Has an Unavoidable Decline in Home Prices Begun?
October 7, 2014
by Keith Jurow
Peter Lynch was one of the best growth investors of all time. As the Magellan Fund manager at Fidelity Investments between 1977 and 1990, he averaged a 29.2% annual return. Q1 2021 hedge fund letters, conferences and more The fund manager's investment strategy was straightforward. He wanted to find growth companies and sit on them Read More
In late September, the former head of Goldman Sachs’ housing research team sent a lengthy report to President Obama. In it, he predicted that home prices would fall by at least 15% in the next three years. He warned that this could push the country back into a recession.
With this blunt warning in mind, let’s look at the state of housing markets around the country.
Revisiting the trade-up housing market
At the center of the housing collapse was the disappearance of the trade-up market. As home prices rose for 50 years until 2006, the first-time buyer was the foundation of the housing market boom. These younger buyers purchased homes that were smaller and less expensive than most houses. The homeowners then “traded up” to larger, nicer homes, enabling other trade-up buyers to do the same.
Trading up was possible because the seller almost always posted a profit on the sale of the house and could plow that into a more expensive home. That worked beautifully as long as prices were rising. When the bubble finally burst in late 2006, speculators dumped their properties on the market in one metropolitan area after another, and prices no longer rose.
Listings soared and sales slowed down even in the hottest markets. Then prices began a precipitous decline. That posed a serious problem for the trade-up buyer. Many found they had little or no profit with which to buy another home. Worse yet, a growing number found themselves “underwater.” Because many had put little or nothing down, the value of their homes were less than the mortgages on the properties.
Exacerbating the problem was that lenders finally tightened up their underwriting standards after the sub-prime market collapsed in spring 2007. They began to demand down payments of 20% or even more. With little or no profit garnered from selling, would-be buyers could not come up with such steep down payments. Nor could first-time buyers.
Given these radical changes, the trading-up game came to a screeching halt. It has not returned and won’t for a long time.
The decline in home prices ended because a horde of all-cash buyers raced in over the last three years to replace trade-up buyers. Even more important, servicing banks around the nation made a concerted effort to substantially reduce foreclosures as well as the sale of repossessed properties. This graph shows how this occurred in California.
You can see how much distressed sales (in red) plunged from their peak in the summer of 2009. This totally artificial restriction of homes on the market leveled off prices.
Here is another key chart showing the tremendous decline in repossessed homes sold on the market in Phoenix.
At the height of the price collapse in early 2009, two-thirds of all houses sold in Phoenix were repossessed homes (REOs). Then the servicing banks decided they had to reduce the sale of foreclosed properties to stem the decline of prices. They have been doing this for five years.
What is the status of these seriously delinquent homes? The servicing banks have put some into formal default (an “NOD”), but most just sit there, as the banks take no action. Many have been delinquent for three to four years with owners who have made few or no payments still living in the house.
Remember, if you have a question or comment, send it to [email protected]