Something that’s often “tossed around” is the idea that housing prices will normalize within a couple of quarters, a year or two, etc. I find this concept of “normalization” funny, to say the least, as it’s basically stating that the housing prices we saw over the last couple of years were normal, sustainable, and supported by sound fundamentals. In other words, people are predicting a return to the heady real estate days of years past.
However, the reality of the situation is far different; housing prices weren’t driven up by sound fundamentals, they were driven up by a combination of speculation, overheated expectations, overspending and bad lending practices. While I won’t rule out the possibility of another Real Estate Bubble, I think it’s a stretch to say that we’re going to see another one anytime soon. Just consider the following factors which provided upwards pressure on prices, that are either ending or will end very soon:
1) Market Psychology: The belief (or the desire) that real estate prices would go up forever, led a lot of people to take on risks they shouldn’t have, whether they were buyers, investors or lenders. Now that people understand that RE isn’t a “sure thing”, it’s unlikely we’ll see this kind of “irrational exuberance” for some time.
2) Rampant Speculation: While I won’t say that we won’t see a time when ¼ homes are bought for speculation purposes, I’d say it’s unlikely that we’ll see it on a national scale any time soon.
3) A return to common sense lending practices: this isn’t just about tightening of credit standards limiting buyers in general; it’s about lenders originating loans that the buyer has a chance of servicing over the long-term. During the boom, many lenders positioned ARMs, interest only and flexible payment (negative amortization) loans as tools that would enable the borrower to purchase “more house”. The borrowers would take on an “exotic loan” where they could only afford the “teaser” payment, once the loan recast/reset, the borrower was left with a loan they couldn’t afford. As lenders wake-up and change their standards, these types of loans will no longer be driving up housing prices.
4) Alt-A lending is practically dead. Whilst it’s often positioned as a tool for the self-employed, I know from personal experience that many loan officers will tell a borrower with full documentation: “If we go with the low documentation loan, we can get you more money”.
5) Subprime lending will be greatly constrained, resulting in fewer home buyers, creating less competition for homes and resulting in greater supply. Again, there are some who are trying to position this is a “travesty” of some kind, but enabling people to buy homes they can’t afford, if only for a few years isn’t a good thing by any means.
6) Foreclosures doubled during the month of July and we already have an inventory problem due to overbuilding, and this excess inventory will create additional downward pressure on housing prices. It’s also quite possible that the over-supply situation is greater than we imagine as more and more people cancel contracts or walk away condos and townhomes they were only planning to buy for speculation purposes. It was not uncommon for speculators to buy up all of the available units within a housing/condo/townhome development, with the expectation of flipping them before they’re complete. As the market slows, expect to see supply increase and more and more of these speculators walk away from their “investments”.
7) Zero money down and piggyback mortgage lending will be greatly constrained as well, taking potential buyers out of the game that have the income to afford a house note, but lack a down payment.
As a result of the above, you’re going to have fewer buyers with less money chasing after a greater supply of homes, none of which points to “housing price normalization” as in a return to the prices and appreciation of the “pre-mortgage crisis” days. People should expect appreciation rates at 1990s levels with pricing that's higher than the late 90s, but not at housing boom levels