Housing bear Gary Shilling and housing bull Mark Kiesel of PIMCO debated the state of the U.S. housing market on Bloomberg Television’s “Street Smart” with Trish Regan and Adam Johnson.
Shilling said that housing prices will decline 20% this year because “there are 2 million inventories, both visible and shadow inventories, over and above normal working levels”, which is “a tremendous overhang.” He went on to say that “excess inventories are the mortal enemy of prices.”
Kiesel justified his bullish stance on the market, saying that, “all inventories you look at, whether new existing or shadow, they are coming down” and “there is only 144,000 new home sales for sale. That’s at a 49-year low.”
Kiesel on purchasing a home in California and whether he’s having buyer’s remorse:
“No. I will say it is a little chaotic because there are a lot of boxes around. I think after renting for six years, my view is that housing prices have fallen about 35% and the inventories are coming down and banks are starting to lend again gradually. U.S. housing looks very cheap relative to international housing. I feel good about putting some money into housing right now.”
Shilling on why housing prices will decline 20% this year:
“Because of excess inventories. We estimate that there are 2 million inventories, both visible and shadow inventories over and above normal working levels. That is a lot. Back in normal times, we built about a million and a half houses a year, so two and a half million is a tremendous overhang. Excess inventories are the mortal enemy of prices. What may happen here is that now that the robo signing flap is settled and the big banks settled for $25 billion with the various state attorneys general and the federal government, they have been holding off on foreclosures because they had enough bad PR. Now they have settled that, I think they will go back to foreclosures. The National Association of Realtors says that when foreclosed houses are sold, they sell at a discount of 19% to existing houses and that drags everything down when you get a big dumping of these houses on the market. I'm looking for another 20% decline and that is what it would take to bring them back to the long-term averages. They go back to 1890 in terms of median single-family house prices.”
Kiesel on how he factor in those inventory levels:
“Currently, we have 2.5 million homes in existing inventories which is down in the last seven years from 4 million. There is only 144,000 new home sales for sale. That’s at a 49-year low. The existing inventory is at a seven-year low. If you look at the shadow inventory, there were 3.6 million homes that were 90+ days delinquent two years ago. Today, there is only 2.9. All inventories you look at, whether new existing or shadow, they are coming down.”
“They are coming down, but they are still huge…Yeah, they are down, but when you count in the shadow, and particularly this category that the Census Bureau has, which are houses held off the market for other reasons, very descriptive. This includes foreclosed houses that are vacant, but not yet sold. It includes houses that people have listed, but they couldn’t stomach the bids they got so pulled them off the market. You count all of that in and you are still over a working inventory of about 2.5 million. You are still 2 million above that when you count everything in.”
Kiesel on what number he’s tracking:
“What I was quoting was the 90+ day delinquencies. If you add that with the foreclosures, you do get to the 3.9 level. The thing about housing is that it’s very much a regional market. The homes that your viewers and people actually would want to buy, you need to look at the existing inventory that is quality. Go out and look for a house now. There is less quality inventory on the market today than a year ago. That shadow inventory will get absorbed quicker than you think because the implied rental yields is roughly 5%-12% in a lot of markets, so investors will line up. Gary, I respect your work and I read your books and if housing goes down 20%, I will back up the truck and likely PIMCO will, too.”
“That's right. At that point the percentage underwater of mortgages would go from now 23% to our estimate is 40%. The equity of people who have mortgages which has come from almost 50% in the early eighties to 17% would go down to about 7%. Virtually nobody with a mortgage would have any equity. What that would do to consumer spending to say nothing to mortgages and mortgage-backed securities derivatives, that is pretty heavy duty stuff. That is recessionary kinds of things. We think that will happen over the next three-four years, one way or the other.”
Kiesel on whether employment levels are at a stage at which consumers are feeling confident enough to make an investment in buying a home:
“If you look at it, we have added 2 million jobs in the private sector over the last year. Confidence is picking up. The U.S. economy is doing well in numerous states and sectors like energy pipelines, technology, autos, manufacturing. There are many areas in the country where there is a housing shortage. The shadow inventory and the amount of homes underwater, there are 11 million homes but it is concentrated really in three states: Arizona, 61%, Florida, 45%. Yes, there are some weak areas, but the fact is that in certain areas, housing is picking up and prices are going up and so again, it’s very regional.”
