So, assuming that John Talbott in his book Sell Now! has established
his case for an actual and vulnerable real estate bubble and
regardless of his reasoning as so what has caused it, where is all of this going?
If you own residential property, maybe even if you don't, you may want
to sit down.
Talbott sees the bubble not so much bursting as unraveling and he sees it happening
on a number of fronts. He sees the biggest threat as adjustable rate
and interest only mortgages coming home to roost. He projects
that $1 trillion in adjustable rate loans will be up for adjustment in 2007
and that homebuyers who could not qualify for a fixed rate of 5.5 percent in
2005 will certainly be unable to qualify at 7 or 8 percent a year or three later.
Therefore, many holders of adjustable rate mortgages will be unable to make
their reconfigured payments, unable to refinance and will have to sell. As more
and more houses come on the market prices will begin to drop and it may not
be possible to sell the property at enough to pay off the mortgage particularly
if the debtor bought with a low down payment loan (and many who are scrambling
to qualify for a house do just that.) Therefore, there will be a snowball effect
as houses stay on the market longer, buyers pull back to see what might happen,
and the inventory is be further expanded by homes that are either given back
to the bank by borrowers in order to prevent foreclosure or are taken by the
lender through legal action.
So, with a glut of houses on the market, prices fall even further. Adding to
this is the author's perception that real estate is not subject to the
usual requirements of supply and demand. That is, he perceives the housing market
as being capable of instantaneously switching from a buyer's to a seller's
market literally overnight
with prices changing accordingly
even if no properties have actually changed hands. Inventories can move in a
matter of days from a two to three month supply to a six or eight month supply
if new houses already in the pipeline are completed while sales slow and sellers
need to get out or decide to cash out. Add to this the number of investors who
have gotten into markets where rentals do not support housing prices and will
be waiting to anxious to bail the minute prices start to decline.
So the market is caput. Houses aren't selling, prices are dropping, inventories
are going through the roof. How bad can it get? Really scary stories and very
dire predictions sell books and Talbott, remember, writes best sellers.
First of all, he believes that without the housing boom the economy would have
actually contracted over the last five years. Instead it has relied on two foundations
- housing and government (military) spending - to expand. As the boom ends he
predicts that about one million real estate agents will immediately
become unemployed followed by another million mortgage bankers, appraisers,
title lawyers and mortgage support personnel. Next will be construction, not
only new home but also the renovation business as owners lose the motivation
to improve homes that have declined in value below the original purchase price.
This sector has an immediate impact on building suppliers and manufacturers
and so on and on. He expects that this impact on the economy will be national
and very possibly global.
Talbott predicts a staggering decline in average home prices by city
over the next five to seven years, which would cover the market (and his credibility)
until 2013. He derives this prediction from home prices in 1997 adjusted for
inflation to 2005 dollars and then shows the price decline necessary to return
to those adjusted 1997 figures before "most of this nonsense started."
In fairness, he does not state that prices will actually erode to this extent
but that this is the real price decline required to return to the 1997 price
level which he views as normal.
The big losers, as might be expected, are those communities that have been
the big winners over the last nine years. The top 14 communities are in California
starting with Santa Barbara, San Diego, and Salinas where Talbott states that
prices must decline 58 to nearly 60 percent to return to 1997 levels. Massachusetts,
New York, and Florida are also presumed to be poised for big declines. Of about
130 metropolitan areas for which he provides data, nearly half must see average
prices drop by over 15 percent to reach those earlier levels.
To apply this analysis to your own home, estimate what its market value was
in 1997 and multiply that number by 1.212 to convert to 2005 dollars and adjust
for inflation. Subtract this amount from your homes estimated current value
and divide the difference by the current value.
However, Talbott is quick to point out that even those communities that have
not seen skyrocketing prices could suffer and just because a metropolitan area
has only seen a five or six percent increase since 1997 does not mean that prices
could not ultimately decline 20 or 30 percent as the entire economy shakes out.
He also sees outlying communities, built along the secondary or tertiary circumferential
highways that many cities have been building to be among the first and hardest
hit. As prices drop closer in (and his book was in press before the
recent increase in gas prices) buyers will have less incentive
to take on a long commute to compensate for getting more house.
So what is wrong with this picture? A few things jump out and one is his all-round
condemnation of the adjustable rate mortgage and his certainty that this product
will do much to sink the ship. One thing he fails to take into account is rate
caps. Most ARMs can only move 1.75 to 2.5 points at each adjustment. As it seems
to be the longer term hybrid mortgages such as the 5/1 or 3/1 that he is concentrating
on, (and these are now more popular than the 1-year ARM) another mitigating
factor may be that during the stable period many borrower's incomes have
improved or will and there will be some increase in equity. Also, hybrid ARMs,
some taking as long as seven years to reach a first adjustment, will spread
out the effects of rising interest rates and perhaps even carry those homeowners
into a new cycle of low rates.
He also doesn't place a high value on the non-investment value of a home.
In fact, he seems to view this as a negative. Many homeowners don't view
their homes primarily as an investment but as a shelter or even an emotionally
charged possession. While everyone loves to talk about the killing they are
making in the real estate market, few who are not forced to sell will rush to
cash out their profits.
We are certainly not shilling for John Talbott's book. He makes a credible
case for a lot of his theories yet some appear to be internally inconsistent
(his indictment of Alan Greenspan and the banking industry seem particularly
flawed if one is to assume that Greenspan was promoting ARMs to shift risk while
at the same time placing banks in a critical situation should the market collapse.)
However, if you wish to read the book in its entirety, here is the publisher's
Sell Now! The End of the Housing Bubble; John R. Talbott, 2005, St. Martins
Press. The cover price is $14.95 but it is available at discount booksellers