The Continued Slow Deflation of the Housing Bubble

July 27, 2009 by  
Filed under Economics

housing_bubbleThe stock market perked up last week. Does that signal the beginning of a return to the good old days? After all, the Obama economic team is feverishly pulling out all of the stops in its attempt to restart the residential real estate markets in a positive direction.

Although the tide may turn slightly, I’m skeptical about whether we are going to see a return to meaningful long term growth in residential real estate values.

In the short term, mortgage interest rates are destined to increase from today’s remarkably low numbers. Inflationary pressures are sure to play a role in moving mortgage rates upward, depressing demand for new housing by marginal buyers.

Baby Boomer Sellers Will Depress Real Estate Prices

An even bigger long term problem is likely to be the price lowering effects caused by 78 million baby boomers moving down and perhaps out of traditional real estate markets entirely. That is precisely what some experts have been predicting, even before the recent price crash.

Two planning scholars from USC published in 2007 a careful and detailed analyis of the relationship between aging of 78 million baby boomers and residential real estate prices.

The theory is this: Real estate prices are dictated primarily by supply and demand. (No mystery there, although mortgage interest rates are also a factor.) For prices to go up, demand for single family housing must at least equal or exceed the supply. I think we can all agree on that.

Enter the baby boomer factor. Beginning in 2011, baby boomers will begin turning 65. At this point – for the first time in our history – the growth rate in the elderly population will exceed that of younger adults. According to the research, the ratio of 65+ adults to working adults (25-64) will increase by 30% in the next decade and by another 29% in the following decade. In some states, the jump in ratio of old to young will be even worse, with Arizona leading the way at +89%.

The study authors then looked at historical home buying and selling rates for different age groups. Here is a graphical representation of what they found:

sell_rate

Note how and where the lines cross. Older folks are big time home sellers. Assuming that aging boomers act in accordance with historical trends, the number of sellers will begin to exceed the number of buyers in many if not most states in the next 10-20 years.  It’s already happened in some states. (Read the full article to see where your state fits.)

This is the conclusion from the study authors:

In sum, supply will be dominated by the actions of aging homeowners who have little ability to postpone decisions, and home builders who cut back as little as possible. Large builders will shift to markets with good growth prospects and scale back their operations elsewhere. Other builders will find niches of underserved demand, particularly among the elderly, even in stagnant or declining markets. Thus we expect the number of properties for sale to grow ever larger, creating a buyer’s market, and vacancies to accumulate in less desirable neighborhoods and parts of the nation.

Makes sense doesn’t it?

This research is consistent with events that occurred since the report was published. It also confirms data discussed in two earlier articles I wrote. One concerns the general economic effects of the baby boomer demographic slide. The other article discusses a likely decrease in demand for, and valuations of, suburban residential real estate.

Strategies in Response to Deflation of the Housing Bubble

So what does a homeowner do with this information? First, it depends on where you live. Different states and regions will be affected differently, in some cases radically so. If you live in the northeast, residential real estate values in suburban neighborhoods occupied by baby boomers may stay flat or decline over a period of many years. In other words, don’t count on making money on a home purchase in those areas.

Neighborhoods may experience a general decline in valuation, making them more affordable to younger buyers. However, as the authors point out, these declines will adversely affect revenues from property taxes. Local governments in suburban areas will feel this. The reaction may be a sharp increase in tax rates, to compensate for the lower tax base.

Excluding retirement meccas, urban residential properties may be the only sector where values will generally increase over the next decades.

One interesting response suggested by the study authors is to increase demand by increasing immigration. Folks who make their living building houses will certainly take notice of this.

The bottom line for me is that the baby boomer effect cannot be ignored when assessing how (or if) home ownership fits into your personal financial plan.

Think about where you live and what you live in, read the article, then decide for yourself what is your best course of action. That’s what Mr. ToughMoneyLove is doing.

Photocredit: Zanastardust


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5 Responses to “The Continued Slow Deflation of the Housing Bubble”
  1. Kacie says:

    Interesting. It makes quite a bit of sense to me.

    I live in Pittsburgh which has more older folks than younger. Housing prices never got out of hand here.

    I can see how as boomers continue to age and move to warmer locations, nursing homes, heaven, that more houses will be available.

    That’s good news for me, since I’m a renter and would like to buy within the next few years.

  2. MasterPo says:

    You know TML, for at least 30 years of my life I’ve heard how the retiring boomers are going to change the whole dynamic of our economy, if not destory it!

    Hasn’t happened yet.

  3. MasterPo says:

    You know TML, for at least 30 years of my life I’ve heard how the retiring boomers are going to change the whole dynamic of our economy, if not destory it!

    Hasn’t happened yet.
    Oops…forgot to say great post! Looking forward to your next one.

  4. Liz says:

    Master Po — the boomers haven’t retired yet! I do foresee a mess with Social Security if that isn’t addressed, and soon. I’m not that close to retirement yet, and still have 3 kids to put through college. But my mother and MIL are both still around, and we’re seeing firsthand that we have GOT to plan for retirement. Fortunately, both have sold their SF homes — we’ll have to worry about ours later, plus ours is a kid-friendly house in a kid-friendly town. So that will help, plus it’s “average,” not huge, not small. Kathy Lane’s book “Die$mart” is helping us with retirement planning, including mistakes to make, how to manage and protect assets if I/we become incapacitated (you need more than a will) and the need to look into long-term care, among all kinds of other valuable nuggets. Estate planning is NOT just for the wealthy — this book has shown us clearly that it’s a must for everyone, young and old, rich and poor, and average.

  5. Interesting take. While I’m with you on many of your points, IMO forecasting long-term economic trends such as these is no different than forecasting the weather. Afterwards, it’s really easy to explain what happened. Beforehand, really tough since there are innumerable variables.

    One factor you didn’t discuss which may play a role with the elderly; they live for a very long time and don’t want/can’t move. Even if they are forced into assisted living, the home is often not sold as a protected asset/inheritance down the road. In a way, the demographic trend of increased seniors may actually tighten the supply – especially in areas where property taxes are lower (so the annual cash-flow required for a paid-off house is low.)

    Personally, I think we’ll continue to see a regression to the mean. Of course, different markets will not fit the pattern.

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