Off Topic: For My Nephew And Wife - Four Graphs And A Spreadsheet

My nephew, age 28, and wife are getting their careers straightened and want to get on with their lives. He's got a new job about an hour's drive away in Northern Virginia and they need to move closer to the job. They are renting a real hole right now. They think now is a good time for them to buy a house.

Based on my watching the investing scene, I strongly disagree. This article covers the information I expect to give them tomorrow night them that will allow them to make a better informed decision. I'm not familiar with the details of their finances (pay, savings, etc.).

Please feel free to leave a comment here for them if you have something to add, especially if you can say anything about the experience of recent home buyers in Northern Virginia. 

USA House Prices

The graph that follows provides a graph of USA house prices that goes back to the late 90s. Housing is an illiquid market (meaning it costs a lot to buy and sell and it is hard to find a buyer if you are a seller) and these kind of markets trend strongly. That means if prices are rising, you can expect them to continue to rise and if prices are falling you can expect them to continue to fall. This is especially true of house prices going back a century. You can see this clearly in the graph below in that prices rose every year from 1992 through 2006. That's a 14 year trend. We are now three years into a down trend with no signs that the down trend is ending. This means we can expect to see house prices continue to fall.

The graph also provides a RED, BOLD long term trend line. This line shows that house prices were rising reasonably steadily throughout the 1990s at around the inflation rate (as they have generally done for around a century). Beginning in 1998, house prices started rising much faster than the long term trend (unnaturally fast). In investing parlance, the price went "parabolic". House prices were in a bubble that popped in 2006.

Its pretty clear from prior history with bubbles, that house prices can be expected to continue falling back to their original trend and will probably (as was the case with high tech stocks with the tech bubble) over shoot and fall far below the trend. So, we have good reason to believe that house prices will continue to fall another 10% (to approximately year 2000 house prices) and can be expected to very probably fall another 20 to 30%.

Long Term USA House Prices

Here's the "just updated" Case-Shiller 100 year home price chart. The main point I see is just how "unnatural" the recent housing bubble was.

Washington DC Metropolitan Area House Prices

Here's the graph for the Washington DC area.

This graph shows that:

1. House prices in the Washington DC area were even more in a bubble than the rest of the country (and will presumably have further to fall).
2. Despite the fact that the Washington DC area is insulated from the economic downturn by all those secure cushy government jobs and the cushy, secure jobs of the corporate wonks that support the government, area house prices are falling hard with absolutely no sign of a change of trend.
3. CONCLUSION: House prices in the Washington DC area can be expected fall at least back to 2000 prices (another 30%) and could easily fall below trend (40%, 50% or 60%).

Mortgage Resets

The graph below shows the number of adjustable rate mortgages that have recently reset or are about to reset. The first wave of those resets (sub prime mortgages) are what triggered the recent wave of housing foreclosures. These were loans given to people with no money down and with bad credit. When they reset, their monthly payments rose and these "home owners" could no longer afford the houses and they were (mostly) foreclosed.

The graph above shows that right now there is a relative lull in mortgage resets. This is the case even while house prices continue to plummet. It shows that in September the mortgage resets start ramping up. Of particular interest in the ramp up of Option Adjustable Rate mortgages and Alt-A mortgages. Here's the low-down on these:

• Option Adjustable Mortgages - these are mortgages that were given to buyers with no money down where they could pick a very low "teaser rate" for the first few years. While on this teaser rate, the principle of the mortgage actually increased. Meanwhile housing prices have fallen. All of the holders of these mortgages are underwater, which means they owe more on the house (much more) than the house is worth. The plan was for the price of the house to rise and before the reset came, the homeowner would refinance into a better mortgage. These mortgages, after they reset, have much higher interest rates than a regular mortgage would have had. The bottom line is that these homeowners are stuck with these after reset interest rates and most of these homes are going into foreclosure (triggering further house price declines).
  
• Alt-A Mortgages - these mortgages were given without documentation (with no proof of employment) with zero money down. All of these mortgages are also underwater and will probably be foreclosed on.

The bottom line is that there is very strong, clear evidence that another large wave of home foreclosures is coming that will very, very probably drive home prices down further. This will continue until mid 2012. So, we have another, independent, method that points strongly to another three years of falling house prices.
 

A Spreadsheet For The Next Three Years

The spreadsheet below (for the XLS click Download 20090629nephewhousebuy) is a very simple model of the expect profit / loss of buying a house of the approximate value that my nephew is considering buying given various outlooks for house prices over the next 3 years. 

There seems to be a pretty strong case for renting versus buying just on the bare economics.

Now, in the case of my nephew its may come down to trusting experts. So, what kind of expert do you want to trust? Someone who is part of the real-estate industry that benefits from folks buying houses? Someone who has a "this has worked for the last 50 years not counting the last 2 years" perspective? Or... someone who was right about the housing crisis that just occurred.

Click Download 20090606gsrdentonhousing for a segment of the Gold Seek Radio Chris Waltzek interviews Harry S. Dent who did correctly predict the housing downturn. That was a really, really useful interview and I recommend it highly.

What do you think? Will my nephew buy this argument? Should he?

MontyHigh, www.worldofwallstreet.us

Comments

[Richard]

You should add the following:

condo/strata fees
utilities
property taxes
maintenance (boiler, roof, lawn, etc)
garbage pick up costs- if there is one.
inflation rate

then;
if renting Rate of return on the down payment if not used to buy a house. (tbill, stock, etc)
choice to invest difference, example; rent $1000 owned house; $1500 diff. $500

the NYT has a very nice flash based one;
http://www.nytimes.com/2007/04/10/business/2007_BUYRENT_GRAPHIC.html