The Housing LOCATION Bubble

The housing bubble may explode in the places least expected.

There’s an old country song where a young female sings about an old man asking her for marriage. He has a quarter acre of land. The chorus of the song, laments her regret, after learning his land is in “downtown San Anton”.

Location, location, location has always been a crucial part of real estate, but I believe it has never been the center of a housing bubble, as it is today. Yes, we have more than a housing bubble. We have a housing location bubble. (I’d also include new development in places like Idaho).

Here’s some data:

If these statistics were given to you in 2014 where would you buy? At first glace, it appears any house in the U.S. would be fine! The average increase is 91%. Cambridge, Massachusetts (where I live) is next, followed by Machias, Maine (my brother).

But…if you look at greatest profits, in dollars, it’s obvious that the nicer the town the more profitable the investment. Therefore, everyone has been buying as much house as they can get because it provides the greatest profit. Default Risk has been trending to non-existent since 2010

As risk lowers people maximize dollar-gains over safety.

We live in a Pleasure Island, as in Pinocchio. An nation run by the Mortgage Man and Realtor Lady. They cheers on all who enter, who mocks anyone with a wage-to-mortgage rate calculator. Go bid, he says, on whatever house you want! Interest rates going up? Be fair! With all that price appreciation shouldn’t banks get a taste! Don’t worry about them. There’s a shortage of tickets onto Pleasure Island and there always will be!

The idea that we would expect housing prices to increase along with wages has become a quaint theory put forward by ivory tower economists. We’re short of housing! Everyone knows that!

With the recent rising of mortgage interest rates, buyers and existing debtors have been slow to worry. In the past, they have been able to replace high interest mortgages with low interest ones (refinancing). Most people believe interest rates are cyclical — in other words, not something to panic over.

I can’t blame them. In nice areas most houses have been going up for decades. Few upper-middle class people have experienced anything but house appreciation in their lifetimes. And boomer parents did even better!

Few think about mortgages in the most fundamental sense. A mortgage is a lump sum of borrowed money which must be paid back in 30 years. The buyer views the monthly payments as building equity. The creditor looks at monthly payments as money that can be re-invested in more 30-year mortgages.

If the borrower can’t make the monthly payments then the lender assumes that if a small payment can’t be made then a big payment will never be made; that is, the lender asks the borrower to pay back the debt it full. The lender does not ask for the house. The lender does not want the house. The lender wants — rather, demands — cash.

If the borrower can’t pay the debt than the lender takes ownership of the house as last-resort. Whatever the house sells for goes towards the debt which, at that time, has accrued not only the unpaid principle and interest, but all manner of additional penalty fees — the buyer still owes the portion of the debt that has not been paid by the sale of the house.

When banks give people more money they bid higher for nicer houses in nicer locations. That’s been the game for the past 10+ years. As more money gets into buyers hands the prices of all houses increases.

The above will continue to work as long as:

o. Buyers keeps their jobs

o. Expenses for the house stay the same (low inflation)

o. Or, if one of the above, their 401ks can fund financial shortages

Building and improving homes is a great for society. But where the homes are, and who can afford them in the future, may not be sustainable.

I believe many of the people bidding up properties in new development in Idaho or old homes in Cambridge will discover that not everyone makes it out of Pleasure Island.

The mortgage grim reaper will be back. Unlike 2008, he won’t come for the blue-collar house flipper. He’s coming for the middle class. He may even make it to downtown San Antonio.

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