It’s time for an update on the real estate bubble, which I have been watching since 2003. About a year ago, I laid out a timelinefor the real estate boom. Knowing real estate happens in 16-yearcycles, I juxtaposed the last boom/bust cycle in the early 90’s ontothis cycle. Here’s what I came up with:
1990 (2007): Prices take a serious plunge. One articleclaims that housing booms are a bad thing and we should hope pricesstay low. Increasing mortgage rates are blamed for the bust. The word“recession” is mentioned. Gloom and doom.
That’s next year. How many times do you think you will hear thewords “looming recession” next year? More than you want to, that’s forsure…
Ah, yes. Recession, recession, recession…Yep, all over the news. Notice I called it a “looming” recession in mypost last year. That’s because “A recession is traditionally defined inmacroeconomics as a decline in a country’s real Gross Domestic Product(GDP) for two or more successive quarters of a year (equivalently, twoconsecutive quarters of negative real economic growth).” (thank you,Wikipedia.) We won’t hit two consecutive quarters this year (or, if wedo, it’ll be 2008 before we know we did.) I think the actual“recession” will start next spring.
2008 will be a disaster year for housing. Let me share with you achoice quote: “‘Recent mortgage disruptions will hold back salestemporarily, but the fundamental momentum clearly suggests stabilizingprice trends in many local markets,’ said Lawrence Yun, senioreconomist for the Realtors.” That’s from this article,published today and titled “Existing Home Sales Fall in 41 States.”Have a good, hearty laugh over that one. Prices are nowhere near“stabilizing.” Homes here have lost about 15% of their value since the2006 peak. They still have a good 25% more to go down from here…andthat’s probably a conservative number.
The proverbial **** has hit the fan here in California. You are no longer able to get an interest rate under 8% for a loan over $417,000.Take note of that number, because I don’t doubt that will become thesubject of a heated political debate. $417,000 is highest rate at whichFannie Mae and Freedie Mac will buy a loan. Loans at or below $417,000are called “conforming.” Loans above $417,000 are “non-conforming”.Since non-conforming mortgages are defaulting at shockingly high rates,and there is more risk associated with them in a market where pricesare going down, interest rates have skyrocketed for those loans.
61.9% of the loans in the Bay Area in January-June 2007 were non-conforming loans.
That’s why this post is entitled “The Game is Over.” The jig is up — there’s simply no way more than halfof the buyers who qualified for home loans in 2005-2007 in the Bay Areawill now be able to afford loans. Add that to the people who can affordhome loans, but don’t want to buy in a declining market, and you have aperfect recipe for huge price drops.
I don’t think we’ll begin to see huge price drops until this timenext year. A year from now is probably the first point at which I’drecommend actually buying a house…no matter where you are in thecountry. Prices are dropping now, but they’ll drop more once all of thebad loans are squeezed out of the system. This is going to take awhile. Sellers haven’t realized what happened…the bomb that justdropped. They’re still pricing their houses 10-15% below peak. It willbe several months before housing prices adjust to this new reality.Don’t kid yourself…this is the new reality. Bernanke may dropthe Fed funds rate later this year by 0.25% or 0.5%, but that doesn’tautomatically mean that you’re going to be able to get a non-confirmingmortgage at less than 8%. Those two things simply aren’t correlated.Mortgage interest rates are dictated by the market for mortgage-backedsecurities and what buyers of those mortgages are willing to pay, notby what the Fed dictates. Remember, in my chart I mentioned that itwouldn’t be until 2010 that houses truly became a bargain. Notice thequote from the early 90’s bust: “1993 (2010): It’s definitely a buyer’smarket. Some people are saddened by the fact that current prices are50% of what they were in the 1980’s.” We have quite a way to go untilwe reach that point. We will get there, but it’s not going to happenmore quickly this time.
I’m happy to wait things out. How are you doing? I hope you soldyour house last year… we’ve passed the point of no return at thispoint, and it’s downhill from here for the next 6 years or so. I’moptimistic about all of this, though. Downturns are when the mostamazing things happen… inventions get made, and people band together tohelp each other. Yes, it won’t be easy. We will be hit harder than wewere in the dot-com boom. But opportunity always awaits.
By the way, if I could make a recommendation… invest in a growingcountry, and get out of dollars. Which country? That’s for you todetermine. 
I’m seriouslyfeeling the hit of the real estate bubble at home. I got into atownhouse in the DC area 4 years ago. My fiancee did the same (albeitwith a much larger down-payment). We’re getting married in April, andwe’ll be selling two townhouses and buying a single family.Unfortunately, we’re looking at a non-conforming “jumbo” loan, justbecause of the cost of living in this area. And we’re only looking athouses that one of our salaries could afford! Because of the interestrate hike, we’ll probably have to use both salaries and then re-financewhen we want to have kids - hopefully with more equity in our home.
Comment by elwing — 8/15/2007 @ 2:06 pm