Housing History Suggests More Slogging Ahead

The housing sector took many years to make a comeback after its bust in the ’80s.

Milton Ezrati of Lord AbbettThe press and the investment community have made much of the good news on housing lately. Certainly the recent upturn in sales, construction and real estate prices is welcome. But if the 1980s housing bust is any guide, popular references to the sector’s strength and imminent recovery grossly overstate the case. The 1980s experience suggests housing will recover only slowly. Residential real estate may well have turned a corner, but major gains and price recovery will likely wait for some time.

Though the housing boom of the 1970s and subsequent bust in the 1980s had different roots than the more recent experience, their pattern is instructive nonetheless.  Back then, the housing surge grew out of the great inflation for which the period is famous. Consumer prices were rising at double-digit annual rates, depressing the value of all financial assets and driving Americans toward real assets, especially real estate. Their buying binge pushed home prices up rapidly, creating, in the process, a greater incentive for people to buy still more. When the Federal Reserve, under Chairman Paul Volcker, took sudden, radical action in 1982 to stem the inflationary tide, the whole structure collapsed. The increase in interest rates engineered by the Fed at first starved homebuyers of credit, but as the Fed began to prevail against inflation, the whole reason for the bias toward real estate investments evaporated.

The associated bust in home buying, building and prices was shocking. In the first year after the 1982-83 peak, purchases of new and existing homes fell almost 20%. Home building carried on a little longer, but by 1984 it had slumped almost 30% from its highs. The median price of a home in the United States fell some 5% in 1984, a minor adjustment by more recent standards, but, in an environment of still high inflation, that amounted to a real loss closer to 9% to 10%.

Though the slide on all these fronts had largely run its course by 1985, the price declines and attendant disenchantment with real estate investing kept the lid on any recovery. Even five years later, in 1990, building activity remained more than 40% below its former peak. Actually, it did not surpass that early ’80s peak until 2003, 19 years after the bust. Purchases of new homes, except for a brief flurry of activity in 1986, took until 1989 to recover former highs. And even in the late 1980s, median home prices nationwide were rising by a mere 5% a year, barely any gain considering the higher inflation of that time.

Though this past picture clearly has some significant differences from more recent events, much is similar. If the recent drive into residential real estate lacked the inflationary impetus of the ’70s and early ’80s, it was sustained, as the earlier boom was, by the lure of a rapid price appreciation that developed its own momentum and tempted investors into using massive amounts of leverage. If the recent collapse resulted less from a radical shift in Fed policy, still the Fed’s restraint between 2006 and 2007 did help foster it. Certainly a sudden disenchantment with residential real estate as an investment was common to both busts. If this past is too different to present itself as a stencil from which to trace the future, it is nonetheless close enough to offer guidance to that future.

This admittedly imperfect guide would suggest that the present recovery is running late. The housing sector stabilized within three years after the 1982-83 bust, while this present recovery, whether gauged by sales, construction or real estate prices, has taken well over five years from its initial slide to offer anything like stability. Of course, the longer wait is a natural reflection of the greater severity of the recent correction, which saw sales, building activity and new home prices fall much faster than in the early 1980s, by 70%, 60% and 30%, respectively, peak to trough. No doubt the recovery would have been delayed even longer if the Fed hadn’t adopted a very easy monetary posture, something it delayed doing in the 1980s.

The 1980s experience suggests that the housing sector’s return to complete health will take at least until 2015, and probably longer by some measures. To be sure, the Fed is offering more stimulus and lower credit costs this time than in the 1980s, but markets must also overcome the deep scars left by the very severe 2007-2009 correction. Even recognizing that precise timing from the past is always suspect, a conservative reading of the record should lead investors and business people to look for something less immediately impressive than recent enthusiasm suggests.


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