Updating the Arrow After Home Prices Drop

The New York Times is reporting, “Home Prices Drop After 11-Year Ascent”:

“The median price in August fell to $225,000, down 1.7% from August 2005. That was the first time since April 1995 that the national median price was lower than the same month a year before.”

On that news, I thought it was time to update my comparison of the U.S. housing bubble with that of Japan’s in the ’80s and ’90s. The current picture looks like this:


A discussion on where previous arrows were put and why can be found in “U.S. vs. Japan Land Prices Pictorial Update.”

I had a much harder time figuring out where to put the arrow for this pictorial update. The reason is because national home prices have actually been declining for some time. I have commented on this many times before, but for new readers, homebuilders have been reporting “full-price sales,” while giving away hundreds of thousands of dollars in incentives, new cars, vacations, upgrades, reduced interest rates, etc., and chalking those expenses up as “advertising costs.” Mammoth price reductions from every national builder have been going on since the beginning of the year.

Palm Coast Florida

Here is a typical example from D.R. Horton:


The above ad came out on Sept. 23 for the Daytona Beach/Palm Coast area. The price on the Grand Teton model was $282,445 and is now $197,445. That is a 30% haircut. Not only is that a 30% haircut, but it is important that the entire subdivision was just repriced 30% lower (plus appliances). Any flipper who paid full price is now 30% underwater (not counting interest expenses, insurance, property taxes, etc. Can that flipper sell for $197,445? Of course not. A realistic price, IF one could find a buyer, might be $185,000. After all, who wants to by a used house when a new one is about the same price, has “free” appliances, and comes with a warranty? Add in real estate commissions and that flipper may be down by as much as 50% or more. Rent it out? Supply of rentals (especially condos) is exploding. Meanwhile, prices continue to drop.

Realtors Warmly Welcomed

This kind of action has been going on for over six months in most of the country to varying degrees. In addition to the enormous price reductions, there is a subtler portion of the ad that shows stress on homebuilders and prices. Right at the bottom of the ad in large type is the message “Realtors Warmly Welcomed.” A year ago, builders refused to split commissions with Realtors. Now builders are offering triple commissions to realtors. That is a dramatic change and right off the bottom line of builders.

More NAR Cheerleading

Let’s tune back in to more nonsense from our favorite cheerleader at the National Association of REALTORS. From The New York Times article:

“David Lereah, chief economist of the association, said he expects prices to continue to fall. ‘We do expect an adjustment in home prices to last several months, as we work through a buildup in the inventory of homes on the market,’ he said in a written statement. ‘This is the price correction we’ve been expecting — with sales stabilizing, we should go back to positive price growth early next year.'”

There is absolutely no indication of working through any housing inventory. In fact, inventory is now up to 7.5 months, compared with 7.3 months a month earlier. Those numbers are from the NAR, so it appears Lereah is not even following his own reports. Furthermore, builders keep on building faster than home sales are rising. Thus, homebuilding continues to add to supply. REOs (real estate owned by banks due to foreclosures) are also rising. That adds to supply. Massive rises in bankruptcies in the Rust Belt and Colorado are adding to supply. The demographics of baby boomers retiring will add to supply for years to come. There is simply no reason to expect either stable prices or inventory to be worked off in this situation.

A more realistic opinion was offered by Ian Shepherdson, chief United States economist at High Frequency Economics: “With inventory still rising, there is no chance of any short-term relief” for sellers. “Prices and volumes have a long way to fall yet.”

Dow Jones offers this commentary by Lereah:

“NAR chief economist David Lereah said an anticipated decline in prices compared with a year earlier has begun and is likely to continue until the end of the year, helping to support sales.

“‘With sales stabilizing, we should go back to positive price growth early next year,’ Lereah said.”

Lereah anticipated a decline in prices? When? What amazing spin from someone buying and recommending Florida condos right before the crash, and who has argued that fundamentals would never let a year-over-year decline happen.

Yeah, right. That is why D.R. Horton is offering 30% discounts and still has no buyers, and various markets like Florida, Boston, Detroit, and now places in California have come to a standstill.


