Homeowners and real estate investors have gotten used to the mantra of “Home Prices Always Go Up“. Chastened by the recent market implosion, their new cry is “Over The Long Term, Real Estate Always Appreciates”. Let me suggest a slight modification to their slogan – “Housing Prices Will Keep Up With Inflation Over A Very, Very Long Time”. It’s not catchy but the the fundamental drivers of real estate appreciation in the U.S. just aren’t there. While it’s possible that home prices won’t decline much further, don’t expect housing prices to start soaring any time this next decade.
The following 5 Factors, will put downward pressure on any price increases for many years to come:
1) Mortgage Rates Are Not Going Lower:
The real estate play on interest rates is over. Current interest rates for a 30 year loan are hovering around 4.5% to 5.25%. Years ago, in the late 90s, you were lucky to lock in an interest rate under 8.0%. In the early 80s, interest rates on fixed rate mortgages soared to 17% or 18%. Back in the early 80s, a good size house in a major metropolitan area fetched around $125K. By the late nineties, that same house went for about $275K and these days it would command a price of $500K.
The real estate industry will point to these figures as irrefutable evidence that home prices always go up. What they don’t tell you is that, because of stratospheric interest rates back in the 80s, the $125K house came with a heavy price tag – monthly payments of $1,883. By the late 90s, interest rates had simmered down a bit and the payment on a $300K mortgage was $2,115. Today, with interest rates as low as 4.5%, financing a 500 thousand dollar house requires a monthly payment $2,533. When you consider how much wages have gone up in the last 25 odd years, the moderate increase in monthly payments is actually pretty reasonable if you factor in wage inflation.
The problem is that rates are not going to zero and there is very little chance that they’ll go much lower than 4.5%. It boggles that anybody would accept a 4.5% return for 30 years.
Perhaps the number one question that’s rattling international bankers from Peking to Paris is how much longer foreign investors will continue to buy our treasuries at current rates. If you factor in the decline of the dollar – many of these investors have taken a major hit in terms of their local currencies. Going back to our real estate theme – the bottom line is we’re not going to see housing price increases fueled by lower interest rates for a long time to come. The far more likely scenario is that we will see increases in interest rates putting downward pressure on prices.
2) Demographics Don’t Support Large Home Price Appreciation:
Our population is growing at an anemic pace. Real Estate is local and that can have an extreme effect on places like Silicon Valley or Las Vegas. But right now, the only places that are driving job growth have massive inventories of houses on the market. Housing and income taxes in Texas are dirt cheap and there are no natural barriers in Dallas or Houston to inhibit urban sprawl – they can just keep building. Real estate taxes in Texas are relatively high which mitigates the ability of people to buy expensive houses even at these low interest rates.
The demographic indicators are sobering. We’re just not having that many babies, certainly not enough to generate the boom in housing that occurred in the 1980s when all of the Boomers saddled with kids entered their peak earning years.
Real estate agents will point out that increased immigration will boost the demand for single-family homes and there’s more than a grain of truth to that. But the vast majority of illegal immigrants couldn’t afford an entry level home even if the bank was willing to lend them the money. It’s hard enough for them to open a checking account. As for legal immigrants, who usually end up working in low paying jobs, the only reason some of them managed to buy a house was the lax lending standards. The small percentage of legal immigrants that manage to land high earning professional jobs are not going to be a significant factor in driving up housing prices. When you consider all the demographic indicators, there is no massive group of buyers waiting out there to snap up the surplus inventory of housing and drive housing prices up.
3) The Boomers Will Sell Homes:
The massive baby boomer population is starting to hit retirement. Many of them are sitting on nice 4 bedroom 3,000 square foot houses that they have absolutely no need for. Even at today’s prices, they can trim down to a nice condo in Miami or Arizona for $100,000 and fund their retirement with the difference they pocket from the sale of their home. The Boomers were a big driver of price appreciation in the 80s and 90s and many of them weren’t quite ready for selling earlier this decade. That trend will reverse and put downward pressure on prices for decades – especially on larger houses and mega mansions. Sure, many Boomers will remain in their houses, but a good percentage of them will decide to downsize to fund their retirements. Few things effect real estate trends more than the great demographic bulge we call Boomers and they are going to push home prices down.
4) Household Incomes will be Stagnant:
Wage inflation pressures comes from a lack of worker supply, competitive bidding, and increasing profits. The supply of workers is huge and unemployment may not peak until 2011. It may reach upwards of 13% officially and 20% unofficially. Globalization will continue to put enormous downward pressure on salaries as American companies search for ways to cut cost and maximize profits. Nothing cuts labor costs better than moving jobs overseas. The lack of profits will also reduce the competitive poaching that drove up salaries in the late 1990s. The other driver that helped catapult housing to such enormous highs was the entry of women into the workforce. But that positive effect is over and won’t have any future impact on home prices.
5) Taxes Are Increasing:
Governments around the country from the local level all the way up to DC have been busy raising tax rates. Even amid a record drop in prices, tax assessments in many localities continue to surge by as much as 20-40%. In addition, state income taxes and sales taxes are all climbing. When you take into consideration the unsustainable federal deficit and the requirements of retiring baby boomers who will cast their votes based on the size of their Social Security check – you have to believe that federal income taxes will rise and become more progressive. Baby boomers always get their way by the sheer force of their numbers and retired people tend to be the demographic that is most likely to vote – upwards of 80% of them make it to the polls and they have plenty of time to volunteer for campaigns. Like interest rates, federal taxes rates are at historic lows. While mortgage interest is tax deductible, it isn’t for the huge number of people that still claim the standard tax exemption. First time buyers will find it harder to save up that obligatory down payment as more of their discretionary income reverts back to taxes. With taxes heading higher, there won’t be any money for higher mortgage payments and home prices will stagnate.
Even seasoned real estate agents that preach and actually believe that real estate always goes up fail to realize one crucial thing: They spent their entire careers in a place and time when all the five of the above supported home price increases. Even if the U.S. burns off this oversupply of distressed housing, don’t expect to see the kind of appreciation that we saw from the early 1980s to 2007: none of the key factors support it. Moreover, none of these factors speaks to the post-bubble market psychology that will cast a dark cloud on real estate for some time to come. And you can never predict when those dark clouds will disappear. Americans might have short memories – but not that short. I’ll take a stab at it anyhow – it will take from seven to ten years before we see a slightly bullish real estate market. Its been nearly 10 years since the NASDAQ melt down and it’s far more likely that we will see another technology bubble before we see the next real estate bubble.
Omie Ismail is the CEO of LiveCheap.com, a website focused on helping people live better and cheaper. A successful software and information chief executive, Omie has a passion for helping people improve their personal finances by making better, smarter, and cheaper decisions. Through
http://www.LiveCheap.com”>Live Cheap, he has helped tens of thousands of people learn to Live the Good Life Cheaply.
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http://www.livecheap.com/house/buying/430-5-reasons-low-interest-rates-wont-increase-housing-prices”>Interest Rates Won’t Increase Prices