Lots of talking heads. Lots of outrage. Even a little fear. Keeping up with economic developments lately is taxing and I mean taxing in its most negative “IRS and April 15th” connotation. Last night Brian Brady and I were interviewing Matt Padilla for Bloodhound Radio. It was a great discussion and got me to thinking about what is (or rather should be) important. I mean, the whole thing can be overwhelming: how did we get here, who’s to blame, what are the macro ramifications of this massive federal bail-out… makes one feel small and even a little lonely in the midst of this big economic world gone ’round the bend.
So I stopped on the way home for a big shot of wheat grass (substitute whatever manly libation you prefer here), calmed down and eventually found myself a little less interested in what it all means and a little more interested in what it all means to the real estate agent on the street. In other words: What is the next step?
Last week I suggested that Wall Street’s Meltdown may actually help the housing industry. Consumer debt will dry up in the credit crunch and this bail-out will not have much impact in that arena. The financial industry is going to come out limping and take some time to lick its wounds. Consumer debt has always been a risk and will end up on the back burner for a while, but the need for profits is always there; where will it come from? Where is the supply of money going to be greatest? Thanks to Uncle Sam it is going to be mortgage money that flows freely. But flowing freely is not the same as distributed evenly and this is where the real potential lies for homeowners as well as real estate agents.
By the end of the year conforming loan limits are going to drop. Here in San Diego they should end up around $625,000. Under that limit there is going to be a large supply of federally backed (and encouraged) cheap money. Over that limit, however, it is going to be a ghost town in a dust bowl surrounded by desert. Over $1 million and it opens up a bit because you are generally talking about buyers with large sums of cash. But between $625,000 and $1 million the ability to finance a purchase is going to tighten up and so too must demand. As you may recall from Econ 101, when demand drops so does pricing. On the other hand, back below the magic limit, the supply of money will create demand and here’s the really interesting part: that demand will bump up against a supply limit. The supply of homes within that range is finite and the demand for homes below $625,000 will remain targeted; it is artificially capped. What happens when increasing demand (due to cheap money) meets a finite supply? Appreciation.
We can expect to see demand driven appreciation knockdown the oversupply of inventory in many parts of the nation over the next year (maybe two). This will drive home prices up to, but not over, the conforming limit. At the same time it will depreciate homes that are over the limit, possibly even push some below the magic line. What does this mean to the agent on the street:
- If you are an agent working with move-up buyers within the temporary loan limits – but over the upcoming conforming limit – their window of opportunity is slamming shut. Get them off the fence quickly and stop taking on new clients in that price range.
- Buyers below the new conforming range will see upward demand on appreciation in direct correlation to their distance from the conforming limit. In other words, the closer in value your purchase is to the loan limit, the less appreciation you will see.
- Sellers below the conforming range will see greater demand and more price appreciation in direct correlation to their distance from the conforming limit as well. In other words, the supply near the conforming limit will grow and appreciation slow (or stop) while the supply at the lower ends will decrease and appreciation grow. If you already have a listing near the conforming limit, time is not your friend.
- As an agent, your marketing should be divided: for listings, your area of focus is the lower end homes where demand is going to increase and market time decrease. For buyers, you can expect the best deals to be nearer the conforming limit where supply will grow and pricing will stagnate.
For the next couple of years you can envision real estate as a great freeway with virtually no tolls and cheap gas. But the speed limit is absolutely enforced. Cars starting out will see rapid acceleration, but as you near the speed limit there will be congestion and a corresponding drop in enjoyment. Eventually the speed limit will be relaxed; in the mean time… enjoy the ride.
Brian Brady says:
An artificial ceiling you say?
Is the $625,000 speed limit too high?
September 23, 2008 — 2:36 pm
Michael Cook says:
Interesting take on things and very optimistic. I had to double check that it was Sean and not Jeff Brown penning this rosy view of the future real estate market. I have a couple of questions for you:
1) How do tighter lending standards fit into your model? With Fannie and Freddie now wholly owned by the government and the latest stings still fresh, I have to think exceptions will be few and far. I would expect this to dampen the pool of buyers, particularly in light of the number of foreclosures, which crush your credit score for at least a few years.
