Monday, August 20, 2007

Housing Economics

Americans had around $10 trillion dollars in aggregate home equity and around $9 trillion in outstanding mortgage debt on family residences. The aggregate home equity number may have just dropped by a few trillion.

Every real estate market is different, but the one I’m familiar with is probably representative of many. In the late nineties, you could buy a 1200 s.f. house for just under $100,000. At the market peak in early 2005, that 1200 s.f. house sold for ~$240,000. One local project has been steadily lowering prices and is now offering the house at $135,000, and is starting to get traffic.

But something else has changed. The government has learned to make money in the business. Our impact fees in 1997 were less than $5,000 per unit. Impact fees today can be over $40,000 per unit. Between these fees and increases in material costs, there really is no incentive to build new housing today. Those building are just doing it to liquidate inventory.

The good news is that housing values cannot drop much lower in the long term, as new supply cannot be created when there’s no money in building houses. The bad news is that, in the short term, there are three dangers:

1. Millions of Americans now owe more than their house is worth. A percentage of them will walk away from their homes, causing more inventory in a market where demand has tanked because of tightened lending practices. It is possible that this could spiral downward.

2. The bigger threat from a national perspective is the potential failure of banks. Banks have loaned lots and lots of money (see $9 trillion above) to people who had little or no equity at the peak of the market. The bank’s bad loan is now secured with a house that yields them a net loss of $100,000 per loan. Read the Federal Reserve's recent bailouts of banks at the link below. July posted 179,000 foreclosures, leaving lenders with a $200 billion hit for the month.

3. The local governments that have become addicted to builder money will come after you next.

Central Banks have so far ‘released’ (really given IOUs on the taxpayer’s backs) over a half a trillion dollars to keep banks liquid. This could be bad.

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