Exuberance in real estate market is irrational

Robert Holt, CDPE/SFR of The [HOLT] Group, RE/MAX Sonoran Hills ~ 9/3/2011

Over the last several weeks I have read one fascinating article after another from some of our local publications (both big and small) that are exclaiming how amazing the current Phoenix real estate market is and how many homes are being sold. In these articles, we are told that the buying is at the same pace we saw in 2005, and we hear from real estate agents who are as giddy as a schoolgirl the night before the big prom.
By the sound of it, one would think that home prices were accelerating through the roof and everyone had tons of equity again. Granted, it is good that the buying has been strong, but I fail to see why there is such exuberance when a blind man can see that we are still in a massive hole. Maybe the digging has stopped (for a while), but the hole is so massive that it is going to take many years for us to climb out of it.
While real estate agents might find joy in the current pace of buying, I do not think the family that bought (or re-fied) their home in ‘03, ’04, ‘05, ‘06, ‘07, ‘08 are all that happy, much less exuberant. To me, the exuberance is irrational at best and irresponsible at worst.
By the way, the term “Irrational Exuberance” was coined by none other than the former Wizard of the Fed, Alan Greenspan. He used the phrase in a speech in 1996 when he was attempting to warn that the U.S. stock market was overheating. Keep in mind that it was Greenspan’s commitment to a loose monetary policy and his utter disdain for regulations that played a major role in every boom bust this country has seen in the last 15 years. Only a minor amount of research on Greenspan reveals how his policies and views created an environment that led to the massive housing bubble. He not only kept interest rates near 1 percent, he did nothing to provide oversight of the subprime market while allowing the national banks to run amuck in the highly risky derivatives market.
The term “Irrational Exuberance” is also a title of a book written by Robert Shiller, who is one of the most rational people in the country and is also the one who along with Karl Case, came up with Standard & Poor’s Case – Shiller Home Price Indices. Shiller, who is an economics professor at Yale, is also one of the most respected economists of our time. He is also the same person who recently declared that he foresees housing falling by as much as 25 percent before we finally find a bottom. He also believes (as I do) that it is highly probable that the U.S. economy is heading back into a recession or worse. However, as I have previously written, I do not think the Phoenix market will fall another 25 percent, unless the unthinkable happens. What is the unthinkable? A dollar collapse, U.S. dollar removed as world reserve currency and/or run-away inflation. While these events are possible, I am not ready to think they are probable.
What I do believe, is that anyone who thinks the Phoenix housing market is ready to take off is uniformed or delusional or both. I hate to bust anyone’s bubble, but the current level of buying is doing nothing more than helping the market to potentially find a bottom. However, the buying (much of it from investors) is not going to give way to any serious level of home appreciation any time in the near future (years). And, while I too am happy to see that we are eating through some inventory, it will do nothing for the homeowner who is seriously underwater except perhaps give false hope.
Look – despite the buying, the fundamentals that drive appreciation are not there. Buying is part of the equation, but for every home that is sold there will be one going into foreclosure if not today then tomorrow or next year or the year after that. Why, such a dire prediction? Well currently, 67 percent of all Phoenix homeowners find themselves with negative equity and more than 200,000 of them are more than 50 percent underwater.
Remember that one of the many reasons this country has never seen this level of foreclosures is because in previous down turns, homeowners would let every other asset go before letting their home go back to the bank. Was this because people were “better people” or more committed to paying their obligations in the past? I say no. The single biggest difference between the past and now is that in past real estate / economic downturns, homeowners had equity in their home and as such they would fight like crazy to keep the home. They fought not because they were more “moral,” but because the only thing they had left was the home and the equity in it. Now, because this downturn has been so severe, homeowners find that they are just really renters paying the bank. Except in this case B of A or Chase does not pay for the HVAC when it breaks down.
Like it or not there will be many more foreclosures to come as more and more homeowners wake up to the complete futility of paying a mortgage that is twice as much as the home is worth. Remember that a home that has fallen 50 percent in value has to appreciate at over 100 percent to get back to a breakeven point.
