Housing balloon springs a slow leak

Picture the U.S. housing market as a bright red, helium-filled balloon bumping around the ceiling for the last couple of years, but currently suffering a slow leak that interrupts its sprightly bounce, suggests Crocker Liu, professor of finance and real estate at the W. P. Carey School of Business. The latest figures from the National Association of Realtors say sales of previously-owned homes dropped 4 percent in June and July, falling to a 30-month low and adding to a record for-sale home inventory of 4 million. However, Liu contends the market is simply reacting to the Mardi Gras good times of the recent past with a much-needed correction.

Picture the U.S. housing market as a bright red, helium-filled balloon bumping around the ceiling for the last couple of years, but currently suffering a slow leak that interrupts its sprightly bounce, suggests Crocker Liu, professor of finance and real estate at the W. P. Carey School of Business.

It's true that the latest figures from the National Association of Realtors say sales of previously-owned homes dropped 4 percent in June and July, falling to a 30-month low and adding to a record for-sale home inventory of 4 million. Yet Liu contends the market is simply reacting to the Mardi Gras good times of the recent past with a much-needed adjustment.

"Just like the stock market, the housing market needs periodic corrections to regain sanity and rationality. This doesn't indicate a freefall," he explains. Editor of the Journal of Real Estate Economics, Liu was a realtor in his native Hawaii, later accepting the position of vice-president of Prudential's real estate investment group. The housing balloon is deflating faster and harder in some states than others, Liu says.

States with strong job growth — Arizona, Nevada, Florida — reflect the general downtrend in housing, but each still boasts lower unemployment than the national average, giving them an enviable edge. That's because job growth provides the gas filling the new and used-home sales balloon, pumped along by population spurts.

At-risk economies typically experience distress in the form of significant layoffs among key employers — "like 5,000 layoffs at General Dynamics or Intel, something large," he continues. In the absence of this type of job loss, housing price slumps suggest a market correction rather than a rapidly-deflating economy.

Back on the historical track

Still, the raw numbers are scary to consumers, particularly in housing hot-spots like Arizona, where single-family resales dropped almost 27 percent during the second quarter of 2006, says Lee McPheters, Ph.D., director of the Bank One Economic Outlook Center and contributing editor of the Arizona Blue Chip newsletter, published by the W. P. Carey School of Business.

"It looks like some huge collapse when compared to last year, but the remarkable thing is how strong previous years were, rather than the fact that it appears to be weaker right now," McPheters notes. Home sellers in high-growth states got spoiled by galloping property valuations and escalating prices, bolstered by an undersupply of houses.

A year ago, it was not unusual for a home in the country's fastest-growing town of Gilbert, Ariz., to sell for over the asking price within a day or two of being listed, says June Junkas, a ReMax realtor in nearby Mesa. "Now, we're seeing houses on the market as many as 90 days, even in Gilbert, stretching up to six months in outlying areas" of metropolitan Phoenix, she adds.

"But sellers still want to list high, like they could last year, and there's no way that will fly. Buyers are offering an average 5 percent below list, and asking the seller to cover closing costs and sellers are doing it." Like the experts, Junkas, who's closest to the market's front lines, doesn't predict a housing freefall. She tells sellers to list their homes at what they would have asked for in early 2004, before the balloon hyper-inflated, and plan on a reasonable wait rather than instant gratification.

We're now back on track with historical growth patterns, she says. If Phoenix metro resales — which have fallen 37 percent since 2005, more than the overall state drop of 26.9 percent — were to drop 40 percent, "this will still be the fourth-strongest year for residential resale activity in Phoenix history," McPheters says.

Buy or wait?

Does this mean potential home buyers should hold off, anticipating even greater price deflation? Not necessarily, according to Liu, who warns that increasing interest rates can offset or even re-inflate a home's overall cost. "An interest-rate increase of 1 percent is a bigger motivation to lock in and buy a house right now than a 1 percent decrease in the house's price. Most people don't recognize this, and wait for price to be cheaper — but if interest rates rise, sometimes they end up unable to afford the darn house," he says.

Interest rate uncertainty is more of an issue now that Ben Bernanke has succeeded Alan Greenspan as Federal Reserve chairman because "his approach is a lot different. With Greenspan, who had a nice, overall sense of what was going on, we knew what was coming down the pike," Liu explained.

"Bernanke, I haven't really figured out yet. My initial impression is that he tends to look more to economic data than Greenspan. He appears to let economic growth (market forces) do the job." Tightening interest rates and higher prices motivate some buyers to abandon traditional, 30-year, fixed-rate loans in favor of variable-rate mortgages tied to specific indicators, such as the "prime plus."

But the mechanism allowing these buyers to own a home also exposes them to interest rate swells. The result is more foreclosures. Liu sums it up this way: "The more creative the financing, the more creative the default is going to be."

The geography of investing

Liu suggests investors consider buying residential real estate in a right-to-work state with warm weather and in-migration that trumps out-migration. Right-to-work laws encourage job growth and draw employers, a sunny climate lures everyone from college students to retirees with big bank accounts, and a growing population provides an increasing pool of workers.

McPheters agrees, and points to Indianapolis, the metro area with the highest home foreclosure rate, as an example. Indiana is not a right-to-work state, suffers cold winters, and reports low in-migration; the state also has an unemployment rate of 5.2 percent — compared to 4.8 percent nationwide — and lots of foreclosures. In contrast, Phoenix, the fifth-largest city in the country, in a warm, right-to-work state with heavy in-migration, ranks 37th in terms of foreclosures.

"Comparing these two cities, the main difference has been job creation," says McPheters. "Indianapolis job growth has been about one percent while in Phoenix it has been closer to six percent." Liu's personal recent personal experience validates the data. Drawn by a better job offer, he relocated from New Jersey to Arizona two months ago, trading a 2,000-square-foot-home for a Scottsdale house one-third larger and slightly less expensive. In Arizona, like New Jersey, he monitors two anecdotal indicators for insight on the local economy.

First, he asks taxi and limo drivers how well their customers are tipping. Second, he keeps tabs on college-grad employment rates. Why? "If drivers are not having problems getting healthy tips, things are good with business. Another telltale sign is if the B and C students are getting job offers. In a tightening economy, even A students can't get jobs," he says.

Real Estate Facts:

• Nationally, July sales of existing homes were down 11.2 percent compared to July of 2005, and 4.1 percent below June 2006, according to the National Association of Realtors.
• The NAR also reports that the national median sales price for existing homes stands at $230,000 in July, up less than one percent compared to a year ago.
• Even if Phoenix home resales fall by 40 percent this year, 2006 will still be the city's fourth-strongest year for resale activity in history.
• Significant job cuts among a region's largest employers are often a warning sign that local home prices will plunge.