What’s Causing the recent drop in Home Prices?

There are more homes on the market and asking prices are coming down.
But how low will prices go before the market favors sellers again?

Markets around the country have seen home prices decline over the last several months, but economic conditions aren’t likely to blame for the dip. So what is? In many cases, it’s buyers’ attitudes.

Real estate normally appreciates one to two percentage points above inflation. Between 2001 and 2005, however, real estate values increased 50 percent, giving sellers an abnormally high return.

That drastic increase leveled off in 2006 and prices and sales began to return to more normal rates — although still far above historical norms — resulting in the third best year for real estate sales ever. Ironically, it was also the first year that national median home prices declined since the NATIONAL ASSOCIATION OF REALTORS® began keeping figures in 1968.

NAR predicts that 2007 will be a year of slight decline, which raises an interesting question: What is causing home prices to drop?

What History Shows

Buyers often retreat out of fear from local market realities such as job losses and overbuilding, two preconditions for metro area housing price declines, according to the Joint Center for Housing Studies of Harvard University’s report “State of the Nation’s Housing 2006.”

Between 1975 and 1999, overbuilding and major employment loss led to price declines nearly 8.3 percent and 4.5 percent, respectively, of the time.

Yet, buying conditions after 1999 changed. Baby boomer wealth poured into the market with larger homesteads and second homes. Generation Xers came into their own with white collar jobs and were able to more easily purchase a home with generous loan programs lenders had never previously offered. Government subsidies continued in the form of low interest rates, hovering at 30-year-lows since 1998.

Home buyer demographics also changed as more households formed, partially due to a surge of immigration and other first-time buyers. Single women, for example, now comprise 22 percent of the home owner market, up from 15 percent in the 1990s.

So Why Are Buyers Reluctant?

Employments up, inflation appears under control with Federal Reserve rates standing pat, and mortgage interest rates are low. Each of these is a strong buying signal for housing. Yet home buyers are moving to the sidelines nonetheless, most likely in reaction to double-digit price gains that occurred in many metro areas — making affordably hit a wall, particularly in California. Buyers simply lost patience with ever-escalating home prices.

When buyers do enter the market, they’re asking home sellers’ to reduce prices. Makes sense for overheated markets, but it’s happening even in areas that didn’t experience the boom.

For example, Dallas’ home appreciation has been under the national median for more than 15 years, so it hardly cashed in on the recent boom. But while many investors already recognize Dallas as undervalued, some buyers still are asking sellers for price reductions.

Dallas practitioner Mary O’Keefe says one of her clients refuses to take her advice when making offers and instead prefers to listen to his Wall Street buddies who don’t live in Dallas and aren’t familiar with sold comparables.

“They’re telling him that he should offer $50,000 less than the asking price,” says O’Keefe, who has been showing the buyer townhomes. “He’s lost out on two great properties with low-ball offers, but he just won’t accept that his expectations are unrealistic.”

Don’t Expect It to Last

Common sense dictates that when prices decline, buyers should jump in. It’s why consumers love department-store sales, year-end car and truck clearances, and stock market fluctuations. Buy low and sell high is what we all wish we could do.

Buyers who are still waiting on the sidelines must learn a basic economic fact of life: if fundamentals aren’t supporting a market decline, then it’s not going to decline for very long. If the nation and local communities are adding jobs and population, a market decline is destined to be short-lived.

Price is a legitimate concern, but with growing inventories, buyers should be taking advantage of an abundant selection. In a seller’s market such a luxury doesn’t exist and slim pickings mean they must take whatever is available.

As for home sellers, they’ll need some patience. Eventually, there’s a point when others begin to recognize a good deal and they’ll make an offer that the seller will accept. The more that happens, the closer the market will be in turning from a buyer’s market back to a seller’s market.

Source Realtor Magazine, January 2007

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