Wednesday, June 18, 2008

How Low Can They Go?

I'm not sure I agree with all the recent comments on Lander's blog about how interest rates will bring prices down. My gut tells me that a home listed at $300,000 now, is not going to fall another 50% due to interest rates. I haven't spent much time mulling this please point out what I may have overlooked.

Right now we are in a situation of oversupply. Currently, prices are moving lower as it gets worked off. At the rate we are going, it seems the extra supply will be worked off by the end of the year (assuming its not just investors buying right now......foreclosures notwithstanding).

If we take much more off today's prices, it will mean we are below the cost to build new homes. Thus, no new homes would be built. Eventually, existing homes will fill due to population growth (the fact that the area is now more affordable may even bring some people back). At some point, this will squeeze supply, bringing home prices up to a point where builders can profitably build more supply.

If interest rates go up, building will pretty much grind to a halt (more than it is now!). Resale home prices are very sticky going down. I doubt we would see prices drop, in line with increases in interest rates, since there is always a lag. In other words, this will take some time to work out, and similar to 2006/2007, purchase activity would dry up as buyers and sellers face off in another stalemate.

I see this scenario taking several years to play out, depending on how long interest rates are up. In my mind, there is just way too much uncertainty related to macroeconomic factors right now, and we are talking a period of many years for this all to resolve.

Personally, I am a bird in the hand kinda gal. I would rather purchase sooner, and get a reasonable price (there are some on par with rent), with a reasonable interest rate, prior to seeing my purchasing power eaten up by rising inflation.

Many argue that home prices will continue to go down (beyond the levels that fundamentals would suggest) as interest rates increase. This would lower my property tax base, my principle, and increase my interest write off. However, I am not sure waiting for several more years is really worth it, if our monthly payment ends up being roughly the same, and I have the ability to appeal my property tax base.

I am looking for a place to live and raise my family. If we can purchase now for the same or less than we can rent, why would we wait? Especially since rents will go up with inflation and decreased housing supply.


Patient Renter said...

Some comments:

a home listed at $300,000 now, is not going to fall another 50% due to interest rates

I don't think anybody has said or implied that.

At the rate we are going, it seems the extra supply will be worked off by the end of the year

Is this assuming that no new homes come on the market and that the shadow REO inventory doesn't exist?

If we take much more off today's prices, it will mean we are below the cost to build new homes

We may already be at that point, but it doesn't matter. The market doesn't specifically care what it costs to build a new home if various other dominant factors are still driving prices down.

Many argue that home prices will continue to go down (beyond the levels that fundamentals would suggest)

What do the fundamentals suggest? It seems to be pretty subjective, but according to most mainstream economists/analysts, what the fundamentals suggest is continually revised downward such that those who do the most suggesting have the least credibility.

If we can purchase now for the same or less than we can rent, why would we wait?

I think you might be paying too much attention to the rental price comparison. If you could buy a house now for the same as rent, and you do, then its value dumps another 15% in 2 years, that could be a good reason to have waited. You should do what is best for your situation though.

Especially since rents will go up with inflation and decreased housing supply.

We are a long long ways away from decreased (back to normal) housing supply (rentals included). I don't have local stats, but nationally we are far beyond the highest vacancy rate in recorded history, 2.9% if I recall correctly (previous to this downturn we had never surpassed 2%).

Patient Renter said...

Especially since rents will go up with inflation

I also should point out - some pretty smart people (see deflationista, Minyanville), who actually called the housing bubble in the face of ridicule from their peers, believe that we are headed for (monetary) deflation, ala Japan. This sort of scenario would see home prices (and rents) slowly bleed down for years. Japan proves it's possible.

I'm not smart enough to understand if and why this will occur, but I tend to put more weight in the opinion of those who forsaw the housing bubble than those who were surprised by it.

Buying Time said...

Thanks PR will look into it.

I'm just not sure I am willing to rent for the next 10 years while this whole mess blows over.

So far its totally been worth the wait. As we get closer to what I consider fundamentals (rent basis, as well as 2000 inflation adjusted price) I will find it increasingly harder to wait.

Patient Renter said...

I don't think anyone would want to wait for 10 years. Losses or not, if owning a home means living your life the way you want, life is too short to postpone it forever.

