The Perfect Storm of Real Estate - not a crash - a correction!
Wednesday, November 26, 2008
In the last few weeks I met someone who called the market downturn of the last 2 ½ years “The Perfect Storm of Real Estate.” I’d never really looked at it that way, but the analogy made ‘perfect’ sense.
If you saw the “Perfect Storm” movie, you’ll recall the weather forecasters as they hovered over the satellite maps and gasped at the oncoming weather systems approaching one another to form the massive tempest that would wreak havoc on the eastern seaboard. When the forecast maps of the market conditions were laid out in front of us all, we, unlike our comrades in the movie, missed seeing the oncoming ominous fronts on the map of the economy as they approached.
Beginning in 2001, our profession began to see interest rates falling. We also began to see a notable decrease in the inventory of homes available for sale. With cheaper money and limited inventory of housing for sale, we all saw prices begin to rise. Like the spawning of a hurricane, the market began its climb to unrealistic and unsustainable levels.
Then, akin to following a hurricane’s growth as it gains strength by feeding upon the warm, moist air it generates, the market began accelerate its advance as inventory diminished to levels not seen in my 24 years in the business. In all of San Diego County at one point in 2003 we had only 2,700 homes available (as I write this today we have 18,172).
As home prices reached levels where payments became unaffordable the market rocked slightly. I don’t remember when exactly – it was late 2003 or early 2004 I think – and home sales faltered briefly. No worries though! The lending industry came up with a solution. Option Adjustable Rate Mortgages – or Option ARMS. These allowed buyers to “pick” a comfortable payment at purchase and keep that payment for 3-5 years before the payment actually adjusted to a fully-amortized monthly loan commitment.
WOW! Buyers could now buy a $650,000 home with little or no money down and make a payment under $1,700 per month. A $650,000 home for under $1,700 per month? “Sure! No problem,” said the lenders. “We’ve done this before. Home prices are skyrocketing. The borrower can just refinance into another Option ARM when the payment goes up.”
And the “Perfect Storm” of rising values continued to grow, fueled by an already loose money supply that became looser still. The inventory of available homes became more depleted, and property values went wild. People who had never owned homes now owned homes they never thought they could afford. Long-time homeowners refinanced or took out credit lines against their newly created equity and bought the ‘finer’ things in life that had eluded them.
America spent! The economy grew. Homes continued to go up in value, and in a short but tumultuous wave, home prices had doubled.
Everything was rosy. Consumers were spending and America was enjoying the highest quality of life we’ve known as a nation. All built on rising home values and the tapping of that equity.
Of course we know now that it was a house of cards. We saw the beginning of the decline in later 2005 as the inventory of homes on the market began to rise. Home prices had reached a point where even with the loans that offered miniscule interest payments buyers could not afford the payments. Interest rates had risen too, and lenders suddenly wanted a down payment from a buyer to fund a loan. Imagine that - a down payment! Unheard of!
Then in 2006 we started to see the foreclosures. Just a few at first, but the horizon was growing darker as the storm approached. “Impossible! Home prices will rise forever,” said some of my peers. “It’s a ripple; nothing more.” Those wonderful loans with the low, low start rate were now adjusting. As the homeowners went to refinance their low interest loan with another low interest loan they found out the horrible truth left untold when they’d purchased; refinance loans only go to 80% of the home’s value. This wasn’t really a lie, but rather simply a fact omitted by an agent or lender at the time of purchase. Most real estate professionals probably thought that appreciation would catch up and it wasn’t important.
As those buyers attempted to refinance though, they found no way out of those mortgages. (At Best Homes we are proud to say that we never advocated zero-down payment ARM type loan products. To date, we don’t know of any of our clients who have lost, or are losing, their homes to foreclosure. Yes – we could have made more money but we evaluated the cost in failed relationships and angst created and chose to recommend our clients stay away from these loan products)
Well we know where this ends up. First the housing market has declined by as much as 40% for single family homes and up to 60% for some condominium conversion projects. Foreclosures are at an all-time high. Equity that was the collateral for the loans has evaporated, bringing about the resultant collapse of many of our financial institutions. The stock market has followed the real estate and financial institutions in the downward spiral.
We, as a nation, were living beyond our means. I’ve personally seen the excess as we’ve muddled through clearing out foreclosure properties. $40,000 wine cellars, $150,000 toys – RV’s, boats, dune buggies, wave runners, motorcycles, and ridiculous money management; all financed with home equity and/or paid for as the principal balance on mortgages rose with negative amortization and equity depletion.
Our desires for more, more, and still more artificially inflated our markets – Real Estate and Financial – and we’re now correcting to a point of reality. The crazy easy money loans are gone, as are the prices of 2004 & 2005. We must stop waiting for the market ‘rebound’ and realize that today’s price is likely what our homes will be worth for some time. Yes, we will be burdened with foreclosures for another 9-18 months, but we’ll get through it. Quality homes in the neighborhoods in which we work are still selling at very good prices.
The Perfect Storm of Real Estate is nearly past. The market is correcting to a level of affordability. Hopefully we’ve learned from our mistakes. Time will tell, but San Diego is still San Diego - the most desireable place to live in the USA.
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