Chicken Little made the famous quote, “The sky is falling, the sky is falling.” Would he have been more believable if he had said the sky is falling, but I expect it to ease down slowly and rebound early in 2008? This is exactly what many real estate professionals have been doing for the past six months.
Here are just a couple examples:
Bob Toll of Toll Brothers, one of the nation’s largest home builders reports to CNN,
I don’t see the market getting better until, at the earliest, April of 2008. But I do think that when a recovery occurs, it will be much quicker than it has in the past because of pent-up demand. You’ve got decent job growth, low unemployment, low interest rates, great corporate earnings reports and tons of money being created and sloshing around the world.
Why April? Why 2008? Since Bob Toll, like myself is a Cornell graduate, I have to give him the benefit of the doubt. I will assume he has concrete data for this projection, but I really have to wonder if he is looking at the big picture. Access to capital has reversed course significantly and has now become a major stumbling block for many would be home buyers. Additionally, Congress is considering adding more rules and regulation to the banking arena, which will inevitably make lending tougher. On the other side of the equation, supply is hitting an all time high. Not only have many of the home builders over built, but adding foreclosures, and longer than average time on the market for regular stock really makes the picture look grim for sellers. It will be very hard for this equation to right itself in less than a year.
Richard DeKaser, chief economist at National City Corp. in Cleveland, writes at Bloomberg.com,
We’ll hit bottom in 2007 in terms of sales, but we’ll continue to see price declines into 2008. Prices tend to weaken for about six months after inventory normalizes, and we probably won’t see that begin to happen until the end of this year.
While Richard shows a bit more pessimism than Toll, he too assumes that the real estate ship will begin righting itself by the end of 2007. By the end of 2007 economists are predicting the first national housing price decline since the depression. Stop and think about that for a minute. A national price decline suggests fundamental issues in the real estate market, rather than a hiccup that will be fixed by the second quarter of 2008 like many people seem to be predicting.
The overall problem with real estate analysis is the failure to consider all of the data. On the positive side, the economy seems to be holding strong. This is reflected in the strong office market that has persisted despite a tighter financing situation. A bit more neutrally, interest rates are low historically, but are significantly higher than two or three years ago. This affects adjustable rate mortgage borrowers and borrowers who decide not to move because of the higher rates. Finally, the subprime lending situation, the tighter lending standards, and the supply of homes on the market make up the bulk of negative real estate factors.
Looking at all of these factors together does not lead me to believe there will be a smooth recovery in 2008. Even with the expected 18% decline in housing starts, consumers will still have problems purchasing homes. Furthermore, the refinance boom of the early 2000’s will turn into the adjustable rate mortgage nightmare of the late 2000’s. Consumers simply will not be able to enter the market.
As an investor understanding how to read between the lines can make buying and selling a more strategic process. The current news might suggest to investors that it is time to get in the market or if investors just hold on for six months everything will be ok. Based on the analysis above, I do not think that is the case. While I will not go as far as saying the sky is falling, I certainly do not expect to see a smooth recovery in early 2008.
Will Farnsworth says:
The subprime crisis will continue to drag down the market into 2008. Consider that 2 million+ ARMs will reset this year into higher rates ($50billion worth in October alone). This will undoubtedly force some borrowers into foreclosure, swell the number of homes on the market and continue to keep downward pressure on home prices.
July 10, 2007 — 2:04 pm
Chuchundra says:
Those that do no study history are doomed to repeat it.
In a normal boom/bubble/bust/recovery cycle, we’d still be expecting another year or so of price corrections. This would followed by several years of steady/stagnant pricing as inflation eats away at the rest of the bubble pricing. Why anyone would expect a “recovery” before then is confusing. Do these people not know the history of their own industry?
Of course, this isn’t a normal cycle. The issuing of recklessly risky sub-prime loans has driven prices to ridiculous heights. When those homes are foreclosed upon and then dumped back on to the market, you’ll see some serious drops as REOs become the comps people look to.
July 10, 2007 — 2:50 pm
Dave Barnes says:
Grammar Nazi:
hiccup and not hick up
recovery and not recover
July 10, 2007 — 2:57 pm
Gerry Davidson says:
Michael,
I concur with you on a real estate recovery. Today’s downgrade of mortgage-backed securities by Moody’s Investors Services and Standard & Poor’s also considering cutting its ratings of mortgage-related debt does not bode well. The scary thing is that the bottom of the well still can’t be seen. I think the subprime problems are what caught most of us by surprise — at least those not in the financial arena of the industry. I for one was anticipating a recovery from the market leveler, supply and demand, based on inventory absorption realignment under normal market conditions. I did not factor in the subprime implications as a left to the other eye. Your other prediction that any inevitable increase in interest rates will further slow a 2008 recovery is spot-on. I don’t think there is such a thing as a normal recovery and as you said, every aspect needs to be applied to real estate analysis. Rude awakening isn’t it? Thanks for your insight and realistic caution.
July 10, 2007 — 4:50 pm
Michael Cook says:
Dave,
Thanks for the corrections. As a child of the spell check generation, my editing skills are often lacking.
July 10, 2007 — 6:22 pm
Chris says:
My gut says that the market will stay about the same for the rest of this year and most of next year. I’m hoping at some point next year or in 2009 it starts to stabalize.
In my city we went from 60 listings, less then one months supply at the hight. To as of today 374, about 11 months supply. I have been tracking the absorbtion numbers and they are off, by a lot, and getting slightly worse. I hope July posts better numbers then June, we shall see.
July 10, 2007 — 6:30 pm
Robert Kerr says:
The ’89 correction took about 7 years to work its way out of the market, before normal affordability was restored and steady growth returned.
Are there any good reasons to think this correction will be shorter or shallower than the last?
July 10, 2007 — 7:27 pm
Marc Brinitzer says:
I just wrote an article covering the recent PMI report for Summer of ’07. This is a revision of their previous predictive model forcasting values in the top 50 MSA’s in the country.
Of course my primary interest was Sacramento CA, but you’re in there too!
July 10, 2007 — 9:47 pm
Morgan Brown says:
Michael – great post. People calling bottom each and every month are beginning to look a little ridiculous. We have home builders still over building (above supply) a massive shake out that is about to occur after the announcement by S&P to stop accepting current rating methods of subprime mortgages, a 2006 crop of loans that is already performing worse than any other vintage, a huge amount of alt-a and prime loan resets in 2007-2010 and an economy where 1 out of every 4 dollars is tied to housing.
We’re not looking for a recovery in 2008 by any stretch of the imagination – those that are have vastly underestimated the severity of current situation.
July 10, 2007 — 10:34 pm