The Housing Chronicles Blog: Tales of a real estate stalemate

Wednesday, March 26, 2008

Tales of a real estate stalemate

When the housing boom turned on a dime into a bust, most builders of new homes first tried incentives, and then when that became the 'new normal' turned to price declines, thus ushering in programs such as price guarantees. Unfortunately, the same rational view of supply and demand was not observed by the existing home market (other than foreclosures, of course), with many sellers with listings attached to home values that may not get for years. From an a story in the New York Times (and a hat tip to the very well-visited, with 53,000 visitors on Monday!):

Overall home sales have fallen a remarkable 33 percent since the summer of 2005. Home prices, on the other hand, continued to rise until 2006 and are now only 5 to 10 percent below where they were in mid-2005, according to various measures.

In most other areas of the economy, this combination of plummeting sales and stable prices would not happen. When demand for airline tickets drops, the airlines cut their prices until they have sold their seats. When stocks become less appealing, share prices fall, sometimes sharply...

Real estate, though, is different. For both economic and psychological reasons, there is no asset more conducive to hopeful overvaluation.

That means real estate slumps tend to grind on for years, until sellers submit to reality and reduce their prices. This week’s batch of economic reports suggest that the adjustment is finally starting to happen. The decline in house prices is accelerating, especially in some of the big metropolitan areas covered by the Case-Shiller index released Tuesday, while the number of home sales has recently risen a bit.

But prices still have a ways to fall. Relative to the economic fundamentals — like incomes and housing supply — the average price nationwide seems to be about 10 percent too high. (This, of course, hides a lot of variation. In Texas, prices look sensible, while in much of Florida and Arizona, they are probably about 25 percent too high.)...

Until house prices stop falling, it won’t be clear how many more people will default on their mortgages. Even homeowners who stay current on their mortgage payments will be affected. With the value of their largest asset dropping, many will decide to spend less and save more, aggravating the economic slowdown...

In many ways, it would be better if the housing correction would happen more swiftly and sharply. The pain might be worse, but it would be over quickly. We seem to understand this principle when we’re removing a bandage. Why, then, is it so much harder with housing?

Because houses are almost perfectly engineered to trick owners into overvaluing them.

For starters, people have an obvious emotional connection to their house. After you have raised a family or enjoyed long meals with friends there, you are naturally going to place a higher value on it than a dispassionate buyer would. It’s your home....

In the wake of the biggest housing boom on record, it’s understandably hard to accept a new reality. Robert Glinert, a real estate agent in the Los Angeles area, said he has recently been saying no to almost half the sellers who have asked him to represent them. Their initial asking price is just too unrealistic.

“People say, ‘I don’t care about the market — my home is still worth what I paid for it in 2006,’ ” Mr. Glinert told me. “And I say, ‘To you. Only to you.’ ”

Doing what Mr. Glinert is asking sellers to do — dropping the asking price below their purchase price — is especially difficult. It’s tantamount to admitting defeat.

David Laibson, a leading behavioral economist, categorizes this sort of behavior under the heading of “the principle of the matter.” His point is that people often go to great lengths to avoid taking a loss — or simply having to acknowledge one. “Even a small loss evokes a sense of frustration,” said Mr. Laibson, a professor at Harvard. “There’s something magical about ‘at least breaking even.’ ”

Often, this hurts no one so much as it hurts the would-be sellers. They stay in homes where they no longer want to live, rather than accepting their loss and moving on. Or they move but endure the hassle of renting out their old home, waiting, usually in vain, for the mythical buyer who understands its charms. All the while, their money is tied up in the house, and inflation is eating away at its real value.

Translation: people are weird.

No comments: