November 16, 2022 – After the big jump in the stock market last week, everybody’s worries should be over, right? Well, maybe not. Real estate looks a bit shaky now! Prices have come down just a notch, but is there more to follow? Are the wheels coming off? Is the market going to crash? What’s the impact of the much higher mortgage interest rates? Are we going to see a replay of the 2008 housing crash? How did interest hikes impact the housing market back in the 1970s and 80s?
Lots of interesting questions! Let’s take a look…
What’s the damage so far?
The good news is that home prices have barely budged so far, see the chart of the Case-Shiller index below; the index is only about 1.3% below its all-time high in June. The bad news is that this index is published with a two-month delay, so we have data only up to August 2022.
So, is this small dip in July and August just the start? In the chart below, I plot the Case-Shiller index adjusted for inflation as well as the CPI rental component (also CPI-adjusted, i.e., the rental inflation over and above average CPI inflation). I normalize the series to 100 in January 2004. I like that normalization because the blue and orange lines intersect around the times when the housing market was roughly in balance, neither wildly overvalued (like 2006) nor badly bruised (like 2011/12). So, for example, 2004 was about appropriately valued, as was the 2018 up to early 2020 before the pandemic hit. And the pre-GFC market bubble shows up as about as much overvalued as the 2012 trough. Pretty well calibrated!
In any case, if we wanted to force the blue line back to the orange line, we’d be looking at another 22% drop. Ouch!
But it’s safe to assume that home prices have likely declined already since August 2022. To get more up-to-date figures, I’ve been tracking the monthly Zillow estimates of our single-family home in Camas, WA, which we bought in October 2018. Home prices in our area peaked earlier, in March 2022, and our home’s value has since declined by 8.4% nominal and 12% when adjusting for inflation. If 22% CPI-adjusted is the target drop of that blue line, we’re already more than halfway there.
But as a side note, since we bought our place four years ago, it still appreciated substantially, even in line with the stock market! In fact, if you consider that an owner-occupied home also pays you an implicit “dividend” in the form of not having to pay rent, our homeownership investment is even ahead of the S&P 500 total return index. In the chart below, I assumed a 6% rental yield, which is common in our area, and a 2.5% drag from expenditures (taxes, insurance, maintenance, repairs, etc.) for a net 3.5% extra housing yield to get an implicit housing total return. So, our current house has been a pretty good investment (just like our previous one). Provided you do the math right and don’t mix up price returns and total returns!
What’s the impact of higher mortgage rates?
Mortgage rates have increased from around 3% in late 2021/early 2022 to about 7% just a few weeks ago (though rates have come down since then already – probably standing at about 6-6.25% now). Bummer! Going from 3 to 7 is a 2.33x move equal to a 133% increase in the rate. (side note: please note the difference between the 4 percentage point increase and a 133 percent increase!) Does that mean that home prices now have to fall by more than 50% to make up for the more than doubling of the interest rate? Fortunately not! Nonlinear mathematics to the rescue! Because the mortgage amortization formula (e.g. PMT in Excel) is not precisely linear and proportional to the interest rate. A 133% increase in the interest rate increases the monthly mortgage payment by “only” 57.8%. Please see the example calculation below, for a sample $500,000 house, a $100,000 downpayment, and a 30-year mortgage with 3% and 7% rates, respectively:
We can now also do the following thought experiment: By how much would the home price have to fall to keep the monthly mortgage payment equal to the previous amount of just under $1,700? It turns out, the mortgage would have to be about 36.6% smaller.
But the good news is that the property value has to decline by “only” 29.3%. That’s a little bit less than the full 36.6%.
In other words, if you still keep the $100,000 downpayment, then you would then cushion the effect on the property price.
Notice that very leveraged borrowers, say, with a 3.5% downpayment and an FHA loan, will feel essentially the entire 36.6% increase. On the other hand, if you had a much larger downpayment, say 40% instead of 20%, as is typical in some of the higher-end homes in my town, the drop in the property price would be lower, at “only” 22%. So, the 29.3% figure is only an average.
