Housing Prices: The Data Everyone Is Missing
Will the housing bubble continue booming, or will it crash like it did in 2008?
It all starts with a very simple formula: Housing prices= income + rates + supply/demand.
These are the main factors, in my opinion, that make-up prices in the real estate market.
To understand how the formula works, I started by looking at prices adjusted for inflation from 1999 to today, using the Case-Schiller Home Price Index.
On the left, it goes from 50 to 200. This isn't the price of the house, as it is just an index. It shows a starting point of one-hundred.
The price was pretty flat until the beginning of the 2000s when the government, the Fed, and a lot of other factors helped us inflate the housing bubble that bottomed out in 2012.
I'd like to point out that prices didn't decline for six years. Then they went gradually up to where we are today, the same level overall as it was in the 2006 bubble. That's why I'm always confident in saying we're in a bubble now because we were in one back in 2006.
The graphic above displays the US housing market in general terms. Nonetheless, individual markets were a lot higher in 2006 than they are today. It's not the same, but overall, prices are just as high.
Any delta between the prices historic trend line and real wages is a “no Bueno zone”, which means prices are expensive.
Whether they are in a bubble or not is debatable, but anything over the 100-year trend line is expensive, anything below is cheap.
The previous graphic chart is one of the main reasons I went almost all in with housing in 2012. I saw it coming down to its historic trend line, so I thought the risk/reward was pretty good. It turned out to be a good bet.
I went on to review incomes with a focus on jobless claims. In the chart below I combined data from continued jobless and initial claims. It goes from 2009 to 2020.
I think in our minds, we think jobless claims are about the same as they were during the GFC. No chance. The pandemic has been at least five times worse than it was during the GFC.
Then jobless claims started becoming “less bad”, eventually plateauing to a level that was close to the peak of the GFC in 2009-2010.
The graphic above illustrates how the continued claims are starting to flatten out. They're not going down at a steep angle anymore. This would lead us to believe that we have a big problem with jobless claims or unemployment ahead of us.
Even when the initial jobless claims started to flatten out, they were still a lot higher than the worst points of the GFC.
What does this chart tell us about income that we can use to predict future prices?
It tells us that there's going to be downward pressure on real wages.
Mortgage rates are the second part of the housing price formula. At the beginning of 2020, they started at 3.62. In December from the same year, rates got down to 2.68% for a 30-year mortgage. That is mind-blowing.
Why have mortgage rates dropped as 10-year treasury yields have moved up?”
The next chart I examined might give us a glimpse as to what supply may be in 2021 or a little beyond. It shows the active mortgages that are currently in forbearance (forbearance plans) from March 2020 to December.
On the left, it goes from one million up to five million forbearance plans.
The CARES Act program began back in March and shot up forbearance plans to 5 million, then it went down gradually. Just like the jobless claims, it has flattened out to stay at a high level where the total of all mortgages in forbearance is upright around 3 million.
What could happen if forbearance plans start expiring en masse?
This could present a huge problem for the supply side of housing. Downward pressure on prices could happen when the forbearance program ends.
The forbearance claims have spiked recently, they're not going down significantly as is expected, which makes a lot of sense when we take into account the damage that's been done to the job market and incomes.
the difference between nominal prices and real prices
It’s critical to understand the difference between nominal prices and real prices. Real prices are adjusted for inflation. That's what you want to pay attention to. Why?
If you look at the home prices in Venezuela, denominated in their local currency, they have gone parabolic, but it doesn't mean that you have any more purchasing power by owning one of those properties.
Most likely, a lot less for the simple fact that it's located in Venezuela.
Why is inflation important?
This is a question that most people don't think through, so let's use an example of the government getting tax revenue.
We always hear that inflation helps the government because they're the largest debtor nation in history. Therefore, if they create inflation, it lowers their debt burden.
Why does inflation lower the government's debt burden?
Inflation lowers the government's debt burden because theoretically, tax receipts will increase to a level that makes it easier to pay down their debt.
If tax receipts don't go up, but inflation goes up, they're no better off, but worse off because their expenses increase.
It's the same thing when it comes to real estate investing.
You usually hear, “Well, inflation helps a real estate investor because it reduces the value of the dollars their loan is denominated in”.
That is, you are paying back your loan with cheaper dollars. Why? It's because rents, theoretically, go up too.
If there is consumer price inflation and rents don't go up at all, technically, you're not paying that loan back with any cheaper dollars. The rents have to go up for inflation to be important.
The chart of home prices adjusted for inflation I referred to in the beginning now makes sense because one of the main factors in a house is the level of income.
You need to have an income to pay the mortgage, even if the interest rates are low. As seen in the past, wages stay pretty consistent with the rate of inflation.
Assuming wages are constant, it's just a matter of looking at home prices adjusted for inflation to determine whether or not it's cheap or expensive.
However, if wages weren't consistent, if they went up and down dramatically like housing prices or stocks, then the chart would look different, as the following chart I created:
The blue line represents home prices, the green one wages. If they progress and remain flat, prices would go up as high as in 2006. That would mean the prices of homes are extremely expensive.
