The real estate crash: We’ve only just begun


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A real estate industry group today announced that there was a nine percent jump in foreclosures during the month of May.

RealtyTrac reported that 205,990 U.S. properties received filings last month, including default notices, scheduled auctions and bank repossessions, marking the first monthly increase since January. Bank repossessions climbed steeply, up 7% to 54,844, after hitting a four-year low in April.

The report also noted that foreclosures made up 26% of U.S. home sales in first quarter and that more than 30% of mortgage borrowers were still underwater.

As someone who just moved to Tucson and spent more than six months searching for and finally purchasing a home, I can add a bit of personal experience to these dry statistics. And my perspective is sadly not encouraging.

When we arrived in Tucson in late October, we thought that we would have an easy time finding the right house. We had owned our Maryland house outright, so we didn’t need a bank mortgage to purchase the house in Arizona. Many people had told us that if you have cash, you will be able to get a good deal. Moreover, the housing crisis suggested to us that there would be a lot of good homes to choose from at reasonable prices.

Diane and I however were very picky. We wanted a single story house with more than 2000 square feet and four bedrooms (a master, two offices, and a guest room). In addition, we wanted the house to have a nice view of the mountains, and be located on the western side of Tucson, reasonably close to the interstate highway.

Fortunately, our real estate agent, Don Ernle, was very cooperative, and willing to take us to see as many houses as we wished.

In the end, we looked at more than 150 houses, covering about two thirds of the city of Tucson. From this experience, we gained a very educated personal perspective of the sad state of the housing market.

I would estimate that from one third to half of all the houses we looked at were either foreclosures, short sales, abandoned by their owners, or houses where the owners had stopped paying their mortgage and the bank had simply not yet taken action against them.

Let me repeat that: Almost half of all homes for sale were underwater, the bank losing money on the mortgage.

This situation was also terrible for the housing stock. When a home is in foreclosure or has been abandoned, there is no one to maintain it. Often the bank is out-of-state, making for an absentee owner. The result is that the house begins to decay. Worse, being empty with no one to watch it the house often gets vandalized. It was very typical for these foreclosed homes to have had all of their appliances stolen, with evidence of squatters having lived there. There might be leaks in the ceilings and holes in the walls. Carpets and floors would often be damaged and need replacing.

Thus, you might be able to get a good deal on the house, but you would also have to spend a lot of money fixing it up.

With almost half the homes in this kind of condition it is no wonder home values have been going down.

And going down they were. From December to April we saw a 10 to 25 percent drop in home prices for the type of homes we were looking at. When in early December we finally came to an agreement on the house we wanted, it was priced at $370K. At the time, this was at the low end of the market price for that type of house, making for a good deal.

The house was a short sale, however, and it took the bank four and a half months to finally approve the sale. When we actually settled in late April, that $370K price was now at the high end of the market. Comparable houses in the same neighborhood that had been priced at $400K in December were now selling for $325K to $350K.

We went ahead with the deal anyway, because the house was exactly what we wanted, and we weren’t really buying it for investment. Moreover, it was still a great deal, as the house was only six years old and had originally sold for $630K, meaning that we were getting it for 40% less than its previous value.

Nonetheless, the experience left me very worried about the future state of the U.S. economy, especially when I have read articles about how the banking industry had, for a variety of reasons, not yet released all their foreclosures to the market. When these homes become available at their typically cut-rate prices (as the article above suggests is finally happening now), home values will surely drop again.

In other words, we haven’t yet seen the bottom of the market.

Why are we in this situation? It is very simple. When Congress in the 1990s decided to force banks to give mortgages to people who could not afford them, it created a glut of buyers. A glut of buyers increased demand, which caused a steep but artificial rise in home prices while simultaneously producing a wave of home construction.

When the buyers who couldn’t afford their homes abandoned them in the late 2000s, the result was a glut of homes with no one to buy them. That, combined with the decaying state of the housing stock because so many homes were unoccupied, caused a collapse in home prices.

The key phrase however that really explains this whole sad story, however, is this:

Congress decided to force

With the best of intentions, Congress in the 1990s inserted itself into the market, trying to artificially allow poorer people to become homeowners. Such things don’t work, and in the end, it caused everyone far more pain.

What next? I am no real estate expert. My knowledge here is based on personal experience and what I read from many news sources on the web. However, I expect the housing market to remain weak for at least five more years, as it is going to take at least that long to cycle through these damaged foreclosures and get them rebuilt, sold, and off the market.

In the meantime, the rental market continues to boom. And if you have spare cash and want an investment, real estate is probably a good place to go.

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5 comments

  • Ralph Buttigieg

    G’day,

    Robert, can you please explain something to me? Whats the rental market like in the United States? If those people lost their homes I would expect they would be renting which would make me think the extra demand would provide good returns.

    ta

    Ralph

  • wodun

    In some ways it is good for renters because some very nice houses are up for rent at decent rents.

    A buddy of mine is renting a nice house but it is in forclosure despite the rent being more than the mortgage. I wonder if it is legal or if the bank would allow the tenants to take over the mortgage?

  • Hi Ralph,

    The rental market right now appears to be booming. First you have the people who lost their homes who have to move into rentals. Then you have the people who have homes but must move who don’t want to sell at a low price and would rather hold on to their houses. So, they rent their house to someone else, and then rent a place for themselves at their new location.

    Either way, there is a lot of demand for rentals, which in turn appears to pushing the rental rates up.

  • Patrick Ritchie

    I think it’s a little unfair to lump all of the fault with Congress and the changes to CRA.

    Over the long run free markets are very efficient at ferreting out unprofitable business practices, but they are also susceptible to boom and bust cycles.

    In this particular case government intervention may have served as a catalyst and perhaps even exacerbated the problem. But it in the end it was the greed of the individual managers and businesses that decided to take short term profits and were either unaware or ignored the long term risks. Please don’t misunderstand me, this is as it should be. Greed is not the problem. This is the same greed that drives innovation via competition and provides better and cheaper products and services to us all, overall greed is good.

    Short periods of irrationality are to be expected in the markets and they will unfortunately lead to situations like the current housing crisis, with or without government intervention.

  • Ralph Buttigieg

    G’day,

    Well, Patrick we have property cycles in Australia too but I’m unaware of anything as bad as the current US situation. We don’t have those government fannymae lenders. Australians borrow from the banks or other financial institutions.

    Some Australians have ventured into the American rental market, buying cheap properties in places like Detroit, only to find they are in area occupied by hoodlums. Some though are doing much better. I know a woman who has been very successful with US rental property and is organising buyer groups. I’m keeping well away from that because if the US dollar collapses, which I think can happen, your money is done.

    ta

    Ralph

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