Housing: A deflationary prison.

The 1930’s all over again.

In the city where I grew up, the massive bank induced expansion of 1880 to 1930 created an army of very wealthy people. 

Buffalo was one of the richest cities in America, an area of not so much Mc-mansions but Mc-castles. By 1940, they started tearing them down. 8,000 square foot stone homes were torn down, their land being worth more than the house. Today the ones that are still standing are law firms, doctors, offices, and charities. 

Why? 

Their cost of maintenance and staffing FAR exceeding the earnings of depression millionaires. Hundreds of “rich” families went bankrupt as markets fell and debts came due. Their children, the fashionable elite, went from having a personal “car man,” to getting jobs as auto mechanics.

Home (or rather housing) economics.

Many modern mansions are ghetto’s waiting to happen.

Let’s be honest. New construction is crap. (This is a direct quote from an Arizona developer friend that builds high end homes.) The framing lumber is cheap, match-stick quality pine. (5.5-inch 2×6’s) The sheathing is glue-based particle board. Exterior “stone” is just ¾ inch stone on matting, nailed onto glue-based particle board. Exterior siding is typically plastic.

The rugs are made from solidified methane, the roof petroleum sludge, the fixtures so cheap they seem to come in empty boxes, and the plumbing petroleum-based tubing.

Inside? Painted pine cabinets, glue based manufactured flooring, painted pine trim, and finally, tile, the only product in most houses worth anything.

The average new house will burn down in half the time a wooden house built in 1950 will and when they burn, the flame is blue from all the petroleum. 

And they are cringe worthy.

An article in a European architecture magazine asked, “why are American houses so bad?” 

In a word, supersize. 

The article went on to say what I did. (above) In their words, 

“In America, mansions are built with the same materials as travel trailers.”

I spend 1/3 of the year in Europe, mainly Austria and Germany, though I am currently in Vietnam. My apartment in Nuremberg was small, but the quality makes US housing look shabby. 

The building, two stories, was made of cement with a tile roof. The windows were made of steel and opened both up and in. Built into the exterior wall was a metal shade that when lowered blocked out any light on the sunniest days. I could make the room pitch dark at noon.

Even though the building was easily 50 years old, the interior was ultra-modern. But most amazing was the flat was so energy efficient, even with Germany’s insane energy costs, the utility bills were an afterthought. 

A US house is a pit where you burn money. 

This is why earnings at stores like Lowes and Home Depot are so high. US suburban 401k millionaires are spending insane amounts of money maintaining these Barbie doll mansions.

We once did an analysis, based on sales and census data, of how much US homeowners were spending on their houses. We determined that it was $1,000 PER CAPITA and that was just in big box home improvement. 

This didn’t include stores like Bed Bath and Beyond, or Amazon. It also didn’t include contractors, swimming pools or hot tubs.

These houses ranged in price from $200,000 to $700,000. Which brings us to housing versus home economics.

And then there’s development costs.

The average gross margin for developers for Mc-mansions is about 20%. (Ironically, these same developers make next to nothing on multifamily.)

This means that your $1 million house STARTS OUT a $800,000 house. Then there’s developer costs. Since these houses are on large lots, (room to cram in more shit) they cost a good deal of money to develop. 

Development includes zoning, site development, the street, electric lines, water, gas and especially, sewer systems. This adds another $150,000 to the bill. Now we’re down to a $$650,000.

In other words, in order to make a profit on a Mc-mansion, by definition, the house has to be a Barbie doll house. No 1930’s craftsmen building spectacular staircases, no hardwood floors, no hardwood entrance foyers, and no hand-crafted solid wood cabinets. Just more plastic. 

Will the 1930’s repeat itself in housing?

First, let’s look at demographics.

What use is a 3,000 square foot house to a couple with one child?

Does any family really need a living room, family room and finished basement? Do they need an 800 square foot kitchen with enough cabinet space for a navy ship? Do they need a swimming pool, fire pit, outdoor kitchen, and hot tub? 