Also, keep in mind that this 29.3% loss in my thought experiment is even more severe than the drop in the (nominal) Case Shiller Index during the 2008-2012 housing bust! But also consider that there is no contractual guarantee for the buyer to get a property with the same PITI as in 2021 and all the loss is borne by the seller. More likely, buyers and sellers will have to share the pain. In other words, property prices can certainly fall from their insane and inflated 2022 peak, maybe by 10-20%. But buyers will also have to cough up 10-20% more if they missed the boat and didn’t buy a place when mortgage rates were at rock-bottom prices. Who will be closer to a 10% loss and who will be closer to a 20% loss needs to be determined. But I would suspect that some prospective homeowners who are currently renting might be willing to choke up some additional cash because the alternative – renting – is getting more expensive at an alarming rate, more than 9% annualized over the past 3 months! Or just move into your mom’s basement!
Attempting a forecast
Going back to the time series chart with the real home price vs. rental CPI prices, what would it take to bring those two lines back into balance again? A 22% drop overnight seems unlikely. Here’s a way to gauge a more likely path forward. Let’s do the following thought experiment:
- Between August 2022 (the last month for which the Cash-Shiller index is available) and August 2023, home prices decline by 10% in nominal terms. Then prices fall by another 2% during the next 12 months. After that, home prices start rising by 2% again going forward.
- Overall CPI increases by 4.4%, 2.8%, and 2.0% over the respective next three years, i.e., 4.4% between 10/2022 and 10/2023, then 2.8% until 10/2024, and 2.0% until 10/2025. This is my personal, proprietary, ERN-lab inflation forecast.
- Also, in light of higher interest rates and to make up for past underperformance, rental CPI will increase by 8%, 5%, and 2% over those three 12-month intervals.
If I extrapolate the three series, home prices, CPI, and the rental-CPI over the next 36 months, we get the following picture for CPI-adjusted home prices and rental-CPI, see below. That looks promising! We don’t even need a total collapse of the housing market to bring valuations back to normal. By early to mid-2024 we’ll be back at pre-pandemic valuations.
A caveat
Not every asset bubble deflates as nicely as in the chart above. Even if it’s true that the fair price isn’t even so far below today’s, it doesn’t necessarily mean that home prices approach their fair value in a nice smooth, monotone way. Exhibit A is the housing crash in 2008-2012. The price could very well overshoot on the downside before recovering. So, if I assume that home prices decline at a 10% p.a. pace all the way to 2025, we get the picture below.
I hope we don’t end up in this scenario. A roughly 30% decline in home prices is even worse than during the Global Financial Crisis. Is it possible that the inflation and central bank uncertainty could cause a housing market meltdown worse than during the financial crisis? This brings me to the next point…
Any lessons from the 70s and early 80s?
If you think a 6-7% rate for a 30-year mortgage is expensive, recall that this was the mortgage rate in the early 1970s. Before rates shot up and reached a level of 18.63% in 1981! Please see the chart below:
Did that 2.5x move in mortgage rates, even worse than our current 2.33x move, cause a housing crash? Amazingly, it didn’t, at least not according to the housing market data I have. The Case-Shiller index doesn’t go as far enough back, but looking at median sales prices, there didn’t seem to be much of a housing crash. There was one year-over-year 0.6% decline between Q1 1981 and Q 1982 but apart from that, prices were mostly up.
Also looking at the data from the Federal Reserve, Publication: Z.1 Financial Accounts of the United States, Table B.101, the total value of real estate on households’ balance sheets never even went down and neither did the home equity (=home values minus mortgages). Not even quarter-over-quarter! Of course, the values in Table B.101 are the aggregates (price times quantity), so they may slightly exaggerate the price index, but since the quantity of the total housing stock doesn’t move that fast, it’s a pretty good indicator that the uptrend in the median home price is legit and not due to some hidden selection bias in home sales.
How is it possible that during this bad mortgage mess prices didn’t decline? Well, of course, prices declined, if adjusted for inflation. But in nominal terms, everybody just muddled through. As I have pointed out previously on these pages, an inflation shock, as painful as it may be, is likely not as bad for the economy as a deflationary shock, like in the Great Depression or the 2008/9 Great Recession. Rising prices make it easier for leveraged agents – both households and corporations – to grow out of their debt burden. Disinflation and especially deflation often act like a much worse wet blanket on the economy than an inflation shock!
