The Housing Bubble

US News and World Report has this on the nations housing markets. “Contrary to popular belief, the housing market hasn’t cooled off that much. In fact, residential real estate prices continue to soar in a number of key metropolitan areas, according to a new study released this week.”

“That’s a good thing, right? Actually, no–because the froth building in housing prices raises the distinct possibility of significant corrections to come in many of those regions.”

“In the first quarter, home prices nationwide rose an additional 7.3 percent, according to a joint study by the financial services firm National City Corp. and the research firm Global Insight. As a result, there are now 71 metropolitan areas–representing nearly 40 percent of all single-family homes–that can be classified as ‘extremely overvalued.’”

“‘The fact that this number of metro areas, representing such a large percent of the total single family market–is extremely overvalued should be a cause for concern,’ said Richard DeKaser, chief economist for National City.”

“Real estate prices eventually correct themselves. And unfortunately for homeowners, it often takes years before home prices start to rise again, especially after a big run up. ‘ the average duration of these adjustments is 3.5 years,’ says DeKaser.”

“So what about families who recently bought into one of these ‘extremely overvalued’ markets in hopes of turning a fast buck? ‘I extend them my deepest sympathies,’ says DeKaser.”

“The frothiest region in the country, according to the study, is Naples, Fla., where home prices are said to be 103 percent overvalued.”

The Naples News. “WCI isn’t the only company dealing with the cooling down of the red-hot housing market by delaying the introduction of new homes and condominiums. Officials with The Ronto Group said Monday they will delay their two communities planned for East Bonita Beach Road from early 2007 to late in the year.”

“Robin Driskill, the company’s director of sales and marketing, said the high inventory of housing stock in Southwest Florida prompted the delay. ‘It wasn’t so much we didn’t want to move forward with (the communities); it is that there is so much investor product diluting what’s available,’ Driskill said.”

“In Southwest Florida, both Lee and Collier counties have more than a year’s supply of homes already on the market. That makes it a smart time to slow things down, even at the cost of a temporary impact on profit, Driskill said.”

“‘It does affect our bottom line. You have something out there that you want to put to work for you, but you are also not dumping money into the ground,’ Driskill said. ‘We have to do that or we dilute the value of our product, and everyone needs to look at it like that. It is just not wise.’”

“Kitty Green, VP for the Bonita Bay Group, said everyone is feeling some effect from a housing market that has seen astronomical increases in value in recent years, at least some of which were fueled by real estate speculators. ‘Our Sandoval community in Cape Coral is a primary buyer community, but they have to be able to sell their existing home to buy the next one, and with all the resales on the market, many are having trouble selling their homes,’ she said.”

“One worrisome sign is that not only have sales dropped, the amount of inquiries have too, Green said. ‘The decline in both is worrisome for different reasons,’ Green said. ‘Traffic is prospective buyers and is essential for future sales.’”

“The cutback in new homes was inevitable, given the percentage of speculative investment in the market during the course of the last year, said Mike Reitmann, executive VP of the Lee Building Industry Association. ‘Don’t know to what extent each one will do that, but each one is going to be evaluating the situation and doing what is prudent,’ Reitmann said.”

“Equally inevitable was the downward revision of profits and earnings for builders like WCI, Toll Brothers and Pulte Homes seen in recent weeks, said Brad Hunter of a Palm Beach-based analysis firm. Construction, insurance and labor costs have risen, interest rates are continuing their climb and the ability of builders to pass those costs to consumers has gone down, Hunter said.”

“‘That’s going to have a negative impact on earnings,’ he said. ‘Plus, sales are off drastically and traffic is down. I expect to see similar reports from other builders as the summer goes on.’”

The Union Tribune reports from San Diego. “San Diego County’s home prices took their biggest tumble for any spring on record last month, DataQuick reported Tuesday. The median price of all homes sold in May was $490,000, down $15,000 from April, although it was still slightly higher than a year ago. Sales slowed for the 23rd straight month on a year-over-year basis.”

“Leslie Appleton-Young, chief economist for the California Association of Realtors, said she no longer uses the term ’soft landing’ to describe the state of the housing market, but has yet to found a way to characterize current conditions. ‘I’m searching for a new moniker,’ she said.”

“She and other industry leaders have rejected analogies like a ‘housing bubble’ prone to popping.”

“In San Diego County, the median price decline in May occurred because of a major drop in the category that includes new construction and condo conversions. That decreased by $71,000 from April to May to stand at $424,000, a reflection of the impact of lower-priced conversion sales.”

“On a year-over-year basis, the new construction and condo conversion median price was $19,500 lower than the $443,500 median price reported in May 2005.”

“In the resale category, the median price of houses and other single-family homes rose by $14,500 from April to May to stand at $569,500, while the median price of condos increased by $2,000 to $397,000.”

