Home Prices Now Compared To Peak of Bubble
Since the peak of the housing bubble, home prices are off anywhere from 10-60% across the nation. A primary factor playing into such high prices during the peak, however, was the aggressive, irresponsible lending. Regardless of the reasoning, when factoring for inflation cities across the nation have homes for sale at prices rivaling those from 1997 – before irresponsible lending began. Of course there are some cities that do not show such significant price discounts, but many of those neighborhoods are very wealthy, very expensive, and less likely to ever see such a decline.
Home Prices Compared to Construction or Replacement Costs Some homes in the US are selling for $60-$70 per square foot. Depending on home quality and the land value, this can equal a 50%-60% savings over costs to build a comparable home in the same area. There are no guarantees that a strong rental market will exist in the short run, but over time it seems a wise choice to purchase assets if they are available at half or even less the cost to build.
Home Prices Relative to Incomes and Rents
During those peak years of the housing bubble, homes were priced around 11 times the median family income in areas such as San Diego. Homes at these prices, financed with an overwhelming amount of debt, are simply not sustainable. Since the banks have pulled back on the lending formulas, homes are now being bought and sold at roughly three to four times the average family income. Also, during the peak of the bubble, homes were being traded at such large multiples of possible rental income that projects were just not affordable from the get go. Now, since houses are being bought and sold at more reasonable prices, they can be purchased and rented with immediate, positive cash flow.
Home Prices in Real Terms, Not US Dollar Terms
Over the last fifty years, the dollar has lost a whopping 98% of its purchasing power when compared to a real asset such as gold. Knowing this, if houses were priced in ounces of gold rather than US dollars it would show that homes are really a bargain these days. The graph here shows that the average home, priced in ounces of gold, could be purchased at historical lows for the past forty years.
You might argue that this is because gold is priced highly today, but I would argue that gold's purchasing power has changed very little over time. Actually, it is the dollar that is depreciating and thus giving the appearance that the price of gold is rising. Gold is quite stable relative to other assets and commodities, it is the dollar that is declining in value due to the US funding its deficits by printing dollars.
The Real Bubble - US Treasuries and Future Inflation
In reality, the true bubble is longer US Treasuries and 30-year fixed rate mortgages. It is comparable to lending to the US – US debt is equal to its GDP and over four times total tax revenue, it’s mind boggling that anyone would even lend to the US for less than 3% per year. An individual homeowner can get a loan around 4% for 30 years at a fixed rate. The value of a home may not appreciate a whole lot in real terms by the end of that loan, but they don’t have to. With inflation, one still stands to make a good profit. Consider it this way – if inflation and interest rates return to 7-8%, one could make 8-10 times the equity investment on the house because of that locked in, 4%, 30 year mortgage. Homes have historically appreciated well compared to unanticipated inflation.
So, it makes sense to quickly finance a home or acquire the maximum home equity loan possible while these rates are so low and invest in hard assets. When inflation returns, the best position to be in is that of the borrower. "Neither a borrower nor a lender be," said Shakespeare, but they didn't have huge government deficits and the risk of future inflation back in the Bard's time.
John R. Talbott, previously a Goldman Sachs investment banker, is a best-selling author and economic consultant to families. You can read more about his books, the accuracy of his predictions and his family consulting activities at www.stopthelying.com.
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