2) How do you get the wait and see / I dont want to catch the falling knife folks off the sideline? Sure prices are declining now, but there is still no big rush to buy. Credit is one issue, but jobs and economic slowdown are another.
3) Will the big back log prevent appreciation? Even with increased demand, doesn’t demand have to skyrocket to make a dent in the current inventory?
4) What about the additional properties you will start to see falling into the $625,00 range? If I am at $650,000 and I cant get a buyer, but at $625,000 they are beating my neighbors door down, guess what, I am going to take the hair cut.
I am not sure your appreciation theory is cut and dry. Many banks will have to shore up their tier 1 capital and get their balance sheet in check. In addition to that, the tighter lending stardars will keep prices from appreciating rapidly by someone offsetting the potentially easy money you describe.
On the other hand, as an owner of a $650,000 property (which should now be conforming in New York City, since its a freaking studio apartment?!) I hope you are right.
September 23, 2008 — 2:48 pm
Thomas Johnson says:
If there is no money for the above $625,000 there is nothing and I mean nothing to stop $750,000 homes from becoming $625,000 homes. Another 20% decline is not out of the realm of possibility. As buyers see $750,000 homes available at blue light special pricing(20% off) the down priced homes will suffer discounts as well since they presumably are not comparable to the above $625,000 inventory.
September 23, 2008 — 3:16 pm
Sean Purcell says:
Brian,
Maybe just the opposite. In a year or two the traffic jam may be unbearable.
September 23, 2008 — 3:25 pm
Sean Purcell says:
Michael,
Funny that you should comment. My idea was to write something for the “agent on the street” who is tired of all the financial talk and just wants to know if there is anything positive on the horizon. But I know how hard it is to let a big, fat economic prognostication get by without swinging. 😉
1) Tighter standards are already here and, possibly, short lived. The government wants the economy to strengthen and improving the world of real estate goes a long way toward that goal. I’m not suggesting stated loans anytime soon (even though they are legitimate and badly needed for the growing class of self-employed in this country), but the DAPs will probably come back. I think if it were politically feasible you’d see FHA allowing 100% financing too, but the politicians need the cover of the programs.
2) Wait and see just may be the appropriate response. It depends a lot on your location. Here in San Diego the “wait and see” group has already missed the bottom. Up in Tom Vanderwell’s area the wait may be much greater. Here’s the thing: prices will appreciate in the areas where there are fundamentals. At the same time, interest rates should trend up as the markets settle. Appreciating prices are hard on a buyer but increasing rates are a killer. As the main stream press begins to recognize the new story (“Great Deals To be Had”) more people will come off the sideline. Especially when they can buy a pretty nice home at rock bottom prices. Again, I am biased by my experience in San Diego; but on the upside, San Diego generally leads the nation into and out of these cycles.
3) Inventory is another regional issue, no doubt. In some areas the saturation rate is close to 4 years, but in others the inventory is dropping already. If the bail out succeeds in preventing the next round of rate increase based foreclosures (scheduled for late 2009 and a big IF) then the worst of the inventory dumping may already be upon us.
4) This is a bigger question. The owners above the magic line will not be able to sell and those that have to sell are going to be in trouble. How many of those are out there is what we don’t know. My optimistic scenario is based on the idea that most will hold on for a couple of years and not dump just below the limit.
If the inventory not only backs up at the limit but also gets dumped on by those who are over the limit but within reach of it… the ripple effect will go down hill and my theory will lose steam quickly. This is, in the end, just one idea on how things may play out.
I try to find the positive and since I have not seen this theory before I lay claim to it here. I am a contrarian by nature and since the press is wildly negative and this is optimistic I believe it has more than a passing chance to at least resemble the final outcome. Finally, I believe lenders want to lend, buyers want to buy and sellers want to sell – this theory takes all of those dynamics into account.
Of course, we all could be headed to hell in a handbasket too… 🙂
September 23, 2008 — 4:08 pm
Sean Purcell says:
Thomas,
See #4 above. You are right about the downhill effect. The question is: how many people need to sell bad enough that they will go another 20% rather than wait it out.
