Should You Buy a House Now?

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by David Galland: Who's
Scoffing Now?



we have had a number of queries about real estate. And no wonder.
For starters, real estate prices have come down. Plus, in an environment
with next to zero interest rates, the idea of possibly picking up
some income-producing property on the cheap holds a certain appeal
to some. Then there’s the fact that real estate is very much
a “tangible” – and so should hold up reasonably well,
should the fiat currency system come undone, as we expect it will
before this crisis is over.

The following,
from reader and correspondent Ross, considers the issue of home
buying from an interesting angle.

My wife
and I have been considering buying/building a house for a while
now. After long months of searching, we have had to ask ourselves
about the "value" of a home. I say this because my parents
in 1972 purchased a 2,000-sq/ft home for $20,000. That was almost
exactly what my father made per year at his job at the time of
purchase. Is this ratio one to consider as a prudent homebuyer
not trying to live beyond his means? I make about $150,000 a year
and can’t imagine purchasing a house here in Pittsburgh for that
price and being happy with that purchase.

My parents
sold their home in 2001 for $180,000, which is obviously 9 times
what they paid for it. We are looking at homes in the low 300s
to purchase, and I can’t imagine the sales price in 30 years being
9 times that price, which would be $2.7 million! So do you see
my line of thinking?

Could hyperinflation
cause the price to "appreciate" that same way over time?
Is inflation what caused my parents home to return 9 times what
they paid for it? The reason I wrote to you regarding this topic
is that I thought maybe there was a future missive buried in this
line of thinking. Maybe not, but if you have time I would love
to hear your thoughts on home purchasing at this time.

In response,
I have to point out the obvious, that all real estate markets are
local. Simply, unless it’s a mobile home, you can’t pick
your home up and move. So, for example, you could offer me a house
in downtown Detroit for free, and I wouldn’t take it. But a
house up the road from me just traded hands at over a million dollars
(for the record, a 25% discount off the offering price). So where,
and when, to buy will largely depend on local market conditions…
and the value proposition of the real estate on offer.

That said,
given the dismal outlook for the U.S. economy and housing in particular,
if you’re going to buy today – you should only do it on
your terms. Don’t let a real estate agent push you into a quick
decision or into raising your bid. Someone might beat your offer,
but with the large housing inventory, the odds are good another
dream house is available just down the block.

Now, as to
the inflation question. If you do the inflation calculation, then
based strictly on the government’s debasement of the currency
over the last 30 years, the $20,000 that Ross’s parents spent
in 1972 is the equivalent of $107,000 today. That they sold the
property in 2001 for $180,000 confirms that there was more than
inflation going on.

As you can
see in the chart just below, while they sold it early on in the
housing bubble, by 2001 housing prices – encouraged by the
Fed’s loose money policies and a collapse in lending standards
– were already on their way to the stratosphere.

While much
of the appreciation in Ross’s parents’ home can be attributed
to currency debasement, it is reasonable to attribute the additional
appreciation to the general housing bubble and, finally, positive
local market conditions.

But that was
then, and this is now. Is now a good time to buy? Again, with the
caveat that all markets are local, my general sense is that it’s
too early, but maybe not by much.

Weighing in
on the “wait a bit longer” side of the argument is the
large inventory of homes. And while that inventory is high, it is
likely understated due to the shadow inventory of houses owned by
fed-up sellers who have pulled their homes off the market in order
to rent them and offset some of their carrying costs while waiting
for better days. In addition, there are millions of houses that
are either in foreclosure or will be before too long, adding to
the inventory.

On the demand
side, because of high unemployment, a sluggish economy, and the
end of government home purchase incentives, home sales are falling
again – indicating no significant decrease in house inventories
anytime soon.

On the flip
side of the argument, today’s mortgage rates are unnaturally
low – and so, unlikely to last. When they begin to rise again,
they are likely to rise a lot, and in relatively short order. First
and foremost, there is no way the government’s benchmark rates
can continue to bump along next to zero, especially not with the
amount of debt and deficits we’re running. And even a return
to a rate close to the long-term norm will have a devastating effect…
starting with mortgage rates (and, as a knock-on consequence, house
sales and prices).

something like 95% of all new mortgages are currently being purchased,
or otherwise guaranteed, by Fannie Mae and Freddie Mac. As you don’t
need me to tell you, those two organizations have essentially been
nationalized and are broke and doomed to fail. Simply, outside of
a full-on communistic system where all property is the property
of the state, the government can’t be the mortgage lender of
first, second, and last resort.

