Scenario: The Residential Real Estate Market Fractures

15Aug11

In the 1980s, I was warning that water was going to become a major concern in the coming years.  This was not due to my brilliance; I just reported what I was reading in assorted articles that seemed to make sense at the time.

In 2005, likewise, I was reporting that the residential real estate market was seriously slowing down — not because I was some kind of real estate expert, but simply because there were reasons to doubt that people would continue to be able to pay steadily higher prices for a place to live.

Like many predictors, I was going in both directions with some of my speculations.  Nobody really knows the future.  You just try to piece it together as new information comes in.  You always are at risk of reversing your opinion later.

In January 2004, I had some predictions that still seem accurate.  For purposes of making money, of course, timing is the whole thing.  Someone who had bet on me back then might have seen their money sit stagnant for years on end.  But for purposes of long-term planning, it may be less important to get the exact timing right.  It’s more a matter of anticipating what problems may be coming down the pike, and making arrangements to counteract or adapt to them.

One of my predictions, in January 2004, was that wages would continue to decline — that, in terms of incomes, “workers in the U.S., going down, will meet Chinese, Thai, or other Asian workers on the way up.”  Globalization made that relatively predictable.  This led to another prediction:

The value of your house will not rise, in nominal terms, if nobody can afford to buy it, or to pay the taxes on it needed to cover governmental deficits, or to pay dramatically higher rates of interest on a mortgage. It has often occurred that the houses that rise most rapidly in value are those that are marketed to the wealthy; it may be that middle-class housing becomes too expensive to acquire and maintain at current real prices. … If people come to see that they must take drastic measures to sell a home to buyers who have less money than before, there could be a selling competition in which housing prices are slashed deeply.

And that’s what happened.

So let us look at the housing market today.  For simplicity, let’s say there are two ways to see it.  On one hand, we may have been living through a dramatic correction in which the real estate market has been digesting all sorts of bad news about employment, incomes, credit, and the economy in general.

The idea of a “correction” suggests that the housing market will eventually finish processing this information.  It will adjust itself to the realities that it should have been gradually absorbing for at least the past ten to twenty years.  (My legal practice in the early 1980s included some work in the area of mortgage-backed securities, so some of this has been building for a generation or more.)  Then, in this scenario, the real estate market will find its feet and go back to work, providing long-term gains to homeowners, just like before.

On the other hand, this may not have been a correction.  This may have been the first shock in a complete, earthquake-style remaking of the real estate world.  In this scenario, what we think we are going back to is no longer there.  The only question is how long it will take us to get to the point where the fog clears and we see that plainly.

In this latter, revolutionary rather than evolutionary perspective, too many of the old rules are being rewritten entirely.  For instance, maybe the highways we have taken for granted are becoming too expensive to let tens of millions of people commute to work from suburban, exurban, and rural settings.  The government, even if it does not go bust, may have no fiscal alternative but to let many of those roads lapse into a potholed state of semi-disrepair.  Even if you, personally, can make the trip from home to work in relative comfort, thanks to your super-macho four-wheel-drive monster truck that rolls over decaying roads with ease, there’s a question as to how many potential buyers will be similarly positioned, when the time comes to sell your house out in the hinterlands.

As I noted in October 2007, it’s not just the highways — it’s the water mains, the electrical lines, and all the other infrastructure that supports the dispersion of population out into the suburbs and beyond.  Likewise, cars are going to be more expensive to build if the underlying economics deteriorate.  The things that cars are made of — steel, for example, and aluminum, and plastic — become more expensive as raw materials (e.g., iron, petroleum) become more expensive; and those raw materials will almost certainly become more costly as millions upon millions of people in Asia and elsewhere start to buy cars.  Even those cars that are manufactured in the U.S. will become more expensive if the dollar loses value, to the extent they consist of parts manufactured outside the U.S.

There has also been, and continues to be, an enormous shift away from the world’s former reliance upon the U.S. as its financial center.  Despite financial upheaval, in October 2008 I could still observe a degree of global confidence in the U.S. that is no longer quite so evident.  There does not seem to be the same need for a superpower.  American specialness — whether seen in New York City or Hollywood or Harvard — is increasingly contested by smart, hard-working people from Shanghai to Rio to Copenhagen.  There is not likely to be a return to the global dominance that made it so easy to create wealth in the U.S. a half-century ago, and that seemed (thanks especially to easy credit) to be continuing right up to 2007.

