The Real Estate Bubble Bust — Where and When is the Bottom?

Here is your daily dose of Doom und Gloom (DUG)TM: I was recently asked by a consulting client where and when the U.S. real estate market will likely bottom. Clearly, the market has until recently been frothy, with all the signs of a speculative bubble. Lots of people that had no business doing so bought “spec” houses. Many of these buyers were under-qualified, often stretching the truth on their mortgage applications when they described their assets and incomes. Many houses were bought with interest only loans. They purchased second, third, or even fourth homes with the goal of flipping them for a quick profits. Now the klaxons have sounded and the spec buyers are crowding the exit doors. Its a Hollywood epic in the making. Recent news reports have confirmed that we are well beyond the to. Bloomberg reports that U.S. home resales are falling. This is the first clear drop in a decade. Meanwhile, the inventory of unsold homes in the U.S.–both new and existing–is climbing. This unsold inventory has grown enormously. In fact the inventory has more than quadrupled in some markets. This has all the makings of a spectacularly declining market in near future. When hardly anyone is buying, the law of supply and demand dictates that prices must fall. I am still pointing to the Spring of Aught Seven for the outright panic and housing market collapse

Based upon the currently overvalued prices (since prices have galloped far ahead of the currency inflation rate), my educated guess is a bottom in 2008 or 2009, with overall declines of around 35% from the recent market highs.(To be more specific: Down 10% in the the least inflated rural inland regions, and down perhaps as much as 60% in the most over-valued metropolitan markets such as Phoenix, San Diego, and Miami. The biggest declines will surely be on the coasts. The old investing axiom “a rising tide raises all ships” also works in reverse. Let’s face it. The tide has been rising for 10 years in most markets, and to mix a metaphor, the pendulum needs to swing the other way for a while.

My advice: If you own a “spec” house, then you should have been watching the market more closely and already sold it. If you can presently sell it for “break even” or even something close to that, then do so, as soon as possible. Ditto if you have a vacation property that you do not intend to keep for your lifetime or that you don’t intend to employ as a survival retreat. If you own rental properties, you should sit down and dispassionately do the math. Consider the potential market decline, and what that will do to rent rates in your area. If house prices drop 30% then rents will drop 30%, or at least close to that. Count on it. If rents do indeed drop and you anticipate a negative cash flow, and you can’t afford to ride out a negative cash flow for 18 to 36 months, then it it is better to cut your losses and sell your rental houses(s) now, while you still can.

If you have a variable rate mortgage on any property, convert it to a fixed rate loan, muy pronto, even if that means that your monthly payment is slightly higher. When the rates rise–and trust me, they will–folks with ARMs are going to get hurt badly when their rates are reset. I call this “ARM twisting” syndrome. I foresee that an interest rate jump of 2 or 3 percent will be a very painful ARM twisting exercise.

If you are comfortable where you are, then stay where you are. Hold on to your cash. Watch and wait for the bottom, and then perhaps do some bargain hunting. Who knows? You might be able to find a nice self-sufficient rural retreat property at the bottom of the market, for roughly 60 cents on the dollar. Don’t buy real estate now unless it is in a relatively safe (read: non-coastal) market and you can buy it at a bargain price from a “motivated” seller. Build an anticipated 35% drop in the market into your purchase calculations. That should limit you to buying only genuinely under-valued bargains.

What if you aren’t comfortable where you are?. What if you presently own a house that is in a vulnerable market and you know that for family, health, or employment reasons that you will be moving within the next three years? (I’m talking to you, Fred.) Then my advice is to take advantage of the market gains and sell you your house. Sell now, and move into a rental house. Yes, I know this is a hassle, but someday you’ll thank yourself for doing so. As previously mentioned in this blog, you might even be able to sell your house to a property management company, and rent it back.

The old saying goes, “buy low and sell high.” In the near future I believe that you will see a lot of your neighbors trapped by their debt burdens and forced into doing just the opposite. It won’t be pretty.