Tuesday, February 28, 2006

Is the real-estate bubble bursting?

Mack Reed of L.A. Voice thinks it might be. One thing's for sure, it can't go on like this forever, and another catastrophic event (earthquake, oil shock, terrorist attack) could really bust the market down.

What I always say is that the current run-up in home prices is due largely to the lending industry's radical change in the kinds of loans available. Home prices are based on what you can afford to pay, or what the bank thinks you can afford to pay, with crazy terms such as interest-only, variable-rate, 80 percent principal with 20 percent second, balloon payments, 40-year terms, and more that I don't even know about. And this is OK for many people because they figure they don't need to have any real money tied up in the house -- equity will fall from the sky in the form of 20 percent and higher yearly appreciation. The best way to tap that equity is to sell and get the hell out of Dodge. But if you need to live somewhere else, you plough that money right back in and at least have some actual cash equity in your home. Find all these colors annoying?

Let me pose this colored-type question: Has your income risen by 20 percent a year? How about 10? Do I hear 5 percent? I didn't think so.

All I can say is that the current pace of appreciation can't last forever.

Best case: Prices will stabilize for a period of five or so years, then will rise again, provided the economy can support it.

Worst case: The aforementioned catastrophic event throws the economy for a loop and prices plummet, making it impossible for people to recoup in a sale. Of course, if you didn't put anything down, it's like you had a very expensive rental for a few years, and "walking away," isn't quite so painful as if you put 20 percent down in cash money when you bought. But then again, if you based your purchase on equity gained from a previous home sale ...

Other worst case: Economic conditions cause the loan industry to stop offering so many "creative" products (notice how everything is a "product" these days?) and the amount of house that new buyers can afford is substantially reduced, leading to a crash in prices in which a overwhelming number of homeowners rush to sell before prices really fall, further lowering the prices due to oversupply.

Back to Van Nuys: Curiously, in our neighborhood the more expensive homes seem to be selling quickly. Stuff from $700,000 to $1 million (never thought you'd see the $1 million Van Nuys home? Well, it's about to happen) is going a lot quicker that the "lower-priced" houses. That's probably because the homes that have a bit more square footage and which have been extensively refurbished are going for $650,000-$850,000, while the trashed-out properties that will need $50,000 or more just to become habitable are starting at $550,000 and going up to $600,000.

The other part of this lopsided equation is buyers who are looking to flip the property and make quick money vs. those who actually need a place to live. I think the speculators are realizing that they need to get a below-market price to actually make money on the deal. The entire low end of the market seems to have a large percentage of sellers who:

a) inherited the property and for some reason think it's worth more than market value (and don't need to sell in a hurry)

b) bought the home with the expressed intent of flipping it and need to hit a certain price to make their profit.

Nothing scientific here, just anecdotal meanderings on my part.

Still who wouldn't want Rainn "Dwight K. Schrute" Wilson's house?

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