As we’ve been warning for some time now, it was inevitable that the overheated real estate market would cool off.
That time has come, but the situation isn’t as dire as it seems.
First, the bad news:
Existing-home sales have fallen by 5.7 percent in the past 12 months.
The median sales price rose by just 4.2 percent over the previous year, which is the smallest gain in five years.1
Meanwhile, in May, the Federal Reserve hiked interest rates for the 16th time in a row, which has pushed the rate on 30-year fixed mortgages to the highest level in four years.
The people who are the most vulnerable in any price downturn are those who borrowed more than they could afford to pay for a home.
According to the Wall Street Journal,2 delinquency rates on home mortgages are rising, and the numbers should continue to swell until 2008.
That’s because mortgage delinquencies usually hit their peak three years after loans are written, and 2005 was a banner year for risky mortgages.
According to the Journal, a study by First American Real Estate Solutions found that 29 percent of homebuyers who received mortgages in 2005 have no equity in their homes or owe more than their house is worth.
In 2004, less than 11 percent of borrowers fell into that category.
These home owners will be hurt the most if prices fall, because they’ll be making payments on houses that are worth less than the amount they borrowed.
Now, the good news:
A driving force behind the housing boom was the purchase of second homes by the Baby Boomers.
For the 75 million members of this generation, one of anything is never enough.
For example, U.S. Census figures reveal that the average American household now has 2.4 televisions and 1.7 cars.
Now, increasingly, one house isn’t enough.
A survey by Harris Interactive for the National Association of Realtors found that 25 percent of Baby Boomers own more than one property. That amounts to nearly 20 million Americans who have bought second homes or investment properties.
Overall, 40 percent of all homes sold today are second homes, compared to just 6 to 10 percent in the past. But that’s not all:
Surveys of buyers of second homes reveal that 60 percent of them own two or more vacation homes, in addition to their primary residence. Obviously, many of those third and fourth homes were bought as investments when prices were climbing.
Now, housing prices have peaked, and in many overbuilt markets, sellers are discovering they have to cut their asking prices.
As Barron’s3 reported in a recent cover story, “After a long string of double-digit annual price increases, a number of second-home meccas across the country are suddenly suffering from plunging sales volume and burgeoning inventories of unsold homes.”
According to local realtors, the biggest bargains can be found in resort communities such as Naples, Florida, where sellers of multi-million-dollar homes have cut asking prices by 25 percent, and in the posh Massachusetts towns on Cape Cod, where one seller reluctantly slashed the cost of a mansion by 42 percent.
In Phoenix, the median price of a home soared by 40 percent in 2005, which was the fastest growth rate in the U.S.
Now, however, the number of sellers in Phoenix is outpacing the number of buyers, and the inventory of homes on the market has surged 500 percent, to 39,000, while sales are down by 40 percent.
Meanwhile, according to the San Jose Mercury News,4 in Silicon Valley, which is always one of the hottest real-estate markets in the country, sales of single-family homes fell by 24 percent this spring compared to the previous year.
Barron’s5 cites a report from National City bank that used a variety of factors, including income levels, population densities, and historical prices, to pinpoint the markets where the prices for second homes have far outpaced their actual value.
The study found that the 10 most overvalued markets in the country are:
Naples, overvalued by 96 percent
? Port St. Lucie & Fort Pierce, Florida, 75 percent
? Bend, Oregon, 66 percent
Napa, California, 63 percent
Fort Lauderdale, Florida, 54 percent
Ocean City, New Jersey, 50 percent
Barnstable, Massachusetts, 46 percent
Nassau-Suffolk, New York, 45 percent
Las Vegas, Nevada, 39 percent
Tucson, Arizona, 33 percent
Of course, there’s a difference between a second-home owner who has purchased a property to use as a vacation home, and one who has bought a house or condo simply in the hope of selling it at a higher price.
The vacationer can derive enough personal value from a condo in Florida he uses every winter that the slide in prices will make no impact.
Obviously, the people who will be hurt are the speculators who bought homes ? often before they were built and with risky zero-down mortgages ? in the hopes of “flipping” them at a higher price to another buyer in the near future.
That strategy is especially risky in the markets where speculation was rampant, because there will be cutthroat competition among sellers as prices drop.
Historically, investors account for about 14 percent of second home purchases.
But in many markets, the percentages are now much higher.
