How to Avoid (and Profit From) The Housing Crisis Coming Our Way

The housing market is rolling over.

And it will get worse as mortgage rates and house price inflation continue to rise.

Contrary to popular belief, initially this will make little difference to a booming US economy because housing stopped being a major economic driver after the last bubble collapsed.

But ultimately it will matter, big time.

Here’s why, and what you can do about it to profit from the next housing depression.

Urgent: The greatest economic catastrophe is about to blindside investors

The Impact of the Crisis Will Be Obvious, But You Can Prepare With The Help of One Clue

When prices decline, the financial system will again be in crisis.

Millions of mortgages will be under water again. Homeowners will either walk away from their mortgages, or be foreclosed. The losses will ripple throughout the financial system and markets, just as they did 10 years ago. And taxpayers will be forced, yet again, to pay for the bailouts of Fannie and Freddie, because this time, we own them.

Ultimately, another housing collapse would trigger the Fed to reverse policy, but that’s still many months away. The Fed will continue to tighten the screws until well after the new crisis becomes apparent. Powell affirmed as much at his press conference when he said that the Fed won’t lower interest rates until there’s a sustained financial decline. And we should well remember just how long it took Bernanke to even acknowledge there was a problem.

So how long do we have? That’s hard to say. But here’s a little clue:

Transaction volume seizes up prior to price decline.

The rollover in sales volume is just starting, and in the last crash, sales plunged for a year before prices broke down. The market having been through this in recent memory, sellers may respond more quickly this time.

Shocking: This is the terrifying new standard for generations to come

Here’s what we know now…

Data from the NAR Reveals How Fast Sellers May Respond

On Wednesday September 26, the NAR released its data on August home sales, which it calls “Pending” but which everybody in the housing market thinks of as “Sold!” This is when the contract is signed, the SOLD sign goes up, and the property is removed from the MLS active listings category. Both buyer and seller have agreed on the price, and both expect to go to closing in 6-8 weeks. In all but 5-10% of such sales, the contracts do close within that window. Very few sales fall through.

The NAR has another stat called Existing Home Sales which it pretends is the real deal, but it’s really just the rubber stamping of the previous sale contract. It’s an interesting data point to us only because it shows the ratio of closings to sales. That reveals something about market conditions.

Are they conservative and healthy, or frothy and unhealthy? For the past year, they have been frothy, with a higher than usual percentage of sales closing as banks have pushed the envelope on qualifying both buyers and the value of the properties.

Meanwhile, prices are still inflating but sales volume is softening. The Wall Street Journal, sister company of under the NewsCorp umbrella, played the news straight, reporting just the seasonally adjusted headline number with little fanfare or editorializing.

“U.S. Pending Home Sales Fell 1.8% in August”

All well and good.

Apparently, they have been stung by “someone’s” criticism that they are also sister companies of NewsCorp’s News America Marketing. That subsidiary’s erstwhile slogan, which they have since buried, was “Your marketing objectives are our business.” I guess somebody over there recognized that this wasn’t the best motto for a company joined at the hip with a “news” organization.

Meanwhile, noted that sales fell to the slowest pace this year. Both it and the Journal mentioned the 1.8% seasonally adjusted pace, month to month, and a 2.3% year to year decline.

Here’s what actually happened. By “actually” I mean the raw data collected from a sampling of MLS’s around the U.S. BEFORE the seasonal hocus pocus is applied. We can easily judge the strength or weakness of the market by comparing the current month’s growth rate with the same month in years past, and by comparing the current month’s annual growth rate with recent months.

On that score, August sales were down 5.7% month to month. That’s the worst August performance since 2015. The annual rate of change was a loss of 2.5%. This was in the middle of the range of the past 9 months. The market is weakening, but the pace of weakening has been mild. There’s no sign of collapse… yet.

Last week the NAR reported prices for August. The median price rose 4.6% year over year. This is slower than at the beginning of the year when house price inflation was running at a 6% annual clip. But as you can see on the chart, the slowing isn’t significant. The inflation trend is still robust.

The problem for the market is that sales have begun to decline as mortgage rates have risen. The 30 year mortgage rate is tied to the yield on the 10 year Treasury. The 10 year yield broke out on Wednesday. Watch out now as mortgage rates move higher!

House prices have kept inflating along with the rising rates over the past 2 years. That has created an affordability crisis that will get much worse when mortgage rates break out.  There will be fewer and fewer buyers at every price level. Sales will dry up.

The sequence of events is likely to be as follows. The 10 year Treasury yield will break out above the May peak of 3.12% (It just happened!). That will lead to a faster and greater rise than we’ve seen so far. The 30 year mortgage rate will break out above the current 4.6%. As mortgage rates rise, fewer buyers will be able to afford to buy at current listing prices. Sales volume will drop sharply, just as it did between 2005 and 2007.

Just as in 2006-08, prices probably won’t break until the year after sales begin to collapse. Home sellers can be stubborn about that. But once a few start to feel the pressure, the dam will break, the number of listings will balloon, and prices will start coming down.

