Housing Consensus Dead Wrong

Before jumping right into housing affordability, it is necessary to consider the affordability of common stocks, investor interest and initial public offerings in the early 1980s through today. Back in 1982, stocks were the most affordable of my lifetime. I can remember pitching Coca-Cola (KO) to investors in 1981-1982 at six-times earnings with a 5% dividend. Only my father and cousin bought it. There was no demand for common stocks when riskless interest rates were offering double-digit returns. There was some issuance of new companies (IPOs) and secondary offerings of existing ones, because it was prohibitively expensive to borrow money at 15-20%.

Fast forward to 1996-2000, when Federal Reserve Chairman, Alan Greenspan, coined the phrase “irrational exuberance” to acknowledge how nutty equity prices were. Price-to-earnings ratios (P/E) rose to the highest levels in our lifetimes and an enormous bubble in IPOs reached a crescendo in late 1999 and early 2000. Investors were firing stock pickers with above-average track records because their next-door neighbor was doubling their money on the latest dot-com wizardry. There was a peak in demand despite the worst affordability in 60 years. Affordability doesn’t dictate demand, demand dictates affordability. Eventually the supply of new shares from IPOs choked the stock market and it fell 40% over two-plus years.

During that same era of very high interest rates (1975-1987), when Coca-Cola was so cheap, single-family residences were historically unaffordable. This lack of affordability didn’t stop home buyers and builders from being very busy. The largest population group up to that time, the baby boomers, were buying homes to meet the demands of their growing families. Just like in stocks, affordability was not the deciding factor in the production of new homes any more than affordability drove common stock issuance.

At the height of the tech bubble in early 2000, single family residences were relatively affordable. However, the U.S. was attacked on September 11, 2001, and in the aftermath interest rates were brought down by the Federal Reserve. Single family residences became the investment of choice for boomers buying second homes and Gen-Xers buying their first or a trade-up home. Loose lending and maniacal behavior caused huge demand for homes and home builders met that misplaced demand by building the most single-family homes three consecutive years (mid-2003 to mid-2006).