Current State of Real Estate

Recently I have begun to dip my toes into the waters of real estate. I have tried to tame my urge to buy a beautiful home for my family to live in - But, I am slowly getting tempted. Why? Well a few reasons. Our place is horribly small, 920 sq. ft. We are outgrowing this place with more and more crap. And ideally, I want to work on a house, giving me projects to do over the weekend.

So, I began talking to a real estate agent, and I started hearing the same lame excuses as why it is a good time to buy - Real estate is lower than it's been in a long time, renting is just throwing money away, interest rates are lower than they've ever been, etc, etc... So, I started realizing what is going on in the real estate industry - and it is now time NOT TO BUY.

Here is what I see as problems and forecast for this.

#1: Interest rates are lower than they've ever been: Okay, this may be true. But, here is the truth of this. Affordability has increased due to the decrease in interest rates. What does that mean? Well, a home that is normally 200,000 at 10% has a payment of 1755.14 for 30 years. Now, when interest rates decrease to 5%, the payment then goes to 1073.64 making for an apparent 39% increase in affordability. These numbers are obviously not accurate, but for the simplicity of it, take it as a roundabout truth. With this, "fact", then more people can afford a home causing an increase in the demand side of home prices. The supply side must then reduce, causing a price increase. Therefore, with a reduction in interest rates, prices will rise... THIS HAS NOT HAPPENED: Prices have been reduced because of alot of varying factors. #1, personal credit has been shot. #2, the economy has shrunk causing real incomes to reduce, causing deflationary pressure on all prices #3, over building has caused increase inventory which has increased the supply side #4, the lowering of asset values has left people to walk away, thus increasing the supply side #5, foreclosures, etc increase supply side.

Sure, demand is rising, but not enough to keep up with the supply side. Moreover, with interest rates lowering, the prices should be rising, so effectively, there is a "real" reduction in home values more than what would be seen if interest rates have risen or stayed the same.


So, what is going to happen? The problem also lies in the fact that inventory
has been bought up, and speculators are coming out buying thinking it's a great time to buy - causing artificial demand. On top of that, we've had a moratorium on foreclosures, giving the false sense of inventory levels decreasing and an end to the real estate mess. So, where are we now? Now that the moratorium is over, we will see a rise in inventory levels. That will further depress prices, causing some to walk away from their homes if they lose value. The economy has yet to see it's bottom, and that may take another hit on people who have just bought a house believing their jobs were stable, and they aren't.

With interest rates being at historical lows, there is only one way up. With the government increasing it's debt size, the interest rates are going to rise due to default risk. Inflation is a thing of the past as there is not enough money chasing the number of goods produced, depsite the governments best efforts. (Think about this: how many trillions of dollars have been lost in the stock market from March of 2007 to the present? Now, think about the paper losses of real estate that have happened from 2005 to present - Next, think about how much the government is spending to help "revive" the economy? Yeah, it doesn't come close to what was lost). So, with the fact that interest rates are going to go up, that will cause prices to further be depressed. Many other factors are inclusive of this, but I am trying to keep it as simple as possible.

Now, let's think about down payment. On that $200,000 house at 5%, you'll need 3% for FHA or 20% for conventional. So, $6,000 or $40,000. Let's go back to our 5% rate 10% rate example. If interest rates double, let's assume real estate drops 39%, as evident by the decrease in payment. That then brings that 200,000 home down to 122,000. If you wait, your downpayment is now 5% or 33%. Your payment at 122,000 at 10% is the same as it would be at 200,000 at 5%, difference being that you now owe less...

So, anyone thinking it's a great time to buy a home - Wait it out... The recover won't be a V, nor a U - It'll more than likely be an L - And that is my prediction on real estate... We are a long way from the bottom.