Saturday, July 28, 2007
HELP, The Sky is Falling!!!!
After reading the papers all week, you'd think that the economy is falling apart and that real estate was the culprit. Three issues are impacting the Real Estate Market and one is a bigger deal than the others.
1. Subprime Lender failures
2. Foreclosures are increasing
3. The ratios of the increase of incomes to the increase in home prices
If you guessed #1 or #2 were big issues, then guess again.
Subprime loans are not the bulk of the market, they make up a segment but certainly not the largest segment. Subrpime lenders with a combination of rapidly increasing home prices caused this problem and those people qualifying for these loans (for the most part) were not taking these loans out blindly. With homes going up in double digit percentages each month, many people wanted to get on the easy money train. These buyers willingly signed up for 100% financing with the carrot that their new purchase would increase 20% in the following 12 to 18 months and then they could refinance at that point into a better loan on the inflated equity.
This worked for a while. Buyers were encouraged by TV programs (i.e. Flip This House) and buyers heard from co-workers (at the water cooler) how they flipped houses and were making large profits. What the buyers and most real estate agents were not paying attention to was, that by the end of 2005 a very important ratio was changing and this ratio would end the party for novice real estate speculation.
The above chart shows how dramatically Incomes and home prices have behaved recently. The gap has reached a peak. This peak does not necessarily dictate a correction. The correction of the early 1990s was driven by high (10%) unemployment and local conditions including the Northridge earthquake.
Here is what is evident.........at least evident when you read past the headlines.
What does this mean for Sellers and buyers?
For Sellers - Price and condition equally are king, followed by location. If you do not have serious upgrades, your task will be harder. Do not put your home on the market unless you are serious about moving. This is not the time to test the waters and see what might happen.
For Buyers - Are you planning to keep the home you buy for 5 years or longer? If yes, then buy now. There is no guarantee that rates will stay this low forever, get a good loan at a good rate today and enjoy that next home. Historically the Real Estate market between 1926 and 1996 increased 11.1% annually adjusted for the highs and lows. From 1996 till the present we have had huge gains which drive the number up even higher. Will the next 5 years bring 11.1% gains? I am not a fortune teller so I cannot say, but the cost of living will be up in the next 5 years and most likely as the historical rates show, real estate will be up higher than the cost of living.
1. Subprime Lender failures
2. Foreclosures are increasing
3. The ratios of the increase of incomes to the increase in home prices
If you guessed #1 or #2 were big issues, then guess again.
Subprime loans are not the bulk of the market, they make up a segment but certainly not the largest segment. Subrpime lenders with a combination of rapidly increasing home prices caused this problem and those people qualifying for these loans (for the most part) were not taking these loans out blindly. With homes going up in double digit percentages each month, many people wanted to get on the easy money train. These buyers willingly signed up for 100% financing with the carrot that their new purchase would increase 20% in the following 12 to 18 months and then they could refinance at that point into a better loan on the inflated equity.
This worked for a while. Buyers were encouraged by TV programs (i.e. Flip This House) and buyers heard from co-workers (at the water cooler) how they flipped houses and were making large profits. What the buyers and most real estate agents were not paying attention to was, that by the end of 2005 a very important ratio was changing and this ratio would end the party for novice real estate speculation.
The above chart shows how dramatically Incomes and home prices have behaved recently. The gap has reached a peak. This peak does not necessarily dictate a correction. The correction of the early 1990s was driven by high (10%) unemployment and local conditions including the Northridge earthquake.
Here is what is evident.........at least evident when you read past the headlines.
- Home prices above the median price are still increasing with no signs of stopping.
- Home prices below the median price are decreasing moderately in some areas.
- Home prices below the median price are taking the longest to sell.
- The number of homes sold last year compared to this year is dramatically down.
- Foreclosures are still only 50% of what they were during the real estate crash of the early 1990s
What does this mean for Sellers and buyers?
For Sellers - Price and condition equally are king, followed by location. If you do not have serious upgrades, your task will be harder. Do not put your home on the market unless you are serious about moving. This is not the time to test the waters and see what might happen.
For Buyers - Are you planning to keep the home you buy for 5 years or longer? If yes, then buy now. There is no guarantee that rates will stay this low forever, get a good loan at a good rate today and enjoy that next home. Historically the Real Estate market between 1926 and 1996 increased 11.1% annually adjusted for the highs and lows. From 1996 till the present we have had huge gains which drive the number up even higher. Will the next 5 years bring 11.1% gains? I am not a fortune teller so I cannot say, but the cost of living will be up in the next 5 years and most likely as the historical rates show, real estate will be up higher than the cost of living.
