What’s the Real State of Real Estate?

One of my favorite topics to idly speculate about has become hot in recent days, starting when I saw Steven Taylor‘s post, positing that the situation with housing (hmmm… what about commercial real estate, and how closely are those tied together?) is structurally different from that of the dotcom bubble.

As often happens, this provoked a related post from James Joyner, who describes his own experiences, noting the regional nature of the market and the increased exposure of those with adjustable rate mortgages. 

Of course, people who have financed a high percentage are in greater danger as well, depending on how much their property has appreciated before a crash, if any, occurs.  There are sufficient interwoven factors that it less likely to be as spectacular a wipeout as can happen with stocks, and the impact level will be highly individualized.

I haven’t decided for sure I believe there will be a crash, but I can’t help but expect a slowdown, at least.  Anticipating being in the house buying market in the next three to five years makes this a topic of great interest to me.  I’d rather do it after than before a crash, and then hope the recovery is solid and terms don’t become onerous.

Jonathan Wilde links to a post by David Bernstein, who predicts a market top within a few months.  He also has a firsthand story of the last real estate bust. 

And he notes the oddity of localities where houses go up and up, but rents stagnate.  I found that interesting in that it does not appear to be the case around here, though rent always has an elasticity lag to real estate.  I you own a rental property you bought for X and reasonable rent that makes it worth renting is Y, the reasonable rent Y need only adjust for increases in costs such as taxes, water, etc.  Increasing to keep current with newly purchased properties is optional, gravy if you will, and typically rent would change no more than once per year, building in slow change.

Rents around here have not been more static than you might expect, and are higher than I could have imagined possible several years ago.  My income certainly hasn’t kept up.  Which is my fundamental concern about real estate prices; how can it go up and up and up when people’s incomes fall behind, and when everyone who can be a customer in a loose market has become a customer?  Granted, there is a second time buyer factor.  The first house is almost impossible.  Appreciation on the first can make the second, bigger house less difficult to achieve, and perhaps that adds enough fuel to the market for staying power.

But I digress.  Jonathan sounds a cautionary note, reminding us what happened in Japan.  I must admit, Japan is in the back of my mind all the time as I ponder what’s going to happen.

We definitely have to buy after things correct themselves, or hope it keeps going long enough that we can get in on the ride without serious consequences.

I think it’s enough of a bubble that there will be some kind of adjustment that is clear, if not sharp and painful.  I wouldn’t be surprised if it happens sooner rather than later.  I could be wrong.

This post ought to refuel the large number of housing bubble Google hits we get here from my previous posts.  That includes specific searches for housing bubble in northern Virginia, Fresno, California, and probably other places I’m forgetting.  The Boston or eastern Massachusetts region would certainly be a prime place to find popping at some point.  When it happened before, I don’t remember it being this heated.  On the other hand, interest rates were higher and money was probably tighter.

If the topic interests you, be sure to check out the posts I linked:
PoliBlog
Outside the Beltway
Catallarchy
Volkh Conspiracy

1. The biggest contributing factor to the last real estate boom/bust was a recession (1987/1988). People lost their jobs and couldn’t pay the mortgages on their homes. They couldn’t sell them fast enough, either. Some folks could barely pay their mortgages even when they still had jobs.  Real estate speculation and banks willing to give mortgages to unqualified buyers also contributed to the problem.

   When the bust came folks realized they had $200,000 mortgages on homes worth only $120,000. Rather than selling at the corrected price and still owing $80,000 they walked away, handing the keys to bank and saying “Good luck!” It was worse in the condo market where condos that had sold at $100,000 were now only worth $30,000.

   I know that the bust caused 5 major banks in New Hampshire to fail (though the bust wasn’t the only reason they went under, but I digress...) All of a sudden there was $1.3 billion in real estate in foreclosure in NH alone which further depressed the real estate values. It wasn’t much different in Massachusetts.

   The conditions are a bit different today. Interest rates are lower and most mortgage lenders carefully scrutinize a borrower’s debt load and credit rating. The economy is growing, albeit slowly, and inflation is low.

   I agree that the present bubble will either burst, or at least deflate, with the ramifications not being anywhere near as dire as they were the last time.

   There is a pent up demand for starter homes that has long been ignored in favor of upscale homes and even “McMansions”. I’d like to think that particular market has run its course and developers will now start focusing on the long neglected first time homeowners. A co-worker of mine has been looking for a house for 4 years now and the only thing he’s found in his price range ($140K) have been handyman specials that were barely habitable. Everything else has been well out of reach for him.

   Deb and I were fortunate that we started looking when we did. There were a range of homes that became available just around the time we started looking and we found one we could afford. Since then the market has dried up and it’s only going to get worse as we approach summer.

   One thing we did was base our mortgage on a single income rather than both our incomes. Since we will have similar salaries we will still be able to pay the mortgage, taxes, and all our bills with one income, unlike some couples we know. The last thing we want to be is ‘house poor’ like them.

   Posted by DCE  on  03/26  at  09:45 PM

2. I’ll admit: I don’t feel like following all of the links right now.
   And yet I still want to weigh in.  So take my opinion for what it’s worth.

   I don’t think the real estate market/bubble will burst, not with interest rates as low as they are right now.  I do think there may be a stagnation of up to a decade.

   ...and what happens if the housing market prices itself out of what people can afford?  You get something like what real estate is like on Oahu.
   There is room for quite a bit more growth of new homes and new apartments, but the inhibitive cost of land (and the subsequently inhibitive costs of any real estate built on the land) means that the square footage of living space is much smaller there than most places on the mainland.  You often have 3 and even 4 generations living in the same home...sometimes building on to make suites for each generation.
   You see a whole bunch of 1- and 2- bedroom apartments for rent, and very few 3- and 4- bedroom apartments or houses, because at a rental rate high enough so the owner doesn’t lose money, the renter would be better off buying.  If they can’t get credit to buy, they cram 6 (as an example) people into a two-bedroom home.
   And yet, there are still people buying $3 and $4 million dollar homes on postage-stamp-sized properties, homes that it probably doesn’t cost more than a few hundred thousand to build in actual materials.
   A shorter answer is: if the housing market prices itself beyond what people can afford, then people re-adjust their expectations and live with less/smaller housing.

   Final point to all potential home buyers:
   Do not purchase the maximum property your home-buying dollar can afford.  Meaning, if you can afford a $300,000 home, purchase one (even if a little smaller) in the $200,000-$250,000 range.  Use the extra money to pay down the mortgage more quickly.  Not only does that mean you can own your house outright in something like 10 years, but you lose far less in interest, and your equity builds more quickly.  Sacrificing by living in a smaller place for 3 years means you have that much more leverage to move up later, makes it easier to keep the home if you find yourself unemployed, and protects you somewhat from a real estate market downturn.

   Posted by Nathan  on  03/27  at  01:26 PM

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