellers will try for “a little more.”

4. Optimism/Pessimism

5. Inflation If money is going to be worth less… seek stability!

Wages: With homes going for 10X to 11X median salary, there is a total disconnect with affordability. We’re seeing job losses from the south bay (e.g., Boeing is talking about closing Long Beach, No one I know can afford to hire, etc.) This indicator points to homes not appreciating. Declining? One indicator won’t answer that question. But it certainly points down.

Inventory: Its huge! We will be at record levels soon. Ok, it might decline in the Fall and winter… but when we see the traditional spring run up in inventory… The market is going to collapse under its own weight. This driver points to declining prices. This is also the driver that resulted in prices getting out of sync with fundamentals.

Job/population growth: We’re seeing good job growth in California, but its at or below the median wage. But United van lines is reporting they’re carrying a lot more weight out of California than into California (see my U-haul index article too). So I’m going to call this one a downward driver, but low intensity.

Optimism/Pessimism: This is herd mentality. We’ve been *very* optimistic on housing for years. So this can only cool. I’m calling this one a minor driver to declining prices. Beware, this driver could cause a rout in home prices if it goes too negative.

Inflation: We run a strong risk of inflation right now. But… If people cannot afford homes, it doesn’t matter what inflation does, people will not buy. I’m calling this driver neutral.

Overall? In order Inventory, Wages, Jop/Population growth, and Pessimism (or declining Optimism) all point to declining home prices. Inflation will get run over. I expect that with declining home prices the speculators will run for the doors thus making the inventory and Pessimism drivers all that much stronger.

In fact, I’m going to make a prediction. Declining home prices will drive down rents. This will pull down the core inflation in 2007 and 2008! Thus, I expect that by 3Q2007 the Fed will drop rates. Will we see inflation? Yes, I expect imported goods to ramp up in price pretty quickly by 10% to 20%. But the core’s largest component is rent. A declining economy also has a good chance of driving down oil prices… Personally, I believe deflation is of greater risk than inflation, but I lack the data to prove such a statement.

My vote is for a strongly declining market, and soon. Some have predicted a Post Labor day massacre in home prices. Judging by the huge number of new signs along PCH… I believe it. Remember, we’ve exited the summer selling season. Inventory should be tight this time of year. Some have noted with all of the homes on the market that the summer rentals will have a hard time getting school year rents… Thus the inventory driver will only grow.

We live in interesting times.

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