Understanding the Housing Slump

There was an interesting news piece this morning on NBC 4, talking about how the Maryland housing market is going to continue like this for the next year. The report was based off of anticipated loss of tax revenues due to the housing slump, and stated that the market is not about to improve in the near future.

This got me to thinking about what exactly it's going to take in order to see any sort of market improvement. In order to see a turn-around, we need to understand what is causing this mess in the first place.

Overpriced Mark-Ups

The housing boom saw townhouses priced at $60k in Waldorf skyrocket to $200k from 2000-2005. Imagine this:

The year is 2002, and you can afford to spend $150k on your first home. You go out and look, don't see anything you like and decide to wait. 6 months later you look again, and now what would have been $150k is now going to cost you $160k. again, there is nothing that you like and you realize that you should probably save a little more money so that you can still afford the payments. Again, the concept of fiscal responsibility makes sense, and so you wait.
A year passes from the time you first started looking, and now you've managed to save an extra $10k and you should be in great shape. The interest rates are low, and so off you go to find that home. But wait, that home you were looking for in the $150k range is now going to cost you at LEAST $215k, and there's now way you're going to be able to afford a payment like that. Unless....
Now your lender mentions that if you were to go with an ARM or interest only financing you could still afford to buy that home that cost 30% less last year, and manage to pay the same rate as if you would have bought a year ago! Sure there is that reset point, but look at how values are going up! you'll be able to refinance before that happens, and in 5 years, won't you be making more money anyways? You'll be able to afford it regardless!

This is where the alarm should have sounded. Sure, if the payments are the same, it wouldn't matter so much, but at some point that payment isn't the same, and everyone has to pay the piper eventually. Your friends are bragging about how much equity they're grown in their homes (Equity is only a value written on a piece of paper, not bills in the bank, another reason people got themselves in trouble), and so you decide it's time to get your slice of the American Dream. So you purchase a house for $215k, $65k more than you would have paid a year ago, and you can finally say that yes, you own your own home.

But how many people really stopped to think about how overpriced a 30% jump in home values over 1 year really is? Traditionally, real estate values have grown incrementally along with income rates, inflation, etc. An annual increase of 30% should have been a big red flag that something was wrong. But who's going to say something? Investors are happy, Homeowners are seeing their "equity"(which they see as permanent) growing, and everyone thinks they've hit a gold mine. (anyone remember the song "She Got the Goldmine (and I got the Shaft)??). Nobody was getting short-changed except the buyers, and hey, that's the cost of doing business in a hot market.

So now lenders are coping with people desperate to buy, and housing prices growing out of their reach. In march the sub-prime notes! Now you can still afford to buy the house you want, you expect the values to rise and that old rule of affording a mortgage worth 3x your annual gross income is thrown right
out the window. As far as lenders were concerned, these rules no longer applied. ARM's became the only way many people could afford to buy a home with the way housing values had jumped.

Let me repeat that:

ARM's became the only way many people could afford to buy a home with the way housing values had jumped.

Builders Cash In

The concept of using ARM's to purchase were not just to afford that little starter home, either. Builders took advantage as well, building Mc-Mansions that most people couldn't afford without these sub-prime notes. The sad truth of it is that the builder is not responsible for making sure you're financial decisions are sound. He's responsible for building that new home you just HAD to have, and when the boom hit they saw an opportunity to builder bigger and better than ever and actually be able to sell them for huge profits, because people who previously had no chance of buying a home that big could afford it (or so they thought).

Where's the Parity?

Essentially people were gambling on FUTURE income, not how much they were currently bringing home. The lenders should have known better. The buyers should have been more fiscally cautious. and now you fast forward to the present day.

We all know the current story, foreclosures estimated to hit 3 million or more. More people losing their homes than in the great depression, and people caught with sub-prime notes are praying that some magical fix is going to make everything better. The problem is that without sub-prime notes, people still can't afford adequate housing. Maryland has seen a 10%-12% decrease in home values, but that still doesn't adjust for the fact that values doubled, even tripled in some areas, where normal growth from 2001-2006 should have been 30%-50%, we saw 100%-200%.

Long Term Factors

Builders are offering very heavy incentives to buyers and have seen there profit margins bleed red ink. The more incentives and discounts they offer, the lower existing homeowners have to go if they want to sell their home. This trend hurts the builders, current homeowners, and everyone except the consumer, who now has more choice for their money.

Foreclosures are being offered at a discount to get them off the books. As foreclosures (and short sales) rise, surrounding home values drop. If you want to sell in this market, you have to lower your price so that it is competitive with that foreclosure down the street.

Buyers are hesitant right now. They see the prices dropping, they know it's likely to continue this way, so what's the rush? The longer buyers hold out, the sweeter the deals get (and the more home values will fall). People are especially cautious when it comes to financing right now as well. Banks are holding low rates, but the criteria has gone way up, making less and less people eligible to qualify for financing and forcing the market to continue with it's over saturation ofavailable homes.

Making Homes Affordable

So we know how and why the market has slumped, and how it got us to where we are today. Now we ask ourselves "how do we fix the problem?". President Bush has offered his solution, and plenty of people have had plenty to say about that. The fact is that the market has to be corrected so that it falls back in line with income totals (again, let's consider that the average home value should be around 3x the average annual income).

Charles County Maryland had a median household income of $62,199 for 2000, and $69,573 in 2005. That would be a growth rate of roughly 2.4%. The median home value in 2000 was $153,000. In 2007 that figure was $314,000. To grow in line with income, that number should be somewhere closer to $169,830, or roughly 54% less than it currently is.

There is no silver bullet to fix this problem. a drop of an additional 30% over the next 18 months would not be completely outrageous in order to return to a sense of economical balance. The fear of recession is creeping up, which will also have a negative impact on home values. Keeping people from falling into foreclosure is a noble effort, but in what way is it really stabilizing the market? The plan is too limited to stop foreclosure rates from rising, instead it's more of a band-aid approach to a gunshot wound. Prices have dropped as much as 12% right now, and while homeowners aren't happy about it, the market has shown just how necessary the deflation is.

~Jonathan Benya

Century 21 New Millennium Team Benya

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