Conclusion
Circling back to the question in the title, am I am scared of a housing crash? Certainly not! Inflationary recessions don’t necessarily sink the housing market, see the 1970s and 80s. Home prices can just stagnate for a while or maybe fall moderately and inflation will bring real prices back into balance over time. Even if the market crashes again as in 2008, so what? I no longer depend on a paycheck and we don’t have a mortgage, so we can just sit out the potential misvaluation on the downside. But so far, I’m not even too worried about that crash. There are some positive signals that the Federal Reserve will soon reach the peak Fed Funds Rate at around 4.75-5.00% and we might just thread the needle and create a soft landing in the housing market. And hopefully economy-wide. I’ll post it here if my assessment changes, so stay tuned!
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Picture credit: pixabay.com
You should offset the imputed rent of your house by the rent you lost by not renting it out. In other words you haven’t really saved any rent. You invested capital in a house to not pay rent, but you’ve lost the ability to earn a return on that capital.
DT – Wrong!! You forgot one critial attribute – “Peace of mind” (that has a cost as well) also If everything goes to hell at least we have roof over heads. I have been there before once in my life and it is no fun.
That’s said – What about you have a lot of excess capital when things really fall apart? Well, the answer is very clear. Major leapfrog moment in terms significant wealth building.
Your choice. Thank me later -;).
That’s a good point: The intangible utility value of owning your place. It’s peace of mind, and probably worth at least another 1-2% p.a.!
DT – you only lose opp cost of capital on the down payment, not the whole value.
My down payment is the whole cost of the house. We never had a mortgage.
Nothing like paying cash for a house, especially with current interest rates! Smart ERN!!
Well, maybe back then I should have gotten a mortgage, then refi in early 2022. But who could have known. Hindsight is 20/20! 🙂
Irrational thinking again. Buying an overvalued asset should never give you “peace of mind”, it should give you the opposite – as the eventual mean reversion crystalizes your losses.
My house is not overpriced. Is your’s? Or do you rent? Has your rent gone up recently?
But that’s what I do in the chart. I compare the return of the housing investment to the return of a stock investment (=opportunity cost). And the housing investment comes out ahead of the stock investment,
To get apples to apples, you need to (1) deduct opp cost of down payment from real estate return and (2) rent expense from stock returns.
That’s what I did.
My down payment is the price of the house. We paid in full.
Instead of subtracting the rental cost from the stock investment, I added it to the home investment. Now my opportunity cost is the S&P500 TR.
As long as you’re consistent and you avoid double-counting we should get the same results.
I’m sure you’re right but I’m just confused by the chart.
Seems to me the formula to determine return in year one is either:
1) Invest all capital in SP500 (x) and deduct rent paid (y). At end of year it’s value of x-y.
2) Buy house in cash, add in rent saved by owning house (factoring in expenses such as taxes and insurance), subtract rent lost by not renting out house (backing same expenses).
As Bill Bernstein wrote, you have to live somewhere, and you’re either going to pay rent or use your capital to do so (ignoring leverage for this example).
I’m guessing I’m missing something but not sure what it is.
No. I compute the total return of both investments. For the S&P it’s easy. For the house I use the price appreciation plus an implicit rental yield.
There is no need to subtract rent from the S&P 500 return.
Afraid? I’m counting on it….this will be the ONLY chance for me to buy my house. Hope it crashes and soon
Well, don’t count on getting getting bargain prices like in 2012. But time will certainly work in your favor. Provided your rent doesn’t go up too fast…
You can’t compare the late 70’s early 80’s to now. Houses were much more affordable and did not consume as much of a home owner’s discretionary income as they do now. As a person currently building a vacation cabin without borrowing I’d love a big housing crash, it would give me a discount on the place. Plus it would be a big bonus for first time home buyers. Home prices are out of reach of too many people and need to fall significantly.
Yes and no. First, that’s the reason why I believe that a drop in house values is imminent. I can’t see how we could possibly muddle through with no nominal value losses as in the 1970s.
