by Gary North
If you want to see a nightmare ad for sellers, read this one:
if you could save $100,000 on a new home
without feeling like you're breaking the law?
It has a photo of a man running, with both arms filled with bags of money.
By the time you read this, the ad may be gone. The deadline date was May 6th and 7th. The ad was run by Centex Homes.
My understanding of economics is this: A seller seeks a high bid. He hopes that someone will offer him more than he paid for whatever it is he is selling. But when push comes to shove — when there are no prospective buyers lining up — the seller has to revise his estimate of what the top bid will be.
This seller had more than one item in inventory. He had six communities/developments full of inventory.
Any home builder who sees the competition knocking $100,000 off the price of their homes has to be worried. That is a lot of money, even in California real estate.
A $100,000 hit means that the builder overestimated demand. Entrepreneurship is the art of forecasting future economic conditions, above all: price. He buys scarce economic resources on the assumption that he is smarter than his competitors in the broadest sense. He thinks he can buy at substantially less today because his competitors have not perceived the opportunity to re-work raw materials into final products. He thinks they are in error about future demand.
Sometimes entrepreneurs are incorrect. Sometimes competing producers are wise to stay out of resource markets at today's prices. It is better to sit on cash.
The problem is, a manufacturer rarely has this option. He has inventory to sell, sales people to employ, crews to employ, bills to pay, and interest payments to meet. He can't pull out of the market and still stay in business.
The plight of the home builders in housing bubble regions is grim. They have begun to hit brick walls of consumer resistance.
What about your area? Are there tremors in the local housing market? Here is a way to find out.
TREMORS NEAR THE CAPITOL
Because Washington, D.C. is where all the tax money flows, high-salaried government employees bid up the price of housing. So, it's a perpetual boom in the region.
But the boom is looking shaky these days. The Washington Post reported on April 29 of a speech by a specialist in the region's real estate markets.
Home prices in much of the Washington region will likely drop 10 percent or more because prices have far outpaced affordability for first-time buyers and investors, according to a forecast this week by Mark Zandi, chief economist of Moody's Economy.com.
Condominiums will be hardest hit, Zandi predicted Thursday at the National Association of Home Builders' spring construction forecast.
There is a reason for the vulnerability of condos. Because they are on small plots of land and share walls, people with money don't want to live in them. So, they serve as entry-level housing for people. First-time buyers these days cannot secure real estate loans that their budgets can handle.
Zandi predicts declines of 10 percent or more in the area made up of the District, Northern Virginia and suburban Maryland excluding the Bethesda area. Bethesda and its surrounding areas, which the Census Bureau has broken into a separate tracking area, could experience a 5 to 10 percent slide from the peak prices of last fall, he said.
Northern Virginia is susceptible to the risk of price declines because it has the highest concentration of condos and has seen the most building generally, Zandi said.
He said that D.C. is one of several markets that face downturns. Others are Atlantic City-Ocean City, N.J.; Las Vegas; Miami; Orlando; and Phoenix. He thinks that for normal areas, real estate prices will go flat through 2008.
Rising mortgage rates are the problem, he says. First-time buyers are locked out, and they constitute 40% of the market.
Until recently, despite rising rates and home prices, lenders had still been able to entice borrowers with loans that required no money down, interest-only payments or other terms that kept monthly payments low, but regulators and lenders themselves have gotten increasingly nervous about exposure to defaults, he said.
"This game is up," Zandi said.
CONDOS NO MORE
It's not just Washington where the condo market is in trouble. The South Florida Business Journal (April 14) reported that companies that have built condos are converting them to rental units.
Six communities with 1,571 units — three in Broward and three in Palm Beach County — have made the switch from condo conversion sales back to rentals.
Some are dubbing it "the great conversion reversion of 2006." It's a move to reposition rental communities, which were slated for condominium conversion sales, back to apartment rentals.
The cause is clear: The would-be buyers cannot qualify for loans. So, the existing owners of empty space are trapped. They are doing what anyone does when trapped. They are looking for people to rent what they cannot afford to buy.
"It's an early-stage trend that will probably accelerate as the market slows even more," Jack McCabe said. "For well-managed communities, the improved cash flow from enhanced rents may help carry them until the conversion sales market comes back into balance."
There are times when it pays to rent. You would be wise to find out if you live in such a home.
LIQUIDITY AND MOBILITY
If someone is on the hook for a huge mortgage, and mortgage rates go up, he cannot readily sell his home at the price he paid. He is in an "upside-down" position: What he owes is worth more than the sale value of the asset.
This is normal in the new car market. Drive off the lot, and you can't sell the car you now own for what you owe. Americans have learned to live with this with their cars. But they don't expect this with their homes. That is why they sign on the dotted line for homes that they cannot really afford. Then property taxes rise, and maintenance costs rise, and — if the have an ARM — monthly repayment costs rise. Yet they can't get out.
They pretend that they can hang on indefinitely. Some can; some can't. Those who can't lose the property in a repossession. But the debt doesn't go away. They still owe the difference between what the house sold for after commissions and what they owed at the time of sale.
This has not yet registered psychologically with most new home owners. They have never seen a down market in housing. Now they are going to.
Lending institutions don't want to become homeowners by default. They are not set up to manage properties. They are set up to hand off mortgages to Fannie Mae and Freddy Mac. These two mortgage-creation giants are also not set up to manage properties. Foreclosed properties are money pits. So, the threat of a wave of foreclosures is a grave one. "Grave" is the right word.
The ability of people to sell their heavily mortgaged homes is now dramatically reduced by the new bankruptcy law. They have traded mobility for home ownership. This is especially burdensome for young married couples, where geographical mobility is vital for upward social mobility.
In the next recession, people who lose their jobs will not be in a position to pick up and leave. They will be forced to take any kind of job just to maintain their mortgage payments. This will greatly benefit employers. They will be able to secure the services of creative people who would not normally work for such wages.
The scene that sticks in my mind from Kramer vs. Kramer is Dustin Hoffman's frantic search for employment. If he did not get a job within a few days, he would lose custody of his son. He was willing to take a major cut in pay, which he explained to prospective employers. His time was short. When time is short, the price is high.
In the next economic downturn, the mortgage payment is going to be the equivalent of losing child custody in the movie. People will do almost anything to hold onto their homes. This is why mortgage lending is preferred by lenders. They understand the commitment of home owners to maintain occupancy. To this is now added the maintenance of credit. Once the person has his home sold out from under him, he is trapped. The debt remains but the house is gone.
For real estate investors, the next recession will be a bonanza. If an investor has some cash and a good credit rating, lenders will be happy to make no-money-down deals on repossessed homes. Beggars can't be choosers.
For young couples who have not yet bought, patience will pay off in many regions.
For those that have bought, it would be wise for them to assess what would happen if the wife lost her job during a pregnancy. If the couple could not maintain the total expenses of owning there newly purchased home, it may be time to get out while the getting is good.
May 16, 2006
Copyright © 2006 LewRockwell.com