Last Updated Jul 28, 2009 10:19 AM EDT
Surveying the wreckage of the residential real estate market, it's hard to remember that as recently as mid-2006, the conventional wisdom was that housing prices nationwide couldn't go down. At that time, homeowners were sitting atop a five-year, 66 percent appreciation in home values and a $6.5 trillion mother lode of home equity. Americans were so confident that their perceived new wealth was real that they extracted $1.2 trillion of it between 2001 and 2006, according to Alicia H. Munnell, director of the Center for Retirement Research at Boston College. Then, between 2006 and 2009, the median sale price fell 32 percent, and $4 trillion evaporated from owners' net worth.
Prices Are Going Nowhere for at Least Seven Years
- Foreclosures are at historic levels: More than 1.7 million homes were repossessed between the peak in 2006 and the first quarter of 2009, according to RealtyTrac. This year, another 3.1 million households will fall into some phase of foreclosure. In a normal market, about 1 percent of loans are in foreclosure. In today’s market, it’s about 4 percent. These properties sell at about 25 percent to 30 percent of their nominal market price, and they are a big percentage of total sales — 45 percent in April, according to the National Association of Realtors. With about one in five mortgages under water, “foreclosures will be with us at significant levels for at least a couple of years,” says Andrew LePage, an analyst with MDA DataQuick, a real estate information service. “It’s going to take a while to burn through all the inventory.
- Defaults on jumbo mortgages will soon surge: The next shoe to drop is likely to be houses at the high end, where jumbo mortgages reside (any amount above $417,000 in most places; north of $729,750 in certain high-cost areas). “Conforming mortgages have benefited from an unprecedented loosening of credit by the Federal Reserve through Fannie Mae, Freddie Mac, Ginnie Mae, and FHA,” Berson says. “Not so the jumbo market. It’s completely moribund.” Jumbo-loan originations dropped 71 percent in the first three quarters of 2008. In California, million-dollar-home sales plunged 43 percent in 2008, the lowest level in five years, according to MDA DataQuick. Paula Brinton, a broker at Re/Max of Cherry Creek in Denver, notes that many adjustable-rate jumbo mortgages will reset next year. “And without financing, there’s not a lot the owner can do,” Brinton says. “That’s where the next round of foreclosures will come from.
- There are too many houses for sale: More than 10 months’ worth of houses were waiting to sell in April, according to the National Association of Realtors. A healthy market would be about 6 months. Distant suburbs have an especially abundant backlog. “These were growth areas where builders offered all kinds of creative financing to get people into their newly built houses,” says LePage. The farther out they are, the less attractive they are for new buyers. “People can get past a lot of concerns about the long drive to work, for example, or how sterile the neighborhood is if they feel they’ve made an investment that will pay off,” he says. Those incentives are now gone, and — with gas prices rising again — the exurbs will be hurting for years.
- Unemployment is too high: Until recently, subprime mortgages drove foreclosures. “For the second half of the year, joblessness will be the driving force,” says Rick Sharga, a senior vice president at RealtyTrac. As long as the unemployment numbers remain high, foreclosures will keep coming.
Economists and real estate pundits quibble over exactly when prices will begin to rise, but everyone agrees it won’t be soon. And, of course, some markets will do better than others. Even after the market does bottom out, most economists foresee several years of stagnant prices as people who’ve been holding back put their houses on the market and builders who’ve been sidelined begin to add new construction to the inventory. “House prices will probably be negative this year, zero next year, and then mostly stagnant for about five years,” says David W. Berson, chief economist with mortgage insurers PMI Group. “After that, the inventory of unsold homes should be worked off enough to go back to the historic rate of appreciation — a little bit more than inflation or about 4 percent a year.”
Why such a pessimistic forecast? Pick any measure of the housing market’s health, and you’ll find powerful and persistent headwinds.
