2010 Was the Worst Year in Housing Ever?So Is Now the Time to Buy?

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By all accounts, 2010 was a terrible year in the housing market. How terrible? An article this week on Yahoo! Finance sums it all up in the headline: New-home sales in 2010 fall to lowest level in 47 years.

That?s almost half a century and longer than most Americans have been alive. But even that doesn?t quite capture the gravity of the situation. Apparently records tracking new home sales only go back to 1963! Or put another way, 2010 new home sales were the lowest on record! In reality, no one really has any idea how far back we?d have to look to find sales figures that low.

Another article on the same subject, released last week from Bloomberg gives some telling statistics: 1.28 million new homes were sold in 2005 (peak) versus 321,000 sold in 2010?that?s a 75% reduction in the number of new homes sold in a space of five years. In addition, we?ve experienced a 30% drop in house prices since the price peak in July of 2006.

The curious way news is reported

Now here?s something interesting about the two articles cited above: both have put a positive spin on those numbers!

The Yahoo piece centers on the fact that December sales were 17.5% higher than November?s, and that economists are predicting a solid rebound for 2011. The Bloomberg article has decided that the truly important story is that the largest builders are poised to grab an even bigger share of the market as sales improve going forward.

Talk about making lemonade out of lemons!

I?m certain that at least part of the reason for the upbeat tone has to do with the January Effect. January is the month that we put last year behind us and start fresh. Resolutions have been made, projections issued and budgets established and we?re never more confident on the success of any of them as we are at the beginning of a new year. As an example, the Dow finally crossed the 12,000 mark this week for the first time since 2008 when it was heading the other way.

Optimism is another factor. I think it?s the natural human state; no matter how bad things get, at least some part of us remains optimistic that it will all get better. And when things get as bad as they have in the housing market, it?s also natural to start to believe that things can only get better.

Why the euphoria on housing may be premature

It?s usually when a market deteriorates the way housing has in the past few years that I?m most optimistic about its future. Inventory is up, prices are down, interest rates are the lowest in history and the economy looks to have bottomed, at least for the near term.
At a minimum I think we?ve reached the point where there are deals to be had.

And yet there are nagging problems with housing that can?t be ignored. Consider the following?

Price/interest rate relationship. House prices have fallen significantly in an environment of record low interest rates?below 5% for a 30 year fixed rate loan for much of the past two years. At any other time in history, significant drops in mortgage rates would resuscitate housing in a matter of months. Something?s different this time.

This begs an obvious question: if low rates failed to lift the market, what affect will rising rates have? If we?re betting that rates remain low for the next couple of years, we?re also betting that the economy will remain weak. How will that support housing? This is an apparent conundrum and we?ll have to wait to see how it plays out.

Home ownership isn?t as tax friendly as it used to be. Income tax deductibility has always been a major driver for the housing market. But the tax benefits of homeownership aren?t what they used to be. Standard deductions have steadily risen over the past five years, while lower house prices and interest rates have shrunk the amount of mortgage interest likely to provide a tax deduction.

The standard deduction for married filing jointly is $11,400 for 2010; at that level, the tax benefit to many homeowners is limited. For some, there will be no deduction at all, since interest, taxes and other deductions will fall beneath the allowance.

Mortgages aren?t as easy to get. Mortgage financing remains much harder to get than it was at the peak of the market when house prices were soaring. No down payment loans are harder to find, while sub-prime mortgages, no doc and stated income loans are all history. All were major drivers of home sales. Unless we?re converting to a largely cash market it?s hard to see activity picking up significantly. Mortgage financing has always been the grease on the wheels of housing, and it remains impaired relative to where it was when the market was booming.

Lost equity.Finally, there?s a pronounced lack of home equity. A 30% decline in house prices has wiped out hundreds of billions of dollars in equity that would be necessary to enable current homeowners to tap by selling their homes to trade up to bigger, more expensive ones. In a nation of non-savers, it?s hard to see where the cash will come from for all those down payments.

How to avoid being a victim of a false start in housing

With all of those factors dragging on housing am I suggesting that you avoid buying a home in the near future? Not at all.

