April 24, 2006

From ‘Sticky’ To ‘Slippery’: A Fundamental Change In The Housing Market?

Technical traders and analysts often talk about support levels or a floor price. In the housing market, real estate agents talk about “stickiness.”

Previous downturns in the housing market have left homeowners owing more that their homes were worth (i.e. “underwater”) and unable, or unwilling, to sell or move. Those who were forced to sell (think job transfer, an unexpected medical expense, or perhaps a new baby in a one bedroom condo) did so at a loss. But the vast majority of owners just stayed put and waited it out – three, five, or even ten years until the market turned around.

And while the housing market might take a turn for the worse, it rarely plummeted. Homeowners sitting on the sidelines made sure of that. These owners kept the market from being flooded with inventory, provided natural resistance to depreciating housing prices, and kept the market out of an associated “crash.”

As Celia Chen writes for the Dismal Scientist, “There is an inherent downward stickiness in home prices, as many homeowners can simply take their product off the market rather than sell at a price lower than they desire." Or according to Kelly Zito of the Chronicle, “even in a slackening market, sellers often resist losing money on a property or simply not making as much as the Joneses next door. Sometimes that can mean sales volumes will decline, but prices will stay resilient . . . . ”

Historically, the vast majority of homeowners could afford to wait as long-term fixed-rate mortgages kept expenses in line with budgets. Month after month, or year after year, homeowners would simply continue to make their mortgage payments and wait patiently for the market, and their equity, to return.

Unlike the Internet’s “new economy,” however, this time it really might be different. While short-term adjustable, interest-only, and negative amortization mortgages have quite literally opened the doors to a whole host of new homeowners, combined with cash flow negative “investment” properties, and highly leveraged buyers without sufficient reserves, they have also created a more volatile housing market.

Instead of not being able to sell in a downturn, many new homeowners might find that they can’t afford to hold (or wait). Mortgage payments will increase faster than incomes, rental income won’t offset an investment property’s carrying costs, and a high loan to value mortgage will constrain an owner's ability to tap into equity to help weather any storm.

And for the first time in history, might we find that the “stickiness” that has traditionally kept the housing market from being flooded with inventory in a downturn, and prices from plummeting, has actually turned quite “slippery?”

First Published: April 24, 2006 12:39 AM

Comments from "Plugged In" Readers

I am not a real estate professional. I bought a house (with reservation) in the city in 2002.
I have a 5.5 fixed 30 year mortgage without
points, so I'm definitely going to be one of the
"sitters" if the market turns. Nonetheless,
it is right to be concerned about the
alarmling number of ARMs issued in the city last year (Dataquick).
So adamkoval's argument is worth considering.

Another bearish argument that rings entirely false
to me as a homeowner is that
houses have a P/E ratio like stocks. Bull.
I had a really nice apartment deal (sweeping ocean
views, $1270 per month) and gave it up
for a house (and approx $4000 per month
expenses and a bread-and-water diet) for several

1) landlord hanging around.
2) no control over bad roof.
3) no control over leaking windows.
4) no control over inadequate electricity.
5) no control over the design of the space.
6) no control over tree root in main sewer line.
7) NOTE CAREFULLY: irrational, but insuperable tendency to resist offering the landlord my own funds to improve his property even though it would have been cheaper and more rational (In P/E ratio la-la land) to do so.

I love to be master of my domain. No tenant
is master of his domain. Therefore, the
utility (in decision theoretic terms) of the house
cannot be measured by a P/E ratio compared to
renting. Not even close. It's a bad joke.
If these stock people were serious, they should at least try to estimate the disparity between utiles
and the money paid in rent, an
elementary decision theoretic point. Do we
even know that it's linear? Lots of smoke but
no light.

Having read real estate blogs since before my
home purchase, I am convinced that the P/E ratio
theory (as applied to the residential market) is propaganda fomented by insanely
jealous stock brokers who lost their jobs
after 2000 and had to sit on the sidelines
watching real estate agents (including ours)
getting rich. The real estate counter-propaganda
is that the market is sticky downward, supply is
fixed, etc. (well represented in these pages).
I expect that 98% of the variance in opinions
on the internet is predictable by which industry the poster thinks he belongs to (although this
blog seems to be filled with pessimistic
real estate people---a credit to its
sincerity, I suppose).