And when will home prices go up? According to Moody's Analytics, a subsidiary of Moody's Corporation and the same ratings firm that is warning the U.S. government that our debt is about to be downgraded from AAA, has predicted that the Phoenix housing market will not see 2006 prices again until 2035. Others say it will be even longer.
No matter what your personal opinion is of those that just walk away from their homes, the fact is there are hundreds of thousands more potential short sales and foreclosures ahead. This of course, will continue to place heavy pressure on home values.
What is worse is that the problem of negative equity is not just confined to those that bought from ‘04-‘07. Data shows that many more people re-fied during that time than actually bought. In fact, the ratio of refinancing to buying was at 75 percent / 25 percent during the boom years. This simply means that all neighborhoods throughout Phoenix (and the country) regardless of when they were built are being devastated by foreclosures.
And, because prices have continued to fall so much, those who bought in ‘08, ‘09 and even 2010 potentially find themselves severely underwater. Many of the homeowners including those that bought in ‘02 and ‘03 are now having to short sell their homes or they are walking away. Keep in mind that many of the sale prices of homes sold today are often less that what they would have fetched in the year 2000.
Adding to the problem is the massive amount of buyers who have used FHA financing in the last 3-4 years. The problem here is that FHA financing only requires a down payment of 3.5 percent of the purchase price. As we all now know, and what I pointed to earlier in this article, homeowners that are underwater are much more likely to walk away from their home. For those FHA buyers that bought anytime in the last 4 years, there is an extremely high probability that they too are underwater, some seriously.
This situation creates a drag on future prices since even if the homeowner stays in the underwater home and does not walk away, there is no real chance of him/her moving up in the market. Move up buyers are a vital component to a housing market. But the only way most people can move up to a larger home is if they take the equity from the one they are in and then apply it to the new home. No equity means no moving up. The problem is made worse when most of these buyers are not seeing anything resembling a pay increase at their place of work.
Meanwhile, we have a market place where over 30 percent of the homes being sold are going to investors (many are Canadians, Chinese and others). While this is good in the sense that it eats up inventory, it could potentially be bad if the world economy takes another nose dive and these folks need their money back and decide to sell at the same time.
Of course, as we all know, lenders are not giving loans to the dead any longer and as such, the ability to get financed is tougher than ever. And, with so many homeowners having their credit destroyed via foreclosure etc., then many would-be home buyers are out of the market for years.
Keep in mind that we currently have historically lowest interest rates and while I am confident that Big Ben will do everything in his power to keep them low, sooner or later, market forces might overtake the little guy behind the curtain. And, should rates rise, expect buying to slow and those that can buy will lose buying power. I should also mention that come Oct., the FHA maximum loan amount will fall from $346,000 to $271,000. With such a sizable reduction in the loan amount, I would think the market between $280,000 and $350,000 is going to take a hit. This will have an adverse effect on all other price ranges.
The issues, as pointed out above, along with continued high unemployment, which only looks to be getting worse, is going to negatively impact Phoenix housing for many more years to come. Sadly, these are just some of the problems facing the economy and housing, which will prevent any real appreciation for years to come.
Look, I am very thankful for the buying ( I own a home too and would like to see values go up), but when I read articles or hear other agents that make it sound like happy days are here again, I am reminded of all the other misguided cheerleading we have heard over the last five years. Folks, I do not want to rain on the parade, but flat and very low growth is the new normal for housing and the economy. While it may prove to be a good time to buy (as long as you are doing it for the right reasons), it is not time to think that all the problems are solved and we are out of the woods. After all, we have seen this movie before, just ask anyone who bought in ‘08 when they were told “we are at the bottom.” Robert Holt, CDPE/SFR of The [HOLT] Group, RE/MAX Sonoran Hills. For info visit TheHoltGroupAZ.com or call 623-748-9583 and tell us your thoughts.