Real Estate Bubble – The Game is Over

It’s time for an update on the real estate bubble, which I have been watching since 2003. About a year ago, I laid out a timeline for the real estate boom. Knowing real estate happens in 16-year cycles, I juxtaposed the last boom/bust cycle in the early 90’s onto this cycle. Here’s what I came up with:

1990 (2007): Prices take a serious plunge. One article claims that housing booms are a bad thing and we should hope prices stay low. Increasing mortgage rates are blamed for the bust. The word “recession” is mentioned. Gloom and doom.

That’s next year. How many times do you think you will hear the words “looming recession” next year? More than you want to, that’s for sure…

Ah, yes. Recession, recession, recession… Yep, all over the news. Notice I called it a “looming” recession in my post last year. That’s because “A recession is traditionally defined in macroeconomics as a decline in a country’s real Gross Domestic Product (GDP) for two or more successive quarters of a year (equivalently, two consecutive quarters of negative real economic growth).” (thank you, Wikipedia.) We won’t hit two consecutive quarters this year (or, if we do, it’ll be 2008 before we know we did.) I think the actual “recession” will start next spring.

2008 will be a disaster year for housing. Let me share with you a choice quote: “‘Recent mortgage disruptions will hold back sales temporarily, but the fundamental momentum clearly suggests stabilizing price trends in many local markets,’ said Lawrence Yun, senior economist for the Realtors.” That’s from this article, published today and titled “Existing Home Sales Fall in 41 States.” Have a good, hearty laugh over that one. Prices are nowhere near “stabilizing.” Homes here have lost about 15% of their value since the 2006 peak. They still have a good 25% more to go down from here…and that’s probably a conservative number.

The proverbial **** has hit the fan here in California. You are no longer able to get an interest rate under 8% for a loan over $417,000. Take note of that number, because I don’t doubt that will become the subject of a heated political debate. $417,000 is highest rate at which Fannie Mae and Freedie Mac will buy a loan. Loans at or below $417,000 are called “conforming.” Loans above $417,000 are “non-conforming”. Since non-conforming mortgages are defaulting at shockingly high rates, and there is more risk associated with them in a market where prices are going down, interest rates have skyrocketed for those loans.

61.9% of the loans in the Bay Area in January-June 2007 were non-conforming loans.

That’s why this post is entitled “The Game is Over.” The jig is up — there’s simply no way more than half of the buyers who qualified for home loans in 2005-2007 in the Bay Area will now be able to afford loans. Add that to the people who can afford home loans, but don’t want to buy in a declining market, and you have a perfect recipe for huge price drops.

I don’t think we’ll begin to see huge price drops until this time next year. A year from now is probably the first point at which I’d recommend actually buying a house…no matter where you are in the country. Prices are dropping now, but they’ll drop more once all of the bad loans are squeezed out of the system. This is going to take a while. Sellers haven’t realized what happened…the bomb that just dropped. They’re still pricing their houses 10-15% below peak. It will be several months before housing prices adjust to this new reality. Don’t kid yourself…this is the new reality. Bernanke may drop the Fed funds rate later this year by 0.25% or 0.5%, but that doesn’t automatically mean that you’re going to be able to get a non-confirming mortgage at less than 8%. Those two things simply aren’t correlated. Mortgage interest rates are dictated by the market for mortgage-backed securities and what buyers of those mortgages are willing to pay, not by what the Fed dictates. Remember, in my chart I mentioned that it wouldn’t be until 2010 that houses truly became a bargain. Notice the quote from the early 90’s bust: “1993 (2010): It’s definitely a buyer’s market. Some people are saddened by the fact that current prices are 50% of what they were in the 1980’s.” We have quite a way to go until we reach that point. We will get there, but it’s not going to happen more quickly this time.

I’m happy to wait things out. How are you doing? I hope you sold your house last year… we’ve passed the point of no return at this point, and it’s downhill from here for the next 6 years or so. I’m optimistic about all of this, though. Downturns are when the most amazing things happen… inventions get made, and people band together to help each other. Yes, it won’t be easy. We will be hit harder than we were in the dot-com boom. But opportunity always awaits.

By the way, if I could make a recommendation… invest in a growing country, and get out of dollars. Which country? That’s for you to determine. 🙂