Look out beloooooooowwwwwww!

What soft landing? A house in Herndon, Va., goes on the market for what seems like a realistic $1.1 million, sells for $530,000.

A soft landing for the housing market?

I don’t think so.

Note that the drop in average sales prices understates the weakness of the market; owners get married to an inflated idea of what their houses are worth, and simply refuse to sell. When a house that was listed for $1.1 million sells after an auction for $530,000, that suggests more than a single-digit decline in values. (That’s a problem for the designers of housing-price futures markets, and for those who try to hedge using those markets.)

David Bernstein of the Volokh Conspiracy, who has been a housing-market bear for more than a year now, has more.

Footnote It seems only fair to warn the reader that I’m not an impartial observer. Not only did I make my own bet by selling my house and moving to a rental unit, hoping to buy back cheaper, but I’m profoundly convinced that high housing prices represent a huge social problem. Moreover, I figure it would take about a 40% drop in Westside real estate to make UCLA competitive in the market for fresh Ph.D.’s.

Author: Mark Kleiman

Professor of Public Policy at the NYU Marron Institute for Urban Management and editor of the Journal of Drug Policy Analysis. Teaches about the methods of policy analysis about drug abuse control and crime control policy, working out the implications of two principles: that swift and certain sanctions don't have to be severe to be effective, and that well-designed threats usually don't have to be carried out. Books: Drugs and Drug Policy: What Everyone Needs to Know (with Jonathan Caulkins and Angela Hawken) When Brute Force Fails: How to Have Less Crime and Less Punishment (Princeton, 2009; named one of the "books of the year" by The Economist Against Excess: Drug Policy for Results (Basic, 1993) Marijuana: Costs of Abuse, Costs of Control (Greenwood, 1989) UCLA Homepage Curriculum Vitae Contact: Markarkleiman-at-gmail.com

18 thoughts on “Look out beloooooooowwwwwww!”

  1. When we moved to our current location (~2y ago), we looked into buying. I did some monte carlo simulations based on recent and historic trends in the local market, and concluded that we might, barely, make up what we'd shell out in taxes over the expected 3-5y stint here. This didn't even factor in a burst in the bubble.
    All I can say is, thank Zuul for Monte Carlo simulations, because we didn't buy. Now there are four houses all around us for sale with no buyers.

  2. Obviously, the $1.1 million to $530,000 is an extreme case, but it makes an important point. That isn't necessarily that there will be a hard landing, though it certainly suggests that's true. But it does show that there is a huge amount of uncertainty about prices – even more than there was a couple of years ago. This can be damaging in other ways, as it prevents people who want to and should be buying from doing so, and keeps others who would prefer to move stuck in their old houses. In other words, the lack of reliable pricing information is preventing people from making utility-improving trades.
    I'll also take this opportunity to brag about my personal real-estate skills, even if they're not nearly as lucrative as Mark's. A few months ago I sold a condo for about 5 percent more (8 percent if you take into account the savings I got from selling it myself) than a similar unit in the same building. The other unit was wildly overpriced and sat for months, while I priced mine relatively low and sold in two days. Again, in a thin and unpredictable market, there will be wide variation in prices that will depend on negotiating and marketing skill (and luck), which naturally makes people wary of participating, since they don't want to get ripped off.

  3. Westside is always going to be expensive, and if prices fall in many desirable cities, will the relative price of houses change enough to make a difference to UCLA?
    The other solution is for UCLA to put its weight behind extending rail down the 10 to santa monica. Than profs could live in a variety of areas and take the train in.

  4. Mark–
    I'm more or less of your mind that the housing market, which surely represents a huge problem for the economy, has the potential to create huge social problems, setting aside the social problems which a recession, at a moment when household balance sheets are as leveraged as they've ever been, will cause. Today's Denver Post provides a look at the tip of that iceberg, in action today. It ain't pretty.
    Best regards.

  5. "
    Is it a good time to buy a vacation home on beach or wait 6 more months ?
    How long can you wait? The smart thing to do is buy a vacation home (in the appropriate location) a few streets in from the beach then wait thirty years for global warming to bring the beach to you.

  6. I'm a Planner and I moved here about 18 mo ago, and didn't buy – obvious artificial inflation everywhere (well, obvious to me). I'll wait another 18 mo or so and look hard.

  7. Shell *out* in taxes? The solitary argument in favor of home ownership right now is the rather preposterous government subsidy. In total, we're pushing Iraq-War levels every year going from other taxpayers to folks who own and owe. Did I miss a verb somewhere?
    On a serious subject, I have long believed that nominal residential housing prices are one thing, and their "true" prices another. When the latter drops too low, the former does not follow, but volume dries up until only those who absolutely must buy do so, at inflated prices that sellers will grudgingly accept. When the latter goes high, you see multiple bids above the ask for every property, the way you did last summer. Each datum indicates that nominal prices tell at most half the story.
    As for UCLA, trust me, you'll be okay.

