Housing’s ‘Mortal Enemy’…Shadow Inventory Looms

Gary Shilling calls for ANOTHER 20% fall in home prices.

He predicts that it will take 4-5 years to just clear out the excessive inventory. Gary uses demographics to make his case. Not enough new families forming = not enough home buyers. Add to this the historic levels of homes entering default and already IN default yet to be foreclosed on.

Is he too pessimistic?

Consider this: Strategic defaulting is increasing as more owners go underwater. As we reported last year, its expected that 40% of ALL homeowners with a mortgage will be underwater this year. Perhaps the biggest negative for housing is the ever lasting fear that housing is no longer a bullet proof investment. Literally, a home was seen as the single best investment anyone could make. It was an American rite of passage into adulthood to become a homeowner. For a majority of Americans being an ‘owner’ somehow put you on a higher plane socially and financially than renting.

Is that true now?

I doubt that anyone under 30 thinks of housing the way all of us old farts do. Its safe to assume that the younger generation (Gen Y, Baby Boomers off spring) will have a different set of expectations and values. Furthermore, how many folks OVER 30-35 question the validity of owning a home? Its impossible to create an economic argument for owning a home vs renting unless ‘appreciation’ is part of the equation. Would YOU buy a home if you didn’t think it would ‘go up’ in value……? Do the math, if you have a mortgage…vs paying cash…and the home doesn’t ‘appreciate’…economically…is renting simply smarter?

From Economics 101: A new academic article in Real Estate Economics turns this conventional wisdom on its head. Using data from 1979 to 2009, the authors demonstrate that renting was the superior investment strategy for most of the past 30 years. Counterintuitive as the finding may be to some, it is actually quite logical. Unless someone possesses the cash necessary to buy a residence, he or she will be renting one way or another. The choice is between renting the property directly or instead renting the capital necessary to buy the property. The amount of capital to be rented is a function of house prices, while the bulk of a mortgage payment is interest, which is the rental payment on this capital. After 2 years, the typical 30-year amortizing mortgage balance has been reduced by less than 3%. This means that a household that took out a $300,000 mortgage with a 5% interest rate to buy a home has only reduced its mortgage balance by $8,600 after two years despite spending nearly $39,000 in total over this period.