As someone who has been through the mill
on the receiving end,
(so I have my own psychology as an ace) the
market is going to be an interesting race between
fixed supply, job growth, interest rates and
foreclosures due to the recent ARM excess
(P/E ratio be damned in the residential market).
Having followed Dataquick religiously since
2002, it seems to me that there are only a couple
of years of extreme ARM excess to flush from the market so the downside needn't be too bad.
Don't listen so much to those stock guys. I was playing around with that stuff, too. In 2000, a group of hippies with a garage in Palo Alto could
capitalize an IPO. How's that for supply?
They don't mention that now, do they?

In any event, I haven't seen a single article
that convinced me that the author, stock broker
or real estate broker, knew anything
about how this interesting race will turn out.

So I may as well predict: some misery until the ARM excess
of the past two years clears out. Then
lots of sitting, as the real estate propagandists
predict, which will establish a bottom at about
2000-2002 levels. Of course, nuking Iran,
shipping all our jobs to India and China at the
speed of light, more
Republican slash-and-steal government, and other imponderable insanities may easily vitiate this prediction and tank the world economy.

Posted by: actual resident at April 24, 2006 12:41 PM

Thank you for sharing your thoughts.

I've been renting here since 2000. It's amazing how the prices have skyrocketed since my first arrival to SF from the Delaware Valley of South Jersey. Talk about initial sticker shock...

I look forward to watching the SF real estate environ responds to market forces.

Posted by: ricin at January 30, 2008 3:22 AM


Is the foreclosure phenomenon at last beginning to peak in California?

Home Front is hearing rumblings that October saw a "meaningful decline" in various foreclosure filings for the first time in two years. The familiar industry trackers – MDA DataQuick, ForeclosureRadar and Foreclosures.com – all acknowledge the change.

They've watched a steep drop in notices of default, those formal warnings issued when borrowers fall two or three months behind on payments. They've seen drops in the number of houses auctioned on the courthouse steps. They've watched the same for trustees deeds recorded with county offices as the final action of foreclosure.

What does it mean?

Posted by: NoeValleyJim at November 28, 2008 10:42 PM

We've been told for a long long time that foreclosures didn't impact the "real SF". If we believe this (and many here countered that all RE is linked in the end), a lesser number of foreclosures should not affect SF neither!

Foreclosures were just a catalyst of this crash. Not the cause. The cause was overvalued RE with flattening salaries using overleveraged debt.

For those who like scientific stuff, I'd compare this with the surfusion effect.

We all know water freezes under 32F. But in some controlled condition, you can bring liquid water way under that without having it crystallize into ice. Just add an impurity or a catalyst and the water suddenly freezes. It starts with the impurity and every molecule around it will follw suit until all is frozen, getting to the state it belonged in the first place.

Real Estate did something very similar. Prices typically oscillate between a median. Land is not produced (not exactly true with RE, cities create tracts out of farmland every day), population grows. Prices slowly go up. When they go up/down too much they are brought down/up by the laws of physics (fundamentals).

What the fed and WS was to control the blowing the bubble for 5 straight years and use every tool available to prevent it from popping. For all this time we defied all the laws of gravity and common sense. Everyone ended up believing that fundamentals didn't matter as they were proven wrong quarter after quarter.

Now came subprime and the foreclosure wave. In early 2007 we were told that this was just a 30-50B problem. No biggie. A few careless souls would be the victims and everyone would be safe.

But everyone missed the point. We were overpaying for RE everywhere and we had done that for more than 3 years building staggering amounts of debt. The foreclosure wave of 2007 was the beginning of the end of a counter-nature situation. The subprime problem was not a cause of the crash, just a catalyst.

Sure this wave comes to an end. But everything is frozen solid.

Posted by: San FronziScheme at November 29, 2008 12:18 AM

Actual Resident, it is interesting you mention lack of maintenance for tenants in rental units. I have a friend who took the opposite course since she has a 2bd rent controlled unit with parking in the Marina for 1,400 a month. If her dishwasher breaks, she buys a new one, if her garage door needs repair, she has a contractor repair it (with owner's permission). She still feels it is way less expensive to cover some of these minor maitnenance costs and keep relations good with her landlord than to "own" a similar sized unit with payments at least 5 to 7 times her rent (not including taxes, HOA, etc.) I admit she would not be able to deal with the "tree root in sewer line" or water coming through the roof, but if I had her situation, with a view that partially includes the Marina green and Alcatraz, I would rather rent as well.

Posted by: anoncensorious at November 29, 2008 6:30 AM

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