  8. Please explain why your analysis causes a problem for "housing-price futures market designers". What makes housing-prices futures any different in "design" than any other futures market? Volatility? That can't be it. Futures markets deal with volatility in lots of ways, not all "designed". The whole point of hedging using futures is to protect yourself from volatility. Whether you get it right or not has nothing to do with what the derivative values are based on – sowbellies, any one?

  9. "On a serious subject, I have long believed that nominal residential housing prices are one thing, and their "true" prices another. When the latter drops too low, the former does not follow, but volume dries up until only those who absolutely must buy do so,"
    I would agree with you if the mortgage industry was the same as it was during the last drop 15 years ago. During this drop, I wonder whether the sellers will be the owners or the representatives of mortgage holders in foreclosures. People don't have the sort of equity that they used to and rents are considerably cheaper than mortgage payments in some areas and circumstances. I think quite a few people will decide to default instead of sell. The mortgage companies won't have the choice to wait out the storm and will be forced to sell at firesale prices. The resulting neighborhood appraisals after these auctions will probably force even more defaults.
    It seems like all the analysis of housing declines are based on historical data. Historical data only goes so far once you realize that a "homeowner" will act much different with a zero down int only ARM than he will with a 20% down 30 year traditional.

  10. If many owners have an unrealistic view of the value of their house and refuse to sell for less this will in fact prop up prices and make a soft landing more likely.

  11. "Moreover, I figure it would take about a 40% drop in Westside real estate to make UCLA competitive in the market for fresh Ph.D.'s."
    If they can find a tenure-track job.

  12. "If many owners have an unrealistic view of the value of their house and refuse to sell for less this will in fact prop up prices and make a soft landing more likely."
    I somewhat disagree with this. The values reported will only be for the ones that do sell. It would basically take all sellers refusing to lower in order for this to occur. Some will get desperate. Others will have no choice and default. Mortgage companies have to sell. When these sales get reported, they will lower all the other values. The question is what happens when strung out people are paying $5000 mortgage payments on houses they could be renting for $2k. Do they default or do they keep paying with the unrealistic expectation that they will eventually make a profit? I guess only time will tell.

  13. The Denver article highlighted an aspect of the market that I had been unaware of before this year (I bought my house 17 years ago), and that is the seller funded downpayment phenomenon. A significant percentage of homes are being sold to buyers without any downpayment whatsoever, not even the paltry 1% that was starting to become more normal (and quite controversial) when I bought. The seller "donates" a percentage amount (around 4-6%) to a "non-profit" that in turn funds the buyer's downpayment, and the seller raises the asking price of the dwelling by an amount equivalent to what he donated. Add this practice to an IOM and/or an adjustable mortgage, and you get an idea of an incredibly unstable situation. Where there's no equity to preserve, forced sales are far more likely. It also explains why many sellers would be so resistant to dropping the price — they would be required to fund the sale.
    Notice, also, that if we had simply kept the old rules and required downpayments and so forth, the price of housing in most areas would have never gotten so high. It's almost enough to make me wish very bad things on banks — real estate agents are hopelessly conflicted because of the structure of their compensation, but banks should know better.

  14. This is comment is for "No Nym." I am 2nd year MPP student and learned about Monte Carlo simulation for the first time last semester (Spring 06). Could you e-mail me at hgran (AT) hotmail.com ? I'd like to know how you set it up, where you got your data from, etc. Ideally, I'd like to see the simulation you ran or run one of my own. Thanks

  15. Jeff C, every seller who refuses to accept a low price and takes his unit off the market is reducing the supply of houses and raising the equilibrium price. Prices will still fall but not as much as if these potential sellers were all willing to take whatever they could get.

  16. James, that depends on whether the number of buyers is stable or shrinking. A bubble market for all kinds of assets is typified by higher and higher prices for fewer and fewer units, until either the number of buyers diminishes in proportion to the number of units for sale, or the sellers simply must sell, and prices start declining. There is no compulsion to buy a house, indeed, there is more likely to be compulsion to sell — because of retirement, a move, or because the property is for investment purposes and the rent/sell economics dictate a sale.
    There is a point at which buyers cannot be convinced that housing will "recover," assuming that they can afford the high prices (many simply cannot), and this seems to be even more likely to occur when rent is cheaper than a mortgage, adjusted for tax benefits. I assume a general correction in lending practices as well, in addition to higher interest rates.

  17. The other issue, I guess, is that Sellers think in terms of the overall price of the house, whereas buyers tend to think in terms of the monthly cost. So sellers tend not to factor rising interest into the list price of their house.

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