Forecasting the short term direction of residential home values, whether nationally or in a specific geographic region, may be one of the most difficult tasks. The fact that home values will rise in the long run is a given, as inflation is a part of the make up of our economy. So, how can you tell when a real estate market has hit that peak or trough in a cycle? Well, first, although you may hear the phrase ‘history repeats itself’ keep in mind that very often in real estate the symptoms repeat but usually not the causes. This is the main reason why the assumption that a downward trend might last four years historically is irrelevant to current or future corrections.
What drove the most recent boom in many of the ‘hot’ markets was emotion, pure and simple. Whether it was the fear of feeling the need to buy a home before one could no longer afford it or the greed that motivated people to invest at any cost, as real estate was perceived as an investment with which one just can’t lose, the result was the same, grossly overinflated home values. Exacerbating the problem were other factors including excessively loose and irresponsible lending practices along with historically low interest rates, real estate professionals more concerned with commissions than offering responsible advice, and a lack of judgment from governmental agencies that could certainly have curtailed the problem instead of ultimately needing to play ‘clean up’. The mainstream media had an enormous part to play in the boom. Sensationalism sells, and most of the focus was given to economic reports that were unidirectional. The general public bases many of their decisions to purchase, or not, on industry professionals and confirm this with what their favorite news anchor has to say. Unfortunately, most of the data reported in the media was biased and came directly from the real estate and mortgage industry.
Now, we hear reports on how real estate prices have bottomed, yet many analysts are predicting more inventory and higher interest rates. How is it that something that seems so simple can find well-informed industry professionals sitting on both sides of the fence? Basically, for people employed in a real estate profession there is an inherent need for optimism when one’s profession revolves around the need for delivering sound advice to potential home owners. If a real estate salesperson or a loan officer was to greet a customer and then proceed to tell that customer that they will be able to buy a home for less money in six months, would that industry professional have a reasonable shot at earning the customer’s business?
As you read this, consider your own local real estate market. Were new jobs added at a high rate through the boom (NOT considering the explosive growth in real estate related professions!)? Was there an inordinate amount of people buying on speculation (now you can include the real estate professionals)? Were the homes in your market incredibly undervalued throughout most of the boom? Did your area suddenly become recognized as a new center for industry, commerce, or resorts? If the answers to these questions are no then the foundation for the phenomenal increase in values was weak, at best.
There were certainly areas where significant growth was warranted, like coastal properties along the Atlantic and Pacific seaboard, resort areas with international appeal such as Lake Tahoe, Aspen and Vail, Hawaii, areas that had seen a large increase in new jobs and growing commerce centers, and also areas that were economically stable and had great potential for investors to obtain a positive cash flow with limited risk. Many of these areas experienced higher paced growth and some still saw values increase above a healthy pace but for the most part were safer markets.
In California, we currently are seeing a rise in home sales. Most of what is currently selling are foreclosures, short sales and homes at auction. It’s my belief that there’s a large seasonal influence and that the trend will be positive through August. When Fall arrives we will see a decrease in buyers, as always. Potential buyers will realize that the enormous supply of inventory will continue to grow, interest rates are likely to increase, and home values will decline. This will be the ultimate time to buy. Sellers, mostly banks that need inventory moved out of their REO, will become HIGHLY motivated to accept very low offers as they will all want to start 2009 with cleaner books. As these properties sell they will contribute to the lowering of values. We’ll still see media reporting information behind the curve and many buyers will be scared until reality hits around the normal start of the 2009 buying season, let’s say March. This will be enough time for the less-informed to see prices legitimately on the rise and will have given them enough time to watch investors bottom feed.
After March 2009 I see values correcting to more appropriate values rather quickly as they will have certainly over-corrected to the negative by then. Foreclosures will be much less common starting in 2009 for several reasons, such as loan modifications will be in place, most people will be in healthier loans by refinancing, and simply the fact that foreclosures are less likely when money is to be made (appreciating home values). Also, lending guidelines will begin to loosen a little. Those, too, have slightly over-corrected in response to losses and it will dawn on investors that once again, mortgage backed securities may offer a reasonably safe and sound investment choice.
Of course, as we live in this great, capitalistic, free society, we will be sure to experience similar market swings in the future. Where there is money to be made there are also people willing to take inordinate risk and throw caution to the wind. Greed will not go away. Being ahead of the curve, recognizing the tell-tale signs, and using sound judgment will always be the safest and most profitable approach. Real estate investing is, and will remain one of the most powerful wealth-building tools available to anyone willing to do their homework.