Alpine Economics

Real Estate Is Back

Real Estate: So Long and Thanks For All The Fun

It’s time for an update on the housing market!

I’ve been doing posts like this since the birth of this newsletter. It’s one of the easiest exercises I do. I literally have no idea what I’m going to write before I write it. I just open up my favorite charts and spreadsheets and then start typing. It feels good because I have no agenda. I just let the data do the talking and usually one or two interesting stories emerge.

Whether you own a home or not, housing is a market that everyone needs to understand. It is a major economic driver and has massive ripple effects, both quantitative and psychological.

I like the market because it is very slow moving and it telegraphs all of its movement in advance. Because of the long-term, slow-moving trends that push the market around, it’s a really easy market to be a contrarian in. Housing is an emotional market and the psychology of the moment invariably finds itself at odds with the long-term fundamentals. That presents regularly-scheduled opportunity for guys like me.

In any case, I believe we are at one of those places right now, or at least sufficiently close to it. I believe that there is a mismatch between the present psychology of the market and the longer-term fundamentals.

Before you get too excited, this is not as dramatic a skew as I saw back in 2006. That was when my coworker and I were sitting in the San Francisco offices of Clarium Capital (Peter Thiel’s old shop) trying to brainstorm every possible way we could get short the housing market. Turns out, none of us were as smart as the Paulson/Pellegrini duo or brilliant oddballs like Michael Burry. The best we could do was just stand on the sidelines and watch the train wreck happen.

This is also not as dramatic a skew as I saw back in 2011. By that point I was writing about this stuff publicly and that was when I felt like the market had reached an opposite extreme. The psychology was so extremely negative, the cost of ownership was so extremely inexpensive, and the supply/demand situation was so favorable to buyers, that it was as good a contrarian entry point as any. It was a very unpopular perspective that generated a mixed response from readers. Some people thought I’d flipped my lid, others were really intrigued by the idea.

My guess is all the forthcoming analysis will generate a similarly mixed response.

A Surface about to Crack

Let’s start by just looking at price.

On the surface, this is what we all care most about.

Case Shiller - June 2013

I doubt think there’s any doom-and-gloomers in the housing market left. But just in case you were or are still one of those people that believes real estate is going to drop another 20% from its post-bubble lows, we have sufficient data to say that this market has officially stabilized.

Don’t let that orange line freak you out. It’s just a trendline. But rather than use a mathematically-derived linear or exponential trendline, I’ve used a “fundamental” trendline. It’s simply the amount that housing should go up by over the long run, the inflation rate + a little bit to account for increases in real wealth. It doesn’t forecast prices perfectly, but over the long run, it can approximate them and let you know when prices are being supported or suppressed by cyclical factors rather than secular. (This trend goes back further than the beginning of this chart.)

Prices are well off the lows and, nationwide, are as strong as they’ve been since before the bubble. Depending on your locale, prices may really be moving. Here in Nevada and the West Coast, they’re on fire. All real estate is local, but as a nation, we all share the same basic macroeconomic backdrop that sets the tone for the housing market.

The anecdotal stories have returned as well. I just heard on one of my Bloomberg podcasts about a fairly typical apartment in Manhattan hitting the market, immediately receiving 10-15 bids with not a single bid below ask. The Realtors I talk to around town routinely tell me tales about how pretty much every house that sells is a mini bidding war. And we’ve all heard the stories of what’s happening in Phoenix and Las Vegas (again).

I’ve also noticed some pushback in the financial press lately. David Stockman even went so far as to call it a “housing bubble part two.” This is insane, of course. Scroll up and look at that price chart again. I’m not sure how anyone can, with a straight face, say that 2013 is a bubble. The data simply don’t support that.

Now, don’t get me wrong. Most of what you read about real estate in the press is bullish and optimistic. It looks like this:

Real Estate is Back

But a few people are starting to ask questions about the sustainability of recent trends and I think they are completely correct to do so. Most of it has to do with skepticism or concern about the fact that the strength is being led by investors as opposed to traditional buyers. The idea is that somehow, this is artificial and transitory and that the whole thing is, as CBS suggested earlier this year, a mirage.

I’ll get into my reasons for being cautious on real estate in a minute. But they have absolutely nothing to do with the fact that institutional investors are the ones doing the buying. If anything, I think that’s a good thing for the market! I know these guys have a track record of doing some pretty stupid things, especially when leverage is involved, but I don’t believe for a second that they’re dumber than the Main Street buyer or condo flipper. These investors have a better sense of what they’re doing and they’ve done the math on how to make a property pencil out. They don’t buy properties that don’t pencil.

In any case, if the real estate market is slowly, on the margins, shifting to one that is more controlled by investors, it makes sense to start paying a whole lot more attention to rents.

A New Way of Looking at Real Estate

To the extent that the argument that investors will crash the market by pulling out has validity — and for the record, I don’t think it does — rents would need to fall apart. I would be highly skeptical of that happening, simply because rents haven’t ever really completely collapsed at the national level. That’s not to say that they can’t, but, as you’ll see from the next chart, rents are a reasonably stable thing and there’s no evidence to suggest they’ve gotten out of control or are facing imminent collapse.

