Wikinvest Wire

Waiting for that one, dumb home buyer

Thursday, March 27, 2008

Amid the very low real estate sales volume in many parts of the country today, the prices of those few homes that are sold are now falling much faster than the asking prices of homes currently for sale.

That fact is clear to see in many neighborhoods as sellers sit and wait, either not knowing or not caring that they have little chance of getting anywhere close to what they're asking unless that one, dumb home buyer shows up who knows less about real estate market conditions than they do.

The New York Times had a story about this yesterday - what some call "riding the market down" - and they touched on a couple of the key issues:

In most other areas of the economy, this combination of plummeting sales and stable prices would not happen. When demand for airline tickets drops, the airlines cut their prices until they have sold their seats. When stocks become less appealing, share prices fall, sometimes sharply.

Just try to imagine stock prices staying roughly flat over a three-year period while sales volumes sank because investors considered the market overvalued. Bear Stearns is still worth $150 a share, and I’m not selling until someone pays me $150!

Real estate, though, is different. For both economic and psychological reasons, there is no asset more conducive to hopeful overvaluation.
That means real estate slumps tend to grind on for years, until sellers submit to reality and reduce their prices.
In many ways, it would be better if the housing correction would happen more swiftly and sharply. The pain might be worse, but it would be over quickly. We seem to understand this principle when we’re removing a bandage. Why, then, is it so much harder with housing?

Because houses are almost perfectly engineered to trick owners into overvaluing them.

For starters, people have an obvious emotional connection to their house. After you have raised a family or enjoyed long meals with friends there, you are naturally going to place a higher value on it than a dispassionate buyer would. It’s your home.
David Laibson, a leading behavioral economist, categorizes this sort of behavior under the heading of “the principle of the matter.” His point is that people often go to great lengths to avoid taking a loss — or simply having to acknowledge one. “Even a small loss evokes a sense of frustration,” said Mr. Laibson, a professor at Harvard. “There’s something magical about ‘at least breaking even.’ ”

Often, this hurts no one so much as it hurts the would-be sellers. They stay in homes where they no longer want to live, rather than accepting their loss and moving on. Or they move but endure the hassle of renting out their old home, waiting, usually in vain, for the mythical buyer who understands its charms. All the while, their money is tied up in the house, and inflation is eating away at its real value.
There are a bunch of houses in our neighborhood that have been on the market since 2006 and the asking price hasn't budged. In some cases the price has been lowered by a tiny amount - for example, from $595,000 to $589,000 - in what seems to be a mini-capitulation for the benefit of either themselves or their real estate agent.

They look ridiculously out of place now that bank foreclosures are coming onto the market priced hundreds of thousands of dollars lower.

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staghounds said...

There is also the fact that you can live in your house while it sits on the market.

I haven't noticed the home price crash in my neighbourhood.

Nick said...

The analogy to stocks is very insightful, but it doesn't go far enough. Stocks have a buy and sell asking price too. The stock value is said to be the last sale price, but the buy/sell spread can be large if the stock value is uncertain, or trading is low. Home trading is just very low, on the order of years, and there's no forced valuation, because each house is unique.

But to be fair, it's not like homeowners are the only people confusing the upper limit of the spread as the valuation. The Fed is "buying" MBS's at face value, even though their spread is down to as low as ~30 cents on the dollar, and they are just as illiquid at the moment as overpriced houses...

Anonymous said...

I see this in my neighborhood. Houses just sit there empty with a for sale sign out front and other for sale signs pop up and come down because the seller (in many cases the bank) has priced them right.

getyourselfconnected said...

When the wife and I were hoe shopping (we never bought) I was laways cracked up when a $400,000 home was "price reduced" to $395,999. Like that $4000 makes any difference! What always kept me from buying was the knowledge that there were suckers that thought that $4000 made any difference. Long way to go yet.

getyourselfconnected said...

Meant HOME shopping above, sorry! Hoe shopping would have been Eliot Spitzer territory!

Anonymous said...

I prefer hoe shopping over home shopping anyway

Anonymous said...

Let me give you some rough numbers real quick. There are approximately 350,000,000 Americans and about 60% of those own homes. This means there are 210,000,000 American home owners. If each homeowner looses $100,000 on average and 90% of these are maxed out on their equity, we are looking at a 18,900,000,000,000 problem. That's right, 18 trillion. These numbers you have been seeing about hundreds of billions are not even close to the loss we will see. And the government thinks they can plug a 18 trillion dollar hole with a 150 billion dollar stimulus package. STAND BY TO STAND BY.

JohnP said...

18 trillion ....??? Let see, if the homes referenced in the post performed like those in my area of AZ, using OFHEO statistics,over the past 5 years, where we gained 78% and then gave back 3.8%. This converts to about a $10-15,000 loss in real dollar value, assuming you were dumb enough to try and sell during the current real estate market. Homes aren't market-to-market daily, like stock are, and even in the stock market no real loss is incurred until you sell.

