Wednesday, January 2, 2008

Your Future Housing Options, Part 1

Research from a multitude of economists, financial experts and housing professionals convey varying levels of negative projection for the U.S. housing market. All cite degrees of blame aimed at self serving lending institutions which made ill advised loans to unqualified buyers, packaged these loans which received a questionable “buy” rating and were then sold in the secondary market. The result, an unprecedented credit collapse in the U.S. economy, opaque institutional liabilities, a lot of finger pointing, and even more questions on how to potentially alleviate further housing depreciation. The resulting housing market plummet affects a large portion of Americans with relatively few solutions on hand. Application of the market strategy of hedging may perhaps be a creative solution for some home owners as a method of protecting what is for most Americans their greatest asset.

Housing valuations commonly utilize a metric based on the house price-to-rent ratio (P/R), which is akin to a price-to-earnings multiple for stocks. This metric is intended to reflect the relative cost of owning versus renting. Naturally, when housing prices are high relative to rents, potential home buyers will choose instead to rent, thus reducing the demand for houses and bring prices back in line with rent costs. Economists suggest that when price-to-rent ratios remain high for a prolonged period, prices are being sustained by unrealistic expectations of future price gains rather than the fundamental rental value, thus creating a bubble.

The application of this price-to-rent formula in key housing markets illustrates the dangerous climb in housing costs over the past seven years.

The price to rent ratio (P/R) compares the median single family home sale price to the median monthly rent for a 3 bedroom apartment in one of the top 10 housing markets. The financing terms assume a 20% down payment on a 30-year fixed rate loan and the historical median home sale price is determined by fitting the HPI index to NAR's median home sale price over the last few years. The median rent is again provided by Housing and Urban Development.

The basic formula suggests buying under the following conditions:

Rental rate + Appreciation - Interest cost > 0

Historically, the real after-tax, after-depreciation interest rate for houses is four percent. From 2000 to 2007 the nationwide P/R jumped from 15 to 24, an increase of 60%. Cities with the largest P/R increases are Tampa, 12 to 21; Washington, D.C., 11 to 26; and California’s east Bay, an area that includes Oakland, 28 to 51. Others argue that the historical P/R value should be 16.7 with the real after-tax, after-depreciation interest rate being 4 percent with additional maintenance costs (roofing, paint, HVAC repairs, broken water pipes, etc) taken into account. These are calculated at 1 percent per year and real estate taxes another 1 percent. To get a real return of 4% given these additional items, annual rent needs to be at least 6% of the house price instead of 4%, which then raises the P/R ratio from 15 to 16.7. For the sake of this blog, we will use the P/R ratio of 15. If the rental rate is 6% of the house price rather than 4%, it lowers annual appreciation rate from 4% to 2% which is not a realistic number. Lower price to rent ratios generally indicate that homes are more affordable.

Correspondingly, the U.S. housing phenomenon is powered indirectly by Asian funding. The Yen Carry Trade by Asian hedge funds exploits a 3.0% differential between U.S. and Japanese long-term interest rates. The yawning U.S. trade gap translates into a gargantuan trade surplus which Asian investors recycle into U.S. Treasury Bonds. Direct Asian central bank intervention, often transferred overnight, offers regular U.S. Dollar support by means of U.S. Treasury Bonds. Thus, Asian bond support is absolutely critical to the housing movement in supplying funds utilized in mortgage financing. Erosion in confidence in the U.S. economy and subsequent reduced investment in U.S. Treasury Bonds, along with the liquidity problem created by the foreclosure crisis, has led to a serious decline in consumer lending and subsequent adverse effects on the housing market.

Many analysts say the worst is yet to come. Banc of America Securities predicted in a report last month that the median U.S. home price would fall 15 percent over the next four years and not rebound until 2012. This is decline is partially fueled by foreclosed housing that causes comparable sales in a given area to under represent their true value. Bank of America, who recently bailed out mega lender CountryWide by injecting them with much needed funds, further estimate that with $361 billion in subprime loans made to borrowers with weak credit scheduled to reset at higher interest rates next year foreclosures will peak in the third quarter of 2008 and will not return to more normal levels until 2011.

The options for homeowners in the face of such negative reports are limited. Few people are willing to sell their homes now to avoid possible declines in the future. But Yale economists Robert Shiller raised one provocative possibility after the latest data was released, suggesting that homeowners may want to consider hedging their homes as a way to protect themselves against declines in their home values.

Continued in Your Future Housing Options, Part II


Anonymous said...

very insightfull

berto said...

Everyone who's interested in buying used or new heavy construction equipment, check out this site There are lots of equipment advertised: Caterpillar, Volvo, bulldozer, mobile excavator, farming machineries, and many more. Just contact the supplier and have transactions directly with the equipment's owner.

Alyson said...

Keep up the good work.

retail clothing franchise said...

The post is very nicely written and it contains many useful facts. I am happy to find your distinguished way of writing the post. Now you make it easy for me to understand and implement. Thanks for sharing with us.