I?ve lived long enough to know that ominous adversities are often overcome by developing trends that have not yet been identified. A new technology could create fresh capital and millions of jobs; an economic or political collapse in a major country or region could send millions of people and billions of dollars flooding into the US; the DOW could race to over 20,000 in less than two years, creating a trickle down wealth effect into the housing market.

But until one of those events (or something similar) become obvious, it?s best to protect yourself and your money so that you don?t become a victim of a false start.

If you do want to buy a home, and think now is the time, consider the following as you do:

  1. Buy less house than you can afford. The time horizons on homeownership are now significantly longer than they were a few years ago. The easier a house payment is to manage, the more staying power you?ll have for what ever the future holds.
  2. Pay less than CURRENT market for what ever you buy. That will provide needed margin just in case prices aren?t done falling. (BTW, the fact that you can buy a house for less than it would have cost five years ago isn?t material?current market is all that matters, and you should buy below it in this environment.)
  3. Have a workable plan to payoff your mortgage early. Refinance options are constrained and there?s no telling how long that situation will continue. If you follow the first recommendation, this will be much easier.
  4. Make the biggest down payment you can afford without leaving yourself completely broke. If you can?t make more than a minimum down payment, it might be better to wait until you can. Take your time?there?s no rush to buy in this market.
  5. Make sure you?ll have a cash cushion after you close on the home, and don?t spend it all on furniture afterwards! You probably won?t be able to rely on a home equity line to cover shortfalls and credit overall isn?t as generous as in the past. This is not a market where you want to be stretched thin!

The above suggestions should keep your financial ship afloat even if the housing market isn?t done falling?and I wouldn?t be 100% certain of that even if 1000 economists say otherwise.

What do you think? Is now a prime time to buy a house? Or do you think there?s still too much to be worked out in the market to take a chance? What suggestions would you make to a person looking to buy now?

( Photo by bluegras )

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6 Responses to 2010 Was the Worst Year in Housing Ever?So Is Now the Time to Buy?

  1. Is your home above, below or AT intrinsic value? That is the question whose answer will tell you whether or not to buy. The simplest way to determine intrinsic value is Comparable Rent. If you could rent the house for less than it costs to pay the mortgage, taxes and association fees, then the home is overpriced. Nationally, based on comparable rent statistics, the market still has a ways to drop.

    I must take issue with your recommendation that people pay off their mortgages early as that is (in my mind) the exact wrong thing to do. Better to take that money that you would put towards principal and tuck it away into some kind of slow but relatively safe growth account. That way you will have it there to pay the mortgage should you lose a job or become disabled. It will grow (while money in home equity has a 0% rate of return) and you will maximize your interest deduction.

    Too many times I have seen people work to pay down their mortgage, get within $50k-100k of doing so and have something in their lives trip up the process. The banks are not forgiving at all in this instance and if you do not have cash reserves to keep up the payments you could lose it all including the equity you have built up over the years. In fact, a bank would much rather foreclose on a home with 10% loan-to-value than one with 90% loan-to-value (or underwater even).

  2. John – Very good point on intrinsic value. I’d never heard it called that (other terms might be rent capitalization value, rent value or economic value), but it is a good barameter. It seems it would be more valuable to apply it in the search for your next home, since the current one is essentially a done deal.

    On paydown the mortgage vs. accumulate more savings, I tend to think of that as an open debate–I even debated with myself over the point before writing it! In a perfect world it’s best to do both. The reason I came down on the side of paying down the mortgage is that as a society we’ve become too casual about carrying mortgage debt. It’s largely considered to be “good debt” and thus exempt from the usual rules of managing debt.

    An emphasis needs to be made on paying the loan off, rather than assuming it’s some sort of funny money debt that can be paid off with a future source of funny money. Millions of homeowners are now coming face-to-face with this assumption right now.

  3. Kevin–I invite the readers of this post to check out your blog-response–and the question that I pose in my comment that follows on his site. Kevin is a realtor and as you might expect, sees things quite differently. Neither of us are right, neither of us are wrong–we just have different takes on the same topic. A reader can benefit by checking out both blogs, then deciding for him(her)self which course of action to take.

    Thanks for the dialogue Kevin!

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