A recent conversation with a client resulted in a request for a compilation of information that would be useful for sellers to remember as we look for a perspective on “fair” values. The following list of points is not comprehensive, but will help most people to get a handle on trends and changes, the power of lending practices, and reasonable expectations based on historical precedent.
First, I would like to address interest rates. A $100,000 loan at today’s rate of 4% will cost a borrower about $477/month (principle and interest only) for a 30 year loan with a fixed rate. At the historically “healthy” rate of 8%, this same loan would cost $734/month. If we woke up tomorrow to those rates, a $500,000 house would have to be reduced to $325,000 for a buyer to maintain the monthly expenditure they could afford. If the rate were 15%, as it was in the early 80’s, the monthly cost would be $1,264. Waking up to this rate would require the same $500,000 house to be adjusted to $190,000 to maintain affordability for the buyers. A note on interest rates is that they will follow the trends of inflation. Lenders can’t be trapped behind loans that are less expensive to the consumer than the current inflation, as they would now be “paying” people to take the loan.
In 2008, the United States economy operated on $800 billion in circulation. In 2011, there is now $2.4 trillion available to circulate because of a few rounds of money printing by the government. Banks that are holding this money are being paid to keep it out of circulation because of the inflation it would cause when injected into the operating economy. We are either paying banks to sit on that money, or they will lend that money to consumers in order to pursue profit. One scenario adds to the national debt, and the other creates a surge in inflation. If inflation rises, the interest rates on all new loans will rise to reflect the devaluing money (see above).
Household income is stagnant. Published reports show the median income today to be at or below the median income from the year 2000, which is the beginning of the rising value surge for housing in the county. These figures are not adjusted for inflation, which means that the typical household has higher expenses today in real dollars despite bringing in fewer of those dollars. This clearly allows a smaller portion of the income to remain allocated for housing expenses. For perspective on housing costs over that period, the median sales price in Montgomery County in the year 2000 was $190,000. In 2005, that number had risen to $425,000. Last year (2010), the median had dropped to $350,000. As can be seen by these direct comparisons, the affordability index of housing is currently facilitated exclusively through low interest rates on fixed rate loans.
In the Fall of 2008, there were major collapses taking place in the banking industry, most notably the collapse of Lehman Brothers. This precipitated a shock to the system, where confidence in housing pricing was shaken and resulted in a roughly 10-12% drop in prices in only 3-4 months. The year over year comparisons of October through December of ’08 vs. ’07 showed about a 15% drop in new contracts. That means that about 15% fewer homes found satisfied buyers as the same time a year earlier. This contraction in buyers only produced a 10-12% drop in value. By comparison, August of ’11 shows a reduction of new contracts compared to August of ’10 of over 33%! September statistics are not published yet, but our “seat of the pants” analysis of the activity supports a continuation of this attitude from buyers. Similar to ’08, there was a trigger event when the federal government’s credit rating was downgraded. This, combined with international economic news in Europe and China, has created a volatile environment that makes buyers feel entitled to tender very low offers. On the surface these offers may seem insulting, but they are most likely a sneak preview of the year to come.
A recovery of about 5% was enjoyed by all in the Spring of ’09. These new values held steady for the better part of two years, but it is important not to confuse the “cycle” of real estate with a direct and corresponding stimulant: cheaper money and incentives. A proper analysis of affordability shows that we should have continued a downward trend in ’09, but a combination of tax incentives for buyers and ever-lowering interest rates (see above for the multiplying effect of these rate reductions) delayed this correction to over-priced housing. The tax rebates ended in the middle of ’10, but the rates have continued downward. Currently, the strong pull-back of buyers despite 4% loans identifies a distinct shift back to price correction. Anyone waiting for the Spring market of ’12 is confusing the stimulant effects of ’09 and ’10 with “market cycles”. In the words of a client during a discussion on the topic, “If buyers won’t make an offer on my house while interest rates are 4%, all of these houses must be worth a lot less than we think.” Very good analysis.
Because the last round of stimulants did not take hold permanently, there will be little desire on the public front for a repeat of those expensive measures. We have new debt to reflect the last attempt and strengthening public pressure to deal directly with the debt problems across the country. It is not likely that there will be a new and significant stimulant to attempt another revitalization.
In the Spring of ’12, most large banks will begin bringing houses to the market that they have repossessed through foreclosure. These banks have held this inventory off the market while foreclosure practices were under review in the court systems. This has created a backlog of foreclosure properties that would have come to the market in ’11 but will now double the supply in ’12. The downward pressure on values will be significant.
The good news for sellers: although buyers typically have general feelings about what is a “good deal”, most of them don’t have as complete of a picture as the one just given to you. A seller that gets ahead of the curve today can sell, get off the down escalator, and watch it correct from the sidelines.