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Perspective: The Housing Market: Facing Up to Reality
Published: June 24, 2008
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By Robert Sheridan, founder, Robert Sheridan & Partners
I don’t know how anyone--whether you’ve been through a depressed cycle or not--can be surprised about the terrible state the housing and financial markets are now in. For more than a year, there has been this monthly "shock and awe" campaign about disappointing housing sales in the media, by analysts, among lenders and the Fed. This ought to stop.
There wouldn’t be this mass industry disappointment if expectations were realistic in the first place. Obviously, they are still not. So let’s remove the blinders and take an unvarnished look at where we are now:
• The severity of the market continues to be underestimated.
This cycle of the housing market has been consistently underweighted. By that I mean there has been a general failure to realistically assess what’s happening in the housing market.
Sales started to decline materially in January 2006 (and earlier in some markets) but prices kept going up until about May 2006. The fact that prices were still going up well into the second quarter of 2006 was probably the reason there was widespread denial that the market had "fallen out of bed," but the reality was that it had fallen. An expected recovery in September 2006 and an anticipated spring surge in 2007 never occurred. Instead--if you were paying close attention to what was happening on the ground--sales absorptions continued to shrink.
By May 2007, it was clear that the market continued to get darker and darker. But buyers were still being very aggressive in pursuing acquisitions. Therefore, prices for product at the wholesale level remained unrealistically high. Then came the financial turmoil of July and August 2007 as a result of the sub-prime mess, which was an accident waiting to happen. Again, the market continued to get darker and darker.
In fact, in the second half of 2007, the market changed every few months in significant ways. Apparently, there are still people who think it will start recovering late in 2008. We certainly do not think so (recognizing that there are variations among markets), at least on a nationwide level. Some markets may not recover until 2010 and, in cases like Florida, a turnaround could take as long as three to five years.
When the markets do bottom, they are certainly not going to bounce up in a kind of "V" graph. The sales rate chart will not look like a funnel. It will look more like the bottom of a frying pan. That is, once prices do bottom, we think it will be a good while (varying by market) before there will be enough absorption to give people rational courage to start raising prices.
Without a doubt, this housing cycle is more severe than any in recent times and continues to be underestimated.
• Price change is coming.
Because there is still an enormous price gap between sellers and buyers, we think 2008 is the year when prices will start coming down significantly. The longer it takes for prices to come down, the longer the cycle will run. But first, some context.
For the first six to nine months of 2006, there was a general denial that the market had “fallen out of bed.” During the second half of that year, we saw the victory of hope over reality. People still expected the market to rebound fairly quickly. By 2007, mezzanine lenders were keeping projects alive but had started asking themselves, "Are we throwing good money after bad?"
Now, in 2008, something has to give. We still believe that it’s going to take significant price decreases in order to give would-be buyers the feeling that they’re not trying to catch the proverbial "falling knife" and start buying.
• That price change could be steep.
As of April, San Diego prices are down about 25 percent but that’s very much the exception to what’s happening in the rest of the country. Prices, for the most part, are only off about 5 to 10 percent, which is why this is essentially a "non-market."
What do I mean by non-market? Sellers are unrealistic about the value of their homes, so prices are still unrealistic. In general, we have data that suggests that prices are down 5 to 10 percent for single-family detached in most markets. Clearly, that hasn’t brought out the buyers. It is hard to believe that anything less than another 5 percent (or more likely 10 percent) will be required before buyers feel they’re approaching a point where it’s safe to buy.
For condos, the decrease will be even greater--more like subsequent decreases of 15 to 25 percent and, in some cases, even more. A Fortune magazine analysis in November 2007 said the housing prices were 15 percent too high. A February 8, 2008 article in Business Week by Peter Coy suggests it’s more like 25 percent.
• A re-finance boom? Don’t count on it.
The steps taken so far by the Fed will NOT fuel a re-finance boom. The reason is straightforward: The sub-prime borrowers who need the help will not be able to re-finance because, in all likelihood, the value of their homes have diminished to the point where they no longer have any equity and they’re living with a mortgage that is greater than the value of their home. This is usually referred to as being "upside down." The more polite description is negative equity.
The people who will be able to take advantage of lower mortgage rates are people who are not in trouble in the first place. So yes, there is going to be an increase in re-financing. But it’s not going to be a re-finance boom--nor will it help the people who need it.
Robert Sheridan is the founder of Robert Sheridan & Partners, a firm overseeing condominium conversions based in River Forest, Ill. Among the first proponents of apartment-to-condominium conversion in the 1970s, Sheridan had a founding role and co-chairmanship of the National Multi Housing Council.
