Market a real fixer-upper

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The real estate industry suffered such a freefall in 2007 that even the most hopeful scenario was for the market to hit bottom by summer, or by autumn, or by Christmas. That turned out to be overly optimistic.

Three months into 2008, the bad news keeps rolling in, and most analysts agree the bottom everyone kept predicting remains elusive at best, and years away at worst.

“I think we are a ways from the bottom — and a long way from any indicators that would even hint at an upturn,” says Mike Simonsen, CEO of Altos Research, a real estate data firm based in Mountain View, Calif.

“It’s a gigantic mess,” agrees Lewis Goodkin, president of Miami-based real estate analysis firm Goodkin Consulting.

There’s no simple answer to how the housing market got into that mess and figuring how it will come out of it is an even more torturous undertaking. But the complex process can be condensed into the following six areas:

1. What went wrong

“Just about every measurement declined in 2007. It was a bad year. Nobody can put a good light on this,” says Lawrence Yun, chief economist for the National Association of Realtors, or NAR.

The trouble started in 2006 and continued into 2007 as wave after wave of adjustable rate mortgages reset at dramatically higher interest rates, says Chris Porter, manager with John Burns Real Estate Consulting in Irvine, Calif.

In 2002 and 2003 buyers flocked to these ARMs, which offered a rock-bottom interest rate for the first five or so years before resetting to a higher variable interest rate. The record-low introductory rates allowed people to buy bigger homes than they might otherwise have afforded.

As resets came at higher rates, those mortgages carried larger monthly payments — higher than many could bear.

Facing foreclosure, many chose to sell and as listings flooded the market, prices began to slip. That sparked another round of selling — this time among investors who had switched from stocks to real estate with hopes of financial salvation through flipping.

More problems began to surface.

“You had people who wouldn’t have been able to qualify for a mortgage with normal underwriting rules using these introductory rates to buy more house than they could afford. You had builders selling to people who they would not have sold to under normal underwriting rules, which made their profits go up and then they plowed more money into creating more supply. You had speculators looking at housing as if it were a security, and the lenders having this attitude that they weren’t going to have to deal with this because appreciation would allow people to refinance their mortgages, and the appreciation would protect everyone,” Goodkin says. “But it was all B.S.”

As more houses went up for sale, prices continued to come down.

“That downturn followed what we knew then, and what we know now, was a totally unsustainable boom period that started in 2002 and ran through 2005,” says Dave Seiders, chief economist for the National Association of Home Builders.

When people got to the point that their selling price couldn’t cover their mortgage, the first wave of foreclosures hit. The market began to crumble and housing went from leading the nation’s economy to dragging it down.

“This was the first time we had this number of foreclosures that weren’t connected with a major crisis of the economy,” Goodkin says. “This was a housing upturn that started when the economy wasn’t rip-roaring, and that ended before the economy went into recession. This was an economic crisis caused by housing, rather than the other way around.”

2. Predictions were off

Even as the housing market disintegrated, major housing analysts across the country spent much of the early months in 2007 predicting better days were in sight, a prediction Simonsen says seemed reasonable at the time.

“At the end of 2006 we actually observed some good strength in the economy. The stock market was up, the economy felt strong. Everyone expected housing would follow,” he says.

“Even though there was some risk, the ratings agencies fooled the market and the investors into thinking housing was rock solid,” Yun says.

As these so-called subprime loans began to default, deeper fissures in the housing market began appearing.

“That took most of us, and me for sure, by surprise,” Yun says. “It was the speed and the scope of the losses that nobody expected. We all saw something coming, but it was bigger and worse than we expected.”

With each increasingly bad economic report, it became more and more obvious that a bottom was not coming any time soon.

“We knew it would be a rough year,” Porter says. “But, while I think that there was this idea that we were going to see the bottom toward the end of the year, the subprime situation really prolonged everything and pushed the recovery into the future.”

Following a record wave of foreclosures, few lenders are in a hurry to return to loose underwriting standards, and many are reacting by adopting tighter-than-normal lending standards.

“The lenders got their teeth knocked in, and now they are ultraconservative,” Goodkin says. “That compounds the problem because now there are more foreclosures and people can’t sell if they are in financial problems, and you see people walk away from homes, which is a bad situation all around.”

3. 2008 outlook

Most statistical indicators show 2008 won’t likely be much better.