Several readers sent in this article for discussion. “All over the U.S. there are stories of a rise in real estate foreclosures. Many people who took those exotic mortgages are struggling to make their payments, and some aren’t making it. Also, a glut of new property supply, especially condominiums, is coming on line.”

“A friend of mine, a very seasoned real estate investor, says in San Diego County, once one of the hottest real estate markets in the country, thousands of new condominiums are getting ready to come to market, just as the market softens. He estimates that over 12,000 new units are coming on line, and the market, at the best of times, can only absorb about 1,000 condominiums a year. If he’s correct, that means 12 years of supply will be ready for market in the next year.”

“The people who are in the most trouble are flippers. Many were buying condominiums off the plans, which means the projects were yet to be built, in the hopes that when the homes were completed, they would sell for a tidy profit. The trouble is many of these flippers, lured into the market by stories of people making a huge killing earlier with a similar strategy, are now the ones to be slaughtered.”

“Now, they either lose their deposit or have to cough up the money for the purchase in the hopes there’s a greater fool than they were somewhere out there real estate. If you recall, the same thing happened around the year 2000 as amateurs jumped into the stock market.”

“In the coming months, I predict we’ll see an increase in people dumping real estate they can’t afford. They’ll be forced to sell because they’ll be eaten alive by a phenomenon known as negative cash flow. Investment properties that you have to feed money to every month are fondly known as alligators, if you can’t afford to feed the property every month, it eats you.”

“I know of one so-called real estate investor (and I prefer to call people like him speculators rather than investors) who has three homes he thought he could flip for a profit, but he priced them too high. Now, $7,500 comes out of his pocket every month to feed the negative-cash-flow alligators.”

“The problem is, he and his wife don’t earn that much a month. Their three alligators are literally eating them out of house and home, consuming the profits they made from other flips, and their savings.”

“To add more pain to the misery, they still have to pay the capital-gain taxes they made from their previous successful flips. They’re toast. The alligators are eating them alive. They can’t afford to feed them, and they can’t afford to sell them because the prices they paid for these alligators are more than they’re worth today. And this is only one story.”

“Now that the market is cooling down, sellers are a little bit more humble. You have more time and can do your due diligence carefully. You can negotiate better terms and make a better deal, especially if the seller has his leg inside an alligator’s jaws. But don’t be in too much of a hurry.”

“A year ago, I sent out a warning to investors, especially flippers, to cash out quickly. I received a lot of irate e-mails from people who thought I was turning on them. They thought I was spreading bad news. Little did they know that by forecasting a real estate downturn, I was spreading good news, good news for real investors and bad news for amateur alligator wrestlers.”

The Star Tribune reports on the May numbers released yesterday. “Sellers continued to swamp the Twin Cities-area housing market in May, leaving a huge pool of inventory for increasingly choosy home buyers. New listings of 11,419 homes in the 13-county metro area were a record high for the 10th consecutive month. At month’s end, 30,179 homes were for sale in the 13-county metro area, up 43 percent from May 2005.”

“While the market conditions are tough on sellers, buyers are in the driver’s seat, and they’re taking their sweet time about jumping into deals.”

“‘There’s a combination of factors going on, rising mortgage rates, especially for adjustable-rate mortgages..and the level of home prices is so high that’s it’s starting to affect affordability,’ said Scott Anderson, senior economist for Wells Fargo & Co. ‘There’s also a sense that buyers are holding off, waiting to see if a bottom forms, or if there’s continued weakness in the market.’”

“Todd Shipman, president of the Minneapolis Area Association of Realtors, said: ‘Rates are reasonably low, there’s a big selection and some motivated sellers. But buyers aren’t pulling the trigger.’”

“One reason for the slower sales may be overly optimistic sellers, observers said. ‘Sellers are having a hard time’ adjusting to lower appreciation rates, said June Wiener, president of the St. Paul Area Association of Realtors. ‘They’re perhaps not being realistic about prices. We’ve seen so many years of high appreciation that this is kind of a sudden change.’”

“The return of contingencies also is contributing to the buyer-seller imbalance, said Shipman. ‘It’s the chicken and egg,’ he said. ‘If the buyers’ house hasn’t sold, they’re reluctant to buy because of the uncertain market.’ In addition, he said, ‘investors have pulled out of the market’ because the slowing home appreciation rate means they can’t earn a big enough return to make a real estate investment worth their while.”

“Economist Anderson said there’s a psychological factor at work, too. ‘When you start to see prices decline, they become reinforcing,’ he said. ‘Buyers hold off, expecting cheaper prices in the future. It’s almost the opposite of rising prices,’ when people rush to buy because they think they’ll have to pay even more if they wait.”

“‘I think the real question is, will the market bottom out, or is this the beginning of a down trend that could be more severe?’ he said.”

