The Housing Bubble

This San Diego Reader article from a few days back was sent in by a reader. “In..San Diego housing market today, two kinds of gamblers are leaving town in a hurry: (1) speculators, or people buying condos to sell them, not live in them, and (2) homebuyers taking on exotic mortgages so they can buy houses they can’t afford. The former have been skipping town for a year, and the latter are being restrained by regulators who fear a wave of foreclosures and defaults.”

“Two abuses are exacerbating this situation: (1) overblown housing appraisals and (2) false statements of family income on mortgage applications. These deceitful practices, typical of financial bubbles, have permitted the gambling game to go on.”

“‘The price of the asset has gone way beyond its long-term fundamentals,’ says Robert Campbell, publisher of San Diego’s Campbell Real Estate Timing Letter. ‘It’s become a Tinkerbell world.’ As regulators ‘tighten up on funny-money loans,’ those housing prices will come down to earth quickly.”

“Campbell just heard the story about a San Marcos fellow who bought a $700,000 home in mid-2004 without putting any money down. ‘Today the home is worth $610,000. It’s $90,000 underwater,’ says Campbell. The fellow hasn’t made a mortgage payment in a year. He figured he would have to sell the house for $760,000 to make the back payments and get out even. But his broker told him that the highest price he could get for the home is $610,000, based on comparable prices in the area.”

“‘There is a silent crash going on,’ says Campbell, who talks to real estate brokers every day.”

“‘I have not yet seen a bankruptcy’ as a result of the exotic mortgages, says bankruptcy trustee Richard Kipperman. ‘But we know it’s coming.’”

“The ultimate engine of housing demand is job growth, and that has been slowing for several years, even as home construction has continued to grow. Sales have been slipping, but ‘we have more product on the market than we need with current levels of job growth,’ says Peter Reeb.”

“Campbell points out that the housing market itself has been a big source of job growth. So an implosion could affect the economy generally. He sees a high probability that Southern California home prices will plunge 20 to 40 percent. His Real Estate Crash Index signaled ’sell’ in August of last year and continues to plummet.”

“Unfortunately, San Diegans have been borrowing against the inflated equity in their homes to continue their consumption. If home prices decline and lending regulations tighten up, that game could slow. Sales at retailers, car dealers, and other consumer outlets could suffer. This will impact jobs and, in a snowball effect, further whack the housing market. An economy based on debt is risky. An economy based on dangerously speculative debt could be disastrous.”

The financial media is reacting to the Toll Brothers guidance. “If you don’t think the housing market has cooled off dramatically, just ask Robert Toll. ‘Selling homes this first quarter was certainly more difficult than one year ago,’ said CEO Toll. He noted that ‘we experienced softening demand in a number of markets.’”

“Toll Brothers, the largest U.S. builder of luxury homes, said fiscal first-quarter orders plunged 29 percent. ‘The higher-end buyers are beginning to realize they don’t have to rush in, that maybe if they hold out prices will moderate,’ said John Tomlinson, a housing analyst. Toll’s shares fell as much as 5.8 percent and dragged other homebuilders lower. Toll’s stock has lost half its value since July on concern sales of its $700,000 houses will be hit harder by rising mortgage rates than cheaper homes.”

“In a fresh piece of evidence that the housing market is cooling, homeowners paid off their mortgages at the slowest pace in almost three years, Washington-based Fannie Mae, the biggest home lender, said today. ‘The Toll Brothers data is telling us that the fairy dust of rising home prices is floating away,’ Stephen Roach, chief global economist at Morgan Stanley.”

“U.S. homeowners paid off their mortgages at the slowest pace in almost three years as rising prices and interest rates cooled the housing market and builders reported declining orders. ‘Rising rates have taken their toll’ on consumer refinancing to turn home equity into cash, said Akiva Dickstein, head of mortgage research at Merrill Lynch in New York. ‘The housing market is showing some signs of slowdown, and Toll Brothers is evidence of that.’”

Even the Motley Fool is catching on. “From Q4 2004 to Q5 2004 the number of vacant homes increased by 427,000, with vacant for sale up 191,000 and seasonal vacancies up 245,000. With speculation by property flippers, vacation home buyers, and retirement home buyers driving demand for new homes, it is not surprising that the nation produced far more homes than were needed for habitation in 2005. All this is leading to a supply glut that finally is impacting prices.”

