US House Prices Look Cheap But Not Cheap Enough
A Look At US House Prices In Honest Money
In 2010, banks repossessed some one million homes in the US.
According to RealtyTrac, 2.9 million households were subject to foreclosure filing. Over 25% of American homes are in negative equity.
With prices down about 25% from the peak, this housing crash is considered as bad as, if not worse, than that of the Great Depression.
There is blood on the streets.
Does that mean it's time to buy? Let's take a look...
Let's start with a chart of the US housing market, which shows the average price of homes sold since the lows of the early 1990s. From a high just above $325,000, the average price now sits at about $250,000.
But this is slightly misleading. This chart only shows homes that have actually sold. The US has an unprecedented inventory of hundreds of thousands of homes, often empty, sitting on banks' books, unsold and unsellable. If there was a way of charting the value of these, and incorporating it into average US house prices, the falls from the peak would be much greater.
US house prices have barely fallen if you measure in pounds
However, another thing that anyone from Britain looking to buy a US home has to consider is the exchange rate. The average US house price may have fallen by 20%. But if the pound has also fallen 20% against the dollar, then to a UK buyer, that house price is unchanged.
And that, in fact, is almost what has happened. I was amazed when I saw the chart below. It shows the average US house price measured in pounds.
Although the US housing market peaked in 2005-6, in sterling terms it actually made a higher high in 2009-10. And we're still trading at the same levels as the 2006 peak. It's entirely due to the woeful fall in the pound's purchasing power.
With recent relative strength of the pound we are looking at falls from about £190,000 for the average US home at the 2010 peak to around about £170,000 now. That's a fall of about 10% – hardly a crash.
(My sincere thanks go to Nick Laird of Sharelynx – who drew this chart for me in the Australian early hours)
So, to the UK buyer, the US housing market still looks expensive. A strengthening pound would, of course, change that.
Looking at it the other way round, Britain's housing market has fallen considerably more if you measure it in US dollars rather than sterling. From a peak of almost $400,000 in late 2007, by early 2009 it had fallen to a low of almost $200,000. A near 50% decline in just over a year – that's quite a drop, although it's since bounced to about $270,000.
(Thanks to Dr Tom Fischer, Professor of Stochastic Financial Mathematics at the University of Wuerzburg, Germany, for the chart).
The truth about US house prices – they're cheap
But as I've noted before, paper currencies are a pretty unreliable measure of any asset's value. So let's have a look at the ratio of US house prices to gold – ie how many ounces of gold it takes to buy the average US home.
Judging by this ratio, US houses are starting to move into the zone where they will soon look a compelling buy. In other words, the time to shift out of gold and into US housing may not be far away.
Take a look at the chart below – my thanks again to Nick Laird of Sharelynx. You can see that over the last 40 years or so, from a long-term perspective, anything under 250 ounces of gold for the average US home is cheap. That doesn't mean it can't get cheaper. But it's still cheap.
Although nominal US house prices did not peak until some five years later, the gold-to-US-house-prices ratio actually peaked in 2001. That was at the start of the US dollar bear market and the gold bull market.
At that point you could sell your home in the US and buy more than 800 ounces of gold. These were similar to levels last seen in 1971, when Richard Nixon took the US off the last vestiges of the gold standard. Nowadays, if you sold the average US home, you would get just 25% of that, 200 ounces of gold, for it. You're looking at a 75% decline.
It all shows the importance of holding a form of money that can maintain its purchasing power. Over the last ten years neither the pound nor the dollar has done that. Gold has. (That won't last forever of course, but it's the case for now).
In 1980, at the peak of the last gold bull market, you can see that ratio hit 100 ounces of gold for the average US home. That's $136,000 in today's money. If we were to reach that 1980 level again – and I don't see why we shouldn't – we are still looking at 50% declines from here for US house prices measured in gold. It may not look much on the chart, given what has gone on before, but it would still be a 50% fall. (This could result from gold rising further as well as from US house prices falling – or both).
These are the frightening mathematics of buying too early into bear markets, compelled by the logic of 'it can't fall much further'. Anyone who has bought stocks in Japan over the last few years will know what I am talking about.
In all, based on the last 40 years, US house prices are no longer expensive compared to gold. In fact they're, shall we say, 'inexpensive'. They may get more so. (I don't have data going further back than this, but in 1930s the ratio descended to 1980 levels).
How do US house prices compare to silver?
I also post here a chart of US house prices measured in silver. Average US house prices have fallen from over 50,000 silver ounces – this peak came later by the way in 2003 – to about 13,000 now. In 1980 that level fell below 3,000 silver ounces! I doubt we'd reach that level again because that was an aberration, caused by the infamous Hunt brothers' attempts to corner the silver market. But 3,000 ounces would cost about $85,000 in today's money.
And here's the point: given the surplus of inventory and the distressed selling, it's possible to buy US houses at considerably below 'market value'. (That's a misnomer because market value is what gets paid, but you know what I mean.) So if you can buy something like an average US home for $85,000 instead of the 'official' average price of $250,000, then that is a compelling valuation.
But given the various problems endemic in the US housing market, I suspect it will be a long time before you see the significant gains associated with a bull market. So your main consideration should not be: 'Will I make money out of this?' Rather you'd be doing something quite 'old fashioned'. You'd be buying a house not as a speculative asset but as somewhere to live.
That's the beauty of recessions. They restore good sense and normality.
About Dominic Frisby
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