Take Action: If you are a seller, get realistic about what you can get for your house. With so little upside in the foreseeable future, you may be better off to sell, even at a loss, since you can probably get back into a similar house at a lower price and very low interest rates. “Some of my clients see it as simplifying their lives,” says Brinton. “After watching what’s happened to others who are overextended, those who have good credit want to buy down,” she says.
If you are thinking of buying, remember that the benefits of homeownership will be what they always were — tax breaks, a hedge against rising interest rates and inflation, the stability of owner-occupied neighborhoods — but they won’t include the kind of massive run-up in equity that characterized the past few years.
First-time Home Buyers and Gutsy Investors Will Make Out Like Bandits
This may be the best opportunity first-time home buyers will have for decades. Not only are prices attractive, interest rates are hovering just above 5 percent, the lowest level in 40 years. And Uncle Sam is kicking in an $8,000 tax credit. No wonder first-timers accounted for 40 percent of all sales in April. In many markets, you can buy cheaper than you can rent. With 5 percent down and a 30-year fixed-rate mortgage on a $150,000 home, your monthly payment would be $805, easily competitive with rents for a similarly sized house in most places, according to Berson.
Speculating in the foreclosure market is far from a sure thing, but some real estate investment firms and a hardy band of investors are taking advantage of the suddenly reduced prices. Most “are responding to sharp declines in sale prices relative to rents, which creates a very good opportunity to buy rental properties,” says Dean Baker, co-director at the Center for Economic and Policy Research in Washington. The demand for rentals has grown as more homeowners sell or are forced from their homes. “Between 2005 and 2007, when the housing market began to really show signs of collapse, we saw an increase of 1.6 million single-family homes, condos, or co-ops occupied by renters,” says Michael Cohen, a global strategist with Property & Portfolio Research in Boston. “There’s a very good chance that the value of these properties will rise at some future point, and these buyers will get a good return on their investments,” Dean Baker says.
Take Action: First-time buyers, save enough for a down payment of at least 10 percent, but shoot for 20. “I have a lot of clients who make a bid on a house only to find it impossible to get a mortgage,” says Doug Murch, a real estate agent with Rose & Associates Properties in Austin, Texas. “Without decent FICO scores, it’s hard to get a loan even if you’re willing to pay a higher interest rate.” And follow the Golden Rules of home ownership: Buy when you feel secure in your job and you plan to stay in the house for at least five years. Allocate a maximum of 28 percent of your pretax income to your mortgage payment, including taxes and insurance.
If you decide to make the move and become a small-time landlord, make sure you have enough financial cushion to carry the expenses during stretches when there’s no tenant, to pay the marketing costs of acquiring a tenant, and to afford repairs. And don’t underestimate the mental toll of dealing with the demands of those tenants at all hours of the day or night.
Your Property Taxes Will Go Up
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It’s a straightforward formula, said Andrew Reschovsky, economist at the University of Wisconsin at Madison. Most states are swimming in red ink. Since legislatures hate to raise taxes, many are faced with draconian cuts to their budgets. The single largest item on most budgets is school aid. Ergo, school districts are going to be scrambling to make up the lost money, and they have only one significant source of revenue: property taxes. “In past research, we found that local governments raised property taxes 25 cents for every dollar of state aid lost,” Reschovsky says. “The cuts in state aid to local governments will be greater than they’ve been in many years,” he says, “and that puts more pressure on property taxation.”
With assessed values falling, local governments will be forced to raise tax rates. “When home prices were climbing, rising assessments kept rates in check,” says Reschovsky. “And most people paid their taxes. The big question now is whether citizens will push back against rapidly rising tax rates. No one really knows.”
Take Action: Property taxes have two components, the tax rate and the assessed value of your property. You have some control over the latter. Make sure that it’s in line with the current value of your home. If it’s too high, challenge it. Locking in a lower assessment right now will reduce your taxes for years to come. Only 5 percent of homeowners appeal their assessments, according to the National Taxpayers Union, despite the fact that as many as 60 percent of taxable property in the U.S. is over-assessed, and most of those who do appeal get some kind of relief.
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