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Real Estate Begins to Cool

Two major themes we have been discussing for quite some time appear to be coming together:

A) Real Estate, though not a bubble, is an extended asset class overdue to retrace;
B) RE has been the dominant sector in the US economy since the recession ended.

Those themes lead us to following: 5 key factors suggest to us that Real Estate has finally begun to cool:

1. Inventory
2. Prices paid
3. time on the market
4. relative strength of Condo sales
5. Mortgage rates

Mortgage rates have ticked upwards to 6% on the decoupling of the Chinese Yuan from the Dollar and the reintroduction of the 30-year Treasury bond.

Given Real Estate’s contribution to economic growth, this is quite significant. Despite recent data to the contrary, the Real Estate complex has been the most robust economic growth engine in the US. We credit half-century low interest rates, demographic trends, disenchantment with equities, and the decreasing availability of buildable plots of land for this phenomenon.

We spoke with Real Estate Agents in the NY area, and they have all noted a pronounced shift. Bidding for Houses is far less furious than it was a few months ago. Sellers who were inflexible on price wait much longer to sell, as Buyers have become more selective. Even the credit worthiness of some bidders is not as strong as it was prior. Anecdotal evidence, combined with quantitative data, suggest that we are now in the latter stages of the housing boom.

As the sector begins to further cool, we foresee several significant elements coming into play: 1) Housing related employment slows and reverses. Think real estate agents, mortgage brokers, durable goods manufacturers, home-builders and retailers. They could move from a hiring mode to laying off sometime over the next 18 months; 2) Major retailers (Home Depot, Lowes, Sears, Bed Bath & Beyond) will feel the pinch, as revenue and profits begin to slow; 3) Home builders, still cheap on a P/E basis, will begin to throttle back growth.

How the builders handle the slowdown will be a function of their prior positioning. Those with little debt, prime locations and a strong back order will likely see only a modest slowdown. However, Jeff Matthews notes that some homebuilders are engaging in speculation; He specific cites Toll Brothers as “playing the spot market.”

The silver lining is that slowing Real Estate gives the Fed the excuse it needs to stop tightening, assuming their motivation was to let some air before a real bubble got too far out of hand.

Given the significance of this sector and the relative modest strength of the rest of the economy, we suspect the Fed will fail in their attempt to engineer a soft landing.

We expect a recession in the 2006-07 time frame.

>

UPDATE August 10, 2005 6:47am

The NAR noted on Tuesday that they too expect Real Estate to cool off into 2006:

A runaway real estate market this year has many economists – and even Fed Chairman Alan Greenspan – fretting about the housing bubble. But the people who sell real estate for a living predict a soft landing for the red-hot market, not a crash that could wipe out homeowners' gains of the last three years.

The Federal Reserve raised short-term interest rates for the 10th consecutive time today, lifting its short-term rate target to 3.5% from 3.25% and signaling that more increases are to come. The Fed ist rying to deal with strengthening economic growth, a slightly less favorable inflation picture and still-low long-term interest rates.

“The housing market is probably close to a peak right now in terms of sales activity, but there is tremendous momentum," said David Lereah, chief economist for the National Association of Realtors. "Sales are expected to coast at historically high levels into next year, but they will trend slightly downward.

>

Source:
Realtors See Market Coasting For The Rest Of The Year
August 9, 2005
http://www.consumeraffairs.com/news04/2005/housing_realtors.html

Monday, August 08, 2005 | 01:30 PM | Permalink | Comments (21) | TrackBack (6)
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Comments

Seems like you're missing a big factor here: increases in rents have not kept pace with house prices. That indicates that there isn't a shortage of housing, but only of one type of housing for which a ready substitute is available. At some point, most people don't buy houses if they can rent one for much less money.

Posted by: royce | Aug 8, 2005 1:58:48 PM

Is that true? Maybe my experience in the area of real estate has been too limited to get a proper picture, but at least in the areas I have been looking (New York - 5 boroughs), rents seem to be keeping pace with house prices quite well.

Posted by: charles | Aug 8, 2005 3:03:54 PM

NY landlords are raising their rents, but how long can you bleed a turnip?

Posted by: papillon | Aug 8, 2005 5:42:55 PM

in the bubblicious california markets of san diego and san francisco, rents have lagged prices for a number of years. In fact prices would have to decline ~40% to reach historical ratios with rents.

Posted by: camille roy | Aug 8, 2005 6:02:55 PM

Barry, Congratulations on making what to many of your TV viewers will seem like a bold call (recession in '06-'07). Your well informed readers have been expecting it.

A very nice summary post!

Best Regards.

Posted by: CalculatedRisk | Aug 8, 2005 7:25:53 PM

Of course housing sales are slowing in August! Housing sales have always been very season based, with the vast majority of the sales happening so that families with children can move during summer break and not interrupt the school year. The houses that didn't get sold in the "school year jump" market of May June and July are problem properties that have now grown stale.

Comparing housing sales in August to housing sales in June is apples to oranges. Compare housing sales/unsold inventory levels to the same month previous years and you'll be more convincing. Otherwise you might as well report that sales of fruitcakes and christmas trees slows in January.

