Housing Fundamentals

In an article written by Floyd Norris in the New York Times on Nov 9, 2007 entitled
"Blame for Poor Home Sales? It’s the Press, a Builder Says" there are some interesting observations on our housing market from a builder that builds homes all over the country.

The news media is extremely effective at keeping the public informed. Unfortunately in their quest to distribute information there is a magnifying effect. When housing values were growing non-stop a few years ago, all we read about was how people were getting rich in real estate. There was praise for the wealth created in the economy due to the rising home values. The mortgage industry's creativity in developing programs that allowed renters to buy homes with little or no money down was credited for the increases in the percentage of homeowners in the country. The combination of easy lending, low interest rates and raising home values was the perfect storm to keep the economy humming along. This helped fuel the real estate boom.

Today we are dealing with a different picture. Home values have been dropping, lending standards have tightened and the attitude that every American should own their own home has changed to home ownership in not for everyone. The industry has given mortgages to people that couldn't afford them and the industry professionals should have known better.

The magnifying effect of the news media is now working in reverse. Instead of inflating a hot real estate market it is now taking a bad situation and making it worse. "The housing market is horrible in most parts of the country, says the chief executive of the luxury home builder Toll Brothers, and he fears it will not get better until the newspapers stop saying how bad it is."

Robert I. Toll, the chief executive, studied the markets his company is involved in and handed out grades. Most got a mark of "F" or worse. "The fact that I differentiate between F, F-minus and F-minus-minus" shows just how bad things are, he told analysts during a conference call. He said those grades go from miserable to outright purgatory."

Toll Brothers is not building in every area of the country so this study is not very scientific but it does have its use. Mr. Toll goes on to say, " Nearly all the decent grades went to markets in and around New York City."

What makes our region different? There are certain things that cannot be questioned. One is the law of gravity & another is the concept of supply and demand. If you look at the regions of the country that have the largest declines in home values, you will find they typically have one thing in common. That is, too much available housing. Inventory increases for one of two reasons or both. There is too much new construction with the result that supply is out of balance with demand or the area is suffering from a decline in population that again is destroying the balance.

There will always be certain cities or regions that suffer an economic downturn. Typically they are cities that depends on one specific business or industry for employment. When that company or industry suffers problems and is forced to reduce the number of people they employ, the ecomony of that city suffers. With fewer jobs, people are forced to relocate elsewhere. The city is ecomonically weakened and there is no reason for anyone to move into the homes that have been left vacant, therefore, resulting in a drop in home prices. Even during the growth years of the housing market, there were areas of the country where prices came down.

The more common reason however, is over building. If you look at the cities with the largest drop in home values, you will find they have been over-developed. Even in a region with a growing population, it is possible to build faster than the rate of population growth. If the rate of increase in residents begins to drop that only makes things worse.

Now let's take a look at our region, New York City and its surrounding areas. What are the two obvious problems that we deal with? First, there is a scarcity of apartments. This is due to a constant increase in the population. Second, it's extremely expensive, if not impossible in many parts, to build additional housing. "Buildable" vacant land is virtually non-existent. To build new housing, a builder usually needs to purchase an existing structure, tear it down and then build something new. We don't have the ability to increase our housing stock by any significant number. This combination of population growth and restrictions on building creates a buffer from house values taking a serious drop.

The cost of a commodity will not decrease as long as the demand for that commodity is increasing. No matter how out of hand a market gets, eventually the laws of supply and demand will bring things back to normal.

If you're thinking about buying a home but you're waiting for prices to collapse, you may want to rethink that position. Local housing demand is going to prevent any serious drop in prices. Although lending standards have tightened, mortgages are still being granted and at historically low interest rates. If inflation becomes a problem, cheap money will disappear, thus making owning a home more & more expensive.

No one can predict the future. Don't let the "magnifying effect" of the news media determine the decisions you make. Look at all the facts as objectively as possible, draw you own conclusions and make the decision from there. If nothing else, it will be your decision!