Home Ownership Series: Understanding the Housing Market Cycle

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Our household shares a contentious relationship with residential housing. We moved a number of times for work and twice bought more house than we needed, leading to some painful losses in real estate due to poor decisions and the market cycle. At the time of this writing, we are currently renting and thinking through if/when we should buy our next home. In previous posts about housing, I’ve shared:

For an important context discussion, also check out Early Retirement Now’s post about Home Ownership and Personal Finance. Karsten politely reminded me that comparing the returns of a volatile equity market to the guaranteed return of not paying rent are two different risk profiles.

When Should I Buy? Understanding The Housing Cycle

One of the biggest challenges in housing is buying at the “right price”. Housing is a market, and like all other markets sentiment is driven by humans and emotions. In his second investor memo ever written, the future billionaire Howard Marks describes the movement of investment markets as a pendulum-like swing:

  • Between euphoria and depression,
  • Between celebrating positive developments and obsessing over negatives, and thus
  • Between overpriced and underpriced

Housing is a market and driven by the emotion of humans. In 2005, all the news about hosing was great. There was new construction everywhere, loose lending to anyone who could fog a mirror, and politicians were touting the virtues of home ownership while credit rating agencies wrote models assuming a perpetual growth in home prices. In 2009-2011, almost all the news out there about housing was bad, foreclosures and short sales were in the news, all new home construction came to a halt, lenders were now being called predatory, and there were few buyers compared to sellers in the market.

By the time 2016 rolled around, the bad news about housing had all but vanished and stories about robust lending and successful investors started showing up. Realtors celebrated the market’s return by purchasing new European SUVs to drive potential clients around. In 2017, Fannie Mae announced they were easing financial standards for getting a mortgage. New home construction is everywhere again, with signs and flags for new developments littering the highway and small houses in desirable areas being torn down for much larger replacements (like the one below that replaced a 1900sqft home).

Seriously, who needs a five car garage?!?

“History doesn’t repeat itself, but it often rhymes” – Unknown, but often attributed to Mark Twain

The housing market’s overall sentiment is similar throughout the country, but also unique to each individual market. Following national trends doesn’t necessarily mean you’ll make money on a market upswing. One of the drivers of our personal losses on housing was the timing of our moves. We sold a house we owned for seven years exactly one spring before the market experienced a recovery in prices. Consequently the next house we bought was *after* a jump in prices bringing prices to at or above a market norm. When we came around to selling the house, the market was still good but had cooled from its frenzy of a year earlier.

So what does the housing cycle look like?

This is a rough overview of what I’ve seen in housing market cycle, starting with the slowdown from the top:

  • There are limited number of buyers relative to inventory. Housing inventory sits on the market for a long time and eventually prices start declining.
  • New building activity slows as the profit margins shrink for builders.
  • Losses due to foreclosures start rising for banks/mortgage companies due to longer hold times and a decline in prices.
  • Lending standards get tighter, first for builders who aren’t selling their inventory quickly then eventually for home buyers. Building activity slows down (or halts entirely)
  • The lack of building activity starts pressures the economy, as home building makes up a small percentage of total economic activity.
  • Consumers start spending a little bit less, due to the psychological effect of their home being worth less and the inability to utilize home equity for economic activity.
  • New buyers are unsure of buying a home, as they don’t want to “catch a falling knife” and buy something that immediately drops in value after purchasing.
  • Prices continue to fall until investors step in and set a floor based off the rental value of the home.
  • Investors buying up inventory eventually spurs a reversal in prices, housing start being bought quicker, lenders losses stop increasing, but stay at a high level while working through problem loans.
  • Natural population growth along with limited supply of new homes coming into the market causes prices to start rising.
  • Eventually buyers that have delayed purchasing start jumping back into the market. Prices continue to rise, fueling this need to “not miss out”
  • Buy-Renovate-Resell Investors get back into the market, picking up lower priced houses and the “ugly” homes that were slower moving.
  • New home builders start re-entering the market now that there’s profit in building a home again. Activity increases but takes time to come online.
  • Prices continue to rise while new construction is coming online. More real estate agents get into the business, the higher home sales fuel more advertising by agents, mortgage brokers, and builders.
  • Banks and mortgage companies ease their lending standards to both builders and homeowners, wanting to “not miss out” on this flood of income that can be made from new home sales.
  • Home sales reach the point of frenzy. New stories of “bidding wars” on the first weekend a property is listed start showing up in news. Buyers start acting irrational due to the lack of inventory, doing things like waiving inspection clauses putting in significant non-refundable option money is being paid.
  • People start justifying why all-time high prices could not possibly reverse, often saying the famous words “this time is different”.
  • Eventually sellers that aren’t really motivated to sell/move put “I’ll move if you pay me this” prices on properties that buyers finally decide is too high.
  • More new home inventory comes on to the market and existing home sales start to slow down. Properties sit on the market longer than they did before before prices start to break down.
  • Sellers that are motivated to sell finally start cutting their asking prices, sometimes multiple times before settling on an offer/buyer.
  • Now the cycle has come back to its starting point

The cycle above for the housing market will not look the same each time, but it should resemble the outline above. Maybe the Pendulum doesn’t swing as high / as low as it did between 2006 and 2010. Housing basically avoided a recession in the early 2000s fueled by declining mortgage rates. The recession of 1991 and the housing struggles of the early 1980s included other macroeconomic influences at the same time as the pendulum swung. As a potential home buyer without immediate pressure to buy, the question I have is: Where are we at in the cycle today?

