Getting real about the real estate bubble

cnn.com ^ | 8-25-06 | Shawn Tully

[Hydroshock]

NEW YORK (Fortune) -- For the past five years, the housing bulls have been trotting out one rational-sounding argument after another to explain why the boom made perfect economic sense.

Forget about a crash, they assured homeowners. Expect a "soft landing" where your three-bedroom colonial in Larchmont or Larkspur not only holds onto its huge price gains, but keeps appreciating at a "normal," "sustainable" rate of 6 percent or so into the sunset.

Real estate slowdown New homes slump worsens

Pace of new home sales falls more than forecast as inventory builds, prices decline. (more) Freebies for home buyers Home sellers are trying to find creative ways to get buyers to sign on the dotted line. (more)

Americans wanted to believe, and they did. Now, the giant popping noise you're hearing is the sound of yesterday's myths exploding like balloons pumped up with too much hot air.

The newest sign that the myth-makers were spectacularly wrong is the data on existing home sales for July. Nationwide, median prices rose .9 percent.

But even that meager number masks the real story. Prices actually fell where housing is most vulnerable, in the bubble markets in the West and Northeast. In the Northeast, they dropped 2.1 percent from July of 2005, at the same time prices nationwide rose around 3 percent, meaning that houses lost over 5 percent of their value adjusted for inflation.

Homeowners just saw their wealth shrink, by a lot. The numbers will only get worse. It's time to examine the clichés that the "experts" - chiefly analysts and economists from realtors and mortgage associations - used to convince Americans that what they're seeing now could never happen. Here are the four great housing myths - and why they never made much sense in the first place.

[wmfights]

"How? They still have a house. Getting upset over paper losses is for idiots."
_________________________

I agree. If you bought your home to make a big profit you bought it for the wrong reason.

[Moonman62]

Stocks don't have to be maintained, insured, or have property taxes. A diversified stock portfolio is safe from any one blowup, and best of all rising stock prices don't raise the cost of living. I'll take Clinton's bubble over W's.

And if someone really wants to invest in real estate they should buy stock in REIT's. No nasty tenants to deal with.

[A CA Guy]

RE crashed on the 80s and lots got burned.
It crashed in the 90s.

Now due to the lowest interest rate loans and bad loans in perhaps history, we have the highest RE gains.

Over the next few years as ARMS go up and interest only loans come due, look for lots of foreclosures.

My concern is this will be heavily felt in the economy as we head into the 2008 elections and could hand us a Democrat President because people will not understand the economics of this.

[Polybius]

-- 5,000 SQUARE FOOT, ALL BRICK, VICTORIAN MANSIONS SELLING FOR $1. These are inner city shut downs now, where the value of the home is less than the value of the crack that could be vacuumed from between the floor boards

Where are these places? Got a link?

If you are serious about such a deal, before you visit his link, visit THIS LINK.

[Oberon]

Everyone was touting the rising prices of homes as the future wealth of America...

...but that's patently stupid. Absent a change in the circumstances or condition of the property, all a price rise indicates is that your dollars are getting smaller.

[ClearCase_guy]

Here's the deal with negative equity.

I buy a house in MA for $500,000 with no money down <-- I just did something dumb
About 60% of my take home pay goes for my mortgage <-- I just did another dumb thing
Home prices in my area drop 20% <-- I just got unlucky

By itself, the housing bubble is not hurting me at all. So far.

I now owe $500,000 on a $400,000 home.

I will have a problem if:
A) I get laid off <-- I just got unlucky
B) The bank calls my loan <-- I just got unlucky

The housing bubble will hurt people who have done several dumb things AND who have gotten unlucky in multiple ways.

Crack will ruin more lives than the housing bubble.

[RockinRight]

I think the "not-so-hot" markets where prices have only climed at or slightly faster than inflation (most of the Midwest and South) will probably not see anything worse than a flattening of appreciation since they hadn't gone up much in the first place.

I don't think a 12-20% decline will happen "nationwide" unless you think that the entire nation exists on the coasts and in the Southwest.

Ever notice the highest priced markets (and most at-risk of decline) are generally in blue states (with the exception of Phoenix and Vegas?)

[wmfights]

"They pass so many crazy laws out there I can't imagine trying to do business there."
_________________________________

I agree.

[TET1968]

Investments:

My own experience, Inner Harbor area....15 years with an average gain of 33% per annum for a total of gain of 500% by the end of 2006 .

Time Warner Inc.'s ( Lord of the Rings, Harry Potter, Batman, Time magazine, CNN, HBO & AOL ) share value for the last 5 years, under Dick Parsons has risen about $1. Total.

Dick's office cost share holders 50 million bucks.
I have a 12" G-4 with a 20" display and a Bose sound system.

[driftdiver]

"In the U.S., however, expect the irresponsible bankers to demand a bailout from you and me, the U.S. taxpayers."

The idiocy of the banking industry is not limited to housing. Look at credit cards as an example. They engage in extremely risky business practices and push new bankruptcy laws thru instead of changing their predatory policies.

[JasonC]

Um, if a 0.9% decline is the popping of a bubble, what's a soft landing?

Prices may crater 50%. Then you can talk about a crash.

Prices may fall 20%. Give the size of the recent run up, you could then talk about a correction.

Turnover of RE vs. total RE outstanding is quite low. The last time most houses sold was maybe 10 or 15 years ago. Some regions the typical holding period might be smaller.

Any way you can see a 10 year holding period that results in a loss? If this is a sharp peak, and prices fall 50%, sure. Right now? 3% declines? Get real indeed.