“The answer, Anderson said, will depend largely on baby boomers, who are approaching retirement. ‘Will they panic, and all put their houses on the market at once,’ hoping to lock in the hefty appreciation gains many have been counting on to help finance a comfortable retirement?”

“‘Or will they hold back, as [sellers] traditionally do when the market weakens,’ hoping that prices eventually will improve? ‘We’re in uncharted territory because of the baby boomers and the run-up in housing prices over the past five years,’ Anderson said. ‘We’re not 100 percent sure how home sellers are going to react.’”

The Financial Times reports on the new Harvard study. “Markets seldom disappoint both bulls and bears for long. But over the coming years the US housing market looks likely to do just that, according to a study by Harvard University. ‘Although housing prices are stretched, it is hard to see the catalyst for a crisis in the market,’ says Nicolas Retsinas, director of the Joint Center for Housing Studies at Harvard.”

“‘The overvaluation looks pretty well balanced by longer term supports for house prices, so we may just see a few years with little action. Houses will revert to being something to live in rather than money makers,’ he said.”

“Over the past five years house prices have outstripped income growth more than sixfold, the median home now costs more than four times median household income in 49 out of 145 metropolitan areas in the US, a record. In 14 metropolitan areas, the median house is now worth more than six times median income. Last year saw the average house price shoot up 9.4 per cent, the biggest rise in the average house price since records started more than 40 years ago.”

“The strongest underlying support for the market comes from accelerating household formation. Demand is being driven not only by population growth but by household fragmentation, as couples divorce or children leave home.”

“Not everyone concurs, however. Many economists say national figures are deceptive, since they obscure pockets of extreme over-valuation in property prices and greater vulnerability to rising rates. Others point to evidence of overbuilding in recent years. Residential investment has risen to 6 per cent of gross domestic product, its highest level in 50 years and much higher than the average of 4.75 per cent.”

The Boston Herald. “New figures show Greater Boston housing is less affordable than ever, with a median-priced home costing nearly six times what the average family makes per year.”

“‘Affordability problems are worsening,’ Harvard University researchers write in their annual study, due out today. The report found that a median Hub-area home sold for 5.9 times local median household income last year. That’s up from 3.2 times median income in 1994, as well as about two times median income in the 1950s.”

“Affordability also dropped to record lows in all three other Bay State areas measured: Barnstable/Cape Cod, Greater Springfield and Greater Worcester. All told, researchers found that more than one Massachusetts household in three spends at least 30 percent of family income on housing. Worse, nearly one family in six pays at least half of everything earned.”

“‘The problem of affordability is not just a low-income problem any more. Middle-income families are facing affordability problems as well,’ said Nicolas Retsinas.”

“The study found Greater Boston municipalities issued just 7,974 building permits for new houses last year, a 16.6 percent drop from 1994. The good news: Retsinas said a lack of excess construction means prices in Boston’s jittery housing market aren’t likely to collapse.”

“The expert said researchers found sharp price drops usually require a combination of overbuilding and big job losses. ‘While there clearly will be a softening and flattening (of Greater Boston house prices), it’s unlikely there will be steep falls in the single-family market,’ Retsinas said.”

“However, he conceded that the Hub’s condo sector, which has seen lots of construction in recent years, ‘may be oversupplied.’”

MSNBC reports on the changes in the housing market. “There’s no denying it any longer. In most parts of the country, the sizzling house market has cooled. The people who make their living selling homes prefer to put a more positive spin on these numbers. They say the marketplace is just going back to normal.”

“‘It’s not normal to have 15 offers on a property,’ says Jim Warkentin, a Realtor in McLean, Va. ‘That’s just crazy.’ For the most part, those crazy days are gone.”

“That may be bad news for sellers, but it’s good news for buyers. In many markets, buyers have the luxury of being able to take their time and negotiate a deal for the first time in recent memory.”

“In Grass Valley, Calif., broker Laura Berman says sales in her Northern California region are down 30 percent from a year ago. The ‘inventory is huge,’ she says, and price reductions are common.”

“‘The buyer is clearly in the driver’s seat,’ says Bob Callahan, who is about to close on a house in McLean. ‘Houses are still expensive,’ he says, ‘but you can find deals now.’”

“The house Callahan wanted was originally listed at $629,000. After two weeks without an offer, the owners dropped the price to $599,000. Callahan got the house for $592,000. He says he could sense the sellers’ ‘willingness to negotiate about the price very early on.’”

“Callahan’s agent, Kate Ryan, says sellers need to understand that the price of a house is set by the market, which is now flat or dropping. ‘That’s hard for a lot of people to deal with,’ she says. Smart sellers need to realize that buyers can now take ‘the pick of the litter,’ and they need to set their asking price accordingly.”

“Laura Berman says the sellers she deals with in the Grass Valley region ‘are mostly in denial. ‘If you have comparable houses, it always comes down to price.’ And now that buyers may have dozens of houses to look at in their price range, they can determine the true value.”