September 23, 2008 — 4:11 pm
Tom Vanderwell says:
“Tighter standards are already here and, possibly, short lived” Sean – would you care to define your time frames in terms of short lived? I think we’re going to see tighter standards until 1 to 2 years after we get a “portfolio” of loans that are actually performing well and real estate isn’t sliding in value. That could be 3 to 5 years from now on a national level?
3) Inventory is another regional issue, no doubt.
Yes, but it’s also one of the absolute main issues. We have way more houses than we have willing and ABLE IN TODAY’S Credit markets buyers. Fix that and you’re a hero. I think I heard Steven Spielberg joking once about the government buying up 1 million homes and blowing them up?
“What happens when increasing demand (due to cheap money) meets a finite supply? Appreciation.”
Yes, that’s true, but when one compares the supply of fresh water in Lake Michigan (20 miles from me) with the demand for water created by my kids playing in the sprinklers, I think it illustrates a delayed reaction in that one. We’re going to have to have a LOT of demand before we can come close to meeting the supply. In my market, the “bread and butter” homes, ($275K to $350K – 2 income, 3 kids etc.) it’s going to take 3 years and 5 months to bring the inventory level down to “normal” IF EVERYONE STOPS PUTTING ANY HOUSES ON THE MARKET. And we all know that people aren’t going to stop. So, in a lot of markets, it’s a long ways until we see appreciation due to increased demand if you ask me. (But not all markets).
Tom
September 23, 2008 — 8:43 pm
Sean Purcell says:
Tom,
“Tip” O’Neil said: “All politics is local” and real estate is a helluva lot more local than politics.
I imagine my ideas reflect my locality more than I suspect, just as I believe your ideas reflect your locality.
As for your questions, I think the slide may already be bottoming out. One to two years from now sounds about right. The world of finance is moving faster and faster. Plus, people have been sitting on the sideline for a couple of years already and demand is building. The generation coming up behind the X’ers is larger than the Baby Boomers were and that’s also a lot of demand.
As for you dilution point, I agree. As I said in my post it depends a lot on location. Your area has over a 3 year supply whereas our supply has dropped below 8 months and continues to drop sporadically. Some of the other coasts are still in trouble (I’m thinking of FL for instance) but middle America is not suffering the same way. E.g. areas of Texas, I understand, are doing quite well.
I’m looking for the widest possible silver lining here and at the same time sharing ways for agents to keep their marketing one step ahead of the competition.
Thanks Tom. I always appreciate your insights and your counter point to my ideas. Balance… if only Wall Street had found some!
September 23, 2008 — 9:16 pm
Michael Cook says:
For the record, although I am an investment banker, I come here because I am a real estate investor as well. I am hoping for any silver lining to get off the sideline and starting buying again. I am not sure to whether to bet on appreciation here in New York City after the inevitable depreciation to come in the next year or two, or to look elsewhere for a quicker recovery.
My biggest concern is the false bottom perception. We have yet to see the economic effects of the current fall out. Job loss in my area has been tremendous and companies have delayed a lot of production. In my opinion these factors could lead to a future recession or slowdown that serves to keep real estate down longer than people here are predicting.
I really do not believe there is a ton of deferred demand. Right now people are not moving because they cant get a loan, they are concerned about their jobs and they dont have access to the same disposable capital. Fixing the first problem still leaves the other two.
September 24, 2008 — 7:21 am
Sean Purcell says:
Michael,
I know you to be a real estate investor, my lame attempt at humor was based on the fact that I also know you to be well versed and articulate on matters of finance. I did not mean to malign your intentions here in any way.
I share the job growth concern with you. As a matter of fact, I share a whole host of concerns! But jobs are the number 1 issue we pay attention to when we are trying to divine what is really going to happen isn’t it?
As for demand, I must once again hide beneath the localism banner. I know that some areas of the nation are bad and still getting worse. I write from (and to some degree for) my area. I don’t think any of us can help but have that bias. Here in San Diego I believe there is pent-up demand. Here’s one of many anecdotal reasons for my belief:
Just this morning I was talking to a REALTOR here whom I respect a great deal. He mentioned how hard it is to work with buyers right now because just about every home they write an offer on has at least two other offers. If the home is priced correctly, we are in the midst of a seller’s market here in San Diego. (I am obviously limiting this discussion to conforming prices.) That means that for every house that sells there are at least two buyers disappointed and still looking. Most of the time it has been my experience that once a person gets into the buying mindset, they continue till they buy.