But also keep in mind that there is no fundamental reason why the home values should fall back all the way tp the 1970s value to GDP (or DPI) ratio. As a much more advanced economy than in the 1970s we should have a higher capital to GDP ratio. We spend less as a % of income on all sorts of basic stuff (energy, food, etc.) and we should spend more on health and housing.
Housing feels expensive here until you compare it to just about every other developed country and then it seems pretty cheap relative to income with a few exceptions like San Fran.
Very true!
Hi Big ERN,
Based on your predicted cpi for the next three years(4.4, 2.8, 2.0) have you changed your opinion on bonds and have you invested in any? As presumably if your forecast approximately correct I would assume very favorable to bonds especially medium to longer term maturities. Even if you haven’t bought yourself do you now view bonds at least currently as a good investing option and if so how would you structure your investment in bonds in terms of maturities and types if you were to make an investment in them? Thanks.
I’m still reasonably optimistic on bonds. The 10Y pays a 1.37% real expected return going forward. One would also expect to make some money off the duration effect once interest rates come down again in 2024 or so.
You could do even better with rolling the 10Y bond for a fixed maturity 10y portfolio (as is done in ETFs). That should probably pay you almost 2% real over the next 10 years.
I still don’t agree with your conclusion that: “Disinflation and especially deflation often act like a much worse wet blanket on the economy than an inflation shock!” This has always been what drives (and probably pays for) all economic thinking, i think it’s flawed. The reason all assets, including houses, have increased since 2008/9, is negative real interest rates preventing asset prices from falling through true price discovery. This has caused all kinds of bad capital allocation to the point where, as one commenter said, houses are unaffordable for all (one of so many bad outcomes). Low interest rates/ high assets prices only saves banks (i.e. their current owners) from bankruptcy at a cost to the people’s standard of living. It’s just another form of corruption like socialism. Had we just liquidated all the banks in 2009, we would all be better off today. The economic lies about the depression that continue today are just there to validate the decisions that preserved the wealth of the owners at that time, and not help the median citizen.
If banks had failed we would have been in much worse shape. As happened in the Great Depression.
I disagree. Great depression was inevitable and caused by loose lending and exacerbated by drought. New banks should have been formed. Instead it’s used as an excuse to bail out banks.
That’s your right to believe that. I disagree with that view.
So for for implementing “a fixed maturity 10y portfolio (as is done in ETFs)” are you thinking of a ETFs such as IBTL etc…? The ishares Treasury ETFs which mature in a given year.
A fixed 10Y maturity. That means you need to roll the bonds, i.e., in 2024 you’d have bonds that mature in 2034. And the year after you need bonds that mature in 2035.
Excellent write up, thank you!
You bet!
Worry not. Trump is coming back to save America again from the socialist hands! Pull back the US from all the conflicts around the world and use our taxpayer money at home where it really matters instead of giving out at will to other countries!
Not sure if this is sarcasm or real. Since I’m an apolitical person I’m just leaning back and watch the soap opera.
Houses built in the 70s & 80s are NOT houses built in the last 10 years – new houses are much larger. The single family house (SFR) price needs (2) adjustments: inflation and size.
The housing market is “sticky” – transaction costs are high (commissions, loan costs and points). And full of time lags:
– the time investment to sell and buy another is substantial
– time from accepted offer to actual close
You can be certain that housing prices will decrease 20% from the March 2022 peak and back in line with the 2012-2020 trend. If the market over corrects, then we will have another housing investment opportunity.
Longer term, higher interest rates forces builders to reduce building and sets the stage for the next cycle of housing shortage and appreciation.
Patientcash is on the right track here. But here’s a few “intangibles” you can add to your analysis: (1) does the current administration’s policy of flooding cities with illegals (causing homelessness) create added demand; and (2) does high inflation from huge debts/ spending create a floor under prices (like it has since 2009)?
Yup. Glad we’re on the same page!
I don’t think that houses will be much smaller though. Certainly not as small as in the 70s.
On bonds, would you hold the IEI ETF or a total bond fund like IUSB or BND?
I’d prefer IEF. Intermediate-duration government bonds (7-10 years).
IUSB, BND would have have too much equity beta because of corporate bonds.