Because the gap between prices and wages has increased, the delta is extreme, it doesn’t necessarily mean that prices went up.
It's not just about housing prices adjusted for inflation, but housing prices adjusted for incomes, you need to have the income to buy the house and pay the mortgage in the first place. For some reason, that's something that everybody misses.
Mortgage Rate Deep Dive
So many people come to me and say, “George, I get it, that the housing market is in a big bubble, prices are at all-time highs, but it just doesn't matter because interest rates, mortgage rates are so low that it makes the monthly payment far more affordable.”
I get it, that's a very good point, so I examined mortgage rates in more detail. I began with a chart of the 30-year mortgage rate.
It goes from January 2020 to January of this year, on the left, from 2% up to 3.5%. Mortgage rates have gone from 3.62% down to 2.68%. The point in the chart I want to stress is from August to January, just a straight downward trend.
Next, I checked out the 10-year treasury yield from January 2020 to January 2021. On the left, it goes from 0.6%, 60 basis points, up to 1.6%. At the beginning of 2020, we were at 1.6%.
Then it crashed down with Covid-19 and became very volatile before reaching around 70 basis points in August. You may start to scratch your head and say, “Okay, well, if the 10-year treasury is a proxy for interest rates in the real economy…
How can mortgage rates be going down?”
I know that they're not tied to the hip and sometimes they can go in different directions, but you need to understand the concept.
One of the key takeaways that very few people are talking about right now is there is a risk premium -or there should be- on interest rates in the real economy.
Even if the Fed is coming in and trying to execute on yield curve control, they are buying treasuries, monetizing the debt to keep those interest rates on T-bills, 10-year, and 30-year treasuries down to where it doesn't affect the overall economy. It doesn't leak into mortgage rates, credit cards, or auto loans.
The problem for the Fed risk premium, because the market is going to look at future inflation expectations and if they are extremely high, it doesn't matter where the Fed is pegging the yield curve, mortgage rates will go up to 8%, 9%, 10%. Who knows how high they'll get.
In other words, the Fed could come in and try to peg the 10-year treasury yield at 1%, but if the market out there creating the loans have a high expectation for future inflation, mortgage rates could be at 9% or 10%.
There could be a huge difference between the two because those lenders know they'll most likely be paid back with cheaper dollars.
To gain a better understanding of this it’s necessary to review inflation expectations currently in the market. Commodities like the price of oil, wheat, or copper in 2020 have gone up. The same occurred with rates on the 10-year treasury, even though the Fed's balance sheet has gone parabolic.
Despite the Fed buying a lot of those treasuries, creating artificial demand, and suppressing yields, the market is telling us through price signals that it expects higher consumer price inflation in the future.
If the market sees higher inflation coming down the road, and there's a risk premium, why on Earth are mortgage rates continuing to go down?
I think you can probably guess, it goes back to the Fed's BS. The mortgage-backed securities the Fed is buying, or mortgage-backed sausages, as I like to call them, was going down.
They were selling them going into Covid-19, but then they reversed course and started buying as many as they possibly could, taking it up to two trillion.
At the beginning of 2020, the Fed had about 1.6 trillion of mortgage-backed securities on their balance sheet, they went down due to Covid-19 and went straight up to about two trillion. Since then, the Fed’s BS has gradually gone higher.
The Fed is taking away or reducing the risk premium because lenders know they can go ahead and flip that loan to the Fed, and still make money because they don't have to worry about being paid back with cheaper dollars.
The Fed will worry about that as the loan itself is on the Fed's balance sheet is infinite. They can be insolvent and it doesn't matter because they can just go to the computer and always print more bank reserves.
If interest rates, the price of copper, wheat, and oil are going up, this is telling us that the market expects more inflation down the road.
However, if mortgage yields are going down, interest rates on a 30-year mortgage continue to go down, this means that the Fed intervention has to be a more powerful crosscurrent than everything else that's going on in the market.
In the future, when we're trying to figure out if prices are going up or down in 2021, we have to understand we don't live, or we don't have anything close to a free market in mortgage rates.
You're probably saying to yourself right now, “Well, George, duh. Hello. I get it.” To think about the probabilities of prices going up or down in 2021, we have to use some game theory and try to determine the impact that central planning will have on those prices in the future.
Headwinds And Tailwinds For Prices In 2021
Will housing prices in 2021 experience a boom or a bust?
This is what it looks like on both sides of the equation:
Boom/Tailwinds (requires central planning)
- Very short supply of houses.
- Low mortgage rates backed up by the Fed buying mortgage-backed securities.
- Stimulus checks are more money in people's pockets.
- Household formation. Millennials and the younger generations have delayed forming households, so if that explodes in the future, it means more demand for houses.
- Forbearance also requires a lot of central planning and government intervention. If you're not required to pay your mortgage, then chances are there's not going to be very many homes for sale.
- Money-printing is everybody’s favorite. Whether the Fed is increasing bank reserves and that's somehow getting out into M2 money supply by monetizing the government deficit.