We are seeing inventory reduction and multiple offers. Lending is about to get freed up, at least to some degree, thanks to the massive socialization of the lending industry. Do I like that? No. Will it benefit my clients and my business? Yes. I don’t pretend to know your area like I know my own. But again, San Diego has proven in the past to be a the bellwether, so let’s make that another silver lining.
September 24, 2008 — 9:14 am
Bob in San Diego says:
“Here in San Diego the “wait and see” group has already missed the bottom.”
No way. What you are seeing is merely a plateau.
“San Diego generally leads the nation into and out of these cycles.”
That wasn’t the case in the 90s. It was last in and last out.
In what past down market was San Diego a bellwether?
September 24, 2008 — 8:52 pm
Sean Purcell says:
This is tiresome Bob. Let’s agree to disagee. You continue to look for rain and I’ll continue to look for the rainbow.
September 24, 2008 — 9:17 pm
Michael Cook says:
Ouch…employement lowest since 9/11.
September 25, 2008 — 8:59 am
Sean Purcell says:
Michael,
“Ouch” is an understatement. All my rainbow watching is for naught if employment does not come around. (I can’t imagine having to stand in the rain while Bob looks out from under his umbrella with a knowing “Told you so” face! 🙂 )
September 25, 2008 — 9:25 am
Michael Cook says:
Bob seems like the kind of guy that would ask you how the weather was as he nestled dryly under that umbrella as well.
The more I look at the data the less comfortable I feel about calling this the bottom. I think people in certain areas are buying now, but I would not be surprised if we were still in this situation nationally next September. Thats a tough call, but I just dont see enough money out in the market.
One problem that people fail to see is that capital expenditures are being delayed because banks simply are not lending. That can only be done for so long before you have to start laying off people or raising dilutive equity to pay for operation and deferred maintenance. I am seeing both in my area, with no real end in site.
September 25, 2008 — 10:33 am
Brian Brady says:
“I am seeing both in my area, with no real end in site.”
I’m less worried about dilutive equity than layoffs. Are you seeing materially large layoffs and are you in Charlotte?
September 25, 2008 — 10:38 am
Michael Cook says:
New York City and yes, materially large would be an understatement.
September 25, 2008 — 1:24 pm
Jim Conner says:
Understanding the article, which I enjoyed, and the discussion, which I also enjoyed, are seemingly macro opinions of the housing market, I offer a real case for consideration.
Regardless if the glass is half full or half empty, I have recognized a crack in the glass.
My daughter and son-in-law and are first time buyers in the San Diego area. I encouraged them to obtain a pre-approval and start looking for “bluelight specials”. This was pre-September 15th. They found a modest starter home. In 1994 it sold for $187K. In 2006 its market value was $571k.
Ignoring the bubble-appreciation, I appreciated it at 5% per annum and came up with a current value of $371K. Current comparables suggest a per square foot price of $196.00 which also supports $371k.
It was offerred in a short sale at $375k. They made an offer and eventually settled at $350k. All was well.
Then, what I see as post September 15th, the environment changed. I can’t use my pre-September 15th principles and have no rational set of principles to apply to this new environment and have discovered my ability to handle variables is limited. There has only been one other offer on the propterty and it fell out of escrow a few months ago.
They both have good jobs, one is a teacher and the other is in a skilled trade with a solid communications company.
They can afford the FHA loan.
They want to proceed with the purchase, I on the otherhand would wait because I can’t convince myself that it has reached the bottom and they only have a 9% cushion at the buying price for further depreciation.
I’m not an expert in anything. I’m a cautious investor with, so far, good luck.
I removed myself from the stock market four years ago because I no longer understood it. I sold my rental properties two years ago because I no longer trusted it.
Any advice or observations/discussion on the instant situtation would be appreciated.
October 18, 2008 — 6:26 am
Sean Purcell says:
I removed myself from the stock market four years ago because I no longer understood it.
