Article: This Could Really Be Our Year (for Real Estate Disaster)

As the weather warms up, the season moves into full swing for Boston’s most lucrative spectator sport: real estate. People swap stories at bars and parties: I hear he paid six-fifty for a one-bed condo, there’s a basement studio in Davis asking four hundred grand, a ramshackle Victorian can’t be had for under a million. Every Sunday afternoon, it’s time to browse the open houses, whistling at prices and dreaming of appreciation, refinancing, and that ultimate luxury, off-street parking.

The statistics are familiar to anyone by now: the average median price for a single-family home in Cambridge passed half a million dollars last year, and three hundred grand for a condo. Somerville sold its first million-dollar single-family home this year. There are only two communities inside route 128 where a condo can be had for under $250,000. Prices keep rising, bids keep coming in over asking price and within days of opening. Winter is normally slower in the real estate market, but not this year, when the market barely paused. After all, this is a market which saw a penthouse condominium sell within fifteen minutes. For five million dollars. In cash.

Some argue that prices will keep rising, albeit slightly slower than in the past. After all, the metro Boston area is a great place to live, interest rates are low, and they’re not making any more land. Besides, it’s an investment. You can borrow a lot now, and the increasing value of the property means you’ll be able to take cash out later on. If you get in now, you can trade up later.

The more you listen to people talk about real estate at cocktail parties and read about it in magazines, though, the more it sounds like stock talk from late 1999. People aren’t investing in real estate so much as speculating, and that means sooner or later they’re going to get burned.

The way home-building and Real Estate Investment Trust (REIT) stocks are looking, people are going to get burned badly. Stock prices for those two classes of company, often used as a proxy for the overall health of housing demand in the US, have risen to record levels in the past few years, but are now starting to weaken, and could drop as dramatically as they rose.

Low interest rates have spurred borrowing, since a larger loan is easier to handle at a lower rate, and people fear they won’t get such a good deal again. But even at a low rate, a big loan is a big loan, and it can be hard to keep up with payments on it. The unemployed are staying jobless for longer periods of time, falling deeply into debt or declaring bankruptcy.

The first to feel the pinch are cars and boats, since people will typically skip payments on those before they fall behind on the house. Repo men find themselves in upscale neighborhoods taking thirty-foot boats as often as they find themselves in blue-collar suburbs driving off with beat-up Civics. Repossessions of expensive cars have increased faster than those at the lower end of the market, but repo men all over the city are busier than ever.

If you’re behind on a car loan, you can usually give up and sell the car, perhaps trading down to a lesser car and a smaller payment. But a formerly rare scenario is becoming more and more common for car buyers: they’ve borrowed so much, and put so little down, that they owe more on the car than it’s worth. It’s called being “upside down” on the loan. In the past, buyers would be upside down for a few months at the beginning of the loan, but would recover quickly. Now, almost a third of new-car buyers still owe more on their current cars than they can get as a trade-in.

Of course, if you’re short on cash, you can always refinance the house and take out some cash, right? Wrong. Refinancing is heavily dependent on rates dropping steadily, and interest rates can’t get much lower than they already are. In fact, economist Steven Roach suggests they need to rise soon, and a lot. Besides, in a painfully ironic twist, it’s hard to borrow money if you need it: a person in need of money is usually a poor lending risk. It’s easy to borrow for a second car or a home if you’ve got a steady job and money in the bank, but once you’re laid off and the emergency fund gets low, it’s a lot harder to find a loan.

If you can’t borrow, you need to depend on what you have. Unfortunately, if you have enough savings put aside for a rainy day — let alone the ninety days financial experts suggest — you may be the only one on your block. Five years ago, the savings rate in the US was about zero, meaning people were spending as much as they took in. At the time, it was considered dangerous, but by today’s standards it looks positively prudent. The savings rate these days is actually negative: people are depleting what little they have saved and piling on the debt.

When the savings rate drops and the income-to-debt-service ratios get too high, you can expect repo men to be working overtime and bankruptcies and foreclosures to come close behind. Banks and other creditors worry enough about a rash of personal bankruptcies that they’ve been lobbying Congress to make it much harder to declare bankruptcy and to extend the length of time your bankruptcy affects your future credit rating.

Still, it’s no surprise that there are plenty of irresponsible people in the world, some of whom have borrowed more than they can repay. That’s been the case for centuries, and it hasn’t changed the underlying fundamentals of Boston real estate: small supply, big demand. Could it be possible that, although people are borrowing too much to buy homes in the Boston area, the homes themselves are worth those astronomical prices?

The rental market suggests otherwise. The Boston Globe notes that rental prices have actually started to slide, and vacancies are hovering around five percent. Some of the vacancies are due to more people buying, but a fair number are due to laid-off workers moving out of state, or moving in with roommates and family to cut costs. Some vacancies open up because tenants are now homeless.

Regardless of the reason, the rental prices are an important indicator of home-purchase values. As house prices have risen, rental prices have failed to rise as fast. Rental prices are still sky-high, as anyone with a newspaper can tell you, but they’re not as bad as purchase prices. That ratio will have to adjust itself sooner or later, and the odds are good that rentals won’t catch up.

Finally, there’s those low interest rates that keep people buying. People feel safe borrowing at five percent, especially since they borrow at a fixed rate for the majority of mortgages. That’s helped people buy, and it’s helped people pay more for houses. But rates can’t get much lower than they are now, and indications are good, according to economist Steven Roach, that they’re going to rise soon.

Once they do, people won’t be willing or able to borrow as much to buy a home. Homeowners that need to sell won’t find it so easy to get the prices they’re asking, much less the over-asking-price bids they’ve come to expect. In fact, we’re already seeing some weakness now: 75 percent of sales so far this year have been below the asking price . If there’s any weakness at all, buyers will try to take the upper hand and bargain further, or just walk away to wait for a better deal. In a rising market, the advantage goes to those who buy quickly, but if it’s stable or falling, there’s a strong incentive to wait. If buyers wait, houses will stay on the market longer, and sellers, strapped for cash, will start to get desperate. Then, things could get genuinely ugly.

Of course, we might not see a really crash, but a softer market is probably inevitable sooner or later. The hard part isn’t pointing out that we’re paying too much– that’s pretty much obvious, just like it was obvious in 1999 that technology stocks were overvalued. The hard part is knowing when the market will stop rising, and whether the correction will be a pause for fundamentals to catch up, or a brutally hard landing.

Cautionary voices are hoping that this summer will be a slow one, indicating a gradual correction, but if winter was any indication we’re likely to see real estate prices continue to rise beyond their true values. Just like in baseball, the stronger things look out of the gate, the more we hope we’ll be in on the big score. If this season is anything like last year, we may see our hopes, and our home prices, raised to new heights, and then cruelly dashed when the fall comes.

Sources:
Repossession agencies: “Repo Man” by Greg O’Brien, Boston Magazine, February 2004
Car loans: Boston Globe, Apr 18, 2003, and Edmunds.com, February 2004
Home sale prices: Boston Globe, Apr 18, 2004
Rental prices: Boston Globe, Apr. 17 2004
Consulted: Dana Morgenstein, Gibson Domain Domain Realty

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