Monday, September 10, 2007

Real-Estate: It's About to Get Worse

It looks like the worst is far from over for the real estate market. The most recent issue of Business Week cited a study published by Banc of America Securities that states that $700 billion worth of adjustable rate mortgages will be resetting between now and December 2008. Compare that to the total of $263 billion of ARMs that reset between January and August of this year. If you believe these numbers the real estate market is about to get a whole lot nastier.

As those ARMs reset and their teaser rates expire, home buyers will be facing higher interest rates and higher monthly payments. It is clear as day that many of them will not be able to handle these higher payments. What's more, if the tightening in credit standards continues, many of these home owners will not be able to refinance their loans and may face foreclosure.

I am guessing that this potential wave of foreclosures is going to add to an already large inventory of houses on the market. In my opinion this means that a substantial decline in house prices is in the cards for 2008. It seems like the truth is even starting to penetrate the fog and haze surrounding the National Association of Realtors. Here is a quote from an article published by the organization on September 5th:

"Pending home sales, a forward-looking indicator, shows existing-home sales are likely to decline in coming months as mortgage disruptions work their way through the housing market, according to the National Association of Realtors.

The Pending Home Sales Index*, based on contracts signed in July, fell 12.2 percent to a reading of 89.9 in July from the June index of 102.4, and was 16.1 percent lower than July 2006 when it stood at 107.1.

Lawrence Yun, NAR senior economist, said abnormal factors are clouding the horizon. “It’s difficult to fully account for mortgage disruptions in the index, and our members are telling us some sales contracts aren’t closing because mortgage commitments have been falling through at the last moment,” he said."

But wait, there is more. In a separate study published by the National Association of Realtors, they also admit that Realtor's Confidence Index was down to 39% in August from 45.1% in July and 51.3% a year earlier. The report also contains the following sentence:

"...practitioners see more traffic from potential home sellers than from prospective buyers."

In economics 101 they taught me that when there are more sellers than buyers prices tend to drop. Incidentally, the confidence index for the West was lowest in the country, at 37.3%. Another couple of interesting insights from the report: according to realtors, 20.3% of their most recent clients wanted to sell their house because "the cost of ownership has become burdensome"... in addition, 40.6% of realtors expect prices in their area to decline in the coming year. Yup, seems like that drug induced euphoria is starting to dissipate...

There is no question in my mind that the housing market has a long way to fall before hitting bottom. The only question is whether it will drag the rest of the economy with it into recession. Sadly, I think that the answer to that question may be "yes".


Kevin said...

I think it's going to be a "hard landing" -- very hard in fact.

Making matters worse is that Americans have fueled the economic "growth" of the past several years by spending on credit or by extracting equity from houses that may now be going down in value. Credit bubbles pop with nasty, nasty consequences.

But it gets worse -- Wall Street is deeply leveraged, much like it was before the Great Depression. Finally, the Yen Carry Trade could cause the value of the dollar to plummet if the Fed starts lowering interest rates.

And if the dollar starts going down, all that national debt we have to finance abroad is going to be a hard sell. Interest rates on the debt could become completely disconnected from the federal funds rate.

I *fear* the real-estate bubble is really a credit bubble that is popping and that we are in big trouble. I hope I'm wrong!

LinBiz said...

I agree with the previous comment and with this interesting blog post. I live in the East Bay of California and knew two years ago that the housing market was going to be quite awful. When "normal" houses began selling for $1+million and "ordinary" people were able to get "miracle" loans to buy them...something was off. Houses prices are dropping like deflated party balloons and there are no sellers...because the buyers can't find anyone to buy their homes...what a tangled market has been woven and yet the building is continuing. Just who are the people who are going to purchase the thousands of houses in the $500,000+ price range and above and where are they going to get the loans to do it? Are we looking at a 2007 Holiday Season that brings recession and inflation and job loss in the stockings?

Shadox said...

Kevin, I sincerely hope you are wrong, and I think I am somewhat more optimistic than you are about our economic prospects.

Linbiz, the funny thing is that I live on the Peninsula (also Bay Area for those readers from elsewhere). Prices out here have barely even budged. My brother in law and his girlfriend are looking for a place and they can find nothing even remotely decent for less than $1.1M - $1.2M. I travel on business frequently and when I speak with my customers and colleagues in other parts of the country about the price of a home in the Bay Area all you can hear is the sound of jaws dropping.