Gary North

[Posted in the fall of 2005.]

The price of any scarce resource is the product of competing bids. Sellers compete against sellers. Buyers compete against buyers.

There are buyers of space to live. There are also renters. In a pinch, we all want a roof over our heads. As we get richer, we want nicer roofs and nicer walls, too. But basic rental space is cheap. You can buy a clean, comfortable, 10-year-old mobile home for $10 a square foot. Inside, you would live better than most of mankind has ever lived.

Wives don't want to live in mobile homes. Husbands don't either. But this has more to do with social status than physical comfort. I say this as a person who lived for four years in a mobile home in graduate school. I liked it. I paid $1,500 for it, and I sold it for $1,500. Rent cost me $50 a month. That was from 1967 to 1971. To see what that would be today, use the Inflation Calculator here:

In that same California town, Riverside, a home that cost $40,000 then costs $400,000 today.

Cities outside of California, which has doubled in population, or Boston, New York City, and Washington, D.C. have not seen comparable increases.

Several factors have driven housing prices higher than other assets: (1) lower mortgage costs; (2) the social pressure to own a home; (3) government-guarantees for banks; (4) the advent of government-related lending institutions which are perceived by investors as possessing government guarantees: "Fannie Mae" and "Freddy Mac."

But in some cities and regions, housing prices have lagged inflation. Salt Lake City is one such area. So is Memphis, Tennessee. You can see if your city's housing market was overpriced, underpriced, or fairly priced in the spring of 2005.

For decades, the median home price in the United States moved up no faster than the overall rate of price inflation.

The median price of a used home in 1968 was in the low $20,000 range. Today, it is about $200,000. As recently as 2002, it was $155,000.

But prices in general are up by more than five times since 1968. That alone would get the average house above $120,000. In a detailed academic study by an economist at the University of Georgia, we discover that the average increase in housing prices, discounted for inflation, from 1968 to 1999, was 2% for new homes and 1.9% for existing homes. It speeded up after 1980: 3.3% for new homes and 2.5% for existing homes (p. 8).

The housing boom since 2002 is temporary. It cannot continue much longer in most regions, because wages today are falling behind rising prices and taxes. People must pay for their houses. If Federal Reserve policies break today's price inflation, then they will also create a recession. Recessions are bad times for home owners. But they are great times for home buyers.

There have been many words devoted to the level of refinancing today. Owners are borrowing at tax-deductible low rates based on their home equity, thereby lowering their equity. Fact: homeowner's equity as a percentage of household net worth is now about 17%. This is very close to what it was in 1968, though way below the 28% in the early 1980's. See "Real Estate Value" chart in the Senate document (above). So, not much has changed.

Another fact: if homeowners' equity is lower today, then there is less likelihood that lenders will repossess homes in an economic turndown. So, liquidity will drop, but prices will not fall very much. The lenders don't want to evict owners. They don't want to find renters for empty homes. It's not like a margin call on a stock or futures contract, which can drop asset prices rapidly.

To compare housing prices with a bubble -- the NASDAQ, 1996- 1999 -- is a serious misuse of language. Don't be fooled. Housing nationally is not headed for a major fall in price. It never is. If the S&L crisis of the 1980's could not bring down the price of housing nationally, nothing comparable is likely to do so.

But there will be greater illiquidity in some regions, and therefore tremendous opportunities for making deals. Expensive homes are headed for discounts. Owners will see their equity disappear, maybe permanently. They will be locked in, unable to sell for enough to pay off their mortgages. If you are such a person, it's time to get your home on the market. It is cheaper and safer to rent.

But if you're talking about Mr. & Mrs. America, housing remains their safest investment. If they had bought a second or third home, mortgaged them, and rented them out, instead of putting money into a 401(k), they would be far better off.

In early 2005, I bought a 4-bedroom, 2-bath home in a middle-class neighborhood for $90,000. If the realtor had shown me the house four days earlier -- before another buyer showed up, after the house had been on the market for 150 days -- I would have paid closer to $85,000. Deals are still available.

I bought here because the area is booming. People are trying to escape the city that is just across the border. They are coming here. I decided to buy in the path of growth. I do not intend to sell the home. I will hold it as a rental if I move. The rental income will pay the mortgage (30-year, 5.37%), insurance, upkeep, and property taxes. Why sell it?

Housing prices will fall in post-bubble regions. Stay away from upper-middle-class homes in upscale neighborhoods. But clean, family-targeted housing in safe neighborhoods are a good investment, if you buy the unconventionally at a discount.

On this site, you can get advice from a real estate investor who has been buying homes since 1970, the man who taught Robert "No Money Down" Allen. Here is what he says: "You make your profit when you buy the home." Yet he bought homes in Sarasota, Florida, which is among the most expensive regions in the country. He made a huge amount of money since 1999 by just sitting. He edits the Real Estate department and forum. If you are serious about real estate, this site is the best place for you to get specific answers.

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