by John M. Curtis
(310) 204-8700

Copyright Oct. 27, 2006
All Rights Reserved.

hat goes up must come down, or so goes the endless cycle in all markets, whether in stocks, real estate or soybeans. Apart from the election year, few experts predicted a precipitous drop in oil prices, dropping $20 a barrel in the past two months. When oil peaked of $78 a barrel Aug. 7, market analysts predicted oil could easily break the once unthinkable ceiling of $100 by year's end. Since that milestone, the market unraveled, sending crude oil plummeting to around $58, still high by historical standards. Despite news about diminishing supplies and runaway demand in China and India, the market still disintegrated. Now real estate faces the same, watching existing home prices drop 2.2% in Oct., the biggest decline since the National Association of Realtors began keeping statistics in 1968. Since Sept. '05, the market has watched a 14.2% drop in existing single-family sales.

      When the Federal Reserve Board under former chairman Alan Greenspan began hiking short-term interest rates in June '04, Greenspan insisted he wasn't targeting the real estate market that watched its values rise, in some areas, over 300%, during the past five years. Over the past year, the median price of single-family homes fell from $225,000 to $220,000. While that seems like a modest decline, the trend presents ominous implications for an economy heavily driven by home equity lines. Declining values coupled with risky adjustable-rate mortgages, many have negative amortization, allowing home equity to shrink by the month. With home equity shrinking, it's only a matter of time before defaults and foreclosures further erode real estate values. Mortgage defaults doubled in California for three months ending Sept. 30, a trend also seen in other states.

      If history's any guide, during the last real estate boom-and-bust cycle 1990-96, California mortgage defaults peaked at 59,897, where they currently stand at 26,705, according to DataQuick. Greenspan saw unsustainable real estate growth in 2004, hiking rates 17 consecutive times. In 1998, Greenspan hiked rates to combat a run-a-way stock market, eventually crashing in Feb. 2000. Unlike the stock market that relies on price-to-earnings ratios to gauge share value, real estate investors get no equivalent benchmarks. Appraisers typically rely on comparable sales data to ascertain values, something, in a way, far riskier than using price-to-earnings ratios. As buyers clamor to buy properties, there's no reality check on values, other than what buyers are willing to pay. Today's real estate market reflects 5-years of unchecked growth, now giving back some of the unrealistic growth.

      Predicting peaks and valleys of any market is no easy matter. Caught up in the euphoria of rapidly escalating values, consumers often forget that buying low and selling high still applies to successful investing. Real estate investors are tempted by low interest rate loans, sometimes called “teaser-rates” that qualify buyers at lower lending standards. Buyers and speculators are so frenzied to get into the market they ignore risky loans that gobble up equity. “We were putting buyers in homes with loans they could not afford to sustain over the long haul,” said Bob Casagrand, a San Diego real estate agent, where values have gone through the roof. Not only can mortgage payments double, homeowners can watch equity evaporate quickly. During market meltdowns, homeowners can't easily “flip” properties, running out of cash, going into default and winding up in foreclosure.

      Before the stock market crashed in Feb. 2000, taking the DOW down from over 11,000 to 7,000 by 2002, few investors imagined the bubble would burst. While the DOW has recently broke new ground, the technology-rich Nasdaq is still 50% of its peak value. If present real estate trends continue, the market will give back some percentage of gains made over the last five years. “Psychological factors have people on the sidelines,” said Lawrence Yun, senior economist with the National Association of Realtors, blaming the current inventory glut on nervous buyers trying to time the market. While Yun sees inventories dropping moderating current price declines, other experts are less optimistic. “The speculative frenzy of recent years is causing a major adjustment, and the happy talk of realtors is prolonging the process,” said University of Maryland economist Peter Morici.

      All markets, including real estate, go through ups and downs. No matter what the hype, there's no market-based investment that's a sure thing. Hog-wild speculators usually get burned, much the same way compulsive gamblers have difficulty leaving the one-armed bandit before it's too late. Like his predecessor, newly minted Fed Chairman Ben Bernanke knew that ratcheting up short-term rates would eventually hit mortgages, causing the real estate bubble to eventually pop. Speculators that bought into the market too late with risky adjustable rate mortgages stand to take a beating if forced to sell. “Frustrated buyers are removing their homes from the market,” said Morici, accounting for what seems like reduced inventory. In reality, sellers that can't hold out will be forced to sell, handing bargains to disciplined buyers. Speculators will find out the hard way that real estate's no sure bet.

About the Author

John M. Curtis writes politically neutral commentary analyzing spin in national and global news. He's editor of OnlineColumnist.com and author of Dodging The Bullet and Operation Charisma.

©1999-2005 Discobolos Consulting Services, Inc.
(310) 204-8300
All Rights Reserved.