In time, as
Fannie and Freddie are revealed for the scams they are – followed
by another trillion-dollar bailout – the government is going
to have to extricate itself from the mortgage business, which will
result in rates being set by the market and not by government dictate.

Thus, buying
a piece of property today with a fixed-rate mortgage of just over
4% would be about as cheap a mortgage as you’ll ever get…
now and for the balance of your lifetime.

What about
inflation? Though one is tempted to add the likelihood of a big
inflation to the “buy now” side of the balance sheet –
because property is tangible – my sense is that it’s mostly
a moot point. While Ross can’t foresee a house that sells for
$300,000 today being worth $2.7 million in 30 years, not only can
we foresee that happening – we’d be surprised if that
were all it sold for. Of course, my reference point is today’s
currency units; in 30 years, much fewer “new dollars”
will likely be necessary.

because the past 30 years represent the salad days of the current
fiat monetary experiment. The fun part, if you will, with everyone
feeling wealthier because they had so many more dollars in their
bank and brokerage accounts, and because the things they owned that
were priced in dollars – Ross’s parents’ house, for
example – had appreciated in nominal terms. The next 30 years,
however, will include the dark years where the fiat monetary system
comes unglued.

When that
happens, some analysts expect that the dollar price of sound money
– gold – will rise to $5,000 an ounce. Other analysts
think it could go much, much higher than that. I don’t know,
and to some extent, as long as I have a sufficient position in gold,
I don’t care. That’s because the dollar is just a piece
of paper with some numbers on it. As long as my gold, and other
tangible assets I own, continue to hold their purchasing power,
even as the number of zeros on the dollar expands – I’m
good to go.

As a tangible,
the price of your real estate is likely to rise in dollars’
terms, but only because the dollar is falling. However, the premium
that Ross’s parents received as a result of the housing bubble
will not rematerialize in our lifetimes. The overbuilding of the
recent bubble years, coupled with fairly straightforward demographics
related to the baby boom and bust – along with the inevitable
return to sane, versus insane, lending standards – will conspire
to keep the value of homes, regardless of their price in dollars,
at or well below current levels for years and even decades to come.

So, no easy
answer to the question of whether now is the time to buy. As with
most things, it comes down to a personal calculation, based on how
much you can comfortably afford to pay. By extension, that requires
further contemplation as to how confident you are that your income
and net worth will continue to allow you to afford the payments
well into the future. Of course, in addition to your mortgage payments,
that calculation has to take into account property taxes, which
are going up, as well as maintenance, association dues, and more.

And because
all real estate markets are local, you also need to do some serious
due diligence on the outlook for local markets. In Ross’s general
neighborhood, Harrisburg, Pennsylvania, just defaulted on a $3.3
million municipal bond payment, and Philadelphia’s finances
are also in poor shape – so, before buying, he should do enough
research to be confident that the neighborhood isn’t going
to deteriorate.

Finally, one
more reason why we may not have to wait overly long before real
estate becomes at least a rational investment. And that reason is
that there is a lot of money on the sidelines just now, both in
the U.S. and abroad. Much of that money is in cash, and much is
in bonds – a disaster in the making.

interest rates start moving up
, and the fiat currencies start
to come down, investors will become fairly desperate to get out
of bonds and into pretty much anything with a discernable heartbeat.
Once housing prices have fallen by another 20%, 30%, real estate
will be again considered a safe asset to own, and some percentage
of money will certainly begin to flow back into it.

So, personally,
I would hold off buying real estate for the time being. At least
in the post-bubble markets where the debt still really hasn’t
been addressed (much of it now sits on the books of the Fed, and
Fannie and Freddie), and where desperate governments will take advantage
of the fact that you can’t pick up and move your house to raise
your property taxes.

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David Galland
is the managing editor of Casey

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