Next crisis? Real estate crash

Truly, I hate to sound an alarm bell on a day like today, when the whole market seems happy, but when life looks like easy street, there is often danger at your door. The danger today is that many investors will be hurt financially if the price of real estate should fall, and sadly, all such investors now have cause for concern.

On September 30 of this year, the Case-Shiller 20-City Index report indicated that in July, home prices, as averaged across 20 American cities, rose by 0.6% from the previous month, just over half the gain (1.1%) that analysts were expecting. More recently, the Mortgage Market Index from Fitch Ratings indicated that between the ends of the first and second quarters of 2014, home prices actually fell.

You can be excused if you missed this potential beginning of the decline. A lot has happened since then, and the real estate market is always throwing out mixed signals. Some pundits are arguing, even now, that the good times are still rolling, but to do so now requires a careful cherry-picking of available numbers. In fact, the real estate market has probably been cooling for 12 months or more. Here's why it is about to go from cool to cold.

With so many companies hiring, it would seem that workers would be in a good position to ask for raises, but this is not the case. The job market still has a fair amount of slack in it, and even though the job shortage isn't nearly as bad as it was a few years ago, workers have either been hired too recently to be confident, or have held on to the fear of losing their jobs that they developed when times were truly bad. Exactly how good things have to get before workers are confident enough to demand real money isn’t clear, but they aren't doing it now.

Despite good employment numbers, wage growth remains at 2% — barely above inflation. In the absence of both the expectation and the reality of upward mobility, nobody's moving up into a nicer house, and this is a big demographic shift. Also, many homeowners still can't afford to sell their houses because they are upside-down (or nearly so) in their mortgages. If wages were up, people could have taken the lump and moved on, but they aren't, and they haven't.

Oh, guess which industry is doing a lot of the current hiring? Yep, the construction industry. Housing starts have continued to rise this year, which is one of the reasons the real estate market seems to be giving mixed signals. In fact, this is bad news, as the addition of too many new homes is dragging prices down. The construction industry must know that it is creating a problem for itself (as I suspect it did in 2008), but we can hardly expect home builders to stop building homes in the current environment, as easy money financing makes it too easy for them to do so. Even if builders suspect that they will soon be operating at a loss, they are likely to keep right on building, because the cost of ramping down and ramping up capacity is ruinous, and they want to be as big as they can when good times return.

Tallying up the score here, we have more and more new homes being dumped on a market that can barely support the homes available now. Expect a deep slowing of real estate sales and an eventual drop in prices. Unfortunately, it probably won’t be until after prices crash that banks decide it might not be such a good idea to keep loaning money to homebuilders, and by then, of course, the rest of us will already be stuck with the consequences. 

Julian Close has been a business writer since the first day of the twenty-first century, having written for PRA International and the United Nations Department of Peacekeeping. He graduated from Davidson College in 1993 and received a Master of Arts in Teaching from Mary Baldwin College in 2011. He became a stockbroker in 1993, but now works for Fresh Brewed Media and uses his powers only for good. You can see closing trades for all Julian's long and short positions and track his long term performance via twitter: @JulianClose_MIC.

Julian Close

Julian Close

Julian Close became a stockbroker in 1995. In his 20 years of market experience, he has seen all market conditions and written about every aspect of investing. Julian has also written extensively on corporate best practices and even written reports for the United Nations. He graduated from Davidson College in 1993 and received a Master of Arts in Teaching from Mary Baldwin College in 2011. You can see closing trades for all Julian's long and short positions and track his long term performance via twitter: @JulianClose_MIC.

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