There are three recessions in the below chart, and rents didn’t crater in any of them, nor did they fall apart during the closest brush with legitimate deflation we’ve had since the Great Depression. During these economic ugly cycles, they just went nowhere for a few years.

As long as the price/rent ratio remains favorable, investors won’t pull out and the market won’t fall apart.

It’s still a very attractive time to buy a house relative to renting. This next chart illustrates that by relating national median rents to the mortgage interest & tax component (money you’re throwing out the window to another party) on a median home.

Housing Rent or Buy - June 2013

In case you wondered why investors have been piling in to the housing market, this is why. The math is very friendly!

Keep in mind that only pertains to someone borrowing money to purchase a home. If you’re paying cash, it’s a different story.

Calculated Risk publishes a price-to-rent Ratio and this looks a bit more normal. If you’re paying cash, it’s not as favorable to get into the market today as it has been in the last year or so.


No surprise, prices have risen faster than rents since the bottom.

Housing is only relatively attractive as an investment if you’re using leverage. If you’re using cash, it’s just a long-term store of value + a little cash flow. It’s better than it was during the bubble, but not as good as it was during the 80’s or 90’s, which isn’t worth panicking too much about because housing had a much more difficult array of investments with which to compete back then.

So now I can hear you asking. What happens if it gets more expensive to get a mortgage? What if interest rates keep rising? Is it game over, man?

That mortgage/rent chart we looked at above was based on a 3.45% 30yr mortgage. What would that chart look like if mortgage rates went back to 5%, which is totally reasonable and where they were in 2010.

Mortage to Rent adjusted - June 2013

I don’t want to alarm anyone and say that the all the recent appreciation in real estate is due to cheap financing, but there’s no question that epic low interest rates have helped spur activity. Point: Bernanke.

A 5% mortgage (or generally higher borrowing costs) would change the game for investors. It wouldn’t completely destroy the real estate market, but it would restore the mortgage interest / rent ratio to a more historically normal level. It’ would be the official end of the days of real estate being a super attractive investment.

Depending on how institutional borrowing costs change, it could affect these investors’ behavior. I doubt it would make them dump their current holdings, but they’d probably go back to looking at other places to allocate new capital in that instance. Like a more profitable carry trade!

If interest rates will be slowly, steadily rising in the years to come, this is going to be a legitimate headwind for housing. (duh!) Put a less-obvious and less-appreciated way: the beneficial tailwinds we’ve received from favorable mortgage rates are over or ending.

This doesn’t mean that the market is completely artificial right now. I hear a lot of people suggesting that rising home prices are totally artificial because of what the Fed is doing and how it’s causing investors to behave. This should sound familiar because it’s spiritually identical to the bear case that many (myself included) have at one point or another in the last 2 years tried to make about the stock market.

I’m not sure that you can say that the activity in the stock market is real but the activity in the real estate market isn’t. Either both markets are being significantly, abnormally affected by Fed rate policy or they aren’t. Both are real or both are fake.

It’s possible to take a middle path here, too. I don’t think the action is as fake as certain extremists claim because there are legitimate macroeconomic and reversion-to-mean factors at play. Nor do I believe what’s happening in the real estate and stock market isn’t being affected in some way by Fed policy. Capital flows to wherever the returns are favorable.

Finally, let’s look at my favorite barometer for the housing market, the good ol’ fashioned price-to-income ratio. This chart has been serving me well for a long time.

Home Price to Income Ratio - June 2013

This paints a slightly more dramatic picture. Go ahead and say anything you want about real estate right now. But do not tell me that the current median home price of $193,300 is cheap relative to incomes. It isn’t. Median prices are now historically expensive relative to incomes.

Don’t panic because we’re nowhere close to bubble territory. It just means that if you’re gonna buy a house today, don’t pay cash. Finance that sucker and make sure you plan on being in it long enough so that you won’t be killed if your 10-20% down payment goes poof in the next year or two.

All right. What we’ve really been talking about so far is the demand side for housing. A lot goes into the mix. And though the demand side is still telling a story that is generally optimistic because of interest rates and public interest, the rate of change is slowing. For all you calculus geeks out there, the second derivative of the trends influencing price is now negative.

Oh, you’re not a calculus geek? Maybe you like NASCAR! Well, in NASCAR-terms, the demand side of the housing market is still cruising along but we’re applying the brakes.

There’s a curve up ahead.

The Supply Side


The single most important thing to watch right now in the housing market is inventory. I’ve said it before on here and I’ll say it again: watch inventory.

To get started, we’ve got a  beautiful chart from Calculated Risk on this.

The graphic isn’t completely obvious at first glance, so let me explain a few things.

First, this shows a rolling, cumulative change in inventory for each week of the year. If this was a consumer good like Cheerios or toothpaste where the inventory levels stay pretty much constant all year long, it would look like a horizontal line at 0%.

Real estate inventory is funky in that it is highly susceptible to seasonal factors. More new listings (inventory) come on in the spring and by mid summer the listings begin to dwindle. Supply goes back down. So every year real estate should look look like a hump, and wherever the curve ends at week 52 is the total cumulative change for the year.