“I am not really excited about the outlook. Not until late ’08 or ’09 at the earliest,” Goodkin says. “And even then, when the real estate market does come back, it won’t be where it left off. We will probably be looking at a landscape that is 30 percent or more below its peak of ’05.”

Yun says he sees at least stabilization on the horizon.

“I don’t see sales falling much from this point,” he says.

He says most subprime mortgages have already left the market either through foreclosure or through quick sales, and he says a stimulus package on its way from Congress has the potential to give housing a bump. Plus, Yun says, a renewed interest in loans insured by the Federal Housing Administration will likely give lower-income buyers and people with dinged-up credit a way to buy in to the market.

Goodkin isn’t as optimistic. “I would bet that ‘more of the same’ is perhaps an understatement. Things could even worsen,”

Simonson agrees that a bottom to the market isn’t on the immediate horizon. “My gut says no. I don’t see any catalysts for a reversal in the market,” he says. “Interest rates can’t go lower. Credit markets won’t open up in any big way. We are looking at a questionable economy rather than looking at coming out of an economic slump.”

4. When will it turn?

“It was a hell of a ride on the way up, and it will be a hell of a ride coming back down,” Seiders says.

In its latest analysis, the NAR predicts another 5 percent drop by the end of the year. The Realtors see an even bleaker for new homes, predicting an 18 percent price loss for 2008.

“The numbers for new homes are down more than 50 percent from their high two years ago, and that needs to decline even further,” Yun says. “We already have a high inventory, and the last thing we need is to add on more inventory.”

Most analysts agree with the general assessment that 2008 will be the fourth year in a row to see falling prices.

“We expect prices will decline, possibly even into 2010,” Porter says. “We already have seen new home prices fall much more rapidly because builders need them off their books and they have deeper pockets and can afford to write it off.”

He says the downturn may take longer on the homeowner side, though.

“Homeowners aren’t quite ready to give up the equity they believe they have,” he says. “They know the home down the road sold for $400,000 a year ago, and they can’t adjust to the idea that they can’t get the same thing for their home today.”

“One thing about pricing is there is so much local variation,” Yun says. “The national number may not be as hopeful as the local markets, where there are some relatively strong markets still.”

He says that while some California and Florida markets did see have huge declines, as well as many of the markets in the industrial Midwest, such as Detroit and Cleveland, there were some bright spots, such as in Texas and the Rocky Mountain states.

5. The donut effect

Even in markets with highly publicized losses, prices didn’t fall in any uniform way.

“There are places where the local economy was strong, investment was strong, immigration was good, and all that came together to hold up the market in some places you might be surprised about,” says Simonsen.

He says places like Manhattan and San Francisco actually had respectable years.

“The weak dollar brought European investors and buyers in, which are holding that market up just fine,” he says. Demand held the market up more than people expected in the core, high-end city centers and prices held strong.

Simonsen says that story repeats itself in many of the major metropolitan areas, largely a result of the increased inventory: With so many houses for sale, buyers who were able to get financing had their pick of the market.

And with the entire city available at reasonable prices, most people chose the areas that had been historically most desirable. “There have been two different markets,” he says. “There was enough inventory in those nice parts of town, that every other part of town ended up doing poorly while the attractive areas stayed strong.”

And not even the tight credit markets took their toll on these areas, yet. “You don’t buy a $4-million home with a subprime loan,” Simonsen says.

But that strength may not hold up through the end of the year, he warns, “We expect an oncoming recession by the end of the year, and with people worried about their jobs, even the high end will weaken,” he says.

6. The bright side

One of the few groups who actually benefit from the morbid real estate market is buyers who have relatively strong credit.

“It is absolutely a buyers market,” Goodkin says. No, the market hasn’t bottomed out, he says but buyers who do their homework and study their market will find terrific values. “As long as you are buying the house as a primary residence, and you are selective, there are good values out there and you won’t get hurt,” Goodkin says.

Some economists are holding out hope that once people start buying, they will begin a chain reaction that will help buoy the market. One indicator that shows they may be on to something is a survey NAR did polling sellers with homes on the market.

“The interesting thing is that 80 percent of those people told us that they want to buy as soon as they sell,” Yun says.

Michael Giusti is a freelance writer and teaches journalism at Loyola University New Orleans.