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Point of Recognition Coming This Summer

Dataquick Information Systems, a real estate data service that reports on many major markets around the US announced Friday that it is rejiggering its methodology for calculating statewide median prices. They said that the net effects will be minimal. Out in the real estate blogoshphere and on the message boards, there were some who felt that this move was just another trick to distort data comparisons more favorably in order to continue the game of placating the masses a bit longer.

It’s not going to matter. Once credit starts tightening as it has in the mortgage market, it’s too late.

I visited my old appraisal firm in West Palm Beach on Friday. My friends there said they are now appraising houses down 20% from where they were at the peak levels. They are using MLS listings rather than closed sales for comps because the listing prices are below those of the recently closed sales, and they are adjusting down from there.

So regardless of whatever statistical massaging the reporting agencies do, it won’t matter, because the actual deals will be lower, one deal at a time, day in and day out.

Anyone who bought a house or condo or refinanced their mortgage in Florida in the last two years is now under water. Next month it will be anyone who bought in the last three years. A couple months down the road it will be everyone who bought in the last 4 years. Florida is the fourth largest state population wise, but in terms of real estate sales and new construction it is second. And in terms of the degree of pain being felt at the moment, it is first. There are a whole lot of mortgage players holding a big smelly wad of bad paper that was originated in Florida–too big a wad to hide with just a little perfume on the books.

Maybe Florida is the worst case, but is California and the rest of the nation far behind? Whereas before no one had to qualify, now, everyone must qualify. And that is a huge problem for a real estate market that was in every sense a massive pyramid scheme.

The real estate market is heading for a cataclysmic implosion. Yet, in spite of the fact that virtually all serious “independent” (non RE industry) researchers and analysts agree that the worst is yet to come, as Sudaca, one of our favorite posters on our favorite message board pointed out, “the message doesn’t hit home.”

The reason for that is simple. Because virtually everyone in the US who can walk upright while chewing gum now owns a home, even the thought of things getting worse is unimaginable. It’s the old “it won’t happen to me” syndrome.

Then again we curmudgeons who actually look at the facts might all be wrong, and collapsing interest rates and the return of easy money will rescue the market.

There’s just one minor problem with that thought. The bottom of the real estate bubble pyramid had subprime as the foundation. At the peak of the bubble, no one needed to qualify. Now everyone need to qualify. In order to get folks in at the bottom of the market– to legitimately qualify them based on standard income to debt ratios–my guess is that they’d have to get housing prices in the lower to middle rungs down around 40-50% in markets that never got too inflated, and down 60-70% in markets that got a “little overheated”.

Let’s say median family income is $46,000, or $3,833 monthly. Let’s use a generous qualifying ratio of 33% of monthly income toward housing. Back in the bad old days when I was in the mortgage and real estate business the guideline was 28%, but we live in more liberal times, even though real estate credit is tightening. At 33% a borrower would qualify for a monthly payment of $1,265. Let’s say that borrower would qualify for an FHA mortgage with a down payment of 3% of the purchase price (also doubtful), so that he or she could finance 97%. For the sake of simplicity, let’s be arbitrary here and assume that the combined monthly real estate takes and insurance bill is $300 a month (definitely not my home state of Florida in this example).

That leaves $910 per month for principle and interest. Let’s assume a rate of 6.75% on that FHA mortgage including the monthly MIP. At that rate and payment, the borrower would qualify for a mortgage of $149,000. At 97% loan to value, the total purchase price would be around $154,000. Do you know any markets where the median price is $154,000? I didn’t think so.

I have been bleating about how bad things are going to get for a long time, and some folks get tired of hearing it. They tell me that I am exaggerating the scope and depth of the problem. In fact it’s true that a few lucky people around the US have yet to suffer the slings and arrows of outrageous fortune. For example, another poster over on the Mark to Market forum at pointed out that things are going quite well in the Raliegh-Durham area of North Carolina. My hometown of Philly is also holding up pretty well.

Raleigh, in the heart of the Research Triangle may just be one of the strongest markets in the country.

Many of those getting the hell out of Florida head for the Carolinas. Ditto for those escaping the overpriced DC market. Areas where housing is cheap relative to nearby expensive markets, and which have a well diversified economic base, are going to hold up longer than the overpriced bubble areas.

