Thursday, November 01, 2007

The Real Estate Bubble Hits Close to Home

Shadox is on the road yet again, on a business trip. What else is new? The good news is that my travels this week have brought me to Washington D.C. where I spent last night having dinner and spending hours of lively conversation with a good friend of mine from business school, who I have not seen in about two years.

One of the many topics that came up in our conversation was my friend's real estate predicament. Several months ago, my friend and his family decided to sell their suburban Northern Virginia house and move to another suburb not far away. The move shortened my friend's commute and brought the family into a better school district. At the time, my friend was pleased that the declining real estate market in the area meant he could get the house he wanted for a lower price. In fact, the previous owners bought the house at the height of the bubble in 2005, and sold the house to my friend at a loss.

After my friend and his wife closed on their shiny new house, they put their own house on the market. The way my friend tells it, they put their house on the market right before the sub prime crisis hit. They were forced to repeatedly slash their asking price, and their house still remained unsold. Eventually, they decided to take the house off the market, and rent it instead. They just found a renter using a broker, and are anxiously expecting their first rent check to arrive in the mail in the next couple of days. The check should cover all but $50 of my friend's monthly mortgage payments.

My friend's entire net worth (minus his 401K) is currently locked up in bricks and mortar. He would like to sell his old house, but cannot afford to do so at a big loss. He is hopeful that the real estate market will pick up and that he will be able to sell the house in a few years. He is very hopeful that he can sell within 3 years, since this will allow him to protect his hoped-for capital gains from taxation. Because their equity remains locked up in the old house, my friend and his wife were not able to roll any of their equity into the new house, and consequently the family's mortgage payments on the new house are higher than they expected.

My friend is a smart, talented and educated person. He holds a well paying, but stressful and possibly precarious, job. Although he did not say so explicitly, I could see that my friend was stressed and somewhat distraught by his financial situation. What can I tell you? My friend is certainly not member of the sub prime crowd. He did not reach above his means in buying his new house. He is a victim of a sudden market turn that caught him unprepared. Even so, I believe that my friend is on sound financial footing and will probably come through the crisis stressed, but financially stable. Unfortunately, the same cannot be said for many others that got caught in this crisis.

As an addendum to my story I would like to add that as sad as I am to see my friend unhappy, I hold firm in my opinion that the government should stay out of the sub prime mess and not attempt to bail out borrowers or lenders. It is simply not the government's job to interfere in such cases. As a side note, I would like to mention that the fact that my friend took his old house off the market rather than sell at a big loss, is an illustration of why real estate prices are more risilient than other asset prices.


Russ said...
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dwr said...

"At the time, my friend was pleased that the declining real estate market in the area meant he could get the house he wanted for a lower price. In fact, the previous owners bought the house at the height of the bubble in 2005, and sold the house to my friend at a loss."

No offense to your friend or to the business school you both attended, but one would assume a first year course at any business school would teach someone to sell assets that are declining in value before buying more of those same assets.

Brip Blap said...

While I feel bad for your friend's personal situation, closing on one home before even having an offer on another is inviting disaster. I've seen that happen to plenty of my brother's neighbors (he also lives in DC) and I can't feel too bad for people who got crunched by the real estate market. I wanted to move, but I listed and tried to sell my house before buying. When it didn't sell at the price I wanted, I withdrew and decided to bide my time.

Kudos to you on the point about not bailing out anyone, though. This country has such schizophrenia about capitalism. Part of capitalism is risk, and everyone who accepted that risk needs to deal with it now. I toyed very seriously with the idea of an adjustable mortgage - actually a monthly adjustable interest-only at the height of the bubble - but did a number crunch and decided I couldn't accept the risk. If the market had kept going up, I would have suffered, so now that it's down I should be rewarded for being conservative... otherwise, we might as well nationalize the mortgage industry and let everyone be risky and wait for government bailouts!

Shadox said...

dwr - your criticism is well deserved. It's a strange phenomenon, but I find that many of my fellow MBAs who make careful calculated financial decisions in their day jobs, fail to use any such judgement when dealing with their personal financial decisions. I can't really explain it.

Brip Blap - I agree. Buying a new house with selling your house first (or at least getting an offer) is lunacy. Don't know why he did it, and I didn't want to come off as insensitive by bugging him about it. I would much rather run to my hotel room and blog about it to the world... :-)

frugal zeitgeist said...

Hear hear with the first two commenters. I do feel empathy for your friend, but it was an avoidable situation. In the real estate bubble, far too many people made similar decisions because they didn't recognize the bubble for what it was.

I agree with your stand about no bailout. The aftermath of the real estate bubble needs to work itself out of the economy over time. (With many more rates about to reset next year, we haven't seen the last of this by a long shot.) Artifically propping up bad decisions might bring political capital, but it's not going to strengthen the overall economic outlook.

Shadox said...

Yes, it absolutely was avaoidable, and if it were a stranger that made that sort of silly error I would probably be on my high horse preaching fire and brimstone. BUT since he is my friend, what he really needs from me is support not a "what were you thinking spiel".