Over a period of decades, there is also a great deal of potential for the remaking of values.  American individualism has many advantages.  Unfortunately, it also brings a lot of alienation, loneliness, and destructive behavior.  People around the world are becoming more urbanized.  Some who might have opted for the comforts of the individualistic suburban life in a prior era, when they could afford it, may instead find themselves appreciating the social advantages of learning to live in closer proximity to other people.  That may become the only thing they can afford, but in some ways it may also be more fun.  The American Dream, with its house with the white picket fence, may gradually be reaching the point of seeming antiquated, as perhaps all dreams must do someday.

If apartments and other forms of clustered habitation become more dominant, the automatic preference for a single-family dwelling may come more into question.  This seems especially likely to happen if increased reliance on apartments brings improved laws and practices for the benefit of apartment dwellers.  In many places, renters have often been at a disadvantage vis-a-vis landlords.  A more professionalized, regulated, or otherwise ethical rental environment may thus exert further downward pressure on demand for houses.

So that’s one part of the revolutionary scenario, where the old market for residential real estate endures the financial equivalent of an earthquake.  Another part of the revolutionary scenario involves water-driven regional upheaval.  The vague 1980s prediction that water will be an issue is gradually being unzipped, as years pass, into a number of more specific consequences.

One consequence that is becoming more evident involves the drying-out of the Southwest and other regions of the U.S.  My prediction in June and July 2006 and again in November 2007 was that people would be moving in larger numbers, during the years to come, from places like Phoenix and Los Angeles to more northerly and midwestern locations.  It now appears that some of those alternate locations are in line to experience their own droughts, though perhaps not as soon.

We could see a large-scale drought-driven exodus from the Southwest — potentially involving millions of people — within as little as a decade.  People won’t stay long when drinking water grows scarce.  One question is whether they will be interested in relocating to another place, albeit cooler, where drought is still a long-term risk.  What seems more likely is that, to the extent they can afford it, people will want to sink roots in places that seem to have relatively deep water supplies.

Of course, there are long-term possibilities that seem like science fiction now.  Fusion reactors could power the pumps and desalinators that could fill pipelines and canals from the Pacific all the way to the Rio Grande.  Atmospheric tricks could change everything.  But we aren’t there now, and it’s not clear when or if we will be.  The most likely prospect at present is that there won’t be enough water for all the people who would be born in or move to the desert Southwest, and therefore those people are going to have to go somewhere else.

Previously, it may have seemed that anywhere would suffice — that people could get all the water they need, almost anywhere in the relatively lush, cool, green states to the north and east.  Now that’s not such a sure bet.  Abnormally dry conditions have been cropping up all along the Atlantic, and even in places like Wisconsin, Michigan, and New Hampshire.  Human nature and markets being what they are, it could easily develop that a town on the shore of Lake Michigan finds that it has all the water it needs, whereas another town just a few dozen miles inland can barely afford to pay for shipments through its pipeline to the lake.

Lake Michigan is a Great Lake.  There are thousands of other, smaller lakes around the country.  Some may be fed from springs, and some communities may draw their water from aquifers or other subterranean sources, that are not at risk of industrial pollution or drying out.  (Along those lines, it seems like the water filtering industry would be a good long-term stock market bet.)  In the revolutionary scenario, one might expect a great deal of upheaval, starting within a few years and continuing for some time, as the science and the facts of water availability are sorted out.  It may eventually be easy for anyone to see why Community A has adequate water, while Community B does not.  But at present, most of us don’t see that sort of thing very clearly.

It seems there could be a lot of relocation, upheaval, and irritation, over a period of years, as the public tries to wrap its head around a world in which something as basic and taken-for-granted as water becomes a complete wild card.  Ironically, established urban neighborhoods in a hustle-bustle place like Chicago may experience much less of this upheaval than a seemingly placid community out in the boondocks.  At any rate, the risk of complete upheaval is not apt to persuade people to invest in the thoroughly inflexible asset of real estate.  To the extent that people don’t simply move into apartments, I’d expect, instead, to see a boom in portable residential structures, and in places to park and live in them.

To sum up, I have sketched out two developments that suggest revolutionary rather than evolutionary change in the residential real estate market.  First, I have suggested that the demand for and affordability of single-family dwellings may decline as it becomes unaffordable and/or undesirable to indulge the highly individualistic and in some ways antisocial vision of the old American Dream.  Second, I have suggested that the stability — indeed, the immobility — of residential real estate could appear risky if not foolish in a world where the necessities of life may require mobility.  I have made that case especially with the example of water, which has the potential to redraw the map of American population, though much the same point could have been made, more subtly and over a longer period of historical time, as changes in the job market over the past three decades have required large numbers of people to pull up roots, abandon their friends and extended families, and go live in other places.

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One Response to “Scenario: The Residential Real Estate Market Fractures”

  1. Another post contains an update to this one.


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