Five Reasons Home Prices May Slump For Years

While the stock market has shot up over the past year, and many expect the economy to rebound, housing has continued to slump. Nationwide, most people who are currently buying expect their home to appreciate over time, and there are many sellers awaiting to sell in a more profitable climate.

Real estate is largely a local phenomenon, as evidenced by the massive runup and subsequent bust in California, Florida, Arizona versus the more stable prices in states such as Texas. So it’s difficult to generalize US real estate prices as a whole.

However, there are some reasons to think that, in general, home prices may not be going up for a long time, and may in fact stay quite stable or dip further.

1. When home prices go up, it is not the building’s value that goes up, it is the land’s value. This should be fairly intuitive. After all, all things being equal, people would rather have new construction than old construction. Buildings decay over time; land does not. So when we are talking about a home going up in value, we are really talking about the land going up in value more than the building goes down in value. So absent a remodeling project (which means you are paying for your home to go ‘up’), the building’s value will slowly decrease over time. It is just a matter of if the land goes up in value more so to make up for it.

2. Past performance does not mean future performance, but we can learn from the past. I’m not talking about America’s past though, let’s look at Japan, whose past experience is more similar to our current experience. Japan’s historic property and stock market bubble and burst in the late 80′s and early 90′s is well known. What isn’t appreciated from this though is that even after the bust (say 1995) until today, home prices have STILL gone down further. That is deflation at work. Here’s a nice little graph.

Most of the time, people think about the past experience in the US, which has been strong economic growth and gradual, sometimes rampant inflation that brought up the price of everything. However, things were different then for the US. America’s response to the current crisis has modeled Japan’s in every degree. Like Japan, we have responded to an asset bubble with stimulus packages that increased the size and debt of government, raised taxes (incredibly deflationary), and allowed banks to sit and hide behind bad loans. Like Japan’s crisis, its private sector is in the process of a massive deleveraging, and there is a low demand for loans. In short, if a past experience is any guide to the future, it is Japan’s past, not our own, and even AFTER the initial crash, home prices have still gone down steadily in that country.

3. Long-term interest rates assume very low inflation. Many people have called treasury bonds the ultimate bubble and that yields can only go higher. But what if they’re wrong? What if treasury yields go even lower on long-dated treasuries? People are currently willing to lend to the federal government at 4.67% over 30 years. Japan’s government borrows at 2.23%. We’ve seen what happened to property prices in Japan over time when investors believed  (correctly) there would be a very low level of inflation.

4. There is still a large oversupply. Banks have been sitting on their ‘shadow inventory’ and have been reluctant to foreclose. The government has initiated many programs to keep supply of homes low, whether it is the new buyer home credit (to push demand forwards and drain out some existing supply) or foreclosure prevention programs, but many of these (such as the tax credit) are winding down and others are meeting with low levels of success.

5. Demographics are not in housing’s favor. Population growth in the US is lower in the past, so there is less new demand for housing. Furthermore, most of the population growth is a result of immigration, and it is unclear if we will have this continued level of immigration in the future. Furthermore, immigrants have a larger number of people per household. The average immigrant household has 3.2 people, whereas US-born citizens have 2.4 on average (source: Hence, 100,000 more immigrants will only need 31,250 more houses, whereas 100,000 more US-born Americans would need 41,666. The baby boomers are also retiring and may wish to downsize their homes.

During late 2008/early 2009, doom and gloom permeated throughout America. The idea of a ‘new normal’ of lower growth was frequently talked about. The recent stock market rally, as well as slowing decline of job losses, has led many to believe that everything will be fine soon and our future will mimic our past. However, there’s a big difference between the world not ending and the strong price increases and economic growth of the past. Japan is hardly a third world country; it’s society and way of life did not collapse after its financial bubble. Nevertheless, even after their economy stabilized, it still saw price deflation in housing for well over a decade.


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