Thank you so much ! So I’m deep in the red on my IUSB now. If I sell out and buy IEF, is it wash sale? Can I tax harvest that?
I’m not a tax expert, but this looks like the perfect tax loss harvesting trade: You sell one fund at a loss and buy another fund that’s sufficiently different, but still highly correlated. For example IUSB and IEF have very different benchmarks.
For example, in the equity space, you can sell VTI and buy VOO (by the way, with a lot more overlap than IUSB vs. IEF) and that’s totally fine.
I would suspect that VOO and SPY and IVV would not pass muster with the IRS because they are different funds from different ETF providers, but they all have the same target/benchmark. (though, even that has not yet been challenged in lawsuits, to my knowledge)
How about an equivalent duration mix of EDV (Vanguard Extended Duration Treasury Index ETF (24 yr duration) b/c STRIPS) and Ultra Short-term Treasuries (e.g. VUSB) with 1 year duration to match duration of IEF (7.7 yrs)?
The mix of EDV and VUSB will have same duration but a better convexity than IEF per what I have read. So the mix will give a better upside if interest rates fall and safer downside if Interest rates for some reason rise even more than expected.
Thoughts, ERN or others?
Interesting Dennis, but it violates my simplicity principle. It’s harder to rebalance as well. I think IEF or VGIT (if you’re more conservative) are better than EDV/VUSB.
Well, rebalance might work itself out if you withdraw money from the position that’s over the target %.
I now added the 30-year Treasury return series to the Google safe withdrawal simulation sheet. If people want to test it.
Eyeballing it, starting from a 60/40 and replacing the 40% 10ybond portfolio with 20% cash and 20% 30y bonds lowered the SWR in both 1929 and 1968. Haven’t researched yet as to why…
Hi Big ERN, thanks for the quick reply and setting up a test bed for this hypothesis.
Thanks ERN, I just switched IUSB or IEF. I guess I could go back to it in 30 days…however…I was just listening to JL Collins on ChooseFi and he again said that the only bond fund you ever need is a total bond fund. Of course he only speaks about Vanguard, but IUSB is also a total bond etf so, I wonder why you don’t agree with the goodfather of FIRE on what to hold for your bond position, ERN ?
*for IEF
I disagree with that assessment. He doesn’t know what he’s talking about. He’s certainly not my godfather. In contrast to him, I ran a lot of SWR simulations. You can go with whatever bond fund you like. I prefer the 10y benchmark bond because it has offered the best diversification benefits over time.
If you go with a bond fund that includes corporate bonds, like the Barclays Agg benchmark, be advised that this fund will have higher yields and less diversification. Think of it as a 60% Stock, 40% Barclays Agg portfolio behaving more like a 70% stock, 30% 10y benchmark portfolio, through the credit risk in the corporate bond fund.
As long as you’re consistent and compare apples to apples, you can pick whatever fund you like.
Like you said, since the 1980s that portfoliovisualizer has data for, using a lower % treasuries has had slightly reward with less risk compared to using a slightly higher % Agg type portfolios. Plus treasuries also benefit from no state income tax in taxable accounts.
Yes, good point!
Awesome ERN. You’re the man. JL Collins gets all this hype in the FIRE community but he’s basically repeating with Jack Bogle says, without using the tools to make it better.
I think of graduations of Fire like this. First David Ransey crowd, then ChooseFI / JL Collns, then, a post-graduation on RiskParityRadio and Big ERN as the ultimate courses
Thanks Big ERN. Big Fan. I’ll stick to IEF, it’s doing well, although checking everyday now I see it swings more than IUSB used but that’s fine. I’lll still get 15k in TLH to use this and in the coming years
thanks for the kind words! 😉
Timely and wonderful analysis Prof. ERN. I “muddled” through the mid 80’s marrying and starting a family in Spanaway, WA with a 12.5% mortgage rate and was quite pleased when I refinanced at 10.5% a year later. I share my experience with the younger Bogleheads at our Tampa chapter to try to convince them that we boomers have been through this high inflationary period and survived, and so will they.
I wonder what Bill Bernstein’s quote that “A house is a consumption item, not an investment” portends in this discussion.
Wow, thanks for sharing that experience! If you survived that, you’ll be fine.
