One of the questions I hear regularly by new homebuyers is “Are we at the bottom?”. They are obviously concerned about making a jump and having the price fall further. People that I have talked with that are knowledgeable in the Real Estate community liken buying a home to “Catching a Falling Knife” – meaning it’s nearly impossible to do so without getting hurt, although the closer you are to the ground, the less likely that this will be as nasty a cut.
It’s a viable question. One I will attempt to address in this blog.
With over 30 years in the mortgage business, I thought I had seen every cycle in Real Estate prices. I lived through the 80′s – the Thrift Crisis and the glut of condos on the market from that era – Prices soon recovered from their “then” historic lows. I watched various booms, driven by different cycles in the economy. Low rates driving refinances which in turn spurred further investment in the economy (the equity driven “Wealth Effect“) – basically found money. Great stuff and of course this was good for every aspect of the economy.
With the drive in the early part of the last decade to put everyone in a home, coupled with Post 911 low rates and ridiculously simple loan qualifying guidelines, we experienced a boom in housing like never before in history. The appetite for homes drove new construction to new levels – well beyond what could be absorbed by normal market growth. Why you may ask? – Because speculators were buying multiple homes. Condo conversions ran amuck – people standing in line for days to get in on the Great Condo Grab – most hoping to flip these “Hot” units for a quick profit. Lenders providing financing with no equity (no money down) favorable payment terms – many with payments that didn’t even cover the interest that accumulated on the loan – made this even easier. People that never before considered Real Estate speculation, jumped in with both feet. I had one client that purchased 14 different condo units – all stated income/stated asset loans. This was by far the craziest market I had ever seen and I even told one developer on a condo project I was working at in September of 2005 “I don’t know when this is going to end but it’s not going to end well. Values will drop” He scoffed at my scenario – after all housing in Florida had never seen a sustained drop in values. The last time we saw a prolonged drop in housing prices in the US was in the ’30′s!
So when the market faltered, I wasn’t surprised, however, I was completely amazed at how far prices have dropped and how long its taken to see a bottom. I had dinner a few years ago with Jack McCabe of McCabe Research and Consulting – a well-respected leader in Real Estate trend analysis – I believe this was in early 2007 and he predicted back then that prices would have to fall to no more than 3 times the median home income for the market. (At the time the median home price was at more like 6 times median home income. That would mean a 50% reduction in values. He was recently on CNBC again addressing housing values.
As the chart clearly demonstrates, the markets that had the biggest gains from 2000 to 2006 (Florida California, Nevada, Arizona) also saw the largest declines in the post 2006 term. Overall price changes in these markets are now in the 0-40% range – more in line with the normal historical appreciation rate for Real Estate. (The norm in Florida prior to 2000 was about 3-5% per year.)
So if the correction has essentially happened, why are we not seeing housing prices heading back up? There are a few reasons. First and foremost are jobs. This has been called a “Jobless Recovery” and without getting into a political debate, let’s just says that the environment has not been prime for companies to begin hiring again. Increases in corporate profits are coming from efficiencies and consumer spending, but companies are not yet hiring – and this impacts he homebuyer market.
The second reason is simple supply vs demand – basic economics. Due to several reasons, demand has not ramped up yet sufficiently. Job growth is one reason, another reason impacting move up buyers is negative equity on their current home. Many people simply cannot sell their current home and satisfy their mortgage. On the supply side, the inventory of homes is still greater than demand and when supply outpaces demand, prices do not typically rise. Take a look at the following chart courtesy of National Association of Realtors, the US Census Bureau and Gary Shilling and Co:
While nationwide, inventories are much lower than they were just a couple of years ago, they are still above the optimum level – but the thing you don’t see in this chart is the “Shadow Inventory” These are homes in some level of foreclosure, have but not on the market or vacant properties that the sellers and could be in excess of 1 million homes.
Until the inventory becomes a more manageable percentage of demand, we will see further pressure on prices. Jack McCabe stated on CNBC in March, that we could see this trend continue for 14-18 months before the market turns around. Based on the trends I am seeing in appraisals for my market (South Florida) the amount of monthly decline has decelerated significantly. Appraisers were at one point adjusting comparables on residential appraisals by 1% per month but this is not the case now – these adjustments have been reduced considerably so this is a good sign.
So is now the right time to buy? That is never an easy question. No different than trying to time any market where values are a product of market fluctuations, buying a home should not be solely a consideration of price vs. return – unless you are buying with the idea of selling quickly for profit. (Although I am seeing a large number of such transactions as investment groups purchase foreclosed properties then resell to new homeowners for a profit) Such consideration for potential homeowners should also be family needs, long term benefits and mortgage costs.
As the economy continues to improve and the specter of inflation creeps back into the market, the Fed will be more inclined to halt the stimulus efforts and eventually begin raising rates to combat inflation – already at higher levels in other parts of the world. The impact on the cost of a new home from rate changes is much greater than a slight decrease in value that may be more temporary.
To demonstrate this, let’s take a scenario of a home buyer who looks at a home currently valued at $250,000. Today’s interest rate on a 30 year fixed rate loan is 4.75%, therefore with 20% down, his monthly payment is $1043.30. Suppose he waits a year to be sure he doesn’t “miss the bottom” and gets the same home for $235,000 – a $15,000 savings! Great huh? However rates are now 1% higher – meaning that even though he is financing less, the monthly payment is now $1097,12 – meaning that he ends up paying $4300 MORE for the home overall due to the higher interest costs over the term of the loan. Suppose he waits and that same home doesn’t drop that much but rates continue to rise – this becomes more dramatic. We are at historic low rates. This low rate opportunity increases the “Value” of the home considerably and for anyone looking to become a homeowner, it is a great time. Take a look again at the first chart in this blog. Housing prices have for the most part returned to levels that are in line with normal valuation curves. Once the job market recovers (and recent reports do show improvement for the past couple of months) demand for homes should rise… Adding further to this is the increase in rental costs due to higher demand for rentals.
With such a substantial decrease in vacancy rates on rental properties, rent increases are expected to jump. It’s now been mentioned on several financial sites and new reports that in most markets its now cheaper to own a home than it is to rent. I expect this trend to continue so it is the best time to buy a home from virtually all perspectives. The best way to determine what is best for you is to talk to a Mortgage Professional about options, costs vs. benefits and prequalifying criteria. We provide this service free of charge. Visit www.prunermortgage.com
UPDATE: From the Federal Housing Finance Agency (FHFA) For South Florida – Housing Prices for Q1/2011 were up 2.5% over Q1 2010… apparantly the “Bottom” Has come and prices are rising.. NOW is the time to consider buying…