BARRY RESPONDS:

The data I am referencing are year over year sales . . .

Posted by: Blackwood | Aug 8, 2005 8:04:21 PM

Housing inventory is up...compared to what? A year ago inventory was at a record low in most hot markets. I'll bet (meaning I don't know for sure, but neither does your post) that inventory levels are back to just elow normal, certainly not high yet. It's kinda like the real Fed Funds rate which is also up from near all-time lows to just somewhat below normal.

Posted by: Henry Jasen | Aug 9, 2005 11:00:39 AM

I think I pretty much agree with your analysis. I do think one factor in slowing sales and reducing prices that you didn't mention is that even if interest and employment remained stable or even if they improved, a hot market has to reach it's limits. This will end with reduced demand and increased supply.

Right now far more buyers than usual are stretched.

I think the whole "bubble" term is distractive. I believe most people who use it are referring to something similar to what you describe not an 80% fall in prices. In the current debate the argument that "there is no bubble" is usually used to imply that prices will increase or at least hold.

Posted by: lollipop | Aug 9, 2005 12:38:35 PM

Yet another great post, but I'm not sure I agree entirely. I think it could be argued that saying "the last bubble saw equity prices decrease by 80%, housing will likely not decrease that much, therefore there is no bubble" implies an underlying equivalence that isn't there. The importance of real estate value to the average family's bottom line is much larger than that of their (often nominal) equity market exposure, which means that a 30% drop could be devastating. In other words, it seems to me that the measure of a bubble is in the breadth and depth of its real impact rather than in specific numbers.

I also think you offer a great insight about financing costs, but I wonder where adjustable-rate financing factors into your analysis. Wouldn't rising yields on the 10-year TSY have a big impact?

Posted by: Jason | Aug 9, 2005 9:11:49 PM

The Philly Housing index (HGX) bounced back over the 50 day MA. Bubble Phobia is on hold for now.

Posted by: Larry Nusbaum, Scottsdale | Aug 10, 2005 11:09:59 AM

I wish we had a better grip on lending practices before this whole thing began -- The fact that someone can own a $500,000 piece of property for $800 a month is outrageous. Reverse amortization loans should be done away with.

Posted by: Scott Wiles | Aug 11, 2005 2:11:14 PM

Retracement is very difft than a bubble being pricked. I think a retracement is due but it's not clear that the bubble is ready to be deflated yet. I'd give it a few more years before it really pops.

Posted by: John Updike | Aug 12, 2005 5:06:36 PM

I live in Washington, DC. A burned out shell here can go for well into six figures. With oild now more than $60 a barrel, won't the demand for housing in DC, NYC, LA, and the like, continue to rise as suburbanites seek housing closer into the various downtowns to cut commuting costs? If yes, won't this demand continue to "fuel" the boom in housing costs in big cities?

Posted by: Takomaguy | Aug 22, 2005 4:59:32 PM

I think John is right, but what will happen to the houses they left in the suburbs......I gues they will need to find buyers first or carry 2 mortgages or rent the houses for less than the mortgages.
Just food for thought

Posted by: Josh | Oct 7, 2005 5:16:15 PM

Its great information on the real estate industry. The information gave me much help on considering wether I should buy an apartment complex or any other properties.

Posted by: Apartment Locator Houston | Nov 7, 2005 4:56:35 PM

There are a lot of mixed local and nationwide news related to current real estate trends...

Here are some titles...

April Home Sales in South Florida Dropped

Florida housing market Showed Mixed Results

Housing Prices still on the Rise

Real Estate Market has Peaked

Real Estate Prices Losing Strength

I think the market is going down...But some ppl out there making up stories not to lose their businesses...

Mabelle Sese

Posted by: Mabelle Sese - Real Estate Agent | Jun 5, 2006 6:14:53 PM

Please comment on the aggressive push from HOMEBUILDERS to do all sorts of creative financing, including "lay-aways" and paying off peoples' existing home in order to get them into new homes? A shiney new home instead of an existing one. Could that be a reason homes are not selling these days? Has this trend ever infiltrated the market like it has today? I think it will impact all of us, when we choose to downsize or upscale, we have to sell our present home first. Will real estate agents and brokers be a thing of the past?

Posted by: Elaine | Aug 28, 2006 8:34:27 AM

The so-called real estate bubble and the alleged decline is vastly overstated and varies very much from market to market. For example, New York City which seems to have new buildings at every corner, the rate of the increase of the population is higher than the construction of new buildings. The result is that the pressure on the market is still the same, if not greater.

Posted by: Avi | Dec 4, 2006 10:07:23 PM

Great article for the real estate industry. The information is useful but i can think that the prices should back on the normal levels , soon.

Posted by: Real estates bulgaria | Mar 14, 2007 8:16:08 AM

Bidders now have become more attentive and they watch out what they are buying.Most of them look for real estate agents to help them and that's why the competition throughout this field of the market is so harsh.

Posted by: Monica Nickoles | Jul 5, 2007 4:40:37 AM

It's only a matter of time before the housing market throughout the world collapses - it has to happen to even out the growth years!

Posted by: Jeff | Nov 4, 2007 4:33:11 PM

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