Anyway,that means there is a lot of wealth still out there ... TREMENDOUS wealth actually ... The BIG UP follwed by the current down leaves a BIG positive net gain.

Maybe we just grabbed the 100k number...

you do the math, my crayon just broke.

Anonymous said...

60% owns home doesn't mean each person in that bracket owns ONE individual home. Say, a family of four owning a house means they live in a house they own. So, for 350 million americans and 60% home ownership, and assuming an average 4 people family, there are about 52.5 million houses ...

Tim said...

A short time ago, B.D., a long-time real estate broker in the West sent me a note that contained the following:

"I loved this article and plan on taking a copy of it (with your permission, of course) on all my future listing appointments!"

Permission was happily granted.

Anonymous said...

I got lucky and sold my home in the middle of last month. It had been on the market for 6 months and I lowered the price aggressively over the 6 months to move it. In total I came down about 10% from when I originally listed it. I had almost 150 couples come through and not a single offer. I got an offer on New Years Eve and took it and ran.

That being said many, many people are in denial about home prices and are holding on hoping the prices go back up. Just yesterday a coworker INSISTED that the prices should be high because of demand.

I will not be buying another house for at least a year till it craters. I am in cash and am staying that way.

Nick said...

The number I have read for total home value in America is 26 trillion; I don't know how accurate that is, though (although it seems plausible). If the market drops 40% nationwide (my WAG for the bottom), that's a loss of 11.2 trillion dollars in phantom/bubble equity. While it's true that it's a large number, a relatively small percentage of it is tied up in bad loans, figure 10% tops. That actually meshes well with the best guess for the total losses due to bad securitized mortgages, which was about 1 trillion. Of course, that makes the IB's most recent collective estimate of 350 billion still a little optimistic...

Side note: I almost put my condo on the market 6 months ago, thinking I could still get 80-90% of the bubble value, and take out a healthy profit. The thing that stopped me was my 30 year fixed at 5.6% and my belief then and now that we're headed for large-scale inflation, which will reduce my effective payment and would steal away cash holdings. It didn't seem like a good bet, when I'd always planned to convert it to rental property eventually anyway, and hold it for the duration of the mortgage; but it was a tough decision.

That said, I'm definitely not going to buy anything else until the market bottoms either. Everyone who thinks the market should be higher is welcome to buy now, and put their money where their mouths are; I wonder how many NAR members are buying atm...

Anonymous said...

"There are approximately 350,000,000 Americans"

BZZZZZT! The United States currently has a population of just over 303 million. How convenient of you to exaggerate it by more than fifteen percent.

"This means there are 210,000,000 American home owners."

How many three year olds own homes?

"If each homeowner looses $100,000"

The mark of a cretin - the inability to spell "lose."

"90% of these are maxed out on their equity"

Total home equity just fell under fifty percent (for the first time). In fact, one third of homeowners own their home free and clear.

"we are looking at a 18,900,000,000,000 problem"

I just read today (from a good source - not from someone like you) that the TOTAL value of all residential real estate in the U.S. comes to about 21 trillion dollars (I see in a later comment that Nick found a 26 trillion number someweher - certainly in the right range).

This ranks as the stupidest piece of "analysis" I have ever read.

stocksystm said...

About 50% of internet users are cretins.

Anonymous said...

All posts have some validity, but some seem to show that they don't completely understand the big picture here. I've found it useful to keep looking beyond the obvious to find the deeper trend and effects on your finances of this mess.

example: Selling a home to avoid losses later makes sense at first blush. But you have to understand the macroeconomic picture fully. Due to several factors including inflation expectations and balance of trade issues, the odds that mortgage rates will remain this low in a couple of years is about nil. So which is worse, losing 20% more of your home's nominal value with your current 5.75% mortgage, or selling and buying later at a 20% discount but having to get a 12% mortgage to do so? You really have to crunch the numbers and see what's best.

Example: Not everyone can live in a house while it's for sale. They may have a job transfer, or job loss which makes the current payment unaffordable. Rents are much lower than carrying costs many places, so renting it out means you're still hemmoraging cash. Anyone who can slash the price to get a sale should do so. Unfortunately, many owe too much and can't do that.

THE BRIGHT SIDE: If inflation does take off badly, you could be paying off that low fixed rate loan with devalued dollars in a few years. But if you're a renter, expect to see rents rise with inflation.

All this is subject to short/medium/long term changes.

How To Sell A House said...

What people need to realize is that if they do not absolutely have to sell their house right now they should not. Many people want to move but do not have to move and are trying to sell. They do not realize how bad it actually is until they put their house on the market for what they think their house is worth.

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