The U.S. housing market outlook for 2008 is somewhat bleak. Mortgage defaults continue to rise, flooding certain locales with more inventory, as mortgage lenders seek to rid themselves of poorly performing loans. The first three months of 2008 may very well be a bloodbath for markets that inflated quickly, regardless of the underlying fundamentals. Parts of California, Arizona, Florida, and Nevada seem most likely to suffer from this final downward push as the weak borrowers are culled from the herd.
Why will the first quarter of 2008 be bleak for housing? Mortgage companies have been losing money hand over fist, in 2007, due to defaults and short sales. I think they're delaying the big losses. REALTORs have been reporting that lenders are becoming increasingly difficult to negotiate short sales in the past few months. It is conceivable that many lenders expect 2008 to be worse than 2007 and are delaying foreclosure activity and short sales until next year. They can "hide" the 2007 numbers in the larger numbers of 2008. It's kind of like limiting your fat intake to 25 grams daily then binging on McDonald's on Fridays. The huge spike in fat grams, ingested on Friday, won't be absorbed by your body and will "flush through your system" on Saturday.
It's a case of pent-up supply. If lenders have 3-4 months of bad loans on their books ,and flood the market in the beginning of the year, it is most likely that we'll see foreclosure and short sale activity, in the first quarter of 2008, that is twice as large as what we've seen this quarter. That increased inventory will put downward pressure on prices for the first half of 2008. The downward spiral, however, should be limited to markets that are driven by lending activity. Pockets within those markets will be impervious to the fall. In San Diego County, for example, La Jolla, Del Mar, and Rancho Santa Fe seem to defy gravity as inland communities drop. Those communities are mostly cash buyers (or low loans to value) while their lesser-priced neighbors rely on mortgage financing. Paradise Valley, Arcadia, North Central Phoenix and parts of Scottsdale seem to be the resilient pockets in Maricopa County.
It's the old adage that the rich get, well..."not poorer" ...while the poor get ...well...clobbered. That is not surprising. The irrational exuberance, displayed by the middle class, during the cheap money orgy, was... well...irrational. Freshman algebra shows us that when we solve for x, it can't equal y. The median income, for an area like San Diego County, is $60,000 and the median home price is $493,000. The affordability equation, even when adjusted for the "sunshine tax" is skewed. If mortgage financing costs about $8 per thousand, and we allow for a full 50% of the monthly income for housing debt service, which is quite generous, we still come up with a maximum loan amount of about $325,000 for the median income family in San Diego County. That suggests that a $175,000, down payment from that family; ...that just ain't gonna happen.
Incomes, in these markets, need to rise or....housing prices, in these markets, simply must decline. If new homeowners don't have the ability to service the debt for a home purchase, they can't buy the property at the inflated price. Look for median prices to gravitate towards that median income. In the San Diego County example, that median price should drop to $400,000. If the "rich get richer", meaning those well-to-do pockets won't drop in value, then the lower end of the market wil get hammered. Therein lies the long-term investment opportunity for the astute property investor.
Housing has utilitarian value, which ultimately trumps economic value. In short, there is value to owning a home even if it is a bit more expensive than renting. There is a peace of mind that comes with property ownership. The ability to paint your walls lime green because it's "you own the sumbitch" does allow for a premium to the traditional investment formula. So, in Phoenix, while the economic value of a home that leases for $700/month may be $130,000, the utilitarian value may go as high as $170,000. If a tenant pays $700 to lease that home, a good borrower could own that home, with no downpayment, for $1133/month or about $850 in after-tax dollars. The question then becomes, "Is $150/month worth it for the right to paint the walls lime green?" I think that the answer is yes.
Read more »
