Saturday, January 1, 2011

Real Estate Pricing Trends

The housing market will likely remain flat for the next 5-10 years.

Recent reports have noted that Real Estate prices have dipped slightly in the last few months, by 0.5% or so.  The Doom-and-Gloom media is almost ecstatic about this, as they love to report bad news.  Bad news sells newspapers.

But the reality is not as bad as all that.  What is happening is that people are owning up to the realities of the market and lowering prices to sell homes.  And home are moving - as prices have dropped, sales are up - November sales being particularly brisk.

Why is this?  For many people, the idea that housing prices had dropped permanently was not registering.  I met a lot of people who said "Well, we're hanging on until the market recovers!" and staying in upside-down, cash-hemorrhaging homes.  They finally realized that the market wasn't going to do a 10-20% recovery any time soon, and they sold.

Others, with the toxic ARM mortgages and other funny-money deals are finally being priced out of their homes and selling.  And still more are being foreclosed upon.  And also, banks are finally completing the foreclosure process, and selling off inventory - they too, living in denial about pricing for many months and finally lowering prices to market levels.

How do I know this?  Am I an expert?  Clairvoyant?  Neither.  I just saw the exact same thing happen between 1990 and 1995.  Housing prices stayed flat for about five years after the last bubble burst in 1989 or thereabouts, and it took several years for the housing inventory to clear up, for foreclosures to go through, and for people to break down and sell at market prices.

We bought some of our best investment properties between 1995 and 2000.  Prices were still fairly low then, although they started to accelerate as interest rates dropped.  Many people, not understanding basic economics, assumed that the high annual price increases were a sign of a perpetual growing market, when in retrospect were just an effect of a rebounding market, lowering interest rates, and some investor euphoria.  Once the euphoria took hold, well things went crazy.

Today we are in the aftermath of a bubble that makes the 1989 bubble look tame - perhaps 5-10 times as worse as the earlier bubble.  Home prices shot up so far and so fast, they have a long way to fall.  And I predict they will stay flat for about 5-10 years, probably closer to 10.  Why is this?

1.  Fear:  Most people are afraid of investments that tanked, so many people will avoid investing in Real Estate or even buying a personal residence out of fear.  I saw this in 1995 when I was buying Real Estate and my friends thought I was crazy.  After all, this "dot com" thing was a much, much better deal, right?  So they invested in "dot com" in 1995 and shunned Real Estate.  Five years later, they licked their wounds from the "dot com" fiasco and looked at Real Estate as a way of recovering from their losses.

2.  Demographics:  Our population is not shrinking, but it is flattening.  So there the rate of growth is slowing, which means it will take a lot longer for an increasing population to swallow up all these spec homes and foreclosed properties.  If we loosened our immigration policy, it would increase the population and increase housing prices - but that is an anathema today, politically.

3.  Recession:  No on has any money to invest in Real Estate, even for their personal home.  Younger people today are poorer than their parents at the same age.  The last of the good-paying blue collar jobs disappeared in the last recessionary wave.  Kids today are farther away from the "dream of home ownership" than ever before.  So the idea that prices will go up is a fantasy, as the next generation will struggle to buy homes at existing prices, if they can even afford that.

4.  Cost/Benefit Ratio:  As I have noted time and time again, one sure way to tell if a home is overpriced is if it is cheaper to rent, than to buy, even taking into consideration the tax deductions available.  In 1995, I could buy a duplex and rent it, from day one, with a positive cash flow.  When prices more than doubled, the people buying the same properties were running a cash deficit.  Today, while prices have dropped significantly, I think they are still a little high.  It is still cheaper to rent than it is to buy in many places.  Until rents increase (which will occur when population grows) many of the bargain homes out there are still not real bargains.

So what does this mean for you, the consumer?  If you are thinking about buying a home, relax.  You are in the cat bird's seat and can choose from a number of homes on the market (with a few market exceptions, of course).  But don't feel pressured to buy right now, as the "bargains" of today will likely remain bargains for the next few years.  If you miss out on a "good deal" don't worry - chances are, the same "deal" will be available to you during the next few years for about the same price.

If you own a home and are thinking of selling, but want to "hold out until the market recovers" you may have to hold out a decade or more - and the cost of waiting that long is horrendous.  You are better off lowering your price, selling the home, and moving on.  Hanging on is going to do little for your bottom line, as the price increase for your home will likely be less than the rate of inflation.

If you are upside-down on your home, I feel for you.  However, chances are, you can't refinance  and you won't have positive equity for some time.  Rather than cash in your 401(k) to make mortgage payments, you should think about other options - short sale, or whatever you need to do to turn things around.  Refinancing is possible, but only if you can pay down your noted to show the positive equity that the banks now require.

Our Real Estate market is merely rationalizing after a decade of irrational price increases.  Some folks think this is horribly unfair, in that all that phantom "equity" they had in their home was "lost" due to some odd economic conditions.  But in reality, today is the "normal" market and five years ago was the oddball situation.  We have not so much suffered a downturn, but are returning to sobering reality after a decade or more of excess.

The good news in all of this is that a stable Real Estate market will make a lot more sense moving forward.  We can now rely on Real Estate as a place to live, not as some inflated token of an investment market.  This may be cold comfort for those caught up in the emotional excesses of the 2000's, but it is the way it has to be - we have to live in reality, always.  When markets stretch out of shape, they often rebound back in very terrifying ways.