Last night I pulled up some very encouraging statistics. The total number of unsold homes in Long Beached dropped from 1033 to 819, in just the last month. A clear indication that the market is firming up. In addition, December saw increased sales activity. Good homes that had been sitting for a while finally started selling and little new competition came on the market.
Why was December such a welcome relief? Because the market was actually getting quite scary. When the best priced homes on the market DON’T sell, prices will fall until buyers decide to re-enter the market. For much of the fall, prices seemed to be in a free fall, searching for the magic price that buyers were willing to pay.
With a combination of lower interest rates and a 8-10% price drop from peak values, homes finally started moving again in December.
To get a feel for the ebb and flow of the market, I have been keeping a close watch on the relationship between the number of monthly sales and the number of unsold homes.
It comes down to supply and demand. The market went bonkers in the Spring of 04 and 05, because there were almost no homes on the market. During these two periods about 250 homes sold every month, and there were only about 200-300 homes for sale. As soon as homes hit the market they would sell, and often for $25,000-$50,000 more than an already optimistic list price. But in the fall of ‘04 inventory rose to around 600 homes and the market slowed considerably, but with interest rates still extremely low the market again took off in early 2005. At the end of 2005 buyers were exhausted, trying to digest another year of 20%+ price appreciation.
As 2006 rolled around the slow steady march of the Federal Reserves “metered” rate increases was starting to take it’s toll. From a low of 1.0% in June of 2003, the Federal Reserve had 13 rate increases through the end of 2005 and in 2006 there were still 4 more to come. Rates hikes finally rested in June of 2006 leaving the short term rate at 5.25%.
See Federal Reserves web site for a history of rates:
http://www.federalreserve.gov/fomc/fundsrate.htm
By my calculations, a buyers home payments went up about 10% even if home prices stayed the same. The first half of 2006 saw the market tread water, trying to hold on to peak values, but inventory toward the end of Spring kept to climbing, as more sellers put their homes on the market and not enough buyers stepped up to the plate. Then, after 4 months of increasing inventory and increasingly frustrated sellers, unable to get “their” price, the market shifted dramatically. Prices were slashed with the net result being home prices falling 8-10% during the year, with more expensive homes seeing a greater drop and lower priced homes holding value better. There were quite a few sellers that realized that “their” price wasn’t going to happen and that if they wanted to get the property sold, they would have to lower their price. Some of these sellers were making multiple payments on both their new home and old home, and simply needed to sell.
The correction was very quick. For the first time in 10+ years, I saw some large price reductions. Homes sellers that had held out for top dollar obtained in first part of 2006, made sweeping price reductions of $50,000 – $75,000. These price changes often elicited multiple offers providing some comfort that buyers were out there at the right price. But the balance of 2006 remained slow and inventory continued to climb. Every two weeks there were a 100 more homes on the market. In late 2006, I wondered, was this very large and immediate correction of 8-10%, just the start?
During the fall, on several of our more expensive listings in the one million dollar range, we received as many as 4-5 low ball offers, usually about $75,000 – $100,000 below already reduced list prices. But even with multiple offers, no buyers were willing to step up to the plate. A clear indication that buyers did not agree with the current list prices. However, with 4 or 5 buyers, you would think it likely that one buyer might step up to the plate? Possible. Or maybe these 4 or 5 buyers would just loose interest and the market might continue correcting. The late summer and fall was certainly a very nervous time for many home sellers.
Inventory finally stopped climbing in late 2006. But could this just be seasonal? How many people want to put their home on the market heading into the holidays? It would be hard to say what the new year would bring, and December is not usually a month to write home about.
Then something out of the ordinary happened in December. All of a sudden a bunch of homes got snatched up, and very few new listings hit the market. Enough properties sold so that unsold homes dropped to 800 from a peak of 1,200, a significant sign that prices were bottoming.
Finally, after continuous price reductions, interest rates easing from the high 6% to the low 6% range, combined with pent up demand from a very slow fall, properties started to move again.
What is likely to happen in 2006? Going forward I anticipate a flat market. Why would I not forecast more price increases. There are several reasons.
First, while inventory dropping from 1,200 homes to 800 homes, is great news, and has helped create a floor for home prices, it is probably only strong enough to stop price declines, not strong enough to reverse the trend and re-ignite a bull market. Sales activity hasn’t really gone back up. The number of sales is still in the lower range, around 200 or less per month.
Secondly, prices had risen enough to hit the breaking point of a buyers ability, and rising interest rates put buyers over the edge. Coming back down in price and rates will certainly help affordability which had stretched buyers beyond the breaking point. However, the lower prices and rates are repairing damage, not making a strong market stronger.
In talking with lenders over the last year, I found a common thread that many buyers purchasing properties were using creative financing such as “Stated Income” or “B Paper” loans or were using 100% financing. This is an indication that buyers had neither the income, credit worthiness, nor the down payment to qualify conventionally. So the market was running out of steam and a correction should not have been a surprise.
Going forward, many of these buyers may need to unwind there excessive debt, putting many homes on the market or greatly increasing foreclosures. It is less likely for foreclosures to dampen some of the more established neighborhoods in Long Beach, but none the less I have started to see some happen, where none had existed for years.
Economically, the big question on everybody’s mind is whether a slowing housing market might turn into a bursting bubble and spread throughout the rest of the economy, creating a snowball effect. Or will inflation moderate enough so that the Fed can ease rates and help the housing market get back on it’s feet and create a much hoped for soft landing?
In the darker days of late fall, I was not so sure about this outcome. But as of last month, the soft landing looks like a more realistic outcome.
What would a soft landing in housing look like? My best guess for this scenario will be 3-5 years of housing prices remaining stable, while buyers incomes increase and play catch up. There might be times when prices move up or down a little, but it will take some time for pay raises to increase affordability before prices head back up.
When the vision of every increasing prices disappears from a buyer’s landscape, there is no longer an urgency to buy now. Maybe waiting till you really can afford to buy is not a bad thing. So when you remove the “Frenzy” factor, you also remove the “Frenzy” premium, and price movements become more orderly.
And an orderly market is preferable to a market that Booms and Busts. It just may be possible that the trip that real estate has had to the moon will likely come back to earth safely, with just normal wear and tear. And as usual, I look forward to keeping you posted.