Housing Inventory Jun13

2010 was the last post-bubble year where inventory was being dumped onto the market. A lot of that inventory was distressed. It colored the extremely negative sentiment of the time.

2011 and 2012 were the years where inventory dried up. Supply contracted roughly 20% in each year, which seems like a fairly remarkable amount. But perhaps it isn’t when you consider how much inventory had been dumped on the market . You old timers may recall me discussing when our local market which had upwards of 18 months supply.

So of course inventory was bound to eventually drop because the market was massively oversupplied. That, coupled with tighter credit standards — fewer people able to buy homes — made it a no-brainer trend for the next few years.

But you can see that the game has totally changed in 2013. So far, inventory has been coming back on the market in a big way. Supply is up 15% so far this year, pacing the levels of 2010. I don’t have good data on the composition of this inventory, but my guess is that it’s being driven mostly by new construction and existing sellers without negative equity as opposed to the distressed-driven trend of 2007-2010.

This is a bad thing for prices. By definition.

I hate do drop some Econ 101 on you guys so early in the morning, but remember this chart? It was probably the first one you saw during Freshman year.

Supply Demand Curve

Increase the supply subject to constant demand and prices go down. Sorry. That’s just the way it works. It’s even worse if you increase supply along with decreasing demand (from higher mortgage rates, say).

Obviously, housing is a much more dynamic and complicated market than a simple supply and demand curve. But this is the basic backdrop against which all other housing trends must contend.

It’s possible that demand for housing increases to offset falling prices. But with today’s less-democratized credit standards and bottoming interest rates, I wouldn’t bet too heavily on significantly rising demand from this point.

Certainly not against this trend of new construction.


Not only is inventory increasing this year, but it will continue to increase because new home starts have jumped tremendously this year. Expect more new homes to keep coming on the market through the year.

Keep in mind we’re still a bit under historically normal levels and a level at which is needed to keep pace with yearly new household formation. So this is not a forecast that the real estate market is on the brink of collapse. It isn’t. You can still go out there and buy a new home and so long as you plan on living in it for a while, feel reasonably good about your purchase.

But don’t be surprised if you buy a new home today and it’s worth a little bit less by this time next year. That doesn’t mean it won’t be worth more 5 or 10 years down the road or that buying a home isn’t a cheaper long-term proposition than renting. It just means that in the short run, all the winds are against you and the near-term risk/reward ratio isn’t nearly as favorable as it once was.

It’s tough to tell what a “normal” level of inventory should be for the real estate market. The folks at NAR hooked me up with archival data which I helpfully charted for you:

Real Estate Inventory and Months Supply - June 2013

What does a normal real estate market look like these days? 6 months supply? I’d be hesitant to draw too many months supply parallels to the pre-bubble days. Supply fell to 4.3 months this January and we knew that was extremely low. Something closer to 6 months feels right. (Realtors, write me about this or use the contact form.)

As for absolute inventory, I’d say that a normal level would be at least around 2.5 million units. That’s about where we were once we recovered from the ’01 recession and stock washout but before we really went on a building binge.

I wouldn’t say we’re back to normal territory quite yet, which means there is still a little room to run. But the latest data on supply should be sending investors a very clear signal that the times are a changin’. There’s no reason to think that by the end of this summer the market won’t at least be back in a normal range in terms of inventory. Inventory in April was 2.16 million units.

This is the 7th or 8th inning of the real estate recovery we’ve been enjoying for the last two years. If you’ve been on the fence about selling your house, now is probably the time to hurry up and do it. Competition is coming and will keep coming.

On the buy side, additional strength beyond here is now going to depend more on macro-economic factors. Incomes will need to rise, buyers will need to feel better and better, and rates will need to stay reasonably low.

 As Time Goes By

You must remember this
A kiss is just a kiss
A sigh is just a sigh
The fundamental things apply
As time goes by

If you’re buying into the market right now with the thought (hope?) that prices are going to keep rising at this rate, I would be extremely cautious. In fact, I’ll just say it: home prices will not continue increasing at this rate. Sorry. Prices could even be flat or lower by this time next year.

The fundamental things apply, folks. Especially in the housing market.

We are clearly at a point where the supply side has turned and is decisively getting less favorable to buyers. There’s a little bit more to be optimistic about on the demand side, but rising mortgage rates could put the kibosh on that enthusiasm, at least for the time being.

Ultra-cheap financing has made housing a relatively attractive proposition for buyers. If that goes away combined with a glut of inventory arriving on the market, you could have a recipe for 10-15% lower prices as early as next fall depending on your locale and depending on how quickly some of these trends move.

I realize that this is not exactly a popular view right now. The world is wildly bullish on real estate at present. Those of you who remember my predictions for 2013 will recall that I, too, am bullish on real estate.

But while I do believe that it is going to remain a relatively strong sector in the economy for plenty of time to come, my bullishness on real estate as an investment is officially drawing to a close. Don’t worry, it’s not time to get all bearish on real estate as an investment quite yet, but the window to be hyper-bullish has definitely closed.



At least you and I will always have Paris…