“Builders loaded up on far too much land (and debt) in recent years and are rushing new developments onto the market in a futile race to unload it before prices fall too far..It isn’t surprising that if you build a house where there is already overcapacity you might have a hard time selling it.”

“NAR estimated inventory of 2,796,000 existing homes for sale, or a 5.1-month supply in December, which is up by 582,000 (26.3%) year over year. A vacant home is a large cash drain on whoever is stuck holding it.”

“Investors in homebuilders, with too much debt and land on their books, and investors in lenders, with too many high risk loans on their books, will be left with substantial losses.”

The Naples Insider has an update on that Florida market. “Real estate over time usually results in a very good investment. And this has been particularly true with Naples real estate. But real estate trends can run in cycles.”

“Overall the number of single family homes and condos available for sell in the Naples area is over doubled that of one year ago. Some communities, and property types have 3, 4 and 5 times more availability than a year ago. I hear a lot of comments from area brokers and sales associates saying such things as ‘The busiest buying time is from February to May, so once the buying season starts thing will pickup.’ Many sellers in the area have been counting on that advice in hopes of getting top dollar.”

“It’s true that historically Naples has higher number of buyers in February through April than other months. But a record number of buyers would be needed to make a marginal difference in the number available for sale.”

“For example, at the end of January 2006 there were more listed for sale over $300,000 then what sold during the 2005 season.”

“A comparison of actives (homes for sale) vs. pending (homes under contract and waiting to close) is a good measure of the health of the housing market. In a healthy real estate market, pendings will make up approximately 60% of of homes listed for sale in the mid price ranges, and 20 - 25% in the highest price ranges.”

“A year ago that ratio was near or over 100% for many area communities; an indication that the market was on fire. In January 2006, the actives vs. pendings ratio for the Naples area was under 20%. An indication of low buying activity.”

“Advice to Naples Sellers: You need to be competitively priced, not only based on trends within your community, but based on property type and leading indicators within the market as a whole. To sell in the short term, you need to be a value leader. Not just when compared to list prices, but when compared to what has actually sold over the previous months.”

“Advice to Naples Buyers” You are in the drivers seat. For most property categories and price ranges, there are many great choices now available for sale. It’s just a matter of paying the right price.”

Lots of predictions out today. “U.S. home sales will drop in 2006 as mortgage rates climb and house prices inch up at rates far below those notched last year, a trade group said on Tuesday, noting the long-awaited housing slowdown has begun. The outlook from the NAR came shortly after luxury home builder Toll Brothers Inc., widely seen as a bellwether for the housing market, slashed its sales forecast for the second time in three months.”

“‘Sometimes people lose sight of the fact that real estate is cyclical,’ the realtors’ chief economist, David Lereah, said. Construction too will tumble to levels not seen since before 2004, Lereah said. He forecast 2006 housing starts at 1.87 million units, down 9.3 percent from the 2.06 million in 2005.”

“Sales of new homes should fall as well, down 8.5 percent to 1.17 million units from a 2005 record of 1.28 million, Lereah said.”

“Gary Shilling, the Sage of Springfield, noted economist and contrarian..writing in Forbes, forecasts, are you sitting down? that ‘the current housing weakness will develop into a full-scale rout.’”

“He goes on: ‘Median home prices need to fall 29 percent to return to their normal relationship with rents and 35 percent to relink with the Consumer Price Index.’ Finally, some good news: He’s predicting only a 20 percent decline in house prices.”

The New York post. “Homeowners in the New York area should brace themselves for more bad news in 2006, with lower sales prices. The city’s metropolitan housing market, including nearby suburbs in New Jersey and Westchester County, will experience a 2.3 percent price dip this year, according to a major mortgage lending company.”

“Other areas in the tri-state region expected to cool off include Nassau/Suffolk counties, with a median home price of $410,000, showing a 4.5 percent fall; Connecticut’s Bridgeport/Stamford area, with a median price of $490,000, cooling off by 1 percentage point.”

“In New York City, Mayor Michael Bloomberg predicts an even more dismal scenario for his constituents. The mayor’s numbers crunchers expect home prices in Gotham to dive 10 percent, while sales of homes will fall 14 percent in the next few years.”

