Home Prices Fall for 6th Straight Month

Housing is front and center today with the release of the Case-Shiller 20-City Home Price Index for January. As expected, housing showed further weakness with only Washington D.C. showing positive growth. San Diego and Washington D.C. are the only cities where home prices have risen year-over-year. On the downside, 4 of the 20 cities in the index- Atlanta, Las Vegas, Cleveland, and Detroit- are now below 2000 price levels. Housing is clearly in the process of double dipping to new lows in this recession. Buyers will eventually step in, but at what levels?

I get the sense that people are confused because I am short-term bullish on certain, but by no means all, housing markets in the U.S. I would like to offer a reminder that in any major trend, whether upward or downward, there are countertrends. The short-term bounce in housing is going to convince a lot of people that housing is back for good. I don’t think this is the case. But in the short run, keep in mind that housing starts are below closings as construction has slowed down considerably. When inventory levels come back to normal, it will take some time for new homes to be built. For all you gold bugs out there, think about what has allowed the gold bull market to sustain itself. When gold started to rise, supply didn’t suddenly flood the market because it takes a long time for mines to be developed. I don’t know when exactly home prices will rise, but I do know that supply will lag. And I do know that supply will eventually come in too strong.

Price to Rent, Price to Earnings

All investments are more or less the same. You need some mental capacity to work out the math and figure out supply/demand dynamics, etc. You also need some common sense. Price to rent ratios in housing are similar to price to earnings ratios because we are talking about cash flow. Of course rents are subject to local conditions in the same way that earnings are dependent on the particular industry. Nonetheless, there comes a point when value becomes extreme.

In stocks, P/E ratios become compressed when the future outlook of a company is bleak. The implied dividends embedded in earnings are actually very robust, yet people are by definition bearish on the future. Another way of putting it is that people are the most bearish when the cash flow situation is the most attractive. Efficient Markets? Yea right.

Yes 6 P/E stocks can easily become 4 P/E stocks. However, if you are focused on cash flow, short-term fluctuations aren’t too concerning. Time your entry right, and you are profiting from the dual factors of an expanding P/E ratio and rising earnings. In certain housing markets, you are seeing rents 120-150% above mortgage payments. Yes home prices might fall, but so what? Eventually the markets will balance out. In the meantime, you are receiving cash flow. I can assure you there will be many people returning multiples on their equity in housing in the years ahead.

But, But But… 

Are you sure? But no ones buying. Wait just a little longer. It’ll get cheaper. Just a little longer.  This is always the type of talk you hear near bottoms. Meanwhile, the big money is stepping in and buying real estate in all cash deals. Boomers will have to trade down to retire: Where will they go? Many of the most depressed markets just happen to have favorable climates. Will retirees who have seen their pensions disappear flood to buy overvalued real estate in New York City? I don’t think so. I am bearish on New York City real estate for a number of reasons, not the least of which is my belief that NYC is losing its status as the financial capital of the world. Every market is different.

I can go on forever, but I won’t. Just think logically about these trends- nothing goes down or up in a straight line.

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