Why Housing Prices Will Keep Dropping in Value

by Alexander Green, Advisory Panelist
Saturday, August 29, 2009: Issue #1079

Good news has been swirling around the housing market lately.

The Commerce Department reported on Wednesday that sales of new U.S. homes surged 9.6% in July.

A week before, the National Association of Realtors reported that previously-owned home sales in July jumped at the fastest rate in 10 years.

Realtors are now reminding us that sales have risen for four consecutive months. Thanks to low interest rates and government incentives, they tell us, housing prices will soon be heading back up.

Don’t bet on it…

I was in real estate for years. Asking my colleagues whether prices were likely to head higher was like asking the Army Corp of Engineers whether a river needed a bridge.

The answer was a foregone conclusion.

In many ways, this is understandable. Real estate agents need transactions. Those transactions are less likely to happen if potential buyers think prices will fall. So there is a strong tendency to put a positive spin on things…

Why Housing Prices Will Continue to Decline…

At the risk of being the skunk at the garden party, however, there are many reasons to believe that housing prices will keep coming down in most markets, especially if you’re shopping the high end.

Here’s why…

• A new survey by the trade publication Inside Mortgage Finance found that only 36% of all real estate sales in recent months involved “nondistressed” properties.
• Of these nondistressed properties, only 31% were “unforced or optional.” In other words, nearly seven out of 10 of even these sellers were in the midst of some financial or personal crisis.

To put this in perspective:

• Two-thirds of home sales are either foreclosures or short sales (i.e. banks taking a loss on the mortgage).
• Only a third of the remaining – roughly 10% of overall sales – comes from something we could call a normal selling process.

That’s hardly encouraging.

Meanwhile, the Mortgage Bankers Association said last week that the number of homeowners behind on their mortgage payments hit a new high in the second quarter, with more than one in eight homeowners delinquent or in the foreclosure process.

These pending sales will put more pressure on sales prices. And, thanks in part to the refinancing boom, it’s estimated that approximately one quarter of all homeowners owe more on their homes than they are currently worth.

So why are the headlines filled with glad tidings about the housing market stabilizing?

Housing Prices Appear to be Hitting Bottom in Some Areas of the U.S.

Because in some areas, especially in the low end of hard hit areas like Las Vegas, Phoenix and Orlando (where prices have fallen more than 50%), housing prices do appear to be making a bottom.

But understand that the median sales price of the more than 400,000 homes that sold in July was $210,100. I’ll bet most people reading this live in a house worth more than that.

And those higher-end homes are precisely the ones that are likely to keep falling in value. Why?

• For starters, government-sponsored incentives don’t benefit the top part of the market. For example, the $8,000 tax credit for first-time homeowners – which ends in November – phases out for single buyers whose income exceeds $75,000 or couples making more than $150,000.
• And low interest-rate mortgages backed by the FHA, Fannie and Freddie are only available on loans below limits set by Congress. That limit is $417,000, excluding certain high-end markets in California, New York and Hawaii.
• Mortgages for amounts that exceed this limit – jumbo mortgages – face interest rates more than a full point higher. Plus, lenders – newly sober – are now requiring down payments of 20% to 30% or more on jumbo mortgages.

Tougher credit standards, higher interest rates and big down payments are set to torpedo the high end of the housing market. And at the worst possible time…

According to First American Corelogic, jumbo mortgages are the fastest-rising category of defaults of all types of mortgages.

Add in the death of home-flipping and the idea that the smartest thing a buyer can do is buy all the house he can afford and the planets are in alignment for lower – not higher – housing prices.

I’m not gloating about this, incidentally. I own two homes myself. But if you’re in the market to buy a new home, caveat emptor.

Housing prices in most markets – especially the higher end – are almost certain to head lower.

Good investing,

Alex

P.S. If you’re looking for a few ways to hedge against the declining value in your real-estate holdings, take a look at our asset allocation strategy.

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