The crisis will become real for the financial system when mortgage collateral value disappears. No doubt there will be contagion into other overleveraged sectors, particularly hideously overvalued commercial real estate tied to balloon mortgages at super low rates. When those balloons come due, commercial property foreclosures will go through the roof, burdening the lenders with nonpaying mortgages. That will be bad for commercial property REITs.

Important: If America doesn’t seize control of this, the consequences could be dire

To Play the Housing Debacle, Here’s What to Short

So how can we play the coming housing debacle in the here and now?

I’d look at the home builder ETF ITB as a short sale. It has already taken a 24% beating this year since the end of January. That has broken the long term trendline from the beginning of the recovery in 2011. But it has also taken the price to the bottom of a trend channel from early this year. That should be temporary support.

If the price falls out of this channel, breaking support, the selling should accelerate, resulting in a steepening decline (Note: this just happened today, just before this post was published). This may not be an ideal short entry point. There should be a rally, either from right here at the bottom of this channel or back to the lower channel line after a breakdown (again, that happened just before we went to posting).

A rally back to the 38 area would be a lower risk entry for a short than right at this support line. But I would not want to miss a breakdown by waiting. If the price breaks down first I would take a half position on the breakdown. A rally back to the 35 area would then be a lower risk entry point for adding the rest of the position (This is now the operative condition).

Put options are not actively traded on ITB. Getting good price execution could be a problem, so I am not recommending that strategy. Shorting the ETF is the only viable option for playing the downside in this case.


Lee Adler

6 Responses to “How to Avoid (and Profit From) The Housing Crisis Coming Our Way”

  1. Hello Lee,

    I enjoy reading your articles.

    Here’s some more fodder for the decelerating Real Estate Market you discuss in your article above. This upcoming Real Estate Market correction/crash will be worse than the previous from ’08 – ’10. A sizable amount of SFRs were purchased as investment properties after the previous crash.

    Here’s the build up for the next correction. After the 2008 – 2010 crash, Blackstone (AKA the smart $) purchased about 50K SFR units in the US valued about $9 Billion US. Many of these homes are rentals providing returns for Blackstone’s investors. The next wave of Wall Street Investors/Hedge Funds jumped on this train and took more distressed properties off the market and turned them into rentals. Thus, creating less supply for the owner occupied purchasers and increasing the run-up of SFR home prices. Between these two tranches of investors, Billions of dollars (liquid asset) were converted into Real Estate (very ill liquid asset). As you know the smart $ hedges all sorts of investment classes against each other. Some of these hedged investment classes will start souring with the current rise in interest rates. To offset these losses, the smart $ will need to liquidate their Real Estate holdings. Here’s where it could get crazy. Unlike stocks, that can be sold in a minutes/hours/days, Real Estate takes more time to sell. One way to sell your Real Estate quickly is to dramatically drop the price so it can sell ASAP. This scenario could spark a Real Estate crash worse than the previous one. Here’s another reason compounding the possible crash. This time around, the US government will not be able to step in and stop the dramatic price decreases from the sale of all those Wall Street/investor owned SFRs. In the previous crash many of the homes were encumbered by mortgages and legal proceedings tied to the foreclosure process. This allowed state governments and the federal government to pressure the banks to stop the foreclosure process. By doing this, the decline in home values was slowed. But this time, the government won’t have the same means to slow the sales of these SFRs. The above scenario doesn’t even account for the 3rd and 4th tranche of investors (mom-pop Air BNB investors and house flippers). The government won’t be too keen on helping out main street investors that made bad bets. Lastly, the foreign investors like China, spent years buying up on up properties on the West Coast of North America. Presently, Australia is in the midst of a major Real Estate correction. This is another country that China loaded up on for Real Estate. I’m guessing some of the Chinese Australian Real Estate is souring, which will need to be offset by selling…you guessed it, the Chinese US Real Estate. This is just another dynamic that could create a nasty housing correction here on the West Coast/San Diego. where I currently live.

    Additionally, the EU and ECB are looking shaky. Deutsche Bank and the Italian Banking system are teetering on the edge. Italy is Europe 3rd largess economy. As well, US Corp Debt and covenant lite loans could face major headwinds if that debt cannot be re-financed.

    I hope I’m wrong.


  2. Lee, the top at 2950 S&P in sept was confirmed with today’s 300 point decline in the dow. We are now in a multimonth decline into yearend…the final low is 2020 but as we move forward the low could move out to 2021 or into 2019….when we get close enough I will know exactly as I have for this top which is the first time in bout 10 years had to be concerned about a top. Keep up the excellent work you do….best, fred cleaves

  3. It’s not rocket science. Housing bubbles continue to form and pop every so often. Instead of a stable market requiring 20% down payments, steady employment, and stable interest rates they always try to stimulate the economy with low interest rates and no or low money down payments. This, and mortgage write offs, causes a massive rise in prices. Then, at the top, things fall apart. We’re almost there again. It’s no surprise, only it’s worse because purchasing power has declined because of low wages and interest rate write offs aren’t as good as they used to be. It’s going to be ugly.

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