When will the real estate bubble burst?
Originally appeared in Hills Publications, August 26, 2005 and ANG Newspapers, August 20, 2005
Is this still a good time to buy? To sell? Should you wait until after the market “crashes?”
I recently attended a presentation by Leslie Appleton-Young, chief economist of the California Association of Realtors (C.A.R.) and one of the country’s most respected experts in real estate trends. Appleton-Young visited the Bay Area to give local Realtors an overview of present conditions and predictions for the future.
Why are prices rising?
According to Appleton-Young, four words answer the question: strong demand, restricted supply. Low mortgage rates, move-up buyers, a flight from alternative investments and speculation (flipping) fall under strong demand. Constraints on new construction and a low inventory of homes for sale explain restricted supply.
In January 1988, California’s unsold inventory index was slightly above eight, meaning it took over eight months to sell the existing homes on the market. In January 1993, a strong buyer’s market, the index reached almost 18. In May 2005, the Bay Area index was only 1.5 months.
Is every Californian a Realtor?
There is an obvious correlation between home sales and Realtor membership. In 1970, fewer than 200,000 California homes were sold and C.A.R. had approximately 60,000 members.
In 1989, at the height of the last seller’s market, there were more than 400,000 closed sales, and C.A.R. membership soared to over 150,000. When, in 1996, home sales declined to around 250,000, C.A.R. membership retreated to roughly 90,000.
With projected 2005 sales in excess of 600,000, it is not surprising that C.A.R. membership is expected to reach 189,000 by year’s end.
Home prices an indicator
When I am asked about the market imploding, the big fear is that prices will reach negative territory. Since the 1970s, median California prices have risen at varying rates. It was not until 1990 that the median price of a home dropped below that of the previous year. Median prices breached 0% (and were minus) in six of the seven years from1990 to 1996.
A majority of current licensees were not even in the business at that time and it is hard for them to imagine having a seller bring to escrow, not receive, a check at closing. Those of us who went through it clearly recall the challenging times and remember the goal of agents was to “survive ’till ’95.”
In our area, the current seller’s market began in January of 1997 and, since then, prices have risen meteorically. Although California and local median prices are still rising, they are doing so at a diminished rate.
Why the market will slow
Appleton-Young cites five reasons for the inevitable slowdown:
- Housing affordability crunch. The median price of existing detached homes was $721,730 in the Bay Area and $662,238 in Alameda County in May 2005. When my “starter” buyers cannot find a two-bedroom home in good condition in a desirable neighborhood for under $650,000, this is a clue that lack of affordability will increasingly impact this market.
Note that I say “good condition,” because too many buyers disregard the connection between condition and value.
In 1988, 2718 California homes sold for one million dollars or more; in 2004, the figure was 33,107. Incomes in the state and locally are higher than national numbers; however, the difference is slight compared to the pricing disparity. This clarifies why the homeownership rate in California is almost 10 per cent lower than in the nation.
- Property tax hit for trade-up buyers. Paying approximately $800 per month in property taxes alone for the median Bay Area house referenced above is not feasible for many buyers.
- Homeowners will stay put longer because they took cash out in a refinance and do not have enough equity to move.
- Homeowners love their low interest, fixed rate mortgage, which is no longer available as rates are rising.
- Interest-only and Adjustable Rate Mortgages (ARMs) are being used by many buyers to bridge the affordability gap. It is predicted that, in many cases, severe and seemingly sudden (after three or five years) payment adjustments will be too much for recent homebuyers to absorb; they will be forced to sell, thereby increasing the supply of housing. This could begin within the next two years.
Signs that slowdown has begun
In addition to a decrease in the percentage change of the median price, other factors reflect a slowing trend. The proportion of closed sales in California with first-time homebuyers is lower than every year since 1981.
A combination of fewer move-up buyers and fewer first-time buyers is having an effect on the market. Although prices are up, as of May 2005, sales of existing detached homes have decreased about seven per cent year-to-date in Alameda County and 24 per cent in Contra Costa County.
Locally, we are beginning to see more homes sitting past their appointed day to review offers. Price reductions, while not widespread, are also becoming noticeable.
Leslie Appleton-Young confirms what I have been telling those who ask about the future of residential real estate in our area. I explain that, although a slowdown is inevitable and overdue, I do not expect prices to “fall off the cliff.” Appleton-Young offers a “soufflé'” simile, likening the future of the market to a soufflé losing air, as opposed to a bubble bursting.
In coming years, price appreciation and the number of home sales will be lower than in the recent past. There will be fewer real estate licensees. As the market “normalizes,” those who entered the business hoping for real estate riches rather than a career will look for other opportunities.
This is an excellent time to sell; sellers remain in the catbird seat. Buyers can still do well if they understand the market and are represented by a competent, caring Realtor. Despite the ups and downs of real estate cycles, owning a home is and will continue to be one of our best, long-term investments.
Condition is Critical
As Is Pointers, Part 1
As Is Pointers, Part 2