Useless Methodologies

Traditional real estate indicators have not served much purpose as predictors of the real estate market. As an example, here is a recent report by the Mortgage Bankers Association titled Housing Demand: Demographics and the numbers behind the coming multi-million increase in households. Superficially, the report makes a lot of sense, supported by many beautiful charts and figures.  Yet, my gut feel is these methodologies are of little use in the future.

 

banknote-1000-greek-drachma-apollo-19871,000 Greek drachma from 1987, depicting the Olympian god Apollo.

 

The Golden Years of Real Estate

Think of real estate ownership as 30 years savings plans.  With the magic of compounding, even a modest but steady 5% appreciation would have stuffed the piggy bank in 30 years.  These savings plans were readily available in the 70s and early 80s.  Unfortunately, those days are over.  It all probably ended with the bursting of the tech bubble in early 2000s.  Purchasers of real estate in the 21st Century so far have not met with the same success as their predecessors.  There are many reasons for this change of fortune, but I am beginning to think of a new World War.  Before you call me nuts, just hear me out.

 

The World at War

The new world wars do not have to be the bang bang kind anymore.  Sure, there are real wars in Syria, Yemen, Iraq, Ukraine, Afghanistan…….   However, there are bigger wars that are far more devastating to the masses.

The cold war against Russia has re-ignited, with economic sanctions in place.  US foreign policy against China is one of containment, so we might as well include China in the new cold war as well.  Then there are economic wars via trade, or anti-trade, treaties.  There are border issues like the immigrants in Europe, the Southern border of the US and even in the middle of nowhere, like those remote islands in the South China Sea.

While these conflicts have always existed somewhere on earth, I believe we are at “war” now because the hostility has escalated to a level that actions and reactions in the form of foreign policy initiatives are intended to and often succeed in mutually damaging the warring parties.  There are no lines between friend or foe.  It is every country for itself.  Leading the charge are the seemingly mild-mannered central bankers.

 

The War of the Central Bankers

If there is a “Sarajevo” of the War of the Central Bankers, then September 2009 has to be it.  That was when Bernanke chose the nuclear option now commonly known as QE.  Here is a chart that we are all familiar with, the chart that shows the Fed’s balance sheet rising from $800 billion to $4.5 trillion.

 

1-Fed assetsAssets held by the Federal Reserve system

 

Among other disastrous consequences of this ill-conceived strategy is the destruction of the fundamentals of monetary policies.  Instead of the intended results of stimulating the economy at home, based on textbook theories, QE is like a weapon of mass destruction against competing economies.  This is the “beggar thy neighbor” strategy, forcing them to retaliate.  Take a look at the impact on currencies.

Euroland struggled for a while and the current field commander Mario Draghi finally declared he would do “… whatever it takes” to make the euro more competitive, or weaker against the dollar.

 

2-EURUSDEUR/USD – “mission accomplished”, Europeans successfully impoverished by central bank fiat – click to enlarge.

 

Japan saw the yen rise to below 80yen/dollar, a level last seen during the Plaza Accord of 1985.  Historians may remember how that went hand in hand with the Japanese bubble and the subsequent collapse the country never recovered from. “Abenomics” put an end to that and the yen rapidly dropped 50% to the 120 range.

 

3-USDJPYAnother demonstration of how the citizenry can allegedly be made “richer” by becoming poorer – USD/JPY – click to enlarge.

 

China was the growth engine of the world during that period.  Rightfully so, the RMB was the only currency that strengthened against the dollar.  Under attack by all the “beggar thy neighbor” policies of its major trading partners, China’s growth is slowing and a frothy stock market has collapsed.  They are finally forced to retaliate with their own devaluation missiles.

 

4-USDCNYChina decides to join the fun (not necessarily voluntarily) – USD/CNY – click to enlarge.

 

Just as the world’s central bankers have battled hard to push the mighty US$ higher against their respective currencies, supreme commander Yellen launched another major offensive with her September 17 FOMC statement, not only leaving rates unchanged, but opening the possibility for a whatever it takes move.  The world will soon see what rabbits the ECB, the BoJ or the PBoC can pull out of their respective hats.

 

But what About Real Estate?

Yes, this rant is actually about real estate.  Real estate text books attribute housing demand to employment and household formation.  These theories sound good on paper but have little to do with the real world, especially during times of war.  Housing demand in the US is divided between the haves and the have-nots.

 

The Haves

The haves do not have to be rich, they simply have to have enough assets that housing is a matter of choice.  They can rent.  They can buy without relying on financing.  They can occupy the dwelling or they can rent it out for income.  They can even buy outside of their own countries. For this group, the decision is whether to own real estate, where to own it, or whether to own US$, or euro, or yen, or gold, or Bitcoin.

This group is international.  In 1979, it was a revolution that enticed all the Iranian “haves” to seek a safe haven for their assets in the US.  In the late 80s, it was the Japanese with the strong yen and no place to put it at home.  The haves of Hong Kong were fleeing the colony before the handover and buying where they could, mostly in Canada.  Numerous peso devaluations prompted Mexican “haves” to come across the border and buy.  Today, it is the Chinese and other Asians who are the most significant forces in the real estate market.

As the new world war escalates, more “haves” should be buying in the US markets.  Domestically, the haves may have no place to put their assets, so real estate is seen as good as a bank account or the equity market.  Internationally, the Chinese may be flocking here if they think real estate prices in China will be going down and the RMB will be devalued.  Europeans may choose to buy in the US, as they see their respective neighborhoods being overrun by a new wave of Africans escaping bang bang wars or extreme poverty.  They may also want to exchange euro denominated assets for US$ denominated ones.

 

The Have-Nots

The have-nots are not poor as defined by official poverty levels.  They are house-poor and do not have the luxury of choice when it comes to housing.  They struggle to save up for a down-payment, struggle some more to qualify for a mortgage in order to buy what they can rather than what they want.

If the Government, operating in the form of Freddie, Fannie, the FHA and the VA were not providing over 90% of all financing for the last 6-7 years, these “have nots” may not have a house. If the Federal Reserve had not been purchasing agency MBS through its QE operations, driving down rates at the long end in the process, these “have-nots” would not have a mortgage to finance a house.

 

5-30-year fixed rates30 year fixed mortgage rates – click to enlarge.

 

During the sub-prime era, these were the same have-nots who dreamed of home ownership, asset appreciation, housing ATMs, and second and third homes.  They do not realize that they may have survived the emergency room, but have actually never left intensive care.

The world has too much capacity.  There may be a shortage of highly skilled labor, but that is only exacerbating the problem.  For example, the smart kids are inventing robots, while the not-so-smart kids will see their jobs replaced by robots.  Income inequality will widen.  The real estate “have-nots” will outnumber the “haves”.  I cannot picture any scenario in which wage income would increase due to a labor shortage.  It is therefore inconceivable that income growth will be the driving force of future real estate appreciation.

 

Conclusion 

Real estate will be driven by forces that have little to do with underlying housing fundamentals.  A young couple looking for a family home may find itself competing against an overseas cash buyer who has a totally different purpose and hence a different concept of value.  Mortgage rates may move up, or down, not because of market forces but due to the Federal Reserve’s say-so, or because some foreign central bank decides to buy/sell a bunch of US treasury debt for its reserves.

For the foreseeable future, I believe US real estate will be a bumpy ride full of surprises.  The wars may be creating better opportunities elsewhere.  Anyone interested in buying some prime Greek properties with me when they finally return to the drachma?

 

Image captions by PT

 

Charts by: St. Louis Fed, Xe.com, Mortgage News Daily

 

 

 

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