Philly, which is a very large market, but cheap relative to NY and DC, its neighbors immediately to the north and south, is also doing ok. It also helps that the Philly and Raleigh areas are really nice, well diversified places to live with great amenities. The principle of reversion to the mean is at work in these areas. They are underpriced relative to nearby markets. They are also not as overpriced relative to their market’s median income. They will start to decline later, and they won’t fall as much.

Perhaps. If we are lucky. If we get a severe nationwide recession, as I think is likely, then all bets are off.

The areas being hardest hit so far are those that are the most overpriced to begin with and had the biggest bubbles, as well as the opposite end of the spectrum–economically depressed areas which cut across the Northeast and Midwest and which never participated in the bubble. Listing prices are down 10% in poor old down-at-the-heels Detroit in the last 9 months. Thriving New York City is down 7%. DC is down 7%. LA and San Diego are down 5%. San Francisco is down 9%. Sacramento down 9%. Phoenix and Vegas are only down 4%. Miami, Tampa, and Orlando are all down around 8%. They haven’t faced reality yet, as inventories continue to mushroom in those markets. These are listing prices. The reduced numbers of sales that are occurring are lower.

Meanwhile the inventory of unsold widgets is building up on the shelves because prices have yet to fall to an equilibrium level. In order for the oversupply of widgets to be reduced, the sellers will need to reduce prices enough to stimulate demand. That hasn’t happened yet.

Miami leads the country in listings with 108,000. Atlanta is the second market to hit six figures in total listings. That’s a whole lot of overpriced widgets on the shelves with more on the way. By comparison the combined number of listings in the 3 metro NY area markets, with 7 times the population of either the Miami or Atlanta markets, was 35,000. Not so many widgets there, but it’s still too many as evidenced by the fact that prices are falling.

So, yes there are still a few markets that aren’t real sick yet because they didn’t drink so much of the bubble poison in the first place. There are others that are sick and dying, and still others that are sick, but don’t know it yet. Eventually, virtually all markets will be dragged down. At the moment few have faced the reality of just how bad things are going to get.

The supply situation will get even worse this summer as the biggest wave of Adjustable Rape Mortgage resets so far hits the market. Foreclosures will balloon from already high levels. This foreclosure inventory will come on the market and individual sellers will suddenly be faced with a wave of competing inventory that is actually priced to sell, rather than for holding and wishing and hoping. Many of those asking prices will be 10% to 30% below current asking prices, which are already down 5-10% in most locales.

The point of recognition is coming this summer.

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  1. Captain's Log

    Lee: Great summary article. Nothing has been so clear to me that this is an unsustainable mania.

    We are witnessing history in the making and now is the time to value independence of thought.

    “Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one!”. Charles MacKay in his book ‘Extraordinary Popular Delusions and the Madness of Crowds’. (TERRIBLE book the way.)

    I like your ARM = Adjustable RAPE Mortgage quip. Very apt.

  2. Peterbr

    Great Article Lee.

    I live on the other side of the Altantic (Ireland) but just got back from Florida and I thought house prices where cheap there (compared to Ireland, UK & Spain etc).

    The house price bubble started here 10yrs ago and a basic starter house here in a Dublin suburb is now over $500,000. London is even more expensive.

    We don’t have much of a sub-prime industry here (as far as I know) but there are plenty of marginal buyers out there. A lot of recent buyers (last 3years) have seen $500 hikes in their monthly mortgages bills in the last 18 months since the ECB started hiking rates. People are aware of what’s happening in places like Florida and that’s making them nervous.

    Right on cue, (just as the bubble is about to pop) local politicians are promising to meddle with real estate taxes to make things more affordable and this has had the effect of stalling the market as buyers are holding off in the hope of escaping large up front (stamp duty) tax bills.

    Its fun to listen to the usual buff from real estate agents trying to talk the market up and cocktail party logic in the chattering classes is that prices might fall 10% or so. I guess not many people here understand bubble dynamics – once the bubble turns it will feed on itself.

    Right now, my guess is that we will see a Japan type deflation here. A slow grind down over a lengthy period of years rather a Florida style meltdown. But who knows?

  3. susan

    I am praying we get that 70% (to 80%) off in my area. I know some people think that’s outlandish but here in coastal WA. we are around 10 X median income.

    How in the world is that healthy for the local economy? A 40% cut would not do it here.

    This market took off like a rocket in 1997 ( days).

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