If you over paid for your home – even a little, you are part of the current problem that threatens the US economy and, because of our very close relationship to the US, our economy too. You need not be an economic whiz to understand the issues nor the impacts they will have on you directly. Below is a simplified view of things as they are and a strategy to make sure you are not on the short end of a bad stick.
Our economy expands year-over-year at a rate that averages about 3.5%. That means that through normal cycles of highs and lows the average rate of growth over long periods of time is 3.5%. What that should mean is that if a non-depreciating asset is purchased, over time, it should have a nice even growth at that same rate.
Over the past few years in the pre-recession period, housing prices have had wildly soaring fluctuations – some by as much as 60% in a single year. There are a few problems about rates of growth in house prices exceeding the rate of growth of the economy. For instance, if wages track more closely to the economic growth rate, then housing becomes increasing less affordable. This is important because the pool of buyers at super-normal prices begins to dwindle and the effect of this is that housing prices should return towards the natural rate of growth of the rest of the economy or incomes need to increase along with prices of goods to inflate the economy to off-set the difference. That hasn’t happened and large numbers of people continue to buy new homes – causing price-induced instability. Imagine a narrow house built of cards that has become so tall that even if you start to widen it, the structure will still be very unstable and likely to collapse.
This instability is the effect of the gap between the economic growth rates, erroneously priced homes and sales to unqualified buyers who get financing based on inflated prices coupled with their own income. This is not the fault of the buyers - financial institutions are issuing mortgages on these over-heated homes because they have shareholders demanding annual returns and that requires more sales to more people – even unqualified people. For many consumers, home purchase prices are well beyond the normal range for being a healthy component of income expenditure. In other words – people are spending too much to carry the debt of their home. From a banking perspective, the result of issuing mortgages for these homes is that it creates distressed mortgage paper that has less value than if that paper were properly secured against income and property value. To eliminate 'bad' mortgages from their books, lenders sell these loans into the capital markets without the knowledge of the borrowers. These are then assembled into different offerings and sold as 'sound' debt investments. The crux of the problem with this is that lenders are moving their bad lending decisions into the investment community where investors big and small attempt to obtain higher yields to offset the higher costs caused by over-valued housing.
So, there’s over-valued housing, over zealous lending and impaired debt paper in the market. So what? Perhaps a hurricane or terrorism effecting crude oil production or refining or wheat crops being spoiled by heavy rain in the mid-west, as soon as there is a significant economic bump consumer prices go up and results in less money with which to make mortgage payments. When this bump happens, it increases mortgage defaults and, in addition to putting people out of their homes; it has lenders liquidating residential real estate to cut their losses. This creates pricing depression in houses and lenders as a result have less secure mortgages again– adding to the supply of distressed financial paper and completing one more cycle of the meltdown.
Knowing that your home was likely over valued is of no help to fixing the problem. A number of 'market corrections' to level things out is what is needed and a 700 billion dollar debt purchase the US government is just one sign of this happening. What can help though is knowing that your next housing decision does not add to the problem and further expose you to more irrational housing inflation and lifestyle contraction.
Simply put, the rational decision is to stop buying new residential property and if you have to, don’t get into bidding wars. And, if you do buy - stay put.
At the beginning of this discussion there was a reference to non-depreciating assets. There are different ways people define an asset. For some it is a thing that generates income. For others, an asset increases in value when it is sold, hopefully generating profit - like any commodity. A house is a special type of asset because it does depreciate relative to its neighbors unless it is maintained and invested in. This is something that is rarely done and is part of the reason the gap between the inflation rate and home price increases are so dangerous. In Toronto for example, termites affect many neighborhoods. What some buyers have done is negotiate a discount off the price to pay for the needed repairs. However, many people do nothing to improve value beyond cosmetics and don’t even fix the damage. This cycle continues in subsequent sales with some owners knowing and others not knowing about the infestation. This makes for a decrepit housing supply in the city with the only advantage being that some buyers negotiate a price based on the infestation. Increases in price with decreasing value are inherently dangerous to the housing system and to you as the owner of decaying and overpriced assets.
As opposed to getting into spiraling inflated house prices based on purchase flips that suffer from over pricing and cumulative legal, realtor and closing fees eroding value, the best recommendation is to hold your property for multiple generations and if there is a need to increase or alter the space – do it on your existing property and plan to enjoy it for a long period of time.
In short – if you bought it, keep it. If you need more of it, expand it. And, if you plan to sell it at some time in the future, maintain it in good condition while staying as free of debt as possible. You will enjoy your money more and even lenders will appreciate that the pool of qualified buyers will increase over time.
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This article was contributed by Ari Berman, a Management Consultant from Toronto, Canada, with a specialization in operations and process change. He has helped companies spanning aircraft builders to soda drink manufacturers to increase their value - finding and improving important details that never got attended to in past. His work in the construction industry includes overseeing commercial construction projects in retail shopping malls across Canada. He can be reached at 647-235-8181 or via e-mail on ari.berman@cmc-advisor.com.links:telegraph.co.uk: Why is everyone worried about house prices?
by Charles Moore; Last Updated: 12:01am BST 19/04/2008
independent.co.uk: We're riddled with debt... but the cure is a killer
by Graham Turner; Sunday, 6 July 2008
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