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Tuesday, January 23, 2018

Is The Bubble Going to Burst?

By now you've probably heard that the real estate market has been going like gangbusters the last couple of years.  Some areas of the country have see an increase of 10%, or more, in values the past couple of years.  Agents are excited and sellers are ecstatic.  However, is there something looming out there?  Could we be headed for another major market correction, like the one in 2007/2008/2009?

I'm not usually a doom-and-gloomer.  However, I know enough to know when the value on anything raises too fast there may ultimately be a downward turn.  This is true of stocks and it's true of housing values.  The market is always cyclical. However, when things turn up so quickly and with such force there is always a greater chance of a "correction."

So, here is my fear.  In my market for the last couple of years (especially 2017) there has been supply/demand problem.  This is true for many markets, but it's been a major problem for my market.  So, what happens?  Well, you have constant bidding wars.  And what do bidding wars do?  They drive up the price of a home.  And while that sounds like a good thing it may not be.  Yes, we all want the value in our markets to rise.  But, we want true value, real value.  What do I mean by that?

When buyers get into bidding wars the home almost always sells for over list price, sometimes dramatically (I've seen them go 10% over and I've heard worse).  But just because a buyer is willing to pay $XXXXX for a home does it make it worth that much?  You've probably heard "well, a home is worth what a seller is willing to sell it for and what a buyer is willing to pay for it."  Isn't that true? Well, no.  Let me explain.

Ask an appraiser or a real estate broker how they determine the value of a home.  There are (3) ways: 1) the cost approach, 2) the income approach, and 3) the sales comparison approach.  For most homes we use the "sales comparison" approach.  This means "comparing" other homes to the one that is for sale and determining, based on several parameters, what a home "like" the one for sale should sell for.  We look at other homes, or "comps" that are similar, are in the area, and have sold recently (usually six months to a year).  By doing so we can see that the "subject" should sell, basically between the high/low values of the comparable sales.  Keep in mind this is somewhat subjective, but it gets us a basic determination of value.  If the "subject" has a lot of updates we feel it will probably sell toward the high end of the comparable sales.  If it has few updates, or needs repairs, it will normally sell toward the lower end of the comparable sales.  There are always variations, but this is always how we determine the "market value" (and potentially the sales price) of a home that is currently for sale.

So, go back to what I said.  If a house is listed for $200,00.00 and it gets multiple offers on it, one for $220,000.00, does that now make it worth that much?  No, not unless the comparable sales can justify it.  So, if the highest comparable sale is for 180K, is it likely that this home is worth 220K?  No, it's not.  So what happens?  Well, sellers, with prompting from their agents, have become very aggressive.  They have begun to tell buyers that they will not sell the home "based on the appraisal amount."  In many purchase contracts there is a clause that says the buyers don't have to proceed with the sale if the "appraised amount" is less than the contract amount. (the appraisal is done by the appraiser, a third-party contractor that the bank highers)  In essence, it's a measure to protect the buyer from over-paying on a property.  But sellers are "forcing" buyers to remove this clause.   So, if that clause is removed then the buyer must proceed no matter what the value comes in at.  So if the house under-appraises for 20K the buyer must still purchase it, and normally must bring $20,000 more as a down payment (because the bank will not loan for more than the value!).  In essence, the buyer has now agreed to over-pay for the home by 20K.

You would think that buyers would be more prudent than to agree to something that will, basically, cost them money.  However, buyers tend to be fearful and under-pressure in a market where everything is tilted toward the sellers.  Unfortunately, I see this mostly with younger buyers who have an "I want this at all cost" mentality.  To be fair, though, there are times when you have to be aggressive if you want the home that you have chosen.  This is true, for sure, but what I've see lately 
is way off the scale of "paying a little more" and being "strategic."  Buyers, in come cases,  are giving up the farm and, I think they may end up paying for it in the long run.  Sellers are smiling all the way to the bank.  However, most sellers are also buyers, so I think some of them are also acting in the same manner when they end up buying their next home. It becomes a vicious circle.  And so, IMO, we get many months of "inflated" home values, with people paying more for homes than they are actually worth. 

Well, as long as values keep going up, all is well, right?  Well, yes.  But that never truly happens.  For example, even if the market flat-lined in 2018 we would have problems.  Why?  Because people who over-paid in 2016 and 2017 are not going to "realize" the value of their homes in 2018.  They, technically, could be under-water on what they owe.  Well, that's not a problem...if they don't have to sell, right?  Yes, but what if we have a down turn in the economy?  Some type of world event?  What if the economy just slows down as well?  People end up selling after a couple of years all of the time.  And what happens when these people who purchase in the last couple of years have to sell in a market down turn?  They end up losing money, because they over-paid and the market caught up with them.  See this new article from Bloomberg, posted 02/22/2018   Is the Market Too Hot?  

I think many buyers, sellers and agents are complicit in creating "inflated" values in the current housing market.   That being said, I don't think everybody is making bad decisions, and I don't think there is some type of conspiracy.  However, I think some agents for sellers and buyers are not properly advising their clients. And I also think some buyers are becoming increasingly short-sighted and are not realizing the potential consequences of being pulled into bidding wars and over-bidding by exorbitant amounts, just to "win."  I like to win, too.  But I think the desire to "win" has to be offset by making good financial decisions.  Yes, it's a difficult market.  But I do believe there is a middle ground to all of this.  It is my hope that in the coming year we will start to see a more "balanced" market, one that is good for all parties. 


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