Bernstein: Yes and no. A house is an investment, if you understand economics and accounting: https://earlyretirementnow.com/2017/11/15/that-house-over-there-is-an-investment/
But it’s also true that too much housing consumption is bad for you, but that’s true for rentals and owner-occupied properties.
Nice and timely writeup Ern, I’m wading into the “just buy the house outright” camp. I think it’ll be a neutral decision for a while, then probably a net benefit long term. That imputed rent savings is real, especially when it’s tax free vs. having a portfolio churning out income and having to use that to turn around and pay ever increasing rent.
Thanks Mr. Shirts! I am following your struggles on Twitter about those insane sellers. Not an easy market to wade into!
If you have the money available it might be a good time to pay cash. Of course, if you need to cash out a ton of money from investments and pay cap gains taxes, that might be a reason against paying the house in full. Depends on your parameters.
Another great writeup!
I think it will come down to whether the fed can fully squash the inflationary spiral for good and not pause if we get a month or two of slightly lower inflation/higher unemployment rates. If not then we may be in for another 1970s.
With so many people locked into long term 30 year <3% mortgages this time around, many can afford to wait out any downturns compared to what happened to the sub-prime borrowers from 2008-2011.
I could see some localized housing busts from the areas that got too hot relative to local incomes in the last couple years if remote workers are no longer pouring in. It seems like after trying both in person and remote work these past two years, a lot of employees and employers prefer the happy medium of 1-4 days in the office so we might not see some of the post covid trends continue.
Also, I think many borrowers will start choosing 10/1 ARMs which still have rates in the 5's with hopes of refi'ing later so the 4% rate spike this year isn't quite as extreme as it seems on the surface.
The ironic thing is that through the rate hikes, the Fed will fuel housing inflation. Academic research found that the central bank should put a low weight on rental inflation. See my paper on this topic, joint with Zheng Liu, Fed Res Bank of SF:
https://www.cambridge.org/core/journals/macroeconomic-dynamics/article/abs/should-the-central-bank-be-concerned-about-housing-prices/7BBAC5BAFA2CA96DF674A28E02D4C529
And it turns out that the non-housing CPI components all line up pretty well: used cars now have negative inflation, healthcare has slowed a bit, energy seems to stabilize. So, it looks promising.
About mortgages: I certainly see mortgage rates go down again long-term. But the Fed Funds Futures rates are still stuck at ~4% going way out to 2027. That 2.5% FOMC forecast for LT-rates is all just a pipe dream. So, don’t rely on dirt cheap mortgage rates long-term!
Interesting research paper, will have to check it out.
Even if rates remain this high, you’re still better off going with 10/1 arms at ~5.5% over a ~6.5-7% 30 year mortgages and just roll them for around the same rate or hopefully better in years 6-11 whenever the opportunity arises. I can’t imagine any financially responsible person would want to keep a 30 year mortgage @7% without ever prepaying anyway. At that high of a rate its hard to argue even investing in stocks instead of prepaying unless inflation is sky high. Very few
I agree, 7% risk free is hard to beat! The only downside of course is the lack of liquidity, but even then the 7% is probably the right choice for most. Prepay mortgage after you get your employer 401k match!
Well, early during the accumulation phase you should be as leveraged possible. But later around the retirement date: not so much! Yes, paying down the mortgage before retirement is a wise choice in general.
Yeah, mortgage rates will go down. The question is how fast. ARMs look pretty good now.
Hi Ern,
love reading about the real estate market (as I am working in that industry in Germany).
I would be interested in your opinion how you would explain the spread between a government bond and a prime office yield. In Germany, the spread tended to be somewhere around 300bps but has now gone down tremendously. I.e. in my view a fund could now secure a mostly safe return almost equal to an (at least somewhat) risky office investment. However, if I remember correctly, this spread was also even reversed (i.e. a prime office asset yielded less than a government bond) in the past.
I am just curious on what you think could be reasons for funds etc. to take on such kind of risk.
Thanks and kind regards
Harald
Thanks!
I’m not familiar with that rate. In the US we have the Prime Rate which is usually Fed Funds Rate +300bps. That spread hasn’t moved, to my knowledge.
