Still Renting

By Mark Kiesel

Based on the current outlook for housing, I will likely be renting for one to two more years. While many factors that influence housing prices have turned negative, I suspect we have not yet hit bottom. In fact, housing prices should head lower throughout the rest of this year and next year as well. Why? Housing inventories remain high, delinquencies and foreclosures are set to rise as homes purchased over the past few years by speculators and individuals with teaser-rate and adjustable-rate mortgages come back on to the market, affordability is low, and sentiment and risk appetite has shifted negatively. Most importantly, the availability of credit is set to take a turn for the worse as lenders tighten credit standards.

This is all great news for renters and buyers who are patient. Over time, housing prices and interest rates should decline, resulting in improved affordability. This adjustment, however, will take time and occur over a period of years, not months. Housing is illiquid and prices are sticky. As a result, potential buyers should exercise patience and not jump back into the housing market too early. A year ago, I described the state of the U.S. housing market as “the next NASDAQ bubble.” The NASDAQ took over 2 ½ years to go from peak to trough. I suspect that housing prices could display a similar pattern, and we are still over a year away from the bottom. Given these risks, I prefer renting versus owning, and an investment strategy which favors defense versus offense.

Unwinding the Housing Bubble

Housing was an asset bubble influenced by bullish sentiment, robust risk appetite and speculation, lack of fundamental analysis, cheap money, inflated appraisals and easy lending standards. These factors helped to drive housing prices up to new levels and the unwinding of these conditions is expected to drive housing prices down. Never before have we witnessed so many people lever-up real estate with so little money down or “skin in the game.” This growth in mortgage debt and risk appetite helped fuel consumer spending and corporate profits. As such, the unwinding of this bubble will have broad consequences for the overall economy.

As the housing bubble unwinds, what are the implications for the overall economy and credit spreads? The U.S. economy will likely experience sub-par economic growth for the next year as declining housing prices lead to weaker consumer spending, slower corporate profit growth, a decline in business investment and less job creation. This environment favors reducing credit risk, especially to cyclical industries and lower-quality sectors of the market. As lending standards tighten and risk appetite turns more conservative, housing prices are likely to face a further leg down.

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