But the better question is, can they afford these things when they have to be replaced? Given the fact that their 401k millionaire parents used home equity loans to pay for much of it, the answer is probably not. 

The cost of a new petroleum sludge roof on a 3,000 sq foot house is between $40,000 and $70,000. These costs have exploded over the last 10 years as petroleum sludge has skyrocketed in price as well as sludge disposal, and not to mention people who are willing to do what’s probably the worse job in America.

Which brings us to depreciation.

Given that these Barbie doll houses are made of cheap materials it only stands to reason they’ll depreciate faster. But not everything in a house depreciates at the same rate.

Even though the structure might last 80 years, how long will a glue-based floor with a 1/16-inch veneer of “real wood” last? 10 years? The petroleum sludge roof is good for 30 if you don’t live in an area with 100-degree summers or a 4-month snow load.

And then there’s the kitchen. Too many cabinets today are so cheaply built the challenge is getting them off the truck and installed before they fall apart. A new kitchen is easily $80,000.

But more importantly, will the homeowner have $50,000 in savings or a $50,000 equity line when the Mexican army has to come and reroof the house. The short answer is no. 

The Macroeconomics of debt. 

First, a couple 1930’s assumptions.

Remember, the 1930’s houses were torn down because they were not economic, not because no one wanted them.

I can assure you, like the smaller mansions that exist today, everybody wanted one. They dreamed fairy tale dreams about them. To this day, people walk by the remaining ones and lament the perfect days gone by. Few things are more alluring to women that houses. 

Those 1930’s mansions did not have anywhere near the depreciation rates Mc-mansions have. They were built of 2-foot-thick stone walls, with slate roofs. The interiors were made with maple, cherry, or white oak. Like their European counterparts, with the right maintenance these houses could last 500 years. 

In fact, even the less expensive homes were built with similar quality. 

Depreciation is a real thing. 

It’s also widely misunderstood and in inflationary environments, hidden in corporate finance, it’s a big reason why companies have AA ratings months before bankruptcy. On depreciating property, if the loan is not paid off AS the property depreciates, it reduces equity all at once in the end. 

For example, imagine you buy a house for $500,000. That oil sludge replacement roof is (say) $50,000. The roof will last 30 years. This means that each year the owner must set aside$1,666 to replace the roof. This is providing the price of petroleum sludge, and the Mexican army doesn’t go up.

As long as the house goes up in price (Houses never go up in value) you’re good. But if it goes down or stays the same, it eats up your equity. To the roof, you’d add all the things that depreciate faster than the structure, kitchen, fixtures, rugs, flooring, paint, yada yada. 

Keep in mind, a single-family home is a maintenance nightmare. 

In 1930, no down payment mortgages didn’t exist. 

In fact, most single-family homes were built as rentals. There was no FED. Home down payments were at least 50% and property taxes were all but nonexistent. 

The dirty little secret of debt is that without inflation, it can’t survive. 

This is due to a number of factors and largely dependent on the type of debt and how it’s paid. 

For housing, a house payment is not deductible, only the interest is. The house is after tax savings. And low interest makes the problem worse. 

This is because absurdly low interest drives up home prices. This is exasperated by the fact that low interest rates allow home buyers to build bigger houses for the same monthly payment. (And higher depreciation, above)

Interest is not really deductible. 

In 2023, the standard deduction that every couple gets it $27,000. But housing deductions are capped by the home mortgage value. Only the first $750,000 of mortgage is deductible. In a 3.5% environment, interest is rarely that high and even then, the value cap kicks in.

The limit on interest deductions is, for many, too small to be an inducement. 

More importantly though, the standard deduction shelters other expenses, like food and transportation. 

The tax price of a new house.

To put it simply, a person must have net pretax earnings of $1.7 million to pay off a $1 million mortgage. This is over the standard 30-year mortgage term and assuming no new home equity repair loans.  