MarketWatch is reporting, “Existing-Home Prices Fall for 1st Time in 11 Years”:

“The collapsing U.S. housing market crossed another milestone in August, as the median sales price of existing homes fell for the first time in 11 years and for just the sixth time in the past 38 years, the National Association of REALTORS said Monday…

“Sales of existing homes fell 0.5% in August to a seasonally adjusted annual rate of 6.3 million, the industry group said. It was the lowest sales pace since January 2004. Sales have fallen five months in a row. Sales are down 12.6% in the past year…

“‘Sellers are finally getting it,’ said David Lereah, chief economist for the real estate group. ‘The price drop has stopped the bleeding. Sales have hit bottom.'”

Let me see if I’ve got this straight:

1. Existing homes fell for the first time in 11 years.
2. Inventories are still rising.
3. Sales have fallen 5 months in a row.
4. Sales are down 12.6% in the past year.
5. “The price drop has stopped the bleeding.”

Does Lereah have an ounce of credibility left?

Northern Virginia

McEnearney Associates posted the “Top 10 Reasons to Be Optimistic About Northern Virginia’s Housing Market.” Let’s look at reasons 8-10:

“10. The softening of the market. Believe it or not, that’s a good thing. There is no doubt that the market is slower and softer in every respect when compared to the last several years. The 20-25% appreciation rates were not sustainable. And the longer they continued, the harder the fall would be…

“9. The media. OK, this may seem a bit tongue-in-cheek, but area homeowners should rejoice every time the national media and even local media predict doom and gloom for area housing — because they have so often been wrong. The relentless drumbeat of negativity seems almost totally disconnected from reality. Our current favorite: Forbes predicts that the median price of a home in metro D.C. will increase only 3% over the next 10 years. Not 3% annually, mind you. A total of 3%. In the best regional economy in the country.

“8. History. The compounded average annual increase in the average sales price of a home in the metro D.C. area over the last 30 years is 7%. (Forbes, are you paying attention?) 7% is normal; 7% is sustainable. We won’t see that in 2006, but an individual’s housing decision should be a long-term decision. Feel good about owning a home here — unless you have to sell right now.”

Reason No. 10 seems to suggest that home prices are going to go up because they are now going down. Obviously, that is silly.

Reason No. 9 ignores the fact that the media did nothing but report good news for years, topped by the cover of TIME in the summer of 2005: “Why We’re Going Gaga Over Real Estate.” As bad as sentiment has gotten, it is nowhere near the extreme we saw at the top. That cover marked the secular peak in housing. Besides, places like McEnearney Associates were bullish when sentiment was bullish, and are now supposedly bullish because sentiment is bearish.

Reason No. 8 proves that the writer of the article does not understand basic math. I agree with McEnearney Associates about there being a “disconnect from reality.” The first disconnect is on an unsupported rise up in home prices, where it was considered “normal” for home prices to rise four standard deviations above rental prices and wage growth. Home prices in many places (Florida, California, D.C., etc.) are up 100% or more in 4-5 years. Obviously, that is not sustainable, even though flippers bought into the concept big-time and are now being toasted over it. A second disconnect is failure to understand reversion to the mean. To average 7%, we will need to see many years of zero to negative growth. A third disconnect is that 7% will NOT be sustainable in a secular downtrend. A fourth disconnect is that prices tend to overshoot in both directions. The implication of that statement on the way down should be obvious to even the math-challenged. (McEnearney, are you paying attention?)

More than likely, we will see prices drop 30-50% over 2-4 years, depending on the bubbliness of the area, then chop sideways or down (again, depending on the market) between 6-10 years. That is what it will take to average 7% a year, given the unprecedented four standard deviations above the mean rise in home prices compared with both wages and rent since 2000. That may also be the best-case scenario.

When the attempt by Lereah and others to spin every piece of news positive is so blatantly obvious, why should anyone pay attention to them? I have news for all the real estate wizards, flippers, and cheerleaders: Sustainable positive price growth is years away. We are closer to the peak (heading down) than the trough (about to head back up).

Mike Shedlock ~ “Mish”
September 26, 2006