“You and I can remember almost a decade ago as this problem was developing and we were on top of it and you were too, that people initially said, the problem was only in subprime mortgages and those are loans that luckily people will never have to meet. Then, they said it is only in Arizona and Florida and Phoenix. Then as it expanded, they said it is bicoastal, don’t worry. Everyone else is safe. Tip O’Neill said that all politics is local and you can say the same thing about real estate. Somehow, the composite, the national numbers are made up of those local pieces. There are a lot of shortages here or the other place. That I think is begging the question, overall, there is still a tremendous excess inventory.”
Kiesel on whether he’ll lower his assumptions about the economy:
“We are looking at basically 1-1.5% real GDP, but you don't necessarily need superfast GDP to get housing to recover. Housing again is down 35%. The inventories are coming down. We are gradually employing more people. Housing relative to other asset classes—equities, bonds—looks attractive.”
Shilling on the New York-area housing market and whether Wall Street money not being what it used to be has affected real estate:
“I think it very much does. If you look at what is happening to the stock markets and related securities in the last month--if this continues, I think we will see a lot of softness in Manhattan and in the Hamptons and other places influenced by that. If you read off the employment verses GDP curve, if you're looking at even 2% real GDP growth, that says that the unemployment rate would chronically rise about 1% point a year.”
Kiesel on the West Coast housing market:
“Housing is very much based on jobs, based on consumer confidence. We were in the subprime capital of the world in parts of Orange County and we can show you houses that are down 50-60%. In my neighborhood, housing prices fell 20-30% from the peak. The economy is not a recession, we are growing, and banks are flush with cash willing to lend gradually and the Fed is set to reflate. The key here is that you want to own a hard asset in a world of very low to negative real interest rates where the Fed is going to print money. You have to own something tangible.”
Kiesel on the opportunity cost of buying a home:
“I think stocks are looking at basically nominal GDP, which is 4% plus dividends of maybe 2, so you are looking at 6. There are rental yields in housing out there above that. Plus, you get the benefit of actually living in the house. From my perspective, I still think that housing beats a lot of asset classes.”
Kiesel on whether PIMCO is looking at housing as an alternative to bonds:
“We own non agency mortgages and those securities benefit from a housing recovery. If Gary is right and we do see housing prices go down 20%, the U.S. will be one of the cheapest housing markets in the world. It is already near one of the cheapest.”
“Actually, it would take a 22% decline in median single-family house prices to bring them back to the long-term trend that Bob Schiller has identified going back to 1890. That has been corrected for CPI, general inflation, and for the tendency for houses to get bigger over time. That would bring them back to the norm. They might seem cheap but there are only where they would have been for over a century.”
Debate a "Mixed Bag"
- I do not think the bottom is in. Yet, I doubt another 20% decline is coming nationally.
- Some high-priced markets may see huge declines, other areas may have already bottomed.
- Inventories are down but still high, especially if one counts shadow inventory and pent-up demand for retiring boomers to downsize.
- Shadow inventory and changing demographics will suppress prices for a long time. Student debt will suppress housing formation for years to come as well.
- Attitudes have changed. Housing is once again considered a place to live, not a retirement savings plan.
- Exuberant attitudes reached a multi-decades peak in 2005. Some overshoot to the downside is expected and it will take years for attitudes just to return to normal.
- I side with Kiesel on the idea that "housing beats a lot of asset classes." In relative terms it is certainly possible to envision housing declines of 10% and equity markets declining 33% or more. While not a prediction, that seems like a reasonable possibility so forget about relative terms and concentrate on the absolute.
- In absolute terms, housing is only a very good buy in areas at or near bottom, and then only if one has a stable job.
- Looking ahead, where are home prices going even after they bottom? My answer is nowhere fast. Yet nowhere fast, is likely to beat equities.
- Gold is a very nice hedge here against many possibilities.
One thing is for sure, when attitudes change to "it's better to rent" (and they have), a bottom is reasonably close.
This is how I currently see things.
click on chart for sharper image
For further discussion, please see New American Dream is Renting; Reflections on Renting Houses, Cars, Books, Clothes; Will Rentership Fuel the Next Boom? What About Home Prices?
Mike "Mish" Shedlock
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