Housing Prices, BB’s and the Bottom of a Bucket

How long will it take before housing prices go up again? In reply to that question, I typically respond, “It will probably take a while longer than most people think and will look a lot like the bottom of a bucket.” When I’m asked why, I’ll usually ask them a question in return: “How long would it take to pick up two million BBs off the beach?” Whomever I’m speaking with usually gives me a puzzled and slightly annoyed look and says, “What’s that got to do with the bottom of a bucket, or, more importantly, when the real estate market will hit bottom or what the bottom will look like? And, for that matter, what’s the bottom of a bucket got to do with anything, anyway?”  Its been the best way I can think of to explain my view of the housing market.

Everyone would agree that picking up a BB from the beach isn’t hard. To pick up two million BBs from the beach, you can give a lot of people metal detectors and magnets to help with the job. It’s still going to take a long time. We’ve got to sell about two million surplus homes in the U.S. It will take a long time to sell them. As long as there are significantly more new homes for sale than there are buyers, prices will remain at investment value. This will result in a long, flat bottom to the market - kind of like the bottom of a bucket. Ahhh, you say, now I’m starting to see what you’re talking about….

At the beginning of 2007, by most estimates there were about two million surplus new housing units (condos and single family homes) for which there was no viable buyer. This triggered a melt-down in housing values that in-turn triggered a domino-like melt down of the economy. The bottom of housing market prices will be when new housing starts are less than new first-time buyers coming into the housing market, and individual housing units reach investment value – the price at which an investor can purchase a home and rent it for a profit. In many markets we’re there – or nearly there. That is not to say that there aren’t other important factors at work here – there are. These are the two of the big ones, though.

Surplus homes are homes for which there are no willing buyers at a particular price. In other words, surplus of existing demand. Annualized new housing starts have for the first time dipped to just below the number of new first time home buyers. In the weakest housing markets you can now purchase a new home and rent it for a profit. Investors are entering these housing markets in increasing numbers and purchasing these homes. As long as fewer new homes are built than there are new first time home buyers, these surplus homes will be absorbed into the market. Depending upon what happens with new housing starts and the number of new first time home buyers in the market, the absorption of these surplus homes will occur faster or slower. For example, if the number of new housing starts remains at its current annualized rate of 500,000 and the number of investors and new first time buyers together buy about 1 million new homes each year, it will take about four years to absorb the surplus new homes. Although investors are beginning to purchase these new homes in ever larger numbers, they are still buying them one at a time. 

Until most of these surplus homes are purchased, the market pricing must remain flat as long as there are more homes available to purchase than there is demand for them. Like the bottom of a bucket, the housing market will likely remain flat for a number of years, while the market works its way through excess supply. Then, when demand for housing finally exceeds supply, prices will rise. Add some inflation, and a lag in new housing construction capacity, and prices could rise pretty fast when the surplus is absorbed.

Then we can all tell stories about the the time when you could buy a house so cheaply, you could rent it for a profit. Ah, the good old days….