Jim, I no longer trade in the options pits, I no longer have a Series 7 and I no longer advise people on their securities investments. But if I did 🙂 , I would frame that statement and give it to every client I had. You have go to know what your goals are and you have to understand why a specific investment satisfies those goals. (E.g. I used to own Home Depot stock. My objective was equity growth. I owned HD because I shopped there all the time. I could see how they take care of their customers and I believe that is a key to retail success. Once I began seeing pallets left in the aisles and customers who could not find an associate, I knew it was time to sell.) You have to know why you are buying something to know when to sell it.
I appreciated it at 5% per annum and came up with a current value of $371K
I think this is a perfectly sound way to evaluate a long term investment in real estate. It sounds like your daughter even negotiated a bit of a deal. The questions your daughter and son-in-law have to answer include: how long do they expect to be in the house and how long do they expect to be in the loan? Why are they buying – long term growth, short term profit, tax breaks? Do they have children or are they plannning to start a family? What kind of reserves do they have? What is their risk aversion? These and other questions probably should have been asked by their agent. Their lender definitely should have asked these questions. If the lender didn’t your daughter and her husband need a new one NOW.
Without knowing the details I do not want to comment on the specific question of your family. As many are finally recognizing for the first time, a real estate investment is, for many people, their largest financial investment and has the greatest impact on a family’s long term financial health. It should not be treated with the cavalier attitude normally reserved for television shopping. (Actually, I believe people put more time into researching appliance purchases than they do looking for the right lender to assist them in the financial aspect of buying… but that is another rant altogether.)
I will say this much: I believe our local market is at or near the bottom and I am advising my clients accordingly. My concern, presently and locally, is more rate based than price based. If a house is a good investment now then a small price drop will not change that fact. But a rate increase can make that same home unaffordable and what would have been a good investment is now no investment.
I would be happy to advise your daughter at no charge, if you believe it might help. Have her contact me.
October 18, 2008 — 9:10 am
Tom Vanderwell says:
I will say this much: I believe our local market is at or near the bottom and I am advising my clients accordingly.
Sean – curious as to what your advice would be if you didn’t believe you were near the bottom? I think in Michigan we could be on the conservative side 1 1/2 years to the more realistic side 2 plus years until we hit bottom. (Especially with the anticipated job cuts that will come if GM and Chrysler merge).
What would you say then?
Tom
October 18, 2008 — 10:37 am
Sean Purcell says:
Tom,
I am fairly confident my answer to your question is no differnet than yours would be, but let’s find out. I would tell them to BUY! BUY! BUY!
No, just kidding. I would ask the exact same questions of my clients I suggested in the previous comment, no matter the local. But how I interpret the questions and the answers would differ a great deal depending on where we are standing. All real estate is local, right?
If I thought the market had another 1.5 to 2 years of down movement my first reaction is: do not buy. But that is a simplistic take on the situation. How long will you stay in the home? If my client said only two years I would not recommend they buy in Michigan, San Diego or anywhere. Too short a time to regain the costs of buying a home without appreciation well above average. That is not on my radar screen. In your neck of the woods we have to look at fundamentals too. San Diego is coming back for a number of reasons and job diversification is one of them. You may be facing a demand issue that extends beyond two years even. Again, hard to recommend buying when you don’t see the fundamentals coming around for quite some time. On the other hand, my client might say they are looking to buy their family home. It’s been in the family for 40 years and will be for another 40. In which case I would not hesitate advising them to buy the property. Or the tax advantage of a home may suit them, even one losing value short term. If they planned on staying in the home for at least ten years, there is another issue to address: rates.
In the end, my bias would be toward waiting, but that has to be tempered by two things: how much depreciation do I still expect (is this drifting down another 5% over two years or is it diving 10% a year for at least a year or two to come?) and to what degree do I believe rates are goiing up. As always, I am more afraid of rates driving me from the market than I am of missing the bottom. What did Buffett say? It’s better to be roughly right than precisely wrong?
Tell me, did I say anything you have not already told your clients?
October 18, 2008 — 2:05 pm
Tom Vanderwell says:
Sean,
Nope, you didn’t say anything that I haven’t already told my clients. Except I haven’t run into the people buying the family farm…..
🙂
Tom
P.S. Check your e-mail.
October 18, 2008 — 5:50 pm