November 23, 2009
LISTEN (mp3 audio) (6:09)
Suppose you owned an asset with a market value of $500,000 in 2007. Because of the economic turmoil of the past two years, that same asset is worth $300,000 today, and is rather illiquid – i.e., there aren’t very many buyers, even at the reduced price. Suppose this asset is your home.
Is it likely that your home, and other personal residences, will regain their lost values? And if so, how long will it take?
Providing accurate financial predictions for the future is difficult even for experts, but residential real estate is particularly hard to figure because the issues impacting homeownership go beyond falling prices. In fact, it’s possible to consider that the United States is on the cusp of a great societal change regarding the “American Dream” of owning one’s home. And since a personal residence often constitutes both the biggest purchase and largest asset in many Americans’ financial lives, the future of residential real estate could have a significant impact on their overall financial well-being. Some things to consider…
A Quick Recap of the Bubble:
Encouraged by government programs to expand homeownership for all Americans, lenders were able to make loans to home buyers with poor credit, questionable income and limited savings. As more people became prospective homeowners, the demand for residential housing went up, both for existing homes and new construction. Increased demand drove a subsequent increase in real estate construction and prices, and the housing boom was ignited. According to the Case-Schiller U.S. National Home Price Index, average residential home values increased almost 90% from 2000 to 2008, an annual increase of just under 8%. In some parts of the country, the increase was even higher.
Alas, the economy softened, and many of the new homeowners with poor credit, questionable income and limited savings proved unable to make their mortgage payments. Large numbers of defaults led to a flood of foreclosures, many of which were unloaded by lenders at steep discounts. With fewer qualified buyers and a glut of homes available at reduced prices, the bottom fell out of the market. The degree of decline varies geographically, but decreases of 30% from 2007 highs are common, with some areas seeing drops as steep as 80%.
Economic Factors
The fallout from declining real estate values has been predictable. First, there are fewer qualified buyers. While reduced prices have motivated some people to buy new homes, the recession has sharply reduced the number of qualified homebuyers – more households are unemployed, under-employed, in transition, or broke. Second, to avoid repeating previous mistakes, banks have understandably tightened their lending requirements, meaning obtaining a mortgage isn’t as easy as it used to be. The end result is a significantly reduced pool of prospect buyers for residential real estate.
A shrinking pool of prospective home buyers makes it harder for existing homeowners to move up, or simply sell their home. When residential real estate was booming, it wasn’t just new homeowners that were buying and selling. Existing homeowners saw a chance to leverage their increased values by trading up to more expensive homes. But with depressed prices, existing home sellers often won’t net enough equity to trade up. And those who would like to sell their home (because of a job change, retirement, or other issues) are finding they can’t afford to take the financial hit of selling in a down market – it makes more sense to stay where they are, or rent out the home.
Geographic Factors
In certain parts of the country, “out migration” is occurring, i.e., people are leaving the area, and overall population is declining. In some areas, the migration reflects declining employment opportunities (such as Rust Belt automotive communities), while other migration may reflect subtle changes in the way people live in the 21st century (more on this in the “Demographic” section). But in any place where the population is declining, the numbers of potential homeowners drop as well, and there’s a strong likelihood housing prices will decline.
The Demographic Factors
Another factor affecting residential real estate is the changing nature of residential housing, particularly as the Baby Boom generation swells the ranks of retirees. Since the end of World War II (and the start of the Baby Boom), the major residential housing trend has been a steady migration to suburban living – stand-alone, one-family residences in subdivisions. According to a September 19, 2009 Wall Street Journal article by Glenn Ruffenach, nearly half of the U.S. population lives in suburbs. These neighborhoods “may have been a good place to grow up. But the suburbs are proving a tough place to grow old.”
He continues:
“Indeed, as the country ages, suburbia’s widely assumed benefits — privacy, elbow room, affordability — tend to vanish. Maintaining yards and homes requires more effort; driving everywhere, and for everything, becomes expensive and, eventually, impossible. (Research shows that men and women who reach their 70s, on average, outlive their ability to drive by 6 and 10 years, respectively.)”
Suddenly, the seclusion of “place of our own” is seen as isolation from extended community. What happens to the residential real estate market if most of America doesn’t want to live in a subdivision anymore?
The Historic Factors
From 1900 to the end of World War II, the national homeownership rate remained remarkably stable at slightly less than 50%; a 1997 report by the Fannie Mae stated the rate was never lower than 43% or higher than 48%. Fueled by the Baby Boom and government-sponsored incentives following the war, the homeownership rate jumped dramatically, rising to 64% in one generation (by 1964), and has remained at this level since.
Is it possible that homeownership might return to numbers similar to the first half of the 20th century? Perhaps. However, as baby boomers age, there may not be enough new homeowners to buy their homes. If the government decides to overhaul the income tax code and eliminate some incentives, some of the mathematical rationale for owning your own home could change.
Dealing with the “ic” factors
For the past few decades, buying a home has been touted as a smart financial decision. The expectation of steadily increasing values, the ability to sell and leverage up to a better home, the access to equity through home equity lines of credit, and favorable tax treatment of mortgage interest led many realtors (and homeowners) to boast “your home is your biggest asset.” Events of the past two years may cause some reassessment.
For many individuals, there is immeasurable intangible value in owning one’s home. This alone could provide justification for buying a home, even taking a mortgage. But while everybody needs a place to live, many of the wealth-building arguments for homeownership might merit a re-examination in light of the changing landscape, both economically and sociologically.
If the particulars of your situation are changing your view of homeownership, there may be ripple effects to other parts of your financial life. You may want to save differently, restructure your mortgage, or adjust your investment priorities, and look at other opportunities.
Those sound like good reasons to meet with your financial professionals, and consider ways to address how the “ic” factors of homeownership may affect you.
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