Friday, December 3, 2010

"Could Your Children Buy Your House?"

I went to go hear a presentation on the housing market at a luncheon sponsored by the Boston Security Analysts Society yesterday.

It was a good meeting, even though the tone of the remarks by the speakers was relatively bearish on the outlook for housing over the next couple of years.

Present on the panel were Karl Case, a Wellesley College professor who also is a founding partner of Fiserv Case Shiller Weiss(the latter publishes the widely followed Case Shiller index of housing prices); Laurie Goodman of Amherst Securities; and Brian Kinney of State Street Global.

I won't go through the whole presentation here; I have attached a link to an excellent summary done by Susan Weiner at the bottom of this post.

The one point on which I do want to comment involves the role of demographics on important economic areas like housing.

In the course of his remarks, for example, Professor Case remarked on the puzzling fact that even though new housing stock is being added an incredibly low rate (echoing the comments from Pulte Homes that I discussed yesterday) the vacancy rate of existing housing remains very high.

It is curious, noted Case, that even though housing would seem to be more affordable today than it has been for decades (through a combination of lower prices and low mortgage rates) the vacancy rate remains stubbornly high. Logically it would seem that vacancies should be declining if there is no new housing stock being added, and yet that has not been the case.

The answer might be that the population of the United States is lower than current estimates. The results of the 2010 census will not be published for some time, but Case hypothesized that maybe the official figures will show that we simply have less people to buy houses than we think, and therefore econometric models need to be adjusted accordingly.

While Case was talking, I was reminded of an anecdote that a very good investment strategist named Chuck Clough used to relate. Chuck worked for Merrill Lynch for a number of years, and was in my opinion an excellent source of investment insights and ideas.

Chuck told me that when he would give talks to groups of senior citizens he would often discuss the future of housing prices. This was back in the 1990's, by the way, long before the housing bubble.

Chuck would look out into the audience of people whose children were mostly grown and ask:

"How many of your children can afford to buy your house?"

Laughs and guffaws would inevitably ensue - what a silly idea, the idea that today's young adults in their 20's would be able to buy their parents' houses.

But then Chuck would ask a follow-up question:

"Well, if your kids can't buy your houses, who will?"


Even though Chuck posed this question more than a decade ago, it still seems relevant today, especially when it relates to house prices.

As we are all aware, real incomes have been stagnant for at least the last 10 years, except for the very highest income bracket. Young college graduates today are struggling to find any work, much less a good-paying job. Yet it remains the case that most people start to buy homes when they are in their late 20's, or early 30's, when they are starting a family. But if they can't afford a new house - even after prices have fallen from a few years ago - this process becomes impossible.

In short - if you want to get really bearish on housing - you could make a case that house prices still have further to fall in order to get prices in line with real incomes.

This would also have implications for older Americans who have viewed their homes as a source of savings. We have always assumed that at some point in your life you will sell your house and use the proceeds to fund your retirement. What if these funds will not be as munificent as we have come to expect?

Food for thought.