johnnymk

http://www.businessweek.com/investor...522_866341.htm


Author and real estate maven John Talbott says the bubble has stretched about as far as it possibly can


John Talbott warned that home prices were ready to fall back in 2003, when he wrote the best-seller The Coming Crash in the Housing Market (McGraw-Hill). A former Goldman Sachs (GS) investment banker who sold debt for clients including Fannie Mae (FNM), Talbott criticized the managements of the housing-finance giant and rival Freddie Mac (FRE) for enabling noncompetitive forces to boost home prices. In this year's followup Sell Now! The End of the Housing Bubble (St. Martin's Griffin), Talbott's take is: "We are in for a fairly rough ride in the housing market for the next five to seven years."

Talbott insists the crash he predicted is right around the corner, as housing markets show signs of cooling. In his latest book, he notes that national home values, adjusted for general inflation, increased almost 61% from 1981 to 2003. In the past three years, home prices have shot up another 35%.

BusinessWeek Online reporter Sonja Ryst recently spoke with Talbott about his bearish outlook for housing. Edited excerpts of their conversation follow.

What do you think is happening to the housing market right now?

The smart money is getting out. The inventory of homes for sale is increasing dramatically across the country. That's typically what happens before you see price declines.... The investors who are flipping homes for profit, like non-owner occupied condominiums, those are the people you would expect to sell first. You're already seeing that happening.

In San Diego, for example, the homebuilders themselves are getting out. I know a condominium developer in San Diego who had properties he was building, and he made offers for people to take them out of the market. He hadn't even completed the building yet, but he was selling the condominiums for ridiculously low prices like $190,000 if the buyer would just come in and finish the floors. He was minimizing his exposure for the downturn. In San Diego, condos are off around 30% -- that's huge. Prices normally trade off 1%.

How much do you think prices will decline, and how long do you think it will take?

I think that it's a worldwide phenomenon, and in the 25 cities that have had price run-ups, which make up 40% of the market, we'll see corrections of 40% to 50% in real terms over the next six years. It has already started, and you'll see it happening in more cities in the May-June time frame.

How did housing prices get so high?

The banks have made a terrible mistake in how they calculate how much to lend. In the early 1980s, about a third of your income had to go to your mortgage and those worked out fine. Today, they've increased that limit to about 40% of your income, and they think those should work out fine, too. But the banks have actually been lending too aggressively.

We're seeing hints about the housing market all over the place. When and how do we know what's really happening to it?

Because of the cyclicality of the business, prices have been down in most places four months in a row. Most cities have seen slight declines in December, January, February, and March. What typically happens is when the weather warms up in spring, people want to move their children during the summer before school starts. The buyers start to come out and then prices start to shoot up in May and June. Those are the two key months. The question is what happens in May and June. Will there be a flood of for sale signs -- people trying to get out at the peak? Or will buyers return to the market?

What happens to the U.S. economy if the downturn you predict really happens?

I think it will be a disaster. Not only will people in fields like banking be unemployed but consumers themselves will spend less. They're spending a lot now because they think their house is worth a million. If they find out it's only worth $400,000, they'll spend less. As foreclosures increase, the banks will get hurt and pull back on lending. That can drive the country into a recession.

What role does the Federal Reserve play?

The Fed messed this up. They had a bad situation with the Internet bubble in 1999 and 2000, and to keep that from turning into a recession they lowered the federal funds rate down to 1% and held it there for four years. That created this real estate bubble.

Didn't you already say all this in 2003?

I wrote my first book in 2003 saying Fannie Mae and Freddie Mac were overleveraged and the market was too high, but I was careful in the book not to say it couldn't go higher. I wasn't trying to call the absolute peak in the market. But now with the Fed basically out of the picture and giving up on 1% interest rates, I think the cracks are beginning to show in the inventory of homes for sale and the way the nonoccupied real estate investors are behaving.

If you call the National Association of Realtors, they will say that prices are going to bounce back up, but there are a million signals that this is serious. It's not like in 2003, when I was talking theoretically that things are overvalued. Now they're more overvalued, foreclosures are up, and investor-owned property prices are going down. It's happening.


Ryst is a reporter for BusinessWeek Online in New York

IrishSS

Good... Housing prices have gotten unrealistic over the past 3 or so years. I consider my income to be middle class (maybe lower middle class considering the area I am moving to), yet there is no way in hell I could afford even a condo/townhouse at this point without taking a interest only loan.

Hopefully within a few years the prices will reach a point where working class people can afford a decent place again...

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mcs328

The prices of condos in my neighborhood just dropped recently. It peaked a few months ago, stayed steady for a while and not it dipped for the first time in years. I hear the hissing.

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gwilks98

I agree there's a bear on the horizon, but it's not going to be near as bad as a stock bubble bursting. The reason is as long as people are financing with fixed rates instead of ARMs, and the job market stays healthy, they will just stay put instead of realizing a loss on their house. No one is going to sell a $400,000 house just because the next door neighbor had to sell his for $250.

We're either going to see a population shift to the midwest where things are cheaper, or it's going to become a foreclosure era where big companies buy up residential real estate and start a giant trend of renting houses.

*Note that my reason for the foreclosures will be due to people overextending their buying power to get a bigger house. Many of those people have high CC debt.
When the rates go up, or when someone loses a job, they'll lose the house.

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MrGreg

People with ARMs about to unlock or interest only loans are going to be hurting. People with fixed rates should be able to ride out any downturn.

And I think any downturn will vary greatly by the local market. I'm sure the most inflated areas will have the most downturn, while places that still have reasonable prices will just settle down a little.

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zippyjuan

There has been massive new condo construction and conversion in San Diego (particularly Downtown) so a huge supply is starting to come on the market. There should be no suprise that the prices will start to come down on those. Housing construction has been much slower due to less available land for that and the fact that developers have been making more money putting up the condos so they have been giving less effort on houses here. I would expect reductions in prices for condos, but not much drop in home prices.

While the adjustable, low payment mortgages have been a larger than normal part of the financing market over the past few years, they are only a small portion of all the mortgages out there and probably many have been converted to fixed rates by now. There will be some seriously hurt when their rates and payments adjust and I am sure some will find their purchase unaffordable, but I do not think there will be huge amounts of forclosures. They will go up definately, but not to vast numbers.

In short, I think we will see a slowing in the increase in prices for houses and a bit of a drop off in condo prices in San Diego. I do not see a major drop in prices of either unless we get hit by another economic shock somewhere. Part of the action is seasonal and as summer starts, house hunting will pick up a bit from what it was in the winter months. Some of that is nicer weather and part is kids out of school.

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VTGreg

I'm sure we can expect another book from this guy in 2 years if the bubble doesn't burst.

There will be corrections in areas where there has been abnormal growth but the majority of areas will not be impacted as much as is being purported.

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Kevster

Since I am seriously looking at selling my house should I get a good offer, I have been looking at how sales have been in my neighborhood recently. Sales are still going well, but the inventory is up now. The average home/condo is on the market for 1-2 months now before being sold in my zip code. My realtor was telling me that it's now settling into a normal market - the way it used to be before the boom and he's actually having to advertise his listings now.

As for the prices, they are flattening out a bit instead of the 10-20% per year price inflation, though they are still up about 5-10% from the first of the year in my area (Beach Cities/South Bay).

The market I am looking at to relocate is definitely in a downturn though. Mrs. Kevster doesn't like it, but I'm telling her we should probably rent for a year to see how prices settle out in Sacramento.

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