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 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 five 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. 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.
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.
2) Demographics Don't Support Large Home Price Appreciation
Our population is growing at an anemic pace. 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. 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. 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 four-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. 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. Globalization will continue to put enormous downward pressure on salaries as American companies search for ways to cut cost and maximize profits. 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%. 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. 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. It's 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 LiveCheap.com, he has helped tens of thousands of people learn to Live the Good Life Cheaply.
For more articles on real estate, visit "Interest Rates Won't Increase Prices".
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