Hello ERN,
greetings from Germany! I am very fond of your blog articles, being a mathematician myself I especially liked your recent articles about adjusted CAPE strategies.
I would love to hear your (and the communities) thoughts on the following simple ‘strategy’ for a 100 % equity portfolio.
Start with 3.5 % (or CAPE-adjusted %) portfolio value and keep elevating withdrawal amount to 3,25% of new portfolio evaluations whenever this amount is higher than before (i.e., for 1 Mio take 35 k per year and when portfolio hits 1.4 Mio, take 39 k forever and once it hits 2 Mio take 65 k forever).
This way you can keep pushing your total withdrawal amount when market goes up over time AND your withdrawal amount it monotonically increasing AND you can skip inflation adjustments when the market goes up.
In fact, it behaves like going into retirement all over again every time the market goes up. This should allow for a comfortable retirement once you arrive in the next bull market.
Note: After initiation I continue with 3.25 % as I would run maximum risk by using market highs for pushing the total withdrawal amount.
But how would that 100% equity portfolio behave when you retire in 1929 or 1968? You never hit the $1.4m or $2m mark, the portfolio goes down and you get with Sequence Risk. Wouldn’t last even 30 years when using a 100% equity portfolio.
Thanks for the quick reply! All right, I should have mentioned your equity glidepath for dealing with Sequence Risk at the beginning of retirement.
Using the glidepath to return to 100 % equity during retirement, one could still follow my idea to increase spending whenever markets move up – right? Without that, one would always be restricted to increase spending with inflation adjustments only.
If you adjust for CPI only when markets are up, how much would your purchasing power decline during the big market disasters? I addressed this “flexibility” rule in Parts 9&10 on Guyton Klinger Rules. Even without the GK step down you could lose a lot of purchasing power when you don’t regularly adjust for inflation.
Well, I had withdrawals of max((1+CPI)*last years withdrawal, 3.25 % of current market value) in mind.
My idea was not to exclude some CPI adjustments but rather to use high evaluations permanently when your portfolio does well.
While median home prices have gone up almost 7x what they were in 1981, home payments are actually only up around 3x since 1981 meanwhile CPI is up 3.3x. In other words, home payments are lower now than they were in 1981 adjusted for inflation.
Obviously, you could’ve refi’d on the way down from purchasing a home in 1981 and homes are bigger now than they were 40 years ago which isn’t reflected in median sales price. The media/internet makes it look like home buying was so much easier for baby boomers than it is now for millennials and that’s not really the case.
My guess is that we see near zero home price appreciation for a few years rather than big drops. 5-6 years of flat home prices with 4-5% CPI would get your graph almost back to in line.
Good point. That might be an even easier to digest adjustment process. But I’m not so confident that the housing market only stagnates for a few years. In a lot of markets we’ve already seen big drops. But I certainly hope you’re right!
Yeah, I could definitely see some big drops in local markets that really got over inflated the last few years but I could see some of the cheaper markets still growing at slightly below inflation.
I live in a market that trailed the case shiller average over the past decade and homes are still going for 3% over on average according to redfin. Middle class people who got priced out of the hot markets will gravitate to the cheaper ones if they have the ability to move.
Makes sense. Here in WA state we grew above the CS index and we saw some declines in prices, homes not selling after several months on the market, etc.
As an aside, do you have any guesses as to why population in OR is declining? I know COL has gone up but so has everywhere else and it’s still pretty affordable compared to neighboring WA and CA. Is it just the high taxes, when there are some 0% income tax states next door in NV and WA?
Simple fact from economics: you get more of what you subsidize and you get less of what you tax. Politicians in Portland subsidize rioters and homeless people and tax law-abiding people. A lot of families are moving across the river to Vancouver, Camas, Washougal, etc.
How different our fear. As a Ukrainian I’m literally afraid that my house will be destroyed by a missile attack.
Yeah, we have first world problems here. We sometimes lose perspective. Thanks for sharing, good luck and God willing you’re going to be OK.
Tell your puppet president to stop fighting this war for the west and stand up for yourselves, your people.
I don’t want to get into the politics here. But notice that back in April a potential peace deal was on the table. Sadly, it was nuked. And more than just one person is to blame for that.
