Tuesday, March 25, 2008

Don't Let Fear Blind You

FEAR is ruling the financial markets. Billions of dollars have been lost in mortgage-related investments. The Federal Reserve worked madly over the weekend to engineer a takeover of Bear Stearns and avert a systemic meltdown. But the big fear remains. How low will house prices go?

If prices continue to fall, mortgage defaults will move well beyond the subprime sector. Trillions of dollars in losses for investors are not impossible. But that doesn’t mean they are inevitable.
In 1997, inflation-adjusted house prices were close to their average levels over the previous half-century. Only four years later, the price of the average home nationwide exceeded anything ever seen before in the United States. Prices continued to rise for another five years, peaking in 2006 at nearly twice the average price in 1997 (as can be seen on the graph on the bottom right, which is based on data collected by the Yale economist Robert Shiller). If house prices are heading back to the levels seen in 1997, then we are facing catastrophe.

But there are good reasons to believe that much of the increase in prices was a rational response to changes in fundamental factors like interest rates and supply. The deeper fundamentals continue to suggest strong housing prices for the future.

Sure, speculation did run rampant toward the end of the housing boom. (The debut of the reality television show “Flip That House” on Discovery Home Channel, followed shortly by “Flip This House” on A&E, was a clear sign that the boom’s end was near.) Prices will fall further, especially in the speculative developments built on the outskirts of the major cities. So yes, we overshot the fundamentals.

Still, especially in coastal areas where zoning regulations have restricted the supply of land that developers can build on, house prices were driven up by increasing population, low interest rates and strong economic growth.

More and more people want to live on the coasts, but land is hard to come by in places like Manhattan and San Francisco. Cities and regions built on ideas — like Boston, Los Angeles, New York and the San Francisco Bay Area — have grown even as areas built on manufacturing, like Detroit and the Rust Belt, have declined. And of course, government isn’t getting any smaller, so Washington and its suburbs, another hot spot of rising house prices during the boom, will continue to grow.

Even in places where land seems plentiful, zoning and other land-use regulations have made it scarce. To meet demand, we should encourage high-density development, but homeowners fought to restrict housing supply when house prices were increasing. Now that house prices are falling, the incentives of owners to restrict supply are even stronger.
Several studies estimate that the average house prices of 2004 were close to fundamental levels, so we may see prices stabilize near that level. Just like any market, bargains are to be had for the careful buyer. Did you know that on days when the stock market is down, often half the stocks are up for the day? You can't paint an entire market, let alone state or city with the same brush. Pasadena Real Estate is very different than Hawthorne yet they are both in LA County. Good deals are to be had by the prudent and patient.


Phil Caulfield said...

Here in San Mateo County, California, we are seeing multiple offer situations in desirable areas, and houses sitting unsold for a long time in others. You are right, it is location, location, location



Here in Westwood, we are seeing similiar activity. 1/3rd of all homes sold this year in area codes 90024/25/64 (Westwood) have sold over asking price. Real estate will always be location, location, location. The premium areas are remaining pretty stable.

Anonymous said...

Don't listen to this guy. Nothing but major price corrections are ahead. Buy now and you'll regret it.

Real Estate is still wildly over priced - irrespective of location. No LA market is immune.


anon #3.. Well you don't have to listen to any oppinions I have but you can't refute facts and statistics. Of the 27 homes sold in Westwood this year, they are selling 98.09% of the list price. Average days on market just over 30 days. So you can comment all you want that major corrections are ahead, but its just not the case in many areas neighborhoods on the Westwood.

Anonymous said...


You sound like a Realtor.

Neelakantha said...

Yes, I agree with this - Good deals are to be had by the prudent and patient.