During the unprecedented run up in housing prices over the last decade, most economists and real estate professionals firmly declared that the market would always move higher. When the recent cooling dashed those hopes, many reluctantly fell back to the “soft landing??? hypothesis, which predicts that price appreciation will return to historically average rates. However the latest housing data, particularly this week’s figures on new and existing home sales, have made these overly rosy assumptions untenable. The “hard landing??? scenario, which envisions real estate prices moving sideways, or actually posting moderate declines, is finally gaining broader credence. But, even this forecast will prove overly optimistic. The real estate market will not land soft or hard, it will crash and burn. Those who did not have the foresight to bail out may be faced with a distinct shortage of parachutes.
The glut of homes on the market, the highest level since 1993, doesn’t even begin to tell the story. Homes were far more affordable back in 1993 than they are today, and there were significantly more renters (who had not yet entered the market) who could potentially buy them. Today, home affordability is at an all time low, and just about anybody who could buy one already has. For those who think the inventory of unsold homes is high now, you ain’t seen nothing yet.
Consider these factors. There are a record number of new homes currently under construction. Real estate speculators who bought solely on the anticipation of rising prices will likely try to unload their properties now that the market has turned. With higher short-term interest rates, those who financed with ARMs will also try to sell their homes to get out from under mortgage payments they can no longer afford to make. A record number of Americans who bought second homes, or vacation properties, will likely reassess the wisdom of those purchases, and put these properties back on the market as well. Finally, homeowners who watched the values of their homes rise for years, but were reluctant to sell them for fear of missing out on even bigger gains, will rush to cash in before all those paper profits disappear.
This raises two pertinent questions. First, where will all the buyers come from to absorb this supply and second, at what terms will lenders be willing to finance these purchases? When prices were rising everyone wanted to buy, no one wanted to sell, and lenders were willing to finance just about any transaction. As a result, there was a “shortage??? of homes for sale, a surplus of buyers, and prices rose accordingly. As prices begin to decline, few will want to buy, many will want to sell, and gun-shy lenders will be reluctant to finance all but the most secure transaction. As a result, the “shortage??? will become a glut, and prices will collapse.
The glut of homes on the market indicates just how overpriced real estate has become. By next year just about every house in America would be for sale if the owners thought they could sell at today’s prices. It is impossible to clear the market at current price levels. The only solution is for prices to plunge. Lower prices will result in fewer homeowners wanting to sell, more potential homebuyers able to buy, and lenders willing to finance the purchases.