According to The Local Market Monitor, a consulting firm that compiled statistics for Barron’s, these are the cities and areas where the greatest number of homes were bought as investments:
? Myrtle Beach, South Carolina, where 58 percent of home buyers were speculators
? Naples, Florida, 45 percent
? Cape Coral and Fort Myers, Florida, 40 percent
? Wilmington, North Carolina, 38 percent
Investors accounted for between 20 and 25 percent of all homebuyers for the remaining six regions in the top 10, including:
? Atlantic City, New Jersey
? Honolulu, Hawaii
? Reno, Nevada
? Miami and West Palm Beach, Florida
? Phoenix, Arizona
? Charleston, South Carolina
According to PMI Group, a provider of private mortgage insurance, excessive speculation is one reason why there’s a good chance that prices will decline in the hottest markets.
PMI studied the trend in home prices, the level of unemployment, and the affordability of houses in each market.
The analysts concluded that San Diego faces the highest likelihood of a decline, at 60 percent, followed by 13 other areas in California.
In areas near Boston and in New York, the odds are at least 50 percent that prices will slump.6
Based on this data, we offer the following five forecasts:
First, a massive crash in real-estate prices that leads to a recession is highly unlikely.
We expect to see a correction in prices, as the Federal Reserve continues to raise interest rates, more homes come on the market, and price appreciation slows or stops completely through 2009.
However, this will not be a repeat of the tech stock crash that destroyed trillions of dollars in wealth and plunged the nation into a recession.
The economy will remain strong, thanks to productivity gains and low unemployment.
Second, the market for second homes isn’t going to dry up completely.
The demographic force is just too powerful.
Those 75 million Boomers are still going to want vacation homes, and even in 2005, as the overall real-estate market began to slow, Americans continued to buy 3.34 million second homes, a 16 percent increase over the previous year.7
Third, because of the price correction, this is an excellent opportunity to purchase a second home.
Because it is a buyer’s market, you can have your pick from a glut of properties, and you shouldn’t have to pay anywhere near the asking price.
Look for a community that provides an ideal balance of good weather, excellent cultural and recreational opportunities, and easy access to your primary residence via a highway or airport.
Choose a location that you can use for vacations now, and for retirement in the future.
Fourth, if you are selling a vacation home that you bought as an investment, you should cut the price as necessary to avoid getting trapped in the glut of homes that will hit the market during the next 12 months.
In many areas, such as Miami and Las Vegas, the market will be oversaturated with new condos when the construction projects already underway are completed.
As Harry S. Dent Jr. points out in the May 2006 issue of his newsletter, another strategy is to be patient and wait until 2010, when prices should rebound briefly after the correction.8
Fifth, shift your money to the stock market. Don’t wait for real estate prices to fall further.
Reallocate your portfolio now.
All those billions of dollars that speculators were using to fuel the real-estate boom will soon be channeled into equities, and stock prices will rise.
According to the Spectrem Group consulting firm, people with investable assets of $100,000 to $1 million currently have more than 33 percent of their assets in real estate.9
As houses and condos become increasingly less attractive as investments, affluent people will allocate more of their money to stocks, which are currently undervalued, and the outlook for the Dow looks extremely bullish through the end of this decade.
References List :
1. To access Brian Wesbury’s and Bill Mulvihill’s commentary on existing-home sales, visit the First Trust Advisors website at: www.ftadvisors.com
2. The Wall Street Journal, May 18, 2006, “Late Payments on Mortgages Rise,” by Ruth Simon. ⓒ Copyright 2006 by Dow Jones and Company. All rights reserved.
3. Barron’s, May 29, 2006, “The Big Glut: Trouble in Paradise,” by Robin Goldwyn Blumenthal. ⓒ Copyright 2006 by Dow Jones and Company. All rights reserved.
4. San Jose Mercury News, May 18, 2006, “Valley House Prices Down; Loan Rates Up,” by Frank Michael Russell. ⓒ Copyright 2006 by San Jose Mercury News. All rights reserved.
5. Barron’s, May 29, 2006, “The Big Glut: Trouble in Paradise,” by Robin Goldwyn Blumenthal. ⓒ Copyright 2006 by Dow Jones and Company. All rights reserved.
6. San Jose Mercury News, April 5, 2006, “Housing Prices Downturn Predicted,” by Mark Schwanhausser. ⓒ Copyright 2006 by San Jose Mercury News. All rights reserved.
7. Barron’s, May 29, 2006, “The Big Glut: Trouble in Paradise,” by Robin Goldwyn Blumenthal. ⓒ Copyright 2006 by Dow Jones and Company. All rights reserved.
8. For more housing market strategies, visit Harry S. Dent’s website at: www.hsdent.com
9. Barron’s, May 29, 2006, “The Big Glut: Trouble in Paradise,” by Robin Goldwyn Blumenthal. ⓒ Copyright 2006 by Dow Jones and Company. All rights reserved.
