Last week, I wrote about the trajectory for housing overall and its implications for home prices over the next 10 years or so. Today, I am going to discuss the implications of this for the economy and for government policies concerning housing.
As background, last June I discussed the concept of compression, and this past January I discussed the stages the housing market goes through from peak to trough.
In short, compression is the process of high-end residential real estate -- properties above the $1 million mark in the suburban coastal cities -- declining from peak to trough in greater percentage terms than lower-priced homes did.
The stages I referred to in January describe the process consumers go through as housing moves from peak to trough. At the peak in values, there is overwhelming consensus that housing does not decline in price, and at the bottom, the consensus becomes that housing does not appreciate.
The final stage of both of these representations is now beginning. What we have to determine now is how long the final stage will take and what's its impact on the economy will be. It could be severe.
For the past five or six years, high-end residential real estate has escaped the decline in property values that afflicted entry-level and mid-level properties. The final stage is for the high-end values to decline, and that process is now beginning. From current price points, a decline in nominal terms of about 25% over the next five years is likely -- i.e., a home priced at $1 million today would be priced at $750,000 within five years.
Although this process represents the last leg of the correction in home prices, it will be viewed the most negatively as it dashes people's remaining hopes of a rebound in home values. And that will signal the final stage of consumers' collective resignation. The market will then consolidate again, and the best-case scenario would be nominal price appreciation at the rate of inflation for 10 to 20 years.
The germane point is that housing for most of the country is already close to its bottom. On a national average basis, a decline of 10% may still be in the cards, but for the most part it's over. However, the economy will suffer as high-end residential real estate values decline, and the stock market is not reflecting any recognition of this at this point.
Just as there are stages that people go through in dealing with housing declines, and just as different segments of the market enter the consolidation phase at different times, there are differences in consumer patterns.
The fall in values for entry-level and mid-level properties caused a contraction in consumer confidence and spending that led to the recession of 2008. But high-end residential real estate and high-end consumption were little affected by those events. In fact, many in the upper 10% of income and asset owners have actually benefited from the monetary and fiscal stimulus, as it has pushed equity indices up 100% in the past three years.
Now, with high-end properties beginning to decline in value, the big question is, will the consumption patterns of the wealthy change? The top 10% of income and asset owners in the U.S. account for about 50% of personal consumption expenditures.
So this is not an idle question to consider. The most comparable event was the impact on housing caused by the collapse of the savings-and-loan industry in late 1980s and early 1990s.
High-end residential real estate suffered massive losses after the Tax Reform Act of 1986, and that was one of the catalysts for the S&L debacle. Values declined an average of 25% nationally within just a few years.
But the U.S. did not enter recession, and consumption remained strong. So there is some cautious hope that consumption won't decline precipitously this time. It is probable and logical, however, that consumption will be affected, and that process may already be starting, as high-end property values are beginning to decline.
I will address this is future columns. For now, one of the issues I am watching is the rate of homes being listed for sale and at what prices. As we move into the spring housing season and there is still no indication that the Mortgage Debt Relief Act will be extended, I am expecting more houses to come to market, and I expect their asking prices to drop.
You can follow this at the Department of Numbers.
