Waiting in the wings
“I’m deserted and depressed in my regal-eagle nest, down in the depths of the ninetieth floor,” sang Ethel Merman in Cole Porter’s musical Red, Hot and Blue. Penthouse and townhouse dwellers in Manhattan’s expensive neighbourhoods have good reason to feel blue themselves 70 years later, at least if they hope to unload their property.
Buyers are on strike, reluctant to step forward unless they can secure a 30% discount from the peak of the market. Although activity has stalled out at the high end, some glimmers of hope do flicker, according to John Burger, senior estate agent at Brown Harris Stevens, New York’s oldest real estate firm.
Burger set the record at $46m (£33m) in 2008 for the highest-ever price paid for a Manhattan co-operative (an idiosyncratic ownership structure – routine in Manhattan – whereby the owners of a flat take a share in the building itself). The star broker sees interest among international buyers who still want a perch in Manhattan. Cleveland, Atlanta or other provincial cities do not command the same appeal.
Aside from the international crowd, Manhattan is the primary residence for 90% of the city’s inhabitants. “It’s home. It’s where their business, livelihoods are, schools are,” Burger explains. “They’ll compromise on a second home in the Hamptons or Connecticut instead.”
Down the scale, the bread and butter $1-2 million market is moving fairly well. In that range, which is considered an entry level price, people need shelter. Many are keen to take advantage of the few remaining tax deductions, for mortgages up to $1 million for a primary residence loan.
Across the rest of the huge country, recent data highlights several findings. The Standard & Poor’s/Case Shiller house price index, most recently released on February 24, shows that national prices have fallen 27.7% from their July 2006 peak. To put that tumble in context, recognise that prices had roared 155% during the previous seven years since 1999. David Blitzer, the chairman of the index committee at S&P, emphasises that today’s decline is national in scale, with barely any turnaround pockets. Looking back about 100 years – except perhaps during the 1930s – home prices always moved in different cycles, not in one all-engulfing tsunami.
On the other hand, the scale of the decreases is still local. Just five states – Arizona, California, Florida, Michigan and Nevada – have seen prices hit about 30%, while the rest of the country is down about 10%. The warmer the sunbelt weather, the steeper the fall: Los Angeles is off 26.4%, Las Vegas down 33% and Phoenix is 35%. In some less clement zones, prices have also pulled back after moonshot ascents. For example, the Washington DC area is weak. “With the new administration, Republicans are moving out and Democrats can’t afford the houses!” quips David Wyss, the chief economist at S&P.
Elsewhere, buyers and sellers are sitting on their hands. According to the National Association of Realtors (NAR), resales dipped 5.3%, to a 12-year low in January. One theory for the stalemate is confusion over President Barack Obama’s stimulus plans. “Some people have held off, as they awaited the resolution of the banks’ financial crisis and the programs the government might make available,” suggests Jed Smith, NAR’s senior economist.
The road to perdition
What goes around, comes around, including spirals. After the 2000 dotcom bubble burst, and Alan Greenspan, the chairman of the Federal Reserve, pumped up liquidity by lowering interest rates, excess funds sloshed into the real estate market.
As home prices escalated, buyers became more confident that they would continue on their trajectory. If you bought in 2002, perhaps you borrowed 80% against the value, but by 2004, the price might be 15% higher, so you were effectively borrowing 90%. “With more hot air in the price, you were borrowing against hot air,” Blitzer explains.
It took a while to unravel, after the crescendo of 2006. Whereas equity markets can lurch precipitously, property moves at a more stately pace. What stocks accomplish in a single afternoon might take a year or so to achieve in the real estate space. Even now, prices in every big city but Detroit remain above their 2000 levels.
Leverage proved the undoing. People had over-borrowed, with too little income support for backing. The the old-fashioned mortgage of 20% down is back in style. By 2006, with leverage at, say, 20 to one, any relatively small drop in price could wipe out a homeowner’s equity. So if somebody had bought a $200,000 home, which happens to be the median price, it could be financed with a $190,000 mortgage.
That equity wipeout gave homeowners an incentive to default and walk away from the mortgages. More homes went into foreclosure, adding to the supply. Overhang of inventory is a critical metric for determining when this wretched spiral might finally unwind. Right now, inventory for existing single family homes exceeds nine months, versus a normal market which should run to about five months.
Where will it end? “Prices will get so cheap that people will be able to afford them with conventional financing,” says Wyss (pictured, top right). The most traditional method to track affordability is by a percentage of income.
At the moment, home prices are at 2.6 times, which is below the historical average of 2.7, and way beneath the high of 3.4 times. While that may sound like a dash of good news, the extra supply is perpetuating the downtrend. As long as mortgagees keep defaulting, the supply will continue to grow.
Smith warns that any turnaround is likely to be modest, “just an uptick beyond the current state, rather than a barn burner”. It will depend, above all, on employment.
Economists’ predictions for recovery range from the fourth quarter to a more pessimistic 2010. Since most expect the economy to continue to shed jobs for the rest of this year, we are hard pressed to promise a housing recovery any sooner.