It seems that every time one opens up a newspaper lately, there are more and more disturbing reports about the state of the nation’s economy and the distressing failure of the country’s housing market.
Are these so-called “doom and gloom” reports destroying the confidence of buyers and lenders? Or are there more tangible reasons for the economic slowdown?
According to the Winans International Real Estate Index, a company which has tracked the national real estate market since 1830, aggregate U.S. new home prices are down 23 percent; new home sales have been reduced by 71 percent; and new property listings are down by 34 percent since the real estate market’s historic peak set two years ago in March 2007.
On a national level, this marks the worst residential real estate bear market in price decline and duration in the last 67 years, according to Ken Winans, the creator of the index. He predicted that the housing market will get worse, but that it will eventually correct itself if one looks to historical precedents.
“This bear market will probably not end in 2009. Past real estate bear markets ended when the average time it took to sell a new house dropped to 3½ months,” he said. “Currently it is taking over nine months for transactions to close due to tight credit conditions.”
Fortunately, while the current condition is bad, it is not record-setting. The worst decline of U.S. new home prices in the last 150 years was the 68 percent decline from 1929 to 1932 during the beginnings of the Great Depression. The worst housing bear market in duration spanned five years from 1853 to 1858.
Considering this information about the worst bear markets in U.S. history, today’s economic grind down is so far just a blip on the national time line. Perhaps comparing “the worst real estate market in modern times” to the high point of the market’s peak in 2007 is a little Chicken Little-ish. Perhaps the sky is falling but maybe it isn’t quite that bad just yet.
By comparing 2008 prices with those of 2007 and earlier is in effect comparing the highest prices against the lowest—a dramatic and frightening image that can feed into an overall loss of confidence by sellers and buyers, according to Enzo Morabito, who has been selling South Fork real estate for some 30 years. From his Prudential Douglas Elliman Real Estate office in Bridgehampton, Mr. Morabito said that it is up to real estate professionals to take charge and calm the qualms and fears of East Enders.
“Sellers are looking to us to set the tone,” said Mr. Morabito, who noted that the real estate industry as well as the overall economy “needs leadership.”
He compared the current economic downturn to the 1980s recession when unemployment reached 12 percent in New York City and interest rates ran even higher.
“In the ’80s recession, banks were willing to lend to home buyers but were charging exorbitant rates, in some cases as high as 18 percent,” recalled Mr. Morabito.
Today’s recession is worldwide and banks are saddled with so-called “toxic mortgages.” In addition, credit is relatively tight. And although rates are comparatively reasonable, since there’s such a large inventory of homes on the market, these sheer numbers of ready house supplies have reduced the asking price for many properties.
Though times are different from the “Go-Go ’80s,” some say the financial hit that is being absorbed now stems from bad loan decisions dating back some 20 plus years ago.
“Requests for 100 percent financing had become common around 1989,” recalls Mr. Morabito. “People wanted 100 percent plus financing to cover things like closing costs and seller’s commission.”
Buyers who opted for an interest-only or payment option on an adjustable rate loan were drawn to a short-term fix to a long-term situation. The primary motivation for this was that it often enabled individuals to qualify for a more expensive home than they could realistically afford.
With this so-called strategy, a borrower could be paying on the mortgage virtually indefinitely and never own much equity in the property. What usually happened, however, was that many borrowers quickly got into unmanageable debt levels, forcing them to either sell the property, probably at a loss, or lose it to foreclosure.
Mr. Morabito said that the initial low payments convinced people that they could afford more house than they actually should buy and that the process was doomed to fail. “This phenomenon was unsustainable,” said Mr. Morabito. “It was too much leverage, often with people who did not fully understand what they were getting into.”
In sales such as these, the buyer built little equity in the home on the front end of the loan. Such transactions led to the widespread growth of the sub-prime loan industry, which provided exorbitant funding to buyers with substandard credit and then “re-sold” the loans to other institutions, mainly Wall Street firms, which repackaged them as securities which they sold to institutional and then retail clients.
“Many people are trying to get out from bad mortgages,” said Mr. Morabito. “What they’re finding is that they often cannot sell their property for what they need. The home ATM is tapped out.”
Thus, the mess was created and has continued to fester today, leaving those who have paid for years still with little equity investment. Of course, the bankers learned from their mistakes, which is why getting a new loan today is very difficult without stellar credit.
In this market, sellers often need to resort to creative lending strategies in order to make a sale and get out from under the household debt if they can.
“We ended up holding the mortgage,” said an eastern Long Island physician who asked not to be identified and whose 20-year-old, three bedroom waterview home was on the market for more than a year before it sold. The buyer was the owner of a small business who was cash rich but had poor credit, and in the current climate could not get a mortgage. The buyer would not comment for this story.
The main risk with the owner holding the mortgage is that he’s also taking on the risk that traditionally would be the job of the bank or other professional lender. Should the buyer default, the former owner might then be forced to take back the property.
In this case, the physician was motivated to make a sale by holding the mortgage because he’d been trying to sell the home for more than a year and needed the money to buy a new residence.
Not long ago a bank may have been willing to take on this cash rich buyer, despite a poor credit history. But today’s tighter credit regulations mean would-be borrowers need to show a reliable credit history, substantial collateral and a healthy debt-to-income ratio with debt exceeding no more than one-third of one’s income.
Late payments on things like income taxes, college loans or credit cards will drive one into a higher interest-rate arena, which in today’s lending environment would require a cosigner on loan documents or possibly result in denial of a loan.
But there is some good news for those who are trying to sell their homes in today’s market, according to Mr. Morabito. He noted that those sellers who are pricing their homes realistically to market conditions are able to sell them. He added that his office oversaw 10 closings in November and December. “These were largely priced ahead of the market,” he said.
Predictably, sellers are not pleased when they learn their property may not earn the price for which they were hoping, Mr. Morabito said. “When we tell them the truth they usually don’t like it, but they’re making moves out of necessity.”
As for the future, no one is sure how long the lackluster economy will hold, but Mr. Morabito said he was hopeful that the East End real estate market would eventually correct itself.
“Hamptons real estate will come back,” he predicted. “The trouble is we don’t know when.”
Joseph Finora Jr. is a freelance writer in Laurel. Contact him at jfinora@optonline.net.
on Mar 10, 2009