This is exasperated by the fact that mortgage interest is front loaded. That means as you may your mortgage down over the years, the tax cost rises. As interest falls in the later years, even the small interest deduction you may have goes away.

 And finally, mortgage lunacy.

 We had a tax client last year whose husband died. He was 69, she was 65. They had a $400,000 Florida single family home with 27 years left on their $350,000 mortgage!!!

Remember, banks can’t discriminate in mortgage lending, not that they would if they could. They’re selling off these mortgages anyway as soon as they’ve made their commissions. 

We have multiple clients with primary residences, vacation homes and winter homes. A rising tide lifts all boats, but what does a falling tide do?

The global macroeconomic look.

All real estate loans are against property. This means eventually, either by default or payments, the loan must eventually settle, and the mortgage contract torn up. 

This is easier to see in corporate finance where loans finance processes. (Equipment, labor, and expertise.) If the loan outlives the process, the company is in trouble. It’s why General Motors and GE went bankrupt.

The US housing market is a hornet’s nest.

The old adage for stock investors is “always know who you’re buying from and who you’re selling to.” 

In northern states with multiple home ownership, high property taxes and declining populations, if you’re going to buy real estate, you’d better have been born with 2 asses because you’re going to lose one. 

And if you think “eventually housing always goes up,” over the last 30 years, home prices have gone up 250%, stocks 300%, oil 400% and gold 600%. (Home value never goes up.) 

My point is that houses are typically not good investments.

This is why Warren Buffet, the most frugal man alive, still owns the same house he bought 60 years ago. The opportunity cost of plowing your money into a Mc-mansion and hoping for a payday is slim. 

I have dozens of friends here in Vietnam that are retired, many in their 40’s. Only one owns a home and he is a retired real estate developer. Some are married couples and believe it or not, it’s usually the wife who will never go back to nesting. 

That said, the typical $1 million house requires $1.7 million in pretax earnings, depreciates at a rate of about $30,000 a year and over 30 years has $450,000 in property taxes dragging you under. 

Add to that $200,000 in developer profit and $150,000 in land development costs and God knows why anybody would buy one. 

A final point…

The fact that we live in an overindebted world would be obvious to a pink plastic lawn pelican. Most Asian cities, including Bangkok, Hanoi, Da Nang, and Shanghai, are littered with half built high rises where construction has stopped in 2021 and has not been resumed. 

I counted, just around Benchakitti Park in Bangkok 23 huge high rises that have been frozen. There are probably 100 in total, across the city. 

There’s a dozen here in Da Nang. 

In the US, commercial property is going for chump change and the bottom has not yet been found. Malls have been bulldozed under for years. How much farther behind can real estate be?

Not far at all. We are now at the same level of existing home sales as 1991, a time when we had 80 million less people. 

And homes are still way too expensive!!!! 

There is no real housing market. 

When markets price products, the assumption is the products are all the same. The market price for oil is based on a specific API grade, sulfur content, etc. But houses, unlike oil are not all the same. 

In US housing you have cities that are generally older high-quality homes next to ghettos. Outside that you have near suburbs, built between 1955 and 1990. Outside that you have the Mc-mansions. 

So, the housing market fall will not be uniform. 

I believe there will be great values in specific near suburbs. 

Many of the houses in near suburb Buffalo are well built brick houses in very nice, albeit older neighborhoods. They are on the small side, which means they cost a fraction of a Mc-mansion to maintain. They also depreciate at very low rates. 

My observation is that the younger generation, as much as people deride them, are much less mall rat capitalist and far more socially conscious than their parents. 

They are less likely to panic sell their house if a black family moves into the neighborhood and find no joy in be-being. That is, sitting in their $100,000 backyard behind an 8-foot privacy fence staring at their empty swimming pool and hot tub. 

Aside from select neighborhoods though, we believe that the US housing market is going through a huge transition. There are trillions in unrealized mortgage and equity losses. This will take decades.