Monday, September 10, 2007

Economy, Economics, and Housing...

My original idea for the title of this piece was "Why my wife & I decided not to buy", which I would have made a sub-title if enabled me to do so. I also touch on a few other things in this post too. So enjoy.

The New York Times had an article recently about the declining job growth and that people are fearing there is a possible recession coming. The article states that the greatest number of jobs lost were in the house building sector of the economy, though it is likely that more job losses are on the way - or have already happened, as the report the article was talking about was for a short time period before some of the layoffs would have all been accrued. Any how...if you want to know more of what the article was about, then I would really highly recommend reading the article.

(Sadly, if you are reading this past 2 weeks from the publish date of the article, then you will either need to look it up in the library, or pay them a small fee. Otherwise, you might need a free account. Any ways...)

I really wanted to address what the problem is with the housing sector from the point of a customer. (Sorry, no consumer language here. I'm a customer!) And before I begin on that, just let me say that I am not an economist or anything of that nature - I have not studied the economy (just had the college and high school econ classes) nor studied the housing sector. This is just my own insight based on my own observations and ideas about financing. So please remember that, and take what I say with a grain of salt. And I recommend that you take this to a real economist, financial adviser, etc. before making any kind of decision on it.

That said...

My wife and I use to live in Fairfax County, VA - one of the most expensive places to live in the U.S. (Not as expensive as Manhattan, but on par with Northern New Jersey and Silicon Valley, L.A. area, etc.) Why did we move? Because we couldn't afford to live there - and it wasn't that I wasn't making good money - I was. However, it was impossible for us to be able to buy a house, or even a townhouse. (Houses were, at that time, starting at $500,000, and for a traditional mortgage that means a $25,000 to $50,000 dollar down payment. Townhouses were starting to get up to starting around $200,000 to $300,000.) So, when the company I am working for was looking to set up a facility in a cheaper area (Cambria County, PA), we opted to be moved there.

So we got there, and decided we would rent someplace for a while while we got use to the area, and found out where my wife (a CPA-in-the-making) would be working. Several months after she got her job, we decided we would start looking for a house to buy - yes buy - with a target of closing & moving in this fall. (We still needed to save some money for the down payment.) So we started looking and did find a couple places that interested us, but then we had to consider the economy...

We don't know how long we're going to be where we are now, and presently I have a 10 minute commute (20 minutes round trip), and she has a 2 hour commute (4 hours round trip) - both times are assuming good weather and traffic of course. So we were looking to even out our commutes...ok, but then there's the economy...

So...what were our considerations on the economy?

Well, first back in June and July there were the reports about the bad mortgage practices by a number of the mortgage companies. I was already a bit concerned by these practices as I knew we could get a loan with nothing down, and even be able to avoid closing costs through the various packages, but...I wasn't interested in that, and I think that those kinds of loans are rather foolish to start with. Also, one shouldn't forget that a lot of those loans also have conditions for the buyer (e.g. when you do sell, you can only have X% profit), so they weren't really attractive to start with.

We went and got pre-approval letters from some banks and did some research and stuff and got things in order before we went to a realtor, which we later learned was smart to do - but don't get too many pre-approvals - as realtors look for that before they will do serious business with you.

So we were protected from that somewhat to start with at least for the mortgage loans we would have gotten...BUT...

Even before this the area where we were looking was a slow moving market, and as I said earlier we did not know how long we would be in this area. What does that mean? Well, we're willing to commit to a 5 year time frame, but not much longer than that. (And you don't really want to buy a house and then within 3 years sell it and move on...that's not really good credit wise, etc.)

The problem then became that with the problems in the mortgage sector (e.g. foreclosures, etc.) and the need for the option to be able to resell in 5 years, the area just was not attractive for a home purchase would have a harder time selling in 5 years than it was before (which may have already been pushing it a little to start with).

Thus, we have decided to wait on a home purchase once again. And no, the Fed lowering the rates will not change that. We're young (in our mid-twenties), and we need flexibility. A market that is (a) over-priced, like it is down in Northern Virginia, or (b) to slow to resell, like it is in Pennsylvania, is just not attractive.

Yes, I do realize that we are adding to the problem some by not buying. But we also don't have the ability to take on the loss of flexibility within the time frame that we want.

