It’s time to adjust personal financial plans to deal with the future of housing prices

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I submitted this rather bleak economic commentary on the future of the residential housing market to the Wall Street Journal this morning. Even though no one likes to be a “downer”, it is important to our economy that individuals recognize the changing economic conditions as the first step toward taking leadership positions to address the underlying issues. Delay in recognizing these changes would be defined by economists as a “market inefficiency”, essentially an unnecessary drag on our economic growth.

Residential housing prices will continue to be under serious pressure for the foreseeable future and may continue to decline in real dollar terms for the rest of our lives. The easiest way to understand the issue, I think, is to first consider the internal component of housing prices: household income. Think of a consumer’s total household income as a pie. We know that health care, energy, taxes, insurance and food will take a significantly larger slice of our pie in the future. What’s left over to absorb the impact? Housing, consumer goods purchases, debt service and savings will be a smaller portion of the pie. In the past, we have relied on the financial rule of thumb that a financially solvent household can spend up to a third of the pie (total income) on housing (mortgage, taxes and insurance). In the future it might only be a quarter of the pie or even less. This factor alone is more than enough to crash a housing market recovery.

Next, we must consider the impact of three of the largest external drivers of housing prices:

First, remember that housing prices since WW2 have been highly dependent on the availability of abundant, easy and liberal mortgage financing. There is no sign that this will resume anytime soon.

Second, long term household income is under pressures triggered by declining productivity. Productive work careers will be shorter due to deficits in early adults’ education and to declining health trends in late careers. Unemployment will likely remain much higher in the future than in the past. In short, American consumers will be less affluent than in the past.

Third, on top of all this, the impact of aging baby boomers leaving behind an excess number of larger, mostly unaffordable housing units will be felt for at least the next decade. Remember that housing, in macroeconomic terms, is essentially a commodity and a so a very small excess supply forced on the market can have a dramatic effect on bringing prices down.

None of this discussion considers the impact of the huge but less predictable forces of inflation, government/political actions, climate change and natural disasters. While we cannot predict the impact of these forces, we do not imagine that the results will be favorable for the economy or the housing market.

When considering all of this in the big picture, I don’t see any realistic probability of a sustainable recovery in housing prices. We will likely see a continued and substantial drop in prices with the bottom of the market, even in nominal dollars, is still years away.

One thought on “It’s time to adjust personal financial plans to deal with the future of housing prices

  1. What are the three keys to successful real estate investing? Location, location, and location. Over the past decade the value of real estate in some areas has more than doubled in value while other locations have dropped by 80% or more.

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