They want peace in order to attack later when they’ll be better prepared.
So, I was planning to buy my first home now but I with mortgage rates at 7%, I don’t think I can get more in in my portfolio. Is it worth to pay down as much as possible, possibly selling out all my brokerage accounts?
Yeah, agree. You might get more than 7%, but with a lot of risk. So, if your portfolio is down only about 15% it doesn’t look too crazy to tap into savings.
But keep in mind the tax implications.
Another route if you already have a lot of money in taxable accounts: a box-trade loan against your portfolio. You should be able to borrow against your funds at around Treasury rate plus 0.3-0.5%. Currently about 4.5% rate for a 5-year loan to Dec 2027.
See current rates here: https://www.boxtrades.com/SPX/17DEC27
My post about the topic: https://earlyretirementnow.com/2021/12/09/low-cost-leverage-box-spread/
Hello and thank you for this article.
Currently we are in Europe, been here for a bit over a year, but we will be returning back to Los Angeles and have to figure out the best way to solve for housing. We are sitting on a lot of cash (were planning to buy a property in Europe where 30% downpayment is required). Looks like the best move now might be to rent for a year or two in LA and try to buy a home mid 2024 with an ARM loan. We can do 0% down loan with no PMI (NFCU) but these interest rates might make us put a downpayment instead of using the cash to renovate a fixer-upper (we love doing this type of work and are quit good at it). Wondering where to park the cash meanwhile.
It’s funny how with investing in stocks and bonds, timing the market is generally a fool’s errand but in real estate, it is quite important. My question to you, if you’d be so kind to take a moment to reply, is how do you factor impending climate crisis effects on housing and the economy in general into your thinking? Changes are happening faster than projections. Weird times.
What would be your advice to someone moving to a new location and deciding whether to rent or buy right now?
When I moved I always bought a house again, within a few months. You might try to sit out the potential housing crash, but be aware that renters are also getting clobbered right now. 8%+ rent increases nationwide, likely higher in the desirable markets.
Really interesting analysis, loved the little bit of long-term perspective you provided at the end! Do you have any advice about if it’s better to pay off a low interest mortgage rate right now, or keep investing in index funds?
I must admit I’m still not sure what my personal take-away should be as someone who was able to get lucky and lock in a fixed rate mortgage (UK) at 1.39% just before interest rates started to go up. I see looking through the comments that you reckon it’s worthwhile being leveraged while accumulating, but I can’t help but feel that this is a really good opportunity for me to pay off my mortgage in the next 4 years.
Currently my plan would be to max out my tax free investments, then split the rest between mortgage and more index funds (purely to keep me and my wife happy, she wants to pay more on the mortgage, I want to stay leveraged and invest more into the index funds), but was wondering if I’m clearly missing a trick here.
4 years left on a fixed rate mortgage at 1.39%, 8-9 years to retirement
Oh, that’s simple. I’d hold on for now if I had a low-interest-rate loan. I’d focus on investing and picking up some equity bargains.
If it’s any help, I bought a bunch of preferred shares (yields 7-8%) on margin (4% for a 5y loan). Sometimes leverage still makes sense even in retirement.
We are 15 months after this article was written and so far it doesn’t look like we’ve had the housing crash that everyone was calling for except for in some localized markets like SF, but even those are already recovering. Some former lagging cities like Chicago, Detroit and Cleveland are now leading the way and seeing 6% YoY gains as people shift their focus towards affordability in this high interest rate regime.
I don’t want to be a “this time is different” person but there does seem like a permanent term shift in the demand for more square footage now that WFH/hybrid work era looks here to stay now we are almost 4 years after the start of the pandemic.
Yeah, it has certainly worked out roughly in the way described in the conclusion: Muddle-through.
Yeah great call!
IMO all these doom real estate housing stats that people keep throwing out to predict a imminent housing crash need to be taken in context how cheap office space is now. If were going to live in a hybrid working environment, we should look at housing+office prices together which don’t look that crazy when combined. I’ve heard some stories of office space in downtown SF going for below 2009 prices WITHOUT inflation adjustments.
Yeah, good point. Combined RE prices should look more in line with historical averages.