And before I go - the issue in Northern Virginia is a key one, and one that is probably affecting a lot more places and Northern Virginia is just an extreme. But the basic problem is that the housing is way overpriced, and it getting to the point where people that have good jobs just cannot afford to even get into the market. If a good down payment (10%) is a year's salary, then it is just realistically unaffordable. This kind of thing will eventually lead to a crash of the market - whether localized to areas like Northern Virginia, or more expansively across the nation.

Northern Virginia got this way due to the boom of the 1990's, where housing prices in the late 1990's jumped highly and places would be on the market a matter of hours. (People would literally go and offer $10k, $20k, $50k more upon arriving just to get.) The result is an overpriced, unaffordable market. After graduating and getting work with a decent salary, I had to look at housing - renting something - and came across another problem with that market. In order to get something that was affordable ($700 to $1000 per month), I would have had to be in a government subsidized apartment complex and the most I could make was $42,000. (I made more.) So I didn't qualify; the only places I could get in were at least $1300 per month, and climbed quickly to $1700 per month. The problem? You should only be paying about 30% income for housing, not 50% or more. (And yes, before we moved we were paying about 60% of our monthly income for housing alone.)

Pennsylvania can be overpriced for other reasons, namely due to that the realtors are typically also the appraisers, so they jack up the price to where they want it to sell. (They've been doing this for years though.) So the 50 year old house sells for about the same as the just built house. And yes, we did see this in our house searching too - in some cases it was almost cheaper to buy land AND build a house than buy a 50 year old house; typically where it wasn't was either due to cost of land or because the house was majorly run down.

But the biggest problem of all is the builders. They want to make a certain amount of profit per house, and so they build houses that are a certain price level (e.g. putting a 3500 sq. ft mansion on a 1/4 acre lot - and yes, I've seen something like that in Northern Virginia, where the house barely fit on the 1/4 acre lot in pretty much every direction). So they build these big expensive homes that a lot of people cannot afford, and it becomes the same problem. So, not only are the existing houses overpriced due, but new homes are too expensive and out of reach of the majority of people.

Due to these reasons, I had told a number of friends, family, and colleagues that the market will crash at some point. Their argument in Northern Virginia was nearly always "well, the government is here, so it'll always go up" - except, post-9/11, the government is formulating plans to diversify where their facilities are located to minimize the impact such events could potentially have, and has a goal of somewhere between 2010 and 2020 of doing so (at least, the last I was aware).

The problem comes down to when the people that are the basis of the market (e.g. the people in their 20's and 30's) cannot afford to buy someplace, then the market is primed to crash. You can't just push it up to upper ages (e.g. 20's becomes 30's, and 30's becomes 40's) because life spans just won't support that.

Then of course, there is the world's concerns over U.S. consumer debt. Why is foreclosing becoming an issue? Because it is a result of bad debt, some of which comes from mortgages, but the vast majority of which exists (whether foreclosed yet or not) in credit debt - e.g. credit cards, pay day loans, etc. Eventually someone has to pay those, and if people die before paying them off, and the debt has to get covered - by the estate, or by the government if the estate won't cover it. If the person didn't own a house, then more likely than not, their assets will not cover their debt.

So, we have the following problems:
1) Housing is too expensive and pushing people out of the market due to affordability.
1a) Existing homes are overpriced.
1b) Builders aren't interested in building affordable homes.
2) Loans and debts are getting too large and is going to start becoming a major liability for the U.S. economy.
2a) Mortgage issues (e.g. foreclosures) are affecting the U.S. economy.
2b) Consumer debt is primed to make it worse as mortgage foreclosures also cause credit card and other debts to be foreclosed on.
3) Due to debt issues, financial institutions are tightening the reigns.
3a) More people will become unemployed as employers cannot get the extra money to create new jobs, or maintain existing jobs.
3b) As more people are out of work, more foreclosures will occur as they cannot pay their debt.

This becomes very circular very fast, and it only gets worse with each cycle. Now, don't get me wrong - I don't think it will lead to a depression, but it will certainly level the markets.

Part of this also goes back to the economy. One economist wrote a few weeks ago (also for the New York Times) that the long term P/E ratio should be around 16, and indeed looking at a really long term it is. But over the last 10 years, it has been hovering around 27, after being at its high of above 40 in the bubble of the 1990's, which is also where was in the 1920's. What does this mean? It means the economy is still overvalued. Unfortunately, most are looking at the 1 to 5 year range when looking at P/E ratios, and in that range it is still 16; the problem is they are not looking long term enough. So, the tech bubble of the 1990's has still to fully deflate.

Well...I better end it for now. Catch you around.