Don’t buy a house right now! HOLD!!!

In the movie Braveheart, there’s a memorable scene where Mel Gibson’s character instructs his men to “hold!” The Scots devised a scheme to dismantle the English cavalry, but it would only work if they waited until the very last moment to strike. With the English cavalry bearing down, Wallace and the Scots probably felt pressured to unleash their plan prematurely, but this would surely have caused it to fail.

Like the Scots, many Americans feel pressured to buy a house in this inflated market because “children need a home to grow up in.” This is the emotional plea that you will typically get from the National Association of Realtors (NAR) and organizations like it.  They play on your emotions, so you foolishly buy into the propaganda even though homes in many areas are more expensive than they were in 2005-2006.  I’m of the position that kids do need a house, but buying one in this second housing bubble is just foolish.

Home ownership now sits at approximately a 50 year low, and that’s because homes are still too expensive for the average family to afford. Several months ago, a housing economist from Zillow reported that it is still a seller’s market with high prices, low inventory, and even bidding wars. Call me crazy, but I’ve always wanted to buy things when they’re on sale.  In many ways this market is more expensive than the one before the 2008 financial crisis because real wages have declined and the net worth of most middle class families has been cut in half.

According to a recently released NAR report, existing home sales for February 2016 were down 7.1%! This could be the start of the softness that I have been looking for, but by no means does it mean that renters should commence their house hunting. Continue to stay on the sidelines while keeping a watchful eye on home prices in your area.  I like to save homes on my Zillow app and check back periodically to see the settlement price.  Although there is little inventory, and listings are moving fast here in Northern VA, homes are usually selling below asking and well below the “Zestimate.”

Like children who have been promised candy, most Americans want it and they want it now! But if you can have the discipline to “hold”, then there is going to be a handsome reward for you after this second housing bubble bursts.

Renting: The New American Dream

rent own

Janet Yellen thinks the economy is doing so well that next week she may raise interest rates for the first time in nine years.  But many of America’s renters would probably beg to differ.  Twenty-five percent of Americans spend more than 50% of their take home pay on rent.  This amounts to 11.4 million people who are simply working to pay their landlord’s mortgage.  With less than 50% of their take home available, many of these rent burdened folks have little to contribute toward an emergency fund or retirement account.

What’s more frightening is that over half of all renters are over the age of 40!  The number of Americans now renting is at a 30 year high while the homeownership rate currently sits at a 48 year low.  Many of these renters are unemployed or underemployed with insurmountable credit card, student loan and vehicle loan debt.  It’s now clear to everyone that the National Association of Realtors dream of homeownership for all Americans is dead.  Well, at least temporarily.

The sustainability of this system is as likely as Bernie Madoff’s investment fraud.  Eventually, market forces will reveal that home prices are too high for real American incomes.  In many markets, home prices will need to fall by 40-50% to reasonably turn renters into homeowners again, and I can prove it.  Currently, the median priced American home is around $280,00, but the median income is only about $55,000.  This means that a typical house is about 5 times a typical income, which is 2-3 times greater for you than it was for your grandparents (1.5-2 times income).

Let’s say that you are lucky enough to have the $56,000 (20%) down payment for a $280,000 house.  Your monthly mortgage payment will be approximatley $1,400.  You earn $2,300 a pay day 24 times a year, but it’s only about $1,700 after Uncle Sam steals his “fair share.”  This typical American will need to spend over 40% of his take home pay on their mortgage, and that’s why Americans are renting.  Most of them can’t even come up with $500 for an emergency, let alone a 20% down payment.  And even if they could, 40% of their take home pay doesn’t leave room to make burdensome debt payments.

In order for our median income renter to be able to afford a home, he should only have to spend 25% or about $850 a month.  To accomplish this at today’s rates (3.75%), the home would have to cost about $165,000 or 40% less than it does now.  This will still be three times greater than the median income, but that will be a much needed improvement to what we have now.  A $165,000 home price would have a down payment of $33,000, which is $23,000 lower (40% off) than it is now.

Renters will become owners again, but not until the U.S. experiences another inevitable correction like we did in 2008.

It’s NOT Different This Time

Episode 21.001CNBC still thinks it is “different this time.”  In a post by Diana Olick entitled Frothy, yes, but don’t call it a housing bubble, she writes “This is not, however, a “housing bubble,” because by definition, an economic bubble eventually bursts, and home prices are very unlikely to fall.”  Olick continues, “…even if the Federal Reserve hikes its lending rate, mortgage rates are unlikely to jump dramatically.”  Well neither part is true, so please erase the last two sentences from your memory.

You see, homeownership is at it’s lowest level since 1967 because average Americans can only afford to rent something small.  They would probably love to have a single family home with a yard for the kids, but exorbitant home prices keep these families in apartments instead.  Interest rates need to go up so they can place downward pressure on home prices.  This will cause the monthly payment on a 30 year mortgage to eventually become more affordable for the nation’s renters.

Another thing to note is that a fair portion of purchasers are only in the market as an investment opportunity.  Olick admits this writing, “About one-third of buyers today are not using any financing, which suggests still strong investor demand.”  Many investors are jumping into the housing market because they’re temporarily able to cash flow these overpriced properties.  The profits landlords are making seem attractive in the short run since the stock market is already rolling over and saving has become obsolete.  These investors will be disappointed in the long-run though because tenants will eventually be able to afford their own place for an even lower monthly payment.

Once these landlords realize that their property is empty, then they’ll try to unload their property at fire sale prices.  The whole scene will turn into a vicious cycle, ultimately resulting in the pendulum swinging to the highest homeownership rate in U.S. history.  When measured in terms of precious metals, these homes will represent a tremendous value for the gold and silver bugs.

It may sound like the bursting of the second housing bubble will lead to economic prosperity, but that certainly won’t be the case.  Increased rates are going to stifle the economy in ways not seen since the Great Depression.  What’s worse is that these increases probably won’t keep up with the real cost of living, so prices will continue to rise on everyday items while jobs dry up.  This stagnation of rising prices in a worsening economy will be too painful for the Fed to ignore.  Most likey, the Fed will announce successive rounds of quantitative easing that will make the first three look modest.  Before anyone even realizes, the Fed could take the country into a hyper-inflationary depression (which I think is very likely) and unleash the Greater Depression ahead.