Saturday, November 17, 2007

"Normal Demand": I do not think that means what you think it means!

I keep seeing a scene from the movie "The Princes Bride" in my head whenever I hear homebuilders and mortgage lenders say that things will turn around when "Demand Returns to Normal". The scene is when the mastermind of kidnapping the princess keeps using the word "inconceivable" through the process of being chased by the dread Pirate Roberts. Finally, Indigo says to the man "I do not think that word (inconceivable) means what you think it means!"

It Depends on What Your Definition of Normal Is
Countrywide Financial, Lennar, Toll Brothers, and the like currently operate under the assumption that demand for residential real estate is under pressure right now, but that within a year or so demand will return to the levels seen in 2003-2005. Maybe not those levels, but close. The homebuilders especially need this to happen as they have built so many homes the absorption rate for the products needs to be high to clear out the enormous inventory they hold.

There lies the problem. Home demand was artificially inflated due to low rates and a hot market psychology. The fundamentals have been hashed out enough times to not go over all the same stuff. The very definition of "Normal Demand" is vastly different for those on the selling end of real estate and mortgages.

Consider the current market realities:
  • Mortgage lending now requiring some documentation as well as some money down
  • Evaporated home equity for buyers of the last 3 years in most hot markets
  • Credit appetite for mortgages restricted going forward
  • The "bigger penis" competiton as it relates to price paid for a home now over
  • Flopping flippers and ghost towns of empty homes

Market psychology is a powerful thing. On the way up and on the way down. The belief that real estate demand will return to levels anywhere near what was seen in the hot times is lunacy.

The astonishing part of all this to me is that you do not even have to go that far back in time to see a bubble bust. Yes, the Nasdaq Tech wreck of 2000 comes to mind, but that was with equities. I mean the real esate crash of 1989-1993. I was a young man of 13 years old in 1989, but I can relate my family experience of the bubble bursting in the late eighties in the greater Boston metro area. Consider this example:

1989-Two family home in a north of Boston city. Assessed at $200,000. Home was put on the market and there was high buyer interest. Never mind the asbestos siding. Never mind the slumping roof. Never mind the flooded basement. 12 offers came in within a week. My mother decided to stay put after a divorce had just become final for "stability".

1992-Same house. My mother would like to start fresh somehwere else. She does not read the financial papers or followed economic matters. Home assessed at $80,000. Not one prospective buyer in 3 months. Finally one intersted party offers $70,000. We stay put.

Thats the reality of a market swing. The home was sold in 1998 for $90,000. Thats what can happen. Consider that the late eighties bubble was NO WHERE near the size of the current one and you can see why the optimism of the real esate industry is foolish.

Demand is returning to "normal". When lending is sound and home prices are dictated by fundamentals there is a natural equilibrium of supply and demand. "Normal" will be defined very differently by those in need of rampant real estate speculation. The sooner the entities involved reconcile this fact, the sooner we can smash the Economic Disconnect as it relates to real estate.

Enough serious stuff, Its Saturday!

Don't know why but I had Kenny Rogers and John Denver on my mind all day.

Kenny Rogers with "Ruby":

John Denver with "Country Roads":

Have a good night!

1 comment:

Anonymous said...

Here is a good paper on real estate boom- bust cycles it looks like to bust duration on average is equal to the boom phase.

Hope the link works.

I saw this in CA in the 90's where I lived. Here are the prices of a new home and the results.

02/26/1993: $81,500
03/03/1995: $15,000
12/10/1997: $85,492
06/03/1998: $63,000
10/19/2004: $173,000

One of my kids bought this in 98 for 63,000 they sold it in 04 for 173,00 it then went on to a value of 268,000 in 06. I fully expect to see this fall back below 173,000before this is all said and done currently it is valued at 206,000