The way I think of it is to put a value on the increase in quality of life you think you'd achieve by owning and weigh that against what it might cost you (potential losses) to achieve that. It's going to be different for everyone.

Husmanen said...

Spoke with my real estate agent yesterday regarding a REO and my potential bid based on my calculations using rents (actual rents) as one element. She said my numbers were too low because the area is not a primarily rental area and buyers don’t buy to rent out the homes. I said this may be true but they cannot be off by 30%, based on her market price and my calculation.

We agreed to disagree about that particular home. But one point we did agreed upon, the market is favorable to me and will continue to be, especially in the Fall 2008 and throughout 2009. She encouraged me to wait and don’t try to jump the gun, there will be ample supply and I should just keep saving.

Funny how things change, both my wife and my agent encourage me to just relax and let the market take its course. I was the one reigning them in earlier. I don’t think it will be 10 years, but at least another year for me and my family. I guess I will be setting up some more pictures and putting some more holes in the walls.

Paul said...

Actually, builders can and do build and sell below their cost to stay in business. I know it doesn't seem logical, but building and selling at a loss helps them get land inventory off the books. The builder can assume a loss on the land, or a loss on the home, or a loss on the builder's overhead recovery. It's all the same. If the cost of the land is $20k, the house is $200k, and O/H is 30K/house (all merely for purpose of discussion), the builder is better served building and selling houses for $300k, and losing money on the land value, but recovering money to cover the builder's overhead, than for the builder to just close it's doors, and still have the carrying costs in the land. Even if the land is encumbered, the lender will sometimes agree to share the builder's pain by a short payoff on the land, so the builder can keep building and selling, rather than have the lender end up getting all the land back in this market. Somewhere, there has to be a bottom. We would all be rich if we knew where/when!

alba said...

The current administration can't afford to acknowledge inflation at the cost of a sinking, but highly manipulated (opinion only), GDP. The banks are still bleeding, and will for a few more quarters. I'm betting on the interest rates holding until W and his crew go home. (while housing prices continue to plummet)

Deflationary Jane said...

Everyone says prices can't go down But guess what? There is no physical backstop in place. Rents can go down, wages can go down, it can all go down.

Where we all begin haggling is over probability.

Think of it as the Hiesenberg uncertainty principle of RE. You can know the direction or you can know the price, you never know both. That's the best analogy I've ever come up with for RE valuations.

Sippn said...

PR - Japan is a lot different than the US - their population growth went pretty flat during that time also - the US continues to open all borders.

Expect Asian immigration to increase from a drip to a trickle - they won't miss a few million people from China, India, etc.

Expect the average price of new housing to decrease - much because of increasing building of multifamily - apartments and mid/hi rise condos - Sac city permits now show majority of residential building is multifamily - 40% 2 years ago, 66% in 2007.

Husmanen - those ratios only work out in mostly rental neighborhoods - is that where you want? What you want might require a premium. Economic sense for auto purchases lands somewhere near a beige Le Car, but I bought a red, big, fast thing. I bet most of you all justified a little premium for the car you wanted!

Gwyn - miss you too, but I can drink alone if necessary! I know you won't miss Davis and its 2 EPA Superfund sites.

Paul - a small % of builders can do that, but as you can see, not all and not very long. Land basis often goes negative in stuff like this - (how?) when the price in marginal places gets so low, the builder has to "write a check" to make it start. Thats where you see projects shut down like they are.

As I recall, Laguna W***t went back to the bank in the early '90s and was bought by a group of developers for just less than 1/2 the loan. Discount provided by BofA.

Sippn said...

DJ - you're right of course.

Since Heisenburg was a subject on Aqua Teen Hunger Force, I can discuss this with my teens. . . right?

I think you're employed below your level - have you thought about professing? or is that just joining the dark side?

Jacob said...

Banks are still taking homes back faster than they can sell then, and you still have a massive tsunami of Alt-A loans waiting to drown the market.

And we have minimal wage inflation while we have too much commodity inflation.

Prices will continue downward until the excess inventory is moved. And that doesnt count sales to speculators who plan to resell in a year.

But, how much is waiting worth to you?

We are down about 50% almost. So what is the worst that can happen, another 50% drop? Maybe more like 30% from here. Could you live with that? Would that drop in value be less then the value you place on having your own house now?