Of course it’s easy to predict a fall with news like this about. “This Saturday is your chance to buy a Centex Home in almost any Centex Sacramento area neighborhood and save $50,000 to $150,000 on selected homes. New construction or one of our ready-to-move-in homes, it doesn’t matter.”

The Wall Street Journal looks at the way the housing market works. “As home prices soared in recent years, so did the percentage-based commissions charged by agents. Residential real-estate commissions in the U.S. totaled $61 billion in 2004, up 42% from 2000. But isn’t this trend at least making Realtors happy? Alas, no. The number of real-estate agents has grown even faster than total commissions.”

“Membership in the NAR, the dominant trade group, totals about 1.25 million, up 63% since 2000. As a result, there’s not even close to enough commission income to keep all those agents in Porsches. The median annual income of real-estate sales agents in 2004 was only $37,600, down from $39,300 in 2002, according to the Realtors. Even that figure overstates agents’ well-being. Because most agents are independent contractors rather than employees of the firms where they work, they need to pay out of their own pockets for such things as health insurance, pension plans (and) driving customers to see homes.”

“A 2003 study by Chang-Tai Hsieh and Enrico Moretti found that when home prices go up in a city, more people become agents. Their productivity, the number of transactions completed per agent, then declines. The result is that income for the typical agent remains low, even though some top performers earn six-figure incomes. ‘Somebody is paying more, us, consumers, but nobody is better off,’ Mr. Hsieh says. He calls it the ‘tragedy of the commission.’”

“Realtors often point to the large number of agents and their relatively low pay as proof that the industry is highly competitive. But as Mr. Hsieh and other academics have found, a large number of competitors doesn’t necessarily mean lots of price competition. Commission rates have come down only modestly in recent years. Real Trends estimates that the average fell to 5.1% in 2004, from 5.5% in 1998.”

“Of course, some brokers do compete on price, including a growing band that charge a flat fee for selling a home. But a recent report from the GAO found that real-estate brokerage firms have ‘displayed more evidence of competition on the basis of nonprice factors, such as reputation or level of service, than on price.’”

“One possible reason for this, the GAO said, is the use of MLS databases. These services allow agents to see how much commission is being offered on each home. They have more incentive to show their customers the homes with higher commissions.”

“Another reason is that Realtors are well-organized and have persuaded states to pass laws discouraging price competition. For instance, about a dozen states prohibit agents from rebating part of their commission income to the consumer. Peer pressure also plays a role: Agents need to cooperate with one another to sell homes, and offering discounts isn’t a good way to make friends in the trade.”

“Yet consumers also are partly to blame. Many people don’t even consider using a discount service or negotiate with their agents on the commission.. The message for consumers is clear. Those looking for a new home should insist on being shown all of them, not just the ones that come with the fattest commissions. Home sellers should interview at least a few agents before choosing one to market their homes”

The Pioneer Press reports on the housing bubble in the Twin Cities. “Attorneys Katie and Paul Bergstrom never expected to be shoveling snow this winter at their previous home in St. Paul’s Cathedral Hill neighborhood. Last September, they moved into their dream home. But the Cathedral Hill home still hasn’t sold, even after the couple gradually lowered the price to $649,500 from $795,000.”

“‘You wake up at 3 in the morning and think, ‘I have to sell that house,’ she said.”

“A cooling housing market is forcing the Bergstroms and others to juggle two mortgages. Though no statistics are available to show just how many homeowners are in that predicament, what is known is that the overall inventory of for-sale homes in the Twin Cities area was 30 percent higher at times during 2005 than in 2004.”

“Real estate agents say the slowdown is causing headaches for home sellers in most price ranges. ‘No deal in this market today is easy,’ said Julie Papeleux, an agent in Roseville. ‘It’s a tough market. There’s a lot (for buyers) to choose from.’”

“Bonnie Cordy and her husband moved to Tennessee last year for his job. They rented an apartment until their new $325,000 house was ready in June. All the while they were making a mortgage payment in Minnesota. The Apple Valley town home they’d originally listed at $329,900 in December 2004 wasn’t selling, even after they dropped the price more than $20,000.”

“‘I felt nervous as we were finishing up the house down here,’ she said. ‘There was no way to swing it all.’ They dipped into retirement savings for the month or two they had double mortgage payments and taxes.”