I've seen some very speculative high end markets, like Nantucket, where prices have fallen 30-35% this year. But from paper only, no transaction, nosebleed levels at the start of the year. The last actual sales 4 years ago for the same house, are lower still by factors of 2 or 3.

Some purely paper gains appear momentarily and vanish. Whoppie doo.

[Truth-The Anti Spin]

In my area of the midwest the condo craze has led to all types of conversions. If developers start having big problems the banks are going to take back the inventory and at that point I have the opportunity to pick up real values.

Take the bay area of California(I know, I know, Liberal hell).

You're looking at $1million homes. Something like 80% of the home sales in the last 6 years are adjustable rate mortgages. In addition, many of them are interest only adjustable rate mortgages.

As interest rates rise, the payments on these adjustable mortgages go up. Many people are already stretched to the limit financially to afford their mortgage in this hyper inflated market.

When people can't afford their mortgages, the homes get foreclosed and the price drops further(supply increases due to foreclosed homes on the market). It's a vicious cycle. If it gets bad enough, foreign investors(they own a LOT of real estate) will pull out, causing the dollar to drop in value, which means the fed has to increase the interest rate further to keep foreign investments steady and the dollar from collapsing.

It sounds like you personally stand to gain, but this could be real bad overall.

[RayStacy]

Touche. There is definitely a reason you can buy a house for a dollar.

[RexBeach]

Well, that's always the problem with booms. At some point, they all end and people get hurt financially. However, this, too, shall pass and all will be well...again.

I remember buying my house in northern Virginia in 1989, just after the top in a very strong RE market. Then the price of the house fell for nearly 10 years. Well, in 1998 that all began to change. Bang, zoom! Up we go!

I reckon we'll head downwards now for a spell. Prices in my neck of the woods are easing somewhat, but not a heckuva lot according to the RE ads I see.

One things certain - this is all going to be very interesting.

[Protagoras]

Bubbles hurt people who have made dumb decisions.

Bump.

[GeorgefromGeorgia]

"I think the one myth that never seems to get debunked is "your home is an investment". It isn't and never has been. It is a place where you want to live. The pull back in the market is not all that surprising and anybody who bought with the idea that the property would continue to climb in real terms throughout the time of ownership should not have bought. However, I don't believe there will be a collapse in values. Those that could afford what they bought will mostly stay put for a while and sell at break even or slight gains."

I agree with some of your comments, and disagree with some. Your home is definitely an investment. Most people buy a home because they want a place to live, and home ownership generally results in a gain on the future sale, particularly if you keep the home for several years. Also, our tax law favor home ownership and the government even set up Fannie Mae to help homeowner get loans.

People in continental Europe (not the UK thanks to Thatcher) are more likely to rent than in the USA. I lived in Germany for four years, and it amazed me that Germans will rent an apartment or house (usually a townhouse or half house) for decades. They don't move as much as Americans, but homes are more expensive in Germany.

True, a home should be purchased because you want a nice place to live and raise a family. You buy in a nice neighborhood because you don't want your home burglarized and your kids beat up. Also, you want good schools and to be able to sell in the future. Still, considering the fact that over time homes generally appreciate and some profit is made, the decision to buy is also a decision that involves a strong business element.

[A CA Guy]

We have lots of people who were burned in the stock market who decided to go speculating into the RE market expecting to get out fairly soon with a profit.

There were lots of unqualified people who got interest only and other risky loans that will be going under especially when the first three year interest only loans come due within 18 months.

Lots of homes are going to be going back to the banks IMO, and the fact that Fannie Mae has some 90+% of all these loans sets them up for a disaster like the Savings and Loan crisis we had from Carter.
Who ends up paying when Fannie Mae has problems?

We could be set up for lots of economic problems.

[capitalist229]

There is no loss or gain until you sell.

And that's what is causing the high inventories. A lack of sellers and buyers.

They are still in the denial stage. But eventually reality catches up when they change jobs or their ARM rate goes way up and they can't afford it.

Until then a housing bust is just speculation.

BUMP>

[Truth-The Anti Spin]

I was quoting someone else, who said that the overbuilt markets will decline. I agreed, and said the bubble markets in places like San Diego and Boston will be most affected.

I agree that less overbuilt/oversold places will be much less affected. A good place to look is the household income/house price ratio... the lower the ratio, the less affected an area will be.

Ever notice the highest priced markets (and most at-risk of decline) are generally in blue states (with the exception of Phoenix and Vegas?)

These cities have the best jobs and are generally the places where people with lots of money would want to live. Additionally, zoning and geography makes land more scarce in say, San Francisco than in say, St. Louis.

[Lowcountry]

So much misinformation and so little time to respond.

1st - The press is more stupid about real estate than they are about almost any other subject they report.

2nd - Median housing prices reflect the sales price of the middle house in a column of houses sold.

3rd - The fact that median prices fell could mean that more starter homes sold than move-ups.

4th - Real Estate IS an investment. But no asset is an investment until you sell it (think about expensive art.) It is only at the point of sale that you can tell if you had a gain or loss.

5th - If you are worried about your home value in lieu of a bank foreclosure, you were in trouble to start with. Your home's value should have absolutely NO affect on your ability to pay for it. That is a function of your income and expense.

6th - Just because your home may have dropped in value this year, does not mean that it will not recover or show a gain next year.

7th - The most likely person to suffer pain in a housing slowdown is the homebuilder. Yes, homesellers can get in a pickle if they are in a hurry to sell, but most homes are worth a lot more today than they were two or three years ago.

8th - If the national press is fixated on this, just relax... and wait for them to start saying how this is Bush's fault!