My Preferred Data:

There are an overwhelming number of data points out there to judge the state of the housing market, from mortgage application data, new home sales, and new construction data. The St. Louis Fed publishes the Case-Schiller US Home Price Index, which captures 22 years of housing data. If you want to look further back to examine another recession, a like looking at the total members of the National Association of Realtors (NAR). NAR provides monthly and annual membership data. My thought process is simple: When housing slows down, many realtors drops their licence. When the market heats up, more realtors register to try to get a piece of the transaction.

Source: National Association of Realtors

The increase/decrease accurately shows the real estate recessions of the early 80s, early 90s, and the depth and intensity of the 2006 peak to the 2012 bottom real estate crash. In 2019, both the Case Shiller price index and the total number of agents is still growing. Prices are moving at a slower pace than the last five years while the agent count continues to rise and surpassed its October 2006 peak in June of 2019. There were over 1.4mil realtors in September of 2019, which is a new all-time high.

So where are we in the cycle?

My short answer is “I don’t know”. I’ve been a seller and observer in one market, then looked for houses in two other markets this year before settling in as a renter. There are some signs that could point to a movement of the pendulum downward in my market. Houses are sitting on the market longer and 1-2 price cuts are happening before a sale. The last overall “jump” in prices I can point to by looking at historical home sales happened more than three and a half years ago. However, there aren’t many other signs that things are bad: We certainly aren’t seeing lenders tightening their standards and builders are still moving forward with building out new subdivisions. Consumer sentiment / psychology about housing still seems overly positive, anecdotally there seem to be more “good” news stores about hosing instead of stories about a slowdown. Mortgage rates have been bouncing around near all time lows which drives affordability.

So What If The Market Is Going Down? Maybe the pendulum has turned, but it is not swinging downward quickly. It could be a short swing and go back up, or this is the beginning of a two, three, or four year process of sliding prices before we find the new floor. Unemployment is near an all-time low which is going to limit the number of forced sellers. There’s an aging population, but the oldest of the boomers is only 73 and not quite abandoning their homes for senior living yet. Even when they do, a retiree seller will have more flexibility to either hold their home longer or turn it over to a management company and become a reluctant landlord.

What about when the downturn happen? I don’t think this this downturn not be as harsh as 2006-2012: Certain mistakes made in that period will not be repeated. There are no AAA ratings on subprime mortgages and “ninja loans” (No Income nor Job & Assets) are a thing of the past. There may be an odd twist that comes from a disconnect between the inventory available and the type of property desired by a new generation of home buyers. My friend Dave over at Accidental FIRE analyzed this recently, asking Have We Reached Peak Home Bloat? I don’t see how houses can continue this trend of ever expanding square footage for each new single family home built.

This trend has to break. I can’t predict when, how, or how quickly, but the disconnecting trend between household size and sqft of new homes is not sustainable. My guess is this issue comes to pass in five to ten years as the early baby boomers get into their mid 70s and start downsizing into single family home. In the market I live in, there are still 60+ year old retirees purchasing new 3,000sqft homes for two people. It makes no sense to me.

So What Does This Mean For Us?

In future series on home ownership I will explore what are the benefits of home ownership verses renting and specifically what we are looking for in a home. We’re still observers in this market both as a potential landlord and as a home buyer and aren’t 100% sure this is the final destination. There is at least another eight months left on our lease we have a friendly landlord, so there is no rush or pressure to make a decision.

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4 Replies to “Home Ownership Series: Understanding the Housing Market Cycle”

  1. Renting can be a very smart housing decision, especially for anyone who is new to a city and unfamiliar with neighbourhoods, or those who may move again within a few years. The transaction costs to home ownership generally mean you need to stay put for several years even in a rising market to make it worthwhile.

    1. Renting is a great decision when you first get to a city – I made the mistake a couple times of buying right away when I moved. I let the short-term pain of potentially moving twice and changing all those addresses blind me to the 8-15% in transaction costs incurred when selling. I never want to make a decision again where the alternative is having no place to live!

  2. The housing market slowed down a lot this year in Portland. We put 2 condos on the market and it’s a tough time to sell. We sold one and I’m going to rent the other until the market improves.
    I think we’ll probably rent when we’re older. You have to do a ton of maintenance when you live in a house. I’m tired of it already.

    1. Thanks for reading and sharing. I looked through my “saved houses” list on Zillow and noticed more than half of what I was watching was removed from the market in late October instead of having the price reduced to find the floor in value.

      I hear you on maintenance, it was painful in the last house and I cringe when I see the foundation company commercial show up on the morning news. I can definitely see a luxury condo rental in our future, especially if we decide to split time in/domicile in Florida.

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