Wednesday, February 22, 2012

THE REAL ESTATE CRASH PART 3: History of the Bubble

Before I tell you what happened to that little house on Laurel Street that we bought in 2004 and frantically tried to sell at the end of  2005, I'm going to tell you a little about the history of the real estate bubble from my prospective.
Our Apartment house today, we don't own it now.  A mansion in 1890.

As I began this series of blogs, I said that in the 1890's  many Victorian Mansions were built. Most people could not live in a house of that size. Most people could not even live in a 2000 sq foot house. They couldn't pay for it. If you look in the older neighborhoods where houses were built clear up in to the early 1960's, you will see houses of about 1000 square feet to 1500 square feet.

But from about 1990 until the real estate crash all kinds of people were building and buying houses like those Victorian Mansions.

So how did we get so that so many people could afford a 2000 to 3000 square foot house?

Rob Painting the Apartment House - 1960's.
A doctor's home in the 1960's was a one story 2000 square foot home. That was after he had an established practice and had been working for 15 to 20 years. I know that because I used to tutor two doctor's children.

In the 1950's a family had to save for a down payment, usually for many years. Banks required from 20 to 30% down.

Real Estate prices are caused by supply and demand. If there are a lot of buyers, prices go up.

These are 2 bedroom 1 bath tract homes in 1949. Sold to GI's on the GI Bill. 

The most important item that kept houses small, and kept prices relatively low was that only the father and husband could get a loan. Also in the 1950's  banks red-lined (bankers drew red lines on maps in certain neighborhoods) certain areas that they would not loan in, usually minority neighborhoods. The banks thought that people in those areas were not good risks. Banks seldom loaned to minorities.

The GI bill was the first  step in the 60 year real estate boom. Returning World War II Veterans could buy one of these two bedroom homes above for $7000. and only about $200 down. They still had to save that down payment.  Minimum wage began in 1938 at 25 cents per hour. It was raised in 1950 to 75 cents per hour.

Slowly in the 1960's it became improper and  illegal for banks to discriminate against minorities or to red-line neighborhoods. That created a large influx of qualified buyers, greater demand, and prices began to rise. But not too quickly because a large number of homes also entered the market  from those red-lined neighborhoods, so the supply kept up with the demand.

Prices were still kept lower because not all the income of the household was counted.

Tom, Fixing a Floor in the 1960's.
Still, only the male head of the house was the qualifier. His wife didn't count and usually didn't even fill out an application.

Bankers began to see in the late 1970's that they could make more money if both husband and wife were added together to make a higher qualifying income. The loan could be bigger and the couple could afford a larger house. By the 1980's real estate prices really took off. They doubled, and tripled in only a few years, and the wife was locked into the market. She now had to work to keep making the payments on the home. That increased demand even more. As her income grew the families thought they could afford  larger and larger homes.

Then came the relaxation and liberalization of marriage, so that even an unmarried couple could have their incomes added to qualify.

1990's Tract homes sold with 5% down. Mansions in the 1890's. Mansions again.
Through most of this time the supply of houses and the demand did not match. More houses were wanted than could be built, so in the 1990's a great building boom began with the larger houses being built in neighborhood after neighborhood, and government regulation even required banks to lend to less and less qualified buyers.

By the middle of the 1990's it became the common thought that home prices just kept rising and would forever, like it was magic or something. Investors would buy a home only to try to sell it in a few months or years at a higher price. Flipping.

Flipping became popular, even having TV infomercials sell the idea over and over.

There was no worry. For fifty years home prices kept rising, rising and rising.  Why would they ever stop rising? It became a world wide custom, part of our culture. It was popular belief and almost everyone believed it. A home became an investment, not a place to live because the price would always go up.

After only a few years of ownership, without even an appraisal, a homeowner could get a second mortgage for as much as he paid for the house. People ran out and bought all kinds of stuff. Some bought more, and more homes, pressuring the market to rise more and more.

Real estate agents pushed houses on investors who couldn't even hammer a nail, women who had never changed a toilet, and younger and younger families, who had never had to repair even a broken window.

Working on a Fence in the 70's
Loans were so liberal that a couple who had little investment in each other, no marriage, only a few months together and even minimum wage jobs could buy the same small house that their grandparents had to save, and save, and save for the down payment. They could get 105% of the selling price loaned to them with  only a $1000 down payment, and that only a deposit that real estate agents convinced sellers should be returned if the buyer didn't go through with the deal.

Absolutely no buyer responsibility.

So much demand. We know people who had to create a resume, like for employment, that they would present with their down payment and offer, so they could be considered for a home because there were so many buyers. That was 2004, 2005 and 2006.

Then some of the short term loans began to come due. Banks had sold mortgages in bundles all over the world, and investors bought them up with the same zeal that home buyers were buying, except that an investor didn't just buy one mortgage, he bought parts of many. Real estate would never stop going up they thought, so the belief was that there was no risk.

It was like real estate was on cocaine. The economy had an addiction  for rising real estate prices.

Supply and demand were finally balanced, but the loans demanded that prices keep rising. Some loans had to be refinanced, but because the property hadn't risen in value, the equity was not there. The owner could not refinance, and he could not pay the balloon payment at the end of the mortgage, so the foreclosures began.

The balancing point  actually hit  about the end of 2005, just when I was trying to sell my little house. I saw it and finally realized what was happening.

A crash was coming. It did and prices dropped, they are still dropping. Government officials, financial writers and real estate agents still believe that real estate is only in a slump. Don't believe it.

I just read today, February 22, 2012, that home sales were the highest in 1 1/2 years. Don't believe that indicates home prices are rising again.

It only means  the number of home sales has risen. since one and one half years ago. That's because the prices are still dropping and investors, and home buyers think they will rise again, or they want a home to live in. There cannot be an increase in demand because so many buyers are permanently out of the market. They never could afford to own a home in the first place, and the market finally realized it.

At the end of the article Lucia Mutikani says, "Distressed properties, foreclosures and short sales, which typically occur at deep discounts, accounted for 35 percent of overall sales last month, up from 32 percent in December."

Our Little Rental 2012 - Now
So today, almost six years after we began trying to sell our little house, sales are still motivated by what financial writers call deep discounts. I don't think so, not discounts. A discount is a price lower than the regular price. Then after the discount the price goes back up.

I think real estate prices are still reaching their real bottom  prices, not "discount" prices. Or in other words one third of the sales were because of extremely low prices compared with the peak of the boom. 

Few people have realized that the peak of the boom was actually an addiction high. An addiction to continually rising real estate prices by the entire real estate market.

I'll tell you more about that in the next edition and how we  finally came out on that little house  sale.