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Annual analysis of the real estate markets: - The USA

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What to Expect in 2015 in the Property Markets

(To the right is a link to an audio version of this article if you would prefer to have it read to you.)

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Please note: I wrote this article at the beginning of november. Since then something drastic has happened to the world economies. The price of oil has dropped about 40%, and lower prices appear to be here for at least the near future. This will impact on the cost of doing business, and will probably help to push economies higher over the near term.

We have an economic war in progress between the US and OPEC, and the US may well win. In short, the US looks to be getting back into the economic driving seat. Maybe we are at the beginning of a turning point here. I may well take another look at the US property market in the new year. As of the first week of December I am no longer so pessimistic about the US property market.

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It’s getting close to that time again. Every year during the later stages of november and early december I start looking at the housing markets and asking myself what we can expect from the next twelve months.

I have also been asked by a reader to make some comments on the American housing market. I have deliberately left that little job till closer to the year end, and it will now form part one of my annual round-up.

First, some general comments on how I am going to approach my year-end analysis. Last year I took three approaches, and made comments dependent upon three alternative scenarios. This year I shall develop some of those points, but instead, I’ll concentrate on areas rather than scenarios.

I will discuss the housing market in the US, I will then turn my attention to the UK, and then Europe generally.

Real Estate in the USA:

My first impression is that the US market is not looking at all healthy, and I will give my reasons in a minute. First though, let me say that the US is a big place, and the country cannot be squashed into a one-size-fits-all category.

There are areas where real estate is doing very nicely, and the rental returns are not just good, they are huge. We are talking about the new shale oil areas in Texas, the Bakken, and Marcellus. Rentals around Williston are bringing in mega returns as I mentioned some time back in my Big Pension (See the side-bar for a link) review of the area.

Other areas are currently doing well, including Florida and parts of California. Los Angeles seems to be on a tear, with Memphis and Seatle doing well. Those who are flipping property in these areas are currently seeing as much as 50% returns.

Two things are spurring on this love affair with real estate: low interest rates, and the group of folks known as millenials. This is the generation born between the 1980s and the early 2000s. The oldest of this group are now in their thirties, and some of them are now in a position to buy.

They comprise a large group; roughly 95 million, so they do have an effect on the market.

Unfortunately, this is only half the picture. One of the really worrying things about the rest of the country is that despite this boost, the general picture is not so rosy at all. We not only have a demographic shift taking place, but an economic squeeze upon the young. Let’s have a look at the situation, and how this is affecting real estate prices and prospects in the rest of America, and may well act as a drag on prices going forward.

There are several factors impinging upon real estate in the developed countries, and they are all unhealthy, and negative in impact.

First, let me state the obvious. We live in a debt economy. That goes for the US, Canada, the UK, the Eurozone, Japan, and China as well.

Those of you who have studied economics will know that is generally regarded as bad news. The reason is simple. If you spend tomorrow’s money today, then you don’t have it tomorrow. The way developed economies have been functioning for the past few decades is to continue to borrow in order to pay current liabilities. When the debt matures (needs to be paid back) governments borrow more, and so the debt is not paid off, but increases. As the phrase goes, the can is kicked further and further down the road.

This blatently irresponsible attitude to the future is encouraged by the low interest rates across the developed world. These low rates are even seen as negative because we are living through an era of deflation. In Portugal, where I live part of the year, inflation is negative (-1%), whereas borrowing rates are roughly 2.5% for property deals. That means the real cost of money is about 3.5% which is very low.

In America the real rate of inflation is anywhere between 10% and 15% depending on whose figures you use. The government pretends it is less than 2% because they conveniently dont count essential items such as food, housing and energy costs. If you accept the government stats then the real cost of borrowed money is, like in Portugal, very low. If you accept the Shadowstats figure then borrowing costs are negative.

As I never tire of saying, when you buy real estate you are usually buying for the longer term. Long term rates will not stay this low, so whatever people buy at today's prices will eventually begin to cost more as interest rates rise.

When they rise is another matter. If you can guarantee low rates for the duration of your loan, and you can get fixed rates in the US, then you are probably on a good deal. Despite that, it means that as interest rates rise new buyers will find the cost of a mortgage more, and that will tend to depress prices.

At the moment we have the illusion that all is well, except that what is effectively happening is that the current generation is borrowing from the next in order to pay their bills. This can’t go on indefinitely, and somewhere along the road there is going to be an almighty bang. The big question is: how long before that happens? I don’t know, but more and more people are beginning to realise that the end is now in sight.

This means that the next generation will be so burdened with debt that they won’t be able to afford higher real estate prices. But that is only one aspect of the problem.

Students leave college in the US with roughly $50,000 worth of debt. How do they pay that back? By living with their parents because they can’t afford to survive and pay rent. They certainly can’t afford to take out a mortgage. That means a double whammy: less demand for rental property, and less demand on the buy side. Less demand equals a fall in prices.

Let’s take that a stage further. Living with parents means delaying or not bothering to have children. That means a drop in population levels. That also means less demand for houses in the future.

Let’s make this a bit worse. Wages in the US are now lower after inflation than they were in 1971.

It gets worse. Real unemployment in the US is hovering around the 23% level. Excuse me but that is rather a lot. Looking to the future, unemployment or underemployment for recent college graduates is running at 45%. Those unemployed folks won’t be buying houses any time soon.

It gets worse. If the government keeps borrowing to pay for the present, the future will have to pay it back. Any money borrowed which has to be paid back ultimately comes from money made in the future. The more of the money made in the future that has to be used to pay down today’s debt, the less there is to spend on other things. In short, the current generation is stealing from their kids, who are going to have a rough time. Hint: they sure won’t be buying houses with all that debt dragging them down.

Let me quote a few analysts. I dont have access to the figures myself, so I am taking them on trust.

Mark Hanson, a former mortgage banker and independent analyst, believes the housing industry overbuilt by 3 million units in the last six years. Why? Because the Fed is making cash available to a wide variety of  “spec-vestors” who bid up prices with no intention of actually living in the houses. This produces a supply hangover – just as subprime financing did in ’07 – that must be liquidated. He expects a 10% to 20% decline in prices over the next two years.

Another analyst is Joshua Pollard, formerly of Goldman Sachs’s housing research team. In a report sent to the White House on September 17, he warned that houses should fall 15% in price over the next three years. One of the reasons is falling income.

The latest report from the Census Bureau shows median family income has fallen from $57,000 in 1999 to just $51,939.

The number of households in the USA is also decreasing. The New York Times reported earlier this year that household formation has collapsed from 1.35 million per year between 2001 and 2007 to only 565,000 between 2008 and 2013.

Short term, the hot areas may well stay hot a bit longer. How long is anybody's guess. Long term, things may improve, but my advice is, if you are going to buy anything in the US at the moment, I recommend what I have always recommended: agriculture and forestry.


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