A periodic blog dedicated to providing commentary and encouraging debate on topics in Economics and Finance.

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Age: 26 Occupation: Private Equity

Tuesday, October 2, 2007

NAR - Worst - Ever Showing for Pending Home Sales

In another shocker, the Pending Home Sales Index released by the NAR reached its lowest point ever (even lower than September 2001).

(Click on the chart for a larger image.)
It's not too often that you see a chart (of real data) with a trend as clean as this one. According to the NAR, the problem now stems from borrowers with "good credit" who can't get loans due to the credit crunch. My only response to this is: Balderdash. As we can see, the downward trend in house sales was firmly in place before the August credit crunch.

There is a term for this: Market Failure - when transactions cease to occur because buyers and sellers cannot come together and agree on a price.

The Buyers' Issues

Now that the Ponzi scheme is up, buyers are facing a brave new world where, if they want to buy a house, they have to:

1. Make a down payment (What is that?)

2. Pay a bloated mortgage bill for a long time (You mean this initial 2% rate is not a real mortgage rate? You mean I have to pay this back? I'm so confused!)

3. Accept subpar returns or declines in the value of their housing.

When you put it that way, forking over $35,000 for the right to pay $2,500 per month, or $30,000 per year (PITI) for a $350,000 townhouse doesn't seem so great, does it? This is especially true when you are getting a lousy return on your house because (i) you bought high and (ii) houses don't go up too much in value under normal conditions anyway.

The Sellers' Issues

This is easy. "What? I can't get the bubble price that Billy Jones got up the street? No way I'm selling for less."

Or "that's not even what I paid for my house!"

Why Prices Have to Fall Further

Eventually, something has to give. In many markets, buyers can't realistically pay the prices sellers are asking for, while a large portion of sellers (at the urging of their agents desperately trying to keep prices high) are simply being stubborn.

Time to address one "myth" commonly used to combat the notion that prices will fall materially: "Nobody will sell for less than he bought his house for."

1. Some people simply have to sell if they can't afford to pay the bills or really need to move. These people will sell for a "buyer's" price and swallow the hit to their down payment or built-up equity, busting comp sets.

2. Most importantly... not everybody bought their house in the last few years. If these sellers have to go, they'll still make a good gain if they sell for 10, 20 or even 30% below the prices they could have gotten in 2005 or 2006 (however reluctantly).

Unfortunately for sellers, their stubbornness has to yield to impossibility (buyer's inability to afford asking prices) if they want to sell their home.

Oh, and by the way, I didn't even mention that the competition for buyers is about to get a lot tougher over the next year as a new wave of inventory sweeps through the markets.

- eternitus


ghu206 said...

When do you think the real bottom will be in?

eternitus said...

ghu, I'll stick to my April post and say April 2009, absent a recession or significantly higher interest rates. I said then that median house prices in the U.S. were about 10-15% overvalued (much more in some real bubble areas).

By 2009, incomes will increase about 6% due to inflation (barring recession) and house prices will have fallen about 10% from their peaks in 2006 (already down about 4% according to case-Shiller index.)

I think this will wipe out the valuation gap. However, if interest rates rise significantly, the adjustment may be steeper and take longer. If they fall significantly (somehow), it make take less time.

dxm113 said...

Another thing I have noticed driving prices down is the fact that there are many unsold new homes in some markets. The builders have to sell at discounts to move their inventory. Methinks that the builders are more willing lower prices - and that is applying pressure to other private sellers.

Where's the consumer's incentive to buy the 30 yr old home when they can buy a new home with a warranty and "upgrades" for the same (or similar) price?