“Then they switched to another agent, who slashed the price another $30,000. It finally sold at the end of August for $291,900, which was about $35,000 less than what they paid in 2003. She figures they lost another $5,000 in retirement savings. ‘It’s money we’ll never get back again,’ said Cordy.”

“For nearly 15 years, Charalyn Warman has been buying houses and town homes, fixing them up and selling them quickly without a problem, until last year. She and her husband sold their South Minneapolis house last March after they agreed to buy a condo that was under construction. Since their condo wasn’t ready, they found a duplex at 54th Street and Pillsbury Avenue and figured they’d fix it up and sell it until the condo was ready for move-in.”

“First, the closing of the duplex was delayed because of a glitch. They didn’t move in until May, so they weren’t able to fix it up in time to sell during the busy spring selling season. Then their condo was ready for move-in and they had to take over that mortgage Sept. 1.”

“Now, they’re living in one-half of the duplex, renting out the other half and they’re planning to rent out the condo. ‘I didn’t plan on having three mortgages at once,’ she said.”

“Meanwhile, the one-bedroom condo is for sale at $324,000 and the duplex is on the market for $650,000. They’ve used the profit on the house they sold as well as some borrowed money to cover the mortgages. ‘I’m sitting here hoping, hoping, hoping something will sell,’ she said.”

The Boston Globe reports on a new overall sales report. “The drop-off in Massachusetts home sales last year just got worse. The Warren Group reported yesterday that sales of single-family homes declined 7.6 percent last year. That is much larger than the 3.5 percent drop in 2005 sales reported recently by the Massachusetts Association of Realtors in its year-end report.”

“”’I would say our numbers are probably more complete because they come from the public record data and not from realtors,’ Tim Warren, chief executive of the family-owned Warren Group said. Warren Group’s data are collected from registries of deeds in each Massachusetts county.”

“John Dulczewski, spokesman for the MAR, confirmed that his organization’s data are culled strictly from real estate agents’ listings in five MLSs’ operating across Massachusetts. The association’s data do not include private transactions, such as a parent’s sale to offspring, or sales by owners, or builders directly to buyers.”

“Owners are typically more successful in selling their own properties in strong housing markets than they are in softening markets, that worse track record may be reflected in Warren’s steeper drop. ‘If the number of sales involving realtors didn’t decline as much,’ he said, ‘then realtors are doing a better job of maintaining their business than builders and for-sale-by-owners are.’”

Reuters has the latest on the homebuilders. “Luxury home builder Toll Brothers Inc. on Tuesday further reduced its forecast for home sales in the current year, as new orders for the first quarter fell 29 percent on slumping demand.”

“The company’s deteriorating forecasts may indicate that the slowing U.S. housing market may be declining faster than previously thought, Raymond James and Associates analyst Rick Murray said. ‘Their quarter ends January 31, and a lot of people have been hypothesizing that the weaknesses we saw in October, November and December would perhaps turn around in the beginning of the year,’ he said. ‘This would seem to indicate that those trends have not reversed course and perhaps have even accelerated to the downside.’”

“Murray also said Toll’s indicator also reflects a tough market in the Washington D.C. corridor, where Toll is a significant player.” “Toll also said slowing demand..forced it to cut its outlook to sales of 9,200 and 9,900 homes during the fiscal year, ending on October 31, from a previously lowered view of 9,500 and 10,200 homes. New orders during the quarter fell to 1,572, from 2,209, while the value of the contracts declined 21 percent to $1.16 billion.”

“‘Demand at our communities, which began to soften in early September, now appears to be improving, although demand pressure from speculators has certainly passed,’ CEO Robert Toll said in a statement.”

“Toll Brothers rattled the market in November when it first cut its forecast to a range of 9,500 to 10,200 from 10,200 and 10,600. Since then, Toll shares, which closed Monday at $31.20 on the New York Stock Exchange, are down 21 percent. Shares were down 3.85 percent at $30 in pre-market trading.”

From Bloomberg: “Robert Toll said buyers were holding off because they expect the market to soften. ‘We believe when expectations of home-price appreciation are strong, buyers are willing to wait a year or more for their homes,’ Toll said. ‘When their expectations are more modest, they are less willing to commit so far in the future.’”