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Discussion of a "Bottom" One Year After a 7 Year RE Market Run Up is Pure Ignorance!

I was talking with my father yesterday about the meanings of the terms recession, depression, inflation, nominal and real prices. My dad (and my mom) are my heroes. They are hard working, god fearing, extremely loving working class folk. BTW, we had this discussion on the way to talking to the local Hyundai dealer to sell us their top-of-the-line, fully equipped Azera model for just over $23,000, brand spanking new. This car has 85% of the amenities as luxury cars literally costing four times as much, not to mention a 7 year warranty. This is the Edmunds pricing breakdown for that exact car.

TMV Pricing Report
2008 Hyundai Azera
Limited 4dr Sedan (3.8L 6cyl 5A)
TMV
What Others
Are Paying
  MSRP Invoice
National Base Price $28,550 $26,517 $27,306
Regional Adjustment
for Zip Code Change
- - $175
Optional Equipment $2,750 $2,538 $2,639
06 Option Group 06 Ultimate Navigation Package $2,750 $2,538 $2,639
Color Adjustment - - $32
Sage Green
Destination Charge $695 $695 $695
Total with Options $31,995 $29,750 $30,847
 
Incentives & Rebates -$2,500
Customer Cash Adjusted True Market Value $28,347

Now, why would they sell us the car for $5k less than what "others" are allegedly paying? The truth of the matter is, as many have already surmised, that the car business is doing horrible. These dealers have inventory on a floor plan (credit line) and they are apparently losing enough money where they are willing to take deep losses in order to move it off the lot. This is a sign of a depressed economy. Hyundai are the "everyman's" car. If these can't move without discounting past the point of extreme pain, the debate about recession and hard landing is simply academic. Okay, I digress. On to the topic at hand.

If I hear another pundit (ex. Ara Hovnanian) query or comment on reaching a "bottom" in the real estate market anytime soon, I am going to scream. In the conversation I was having with my father, I explained the current housing like a ball that we usually play with at ground level. Ground level is the equilibrium point. Now, I said, imagine throwing that ball 50 feet into the sky, then expecting it to suddenly stop in mid-air or 5 feet down in its descent back to the ground - ex. finding the "bottom" that the CNBC crew are in search of and expecting to come sometime next year. Physically, and realistically, this expected stop (or bottom) for the ball just ain't gonna happen. The same can be said for real estate values. When things pop that far outside of historical mean, expect a reversal. The following graph makes this point crystal clear, congealing the entire conversation I had with my pops into one picture...

Looking at the real (inflation adjusted) prices of homes over time and comparing them to the rates that tend to power them and the costs to build the home, that ball that was thrown up 50 feet into the air (the blue line) will have to drop at least 50% before it even comes close to hitting the ground again (the largest distance between the two lines, historically, excluding the 1997 spike, at at a realistic minimum). So all those guys who think the largest historical housing price spike since the US gold rush that lasted at least 7 years will be over after a year or two of relatively minor correction, study your history!

Now there is another way of looking at this. Many people ask me when I think the housing market prices will stabilize. I say the that houses will sell when people will be able to buy them. After the long run up, median prices have outstripped median incomes by so much that the (vast) majority of housing stock is out of reach of the everyday working couple. People like my mon and dad. It's as simple as this - houses won't start selling until people can buy them.

So taking the previous, and rather simplistic but highly informative theses into consideration, any one who believes that housing industry and financial industry that levered up on real assets and related securities at the very tippy top of that blue line in the first graph will stop writing down values by year end or even next year, I strongly suggest you start studying your history. It will be decades before we see those prices levels again. Where excessive leverage has come into play, it is quite possible that some of these assets may actually NEED to be written down to zero. Just look at the first chart and think of buying at that apex with 30x leverage, then having to suffer the trip down as the ball falls back to the ground.

 

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