Bust/Headwinds (free market involved)
- Shortage of supply creates the incentive for more supply in the future. The cure for high prices is higher prices. The higher prices increase, the more builders are incentivized to create more supply.
- How far down can rates go? We're already at the zero bound. Are we going to get negative rates? If we do, is the Fed going to be able to buy enough mortgage-backed securities to get the interest rates on those 30-year mortgages down even further than they already are? There's not much room to go down, but there's a lot of room to go back up.
- The real economy. We're in a massive depression if you didn't have all of this deficit spending and stimulus checks.
- 52% of young adults, 18 to 29, live at home with their parents, a staggering amount. If you're living at home with your parents watching or subscribing to OnlyFans, the chances are you're not going to be forming any households anytime soon.
- Stagnant or maybe even declining wages when you adjust for inflation. Wages are part of the equation as big as interest rates.
- The true unemployment rate shows us there could be a lot of downward pressure on wages in the future.
Let's not forget: Without all the central planning and government and Fed intervention, the economy would be in a massive depression.
Whenever I see the talking heads on Bloomberg or CNBC, they're always saying that the economy has been fantastic over the past 10 years.
If that's so, then why have we needed 0% interest rates?
Why have we needed QE infinity?
Why has the Fed's balance sheet gone from 800 billion up to over seven trillion if the US economy is so healthy?
It's a rhetorical question.
The bottom line is the US economy is just like a heroin addict in the sense that you have to give it more of the drug just to keep it alive.
A lot of money-printing can drive prices higher, whether is done by MMT, UBI, or stimulus infinity where they turn bank reserves into legal tender.
The conclusion I want you to draw is that if we have a boom in prices, it would be predicated upon central planning. A bust would come if we allowed free-market capitalism to take over.
If you are bullish on housing prices in 2021, you're bullish on central planning. If you are long the housing market in 2021, you are long central planning and you're short free-market capitalism. I don't think that's a very good bet long-term.
What do I think and what is my opinion on housing prices in 2021?
In the long-term, I think housing prices adjusted for inflation have to come down. At some point in time, we have to come back down to our historic trend line and match up prices with incomes.
In the short-term, over the next year, I think we could see both a boom and bust. I created the chart below, it shows what prices could do in 2021.
They could go up in nominal terms, but down in real terms when you adjust for inflation. Your home price could go up by 10%, but if inflation goes up by 15%, you would lose purchasing power.
If your home buys less stuff when you sell it than when you bought it, you lost purchasing power regardless of whether or not the price went up.
Let me tell you a little story. The last time I spent a lot of time in the United States was in 2012. When I retired, I started buying a lot of real estate in Kansas City.
Occasionally, I would go to Chick-fil-A when I didn't have time for lunch. I'm not a big fast-food guy, but I'd go through the drive-through, I'd get a grilled chicken sandwich and one of those little cups of yogurt.
I just went back to Chick-fil-A for the first time in 2020, got the grilled chicken sandwich and the yogurt. The price of the meal was almost $14. I almost fell out of my car.
I looked at the receipt because I thought they overcharged me. They didn't, that was the actual price. Just that little cup of yogurt increased in price to like $5.50, or almost $6. It completely blew my mind.
What's my point?
If you look at my real estate portfolio, most of those homes I purchased in 2012 were about $75,000. Today they are worth about $150,000 or $160,000.
You may say, “Oh, my gosh, George, that was an incredible investment. You knocked it out of the park. Your homes have appreciated tremendously. You're doing all right.”
Let's think this through. I can't buy any more Chick-fil-A today with those houses than I could back in 2012, maybe less indeed.
I want to point out that, even if you lost purchasing power on the real estate as in my Chick-fil-A example, if you had a 30-year fixed-rate mortgage, you would be making money on the debt.
Because you'd be paying the debt back with cheaper inflated dollars assuming those rents went up or assuming your income went up with the rate of inflation.
What's the main takeaway?
What's the value bomb in this article?
I want you to make a shift in your thinking right now, here today. Back in the good old days of free-market capitalism, the property you purchased was an asset on your balance sheet and the debt, the mortgage, was a liability.
Today, as crazy as it sounds with all of the central planning in this upside-down world, I think the balance sheet of the average Joe has shifted.
Again, before, the house was the asset, the debt was the liability. Now, I think the debt could be the asset and the property itself the liability.
From my perspective, nominal prices for housing in 2021 maybe stay flat, go up a little bit, maybe down a little bit, not too much of a change as real estate takes a long time for it to change direction. Just like in 2006, prices took six years to drop by 50% and find the historic trend line.
Let me be clear: My opinion on prices in 2021 doesn't matter that much. What you should be most concerned with is changing your thinking, understanding that in the future, there will probably be a lot of money-printing, and central planning. The market is seeing higher inflation expectations, so you look at your balance sheet.
If you do own real estate, instead of seeing it as an asset, now I might even see it as a liability. On the other hand, that 30-year mortgage, if you know what you're doing, that's going to be your asset in the long term.