Wednesday, February 01, 2006

A Vicious Downward Cycle?

Certainly a major event like a war, a nuclear attack, a recession, George Bush growing a brain, etc. would be sufficient to cause a decline in the housing market. But instead, it will probably be something seemingly minor. So what might be the innocuous event (and here) that starts the vicious cycle that sends the housing market down? I think it might be as simple as a change in mass expectations.

Try this on for size:

If expectations change, if enough people think house appreciation is flat or small, then there will be less demand for houses. Certainly, people would have a harder time justifying paying such stratospheric prices for a house ("why buy a house when it won't increase in value very much, if at all, in the next few years and I can rent the equivalent house for much less at least for now? And if I rent now and prices decline, then I can buy more house later. It's a win-win.").

People who bought a house recently will be unwilling to sell below their cost, so most of them will just sit and wait, hoping; some might take the hit because they are forced to, but most won't.

But what about all those people who bought their house a while ago? They can afford to sell at a steep discount because they've built up significant equity. If they can afford to wait to sell, then they too will try holding out for top dollar. But what about those folks who bought a long time ago and must sell sooner rather than later for whatever reason? They will mark their house price down not because they want to but because they have to and because they can afford to. Because house prices are set "at the margin" these folks just reset the sale value of all the houses owned by the "hold out, wait and see" crowd as well as for the next person who bought a long time ago and is now deciding to sell and can afford to discount. And so on and so forth...

Since house prices aren't appreciating much, if at all, the cash-out refi (aka "housing ATM") fails, resulting in people spending less on stuff and services. Companies that make stuff and provide services aren't earning as much as before, so these companies lay off some employees. These laid off employees have difficulty making their housing payments or find work somewhere else and have to relocate and so have to sell their house.

And so on and so forth...

Some choice quotes:
If there's indeed a U.S. housing bubble - something most analysts now seem to acknowledge - it's deflation will have an impact, and perhaps a serious one.

We're probably going to find out over the coming months, because the evidence keeps piling up that the air is leaking out of the U.S. housing market.

The latest sign comes from sales of existing homes in December, which surprised analysts by dropping an unexpectedly sharp 5.7 per cent, to the lowest level in two years.

Price gains, which had been soaring at an annual rate of 16 per cent two months earlier, chilled to just over 10 per cent. The backlog of unsold homes, which had risen recently, remained high.

There are plenty of other signs that residential real estate is losing its powerful ability to boost economic growth.

Ian Shepherdson, chief U.S. economist with High Frequency Economics, expects price increases to slow much more, deflating homebuyers' expectations of future price gains. "This will be the trigger for a serious collapse in home sales later this year," he predicts. "The housing market is a bubble and it will burst."

All this is scary stuff if you believe that when a bubble bursts, prices plummet. Happily, that's not always the case. For the housing market, all that would be required to burst the bubble and collapse speculative activity would be for prices to plateau, or even to grow much more slowly.

This would still exert quite a drag on U.S. economic growth. Beyond the substantial impact of any pullback in home-building, the so-called "wealth effect" would evaporate.

The bad news is that this benign picture assumes that nothing else goes wrong - with interest rates, with the global economy or with highly speculative markets like California's, where it's at least conceivable that housing could crash, not just deflate.
It seems it is already happening. The number of listings in the Bay Area showing price reductions has soared.


Anonymous Anonymous said...

You could've made this point without the instinctive Marin Bush bashing.

Feb 1, 2006, 2:19:00 PM  
Anonymous Anonymous said...


I have been checking out the Marin Heat Index site and there are some very telling charts that I think are clearly indicative of a slowdown. I won't bore you with how the index is calculated but anything between .8 and 1.24 is normal. Currently the overall market is a fairly chilly .67.

Condos are plummeting, having been a 2 or above (meaning spicy hot) for all of 2004 and most of 2005, are now at .55 (frigid).

Houses under $600k were a piping 3-ish for most of 2004 and 2005 and took a dive in fall 2005, currently registering .75 (tepid).

Houses between $600-800k are still holding up at 1.63, not far off the previous two years averages.

Houses between $800k-$1m are tepid at .89, well off their 1.5-2 range of the past few years.

So, with condos and low-priced SFH's dropping dramatically, either investors are bailing and/or or move-up buyers are trying to unload so that they can step up to the $600-800k class (or perhaps cashing out and leaving?)

Once this low-end inventory is digested (i.e. sold at below recent comps or removed from the market), the only bright spot of 600-800k is going to hit a wall and I think it is pretty much game over in Marin real estate until incomes catch up with recent prices.

Unlike every realtor that thinks this is a normal seasonal slowdown, these graphs do not lie. Historically, by February, things start picking up around here and that is clearly not happening.

So, even I am questioning the wisdom of hanging on to all three properties through the next 5-7 year flat spot. The only thing that confuses me a little is our local economy seems to be doing well these days and I am not sure we have ever had a significant decline in home prices in the face of a relatively strong economy.

Of course as the absence of the housing ATM takes its toll on consumer spending, that economic decline could start soon.

Feb 1, 2006, 3:53:00 PM  
Blogger fredtobik said...

There hasn't been a house for sale in my area since October. I am anxious for summer...

Feb 1, 2006, 4:10:00 PM  
Blogger Marinite said...

As far as California is concerned, I think San Diego is leading the charge in downward house prices. Marin is following with a few months lag time. That's what it seems to me at this point anyway. I don't think Marin will hit bottom quite as hard as SD. But hard enough. We'll see...

Feb 1, 2006, 5:29:00 PM  
Anonymous Anonymous said...

I buy probates', foreclosures, vacant houses etc. When a forced sale happens at the local courthouse that deed is called a "trustee's deed" or some variation of the sort. Well over the last few years I've seen nothing but one, two and maybe three of these sales each month. While doing research on a foreclosure yesterday I was on the recorders online research page and went to see if things have changed for the new year and BOOM! Trustee's deeds went up to 8 in one month. This is a small number but significant because the amount of trustee sales almost tripled in one month. That's huge since trustee sales allow for a more competitive market place ( why should I buy your house for 500k when I can get a foreclosure for 450k? ). This goes back to the spiral of the market dropping. Now that competition is begining to show it's face, homeowners who have to sell this must be done, will have to settle for a new price...oh and then it happens again and again and again and again.....

Feb 2, 2006, 7:06:00 AM  
Anonymous Anonymous said...

That previous post was for Solano County.

Feb 2, 2006, 7:06:00 AM  
Blogger sf jack said...

"So, even I am questioning the wisdom of hanging on to all three properties through the next 5-7 year flat spot. The only thing that confuses me a little is our local economy seems to be doing well these days and I am not sure we have ever had a significant decline in home prices in the face of a relatively strong economy."


FWIW - the '89-'90 housing cycle top was *before* the mild (by national standards) '91 recession.

So some would say it was a "cause" of that recession, which was then extended locally by a California recession (defense layoffs in ensuing years down south, etc.).

It could be different this time in that California stays stronger while there's a national recession.

But I doubt it.

Feb 2, 2006, 9:53:00 AM  
Anonymous Anonymous said...

Great post...yes the real estate decline is really well underway.

I just read another very insighful article by a San Diego real estate broker, it too is MUST READ. It is located at:

Feb 3, 2006, 9:09:00 AM  
Blogger Marinite said...

When you want to post a long URL, pleae use


Feb 3, 2006, 1:15:00 PM  

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