Housing's Downward Spiral

I can only speak for what I have observed on the local market, but I do believe that what I have witnessed is representative of much of the rest of the state and country.  As a real estate appraiser, I had a front row seat for the bubble and burst in the real estate market. 

Locally, market values began to increase late in 2004, at a rate above typical market cycles.  During 2005, home prices in this part of Arizona increased approximately 50%.  Heading into 2006, there continued to be some price appreciation but during the year they leveled off.  The year 2007 began with fairly level prices but ended with the beginning of the burst already in the rearview mirror. 

Since 2007, we have continued to experience declining market values and have not yet found the bottom.  To date, it appears that the home and land prices in this area have not only lost the run-up in prices from 2004-2006, but are presently at levels of around 2000-2002, and still in a state of decline.  We continue to have an over-supply of listings in almost all categories (land:  vacant lots and acreage, homes:  from small beginner houses to the large custom homes).  Foreclosure activity is present at every level - price and size.  Basic economics dictate that as long as there is an over-supply of listings, there will continue to be downward pressure on prices.

Where and when will this slide hit bottom?  Under normal conditions, I believe that we already would have bottomed-out and would have begun a gradual recovery in the real estate market.  We do not have "normal conditions".

We have a government that is altering just about every aspect of the process.  They are offering tax credits, subsidized housing, refinance opportunities where homes are worth less than the loan balance, they are once again sponsoring loans with little to no down payment and accepting transactions where sellers pay the buyers' closing costs.  The stated intention is to spur the housing market.  The actual result has been a dismal failure.

We have reported unemployment around 9.5%, which represents only those filing unemployment claims, and real unemployment around 16%.  We have consumer confidence at a very low level with a high degree of uncertainty as to the future economic outlook.  We have national leaders intent on socializing various aspects of our economy and specific industries.  The last two years of bailouts and stimulus plans, which have not worked, have the public in a state of confusion to some degree. 

This negative atmosphere has dominated much of the housing market.  Where there are buyers, they are expecting and receiving bargain prices.  With the drastic reductions in home values, many homeowners find themselves upside-down (their home is worth less than the balance of their mortgage).  Some are staying and hoping for better times ahead.  Others are losing their homes.  Some who are experiencing foreclosure have no options due to job loss, etc.  Others have given up on a quick turnaround in values and have accepted, that financially, it does not make sense to keep making payments on a bad investment.  They choose to walk-away and let the lender have the home back, even though they could continue to make the payments (this is referred to as a "strategic default"). 

The lenders and investors are encountering staggering losses.  Many, if not almost all, properties that they take over in the foreclosure process, are being ultimately sold at a loss to the lender.  It is not unusual for a REO property (real estate owned - foreclosure) to be sold by the lender for less than half of the mortgage balance. 

That is the current picture of the housing crisis.  This is my assessment of the situation. 

In my opinion, the downward spiral in prices is self-perpetuating.  Actions being taken are having the net effect of causing more actions to be taken.  The banks (this will be an all-inclusive term to cover all lenders, investors and the secondary mortgage market - Fannie Mae and Freddie Mac, plus FHA and the VA) appear to be adopting a mindset of, "just deal with the loss and move the inventory".  There is some pressure on the banks to sell the REO properties in their inventory in a short period of time.  Holding these assets costs additional money each month.  They do not see any advantage in being patient in finding a buyer as the value will be lower three months from now.

Additionally, there are numerous foreclosures needing to be moved by various banks.  There are a limited number of buyers, even with historically low interest rates and bargain prices.  The banks end up competing with each other for the next buyer to come along.  As one bank lowers the asking price on an REO (and this is done on a routine basis - every few weeks), the other banks feel pressure to then lower their REO prices in order to compete.  This creates a spiral that has resulted in prices for some properties that are lower than they have ever been in certain developments.

Investors have learned to be patient, the price will be lower, later.  Banks have learned to be impatient and many are accepting very low offers.  In many portions of the market, which have been heavily affected by foreclosures, lender activity is dominating the market and continues to re-establish new lows for market values.  REO sales control the market in some price ranges.  If a homeowner needs to sell their home, they are forced to compete with lender-owned properties.  This results in non-REO homes being sold in the same price ranges as the REO homes. 

Locally, the lowest priced homes appear to have decent activity.  Homes that were $350,000 at the beginning of 2006, can be purchased under $200,000.  Higher priced homes are rarely selling as there are a very limited number of potential buyers.  As there is considerable REO activity in the higher price ranges, these REO listings are basically establishing the market.  As the banks continue to drop their asking prices, the market collapses and everyone loses.  Currently, there are luxury homes for sale as REO listings with asking prices less than one third of the last sale price for the home.  Some vacant lots are less than one fourth of the last sale price.  Still, very few takers. 

The policy of a continual lowering of asking prices by the banks not only causes their losses to be larger, but also forces the taxpayers to absorb more of the losses as we continue to bail out the various players in the loan process.  The competition and pressure among the banks to move inventory has established the unending, downward spiral in prices.  The much lower market values, as a result of the REO activity, in turn, causes more people to be upside-down and to end up in foreclosure.  The additional REO on the inventory adds more pressure to get it sold, even at more price reductions.

Currently, some of the major players in keeping the market from finding the bottom and leveling off, are the banks - some of the ones who have the most to lose.  Until they decide that the prices are already too low and agree to hold steady, we will not see stability.  They have the ability to help themselves and the rest of us at the same time.  Will they learn patience?  It truly is a virtue long forgotten in this market.