Sellers' 'Hopeful Overvaluation' Dragging Out Housing Bust

Amid the very low real estate sales volume in many parts of the country today, the prices of those few homes that are sold are now falling much faster than the asking prices of homes currently for sale.

That fact is clear to see in many neighborhoods as sellers sit and wait, either not knowing or not caring that they have little chance of getting anywhere close to what they're asking unless that one, dumb home buyer shows up who knows less about real estate market conditions than they do.

The New York Times had a story about this - what some call "riding the market down" - and they touched on a couple of the key issues:

In most other areas of the economy, this combination of plummeting sales and stable prices would not happen. When demand for airline tickets drops, the airlines cut their prices until they have sold their seats. When stocks become less appealing, share prices fall, sometimes sharply.

Just try to imagine stock prices staying roughly flat over a three-year period while sales volumes sank because investors considered the market overvalued. Bear Stearns is still worth $150 a share, and I’m not selling until someone pays me $150!

Real estate, though, is different. For both economic and psychological reasons, there is no asset more conducive to hopeful overvaluation.

That means real estate slumps tend to grind on for years, until sellers submit to reality and reduce their prices.
...
In many ways, it would be better if the housing correction would happen more swiftly and sharply. The pain might be worse, but it would be over quickly. We seem to understand this principle when we’re removing a bandage. Why, then, is it so much harder with housing?

Because houses are almost perfectly engineered to trick owners into overvaluing them.

For starters, people have an obvious emotional connection to their house. After you have raised a family or enjoyed long meals with friends there, you are naturally going to place a higher value on it than a dispassionate buyer would. It’s your home.
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David Laibson, a leading behavioral economist, categorizes this sort of behavior under the heading of “the principle of the matter.” His point is that people often go to great lengths to avoid taking a loss — or simply having to acknowledge one. “Even a small loss evokes a sense of frustration,” said Mr. Laibson, a professor at Harvard. “There’s something magical about ‘at least breaking even.’ ”

Often, this hurts no one so much as it hurts the would-be sellers. They stay in homes where they no longer want to live, rather than accepting their loss and moving on. Or they move but endure the hassle of renting out their old home, waiting, usually in vain, for the mythical buyer who understands its charms. All the while, their money is tied up in the house, and inflation is eating away at its real value.

There are a bunch of houses in our neighborhood that have been on the market since 2006 and the asking price hasn't budged. In some cases the price has been lowered by a tiny amount - for example, from $595,000 to $589,000 - in what seems to be a mini-capitulation for the benefit of either themselves or their real estate agent.

They look ridiculously out of place now that bank foreclosures are coming onto the market priced hundreds of thousands of dollars lower.

Comments

[flatman]

Absolutely agree - visited a couple of open houses this weekend and the unreality of the situation was pretty clear. I asked a listing agent why one house I saw was being offered at an astounding $200K over a recent assessment and his contrite answer was that the owner 'didn't care whether he sold it or not'. Meanwhile 2 other house in the same development were selling at or near their assessed valuations. BTW all the potential buyers were from FL and CA. This was in NC.

[Vyssotsky]

There's an additional aspect not mentioned in the article. Very roughly, sellers of owner-occupied homes can be divided into two groups: those who need to sell and move, and those who are thinking of selling but aren't sure and don't much care when. The latter group is larger than most people realize (although real estate agents are familiar with the phenomenon and often frustrated by it). It includes "empty-nesters", elderly individuals whose spouse has died, heirs who can't agree what to do with the old family homestead, and various others. If there is no pressure to sell this year rather than 3 or 5 years from now, a very common way of avoiding decision is to overprice the home and let it sit. Such sellers reduce the asking price only when they conclude, for whatever reason, that now is the time to sell. Indeed, many such homes are listed, then pulled off the market, listed again in a few months or a year, and the cycle repeated, until finally the house is listed at market price. It's the outward manifestation of inner uncertainty about what to do, as for example: "I don't need this much house, but I also don't need the money right now, and it's still a practical place to live, so should I sell or not?"

[Malkiel]

Given that this is an economics-based website I don't quite understand why competent analysts (my assumpution, perhaps some of you guys aren't?!) don't even take cognizance of the decisive technical fact for large numbers of homeowners when making these observations about pricing: homeowners, unlike institutions, can't simple write off monetary losses. Some of these homes have lost as much value as one or two year's worth of the homeowner's salary, a huge order of magnitude. There won't be a closing on a new house unless the homeowner can pay off the mortgage on the house they occupy as part of the deal, and when you're upside down over a year's salary on the current mortgage that's not going to happen. Many homeowners, perhaps most homeowners who are stuck on their price stay that way because they have no other viable strategy in the marketplace than to keep paying the current mortgage and wait for a buyer at the price they need to leave without becoming homeless and penniless...

[HARM]

"Many homeowners, perhaps most homeowners who are stuck on their price stay that way because they have no other viable strategy in the marketplace than to keep paying the current mortgage and wait for a buyer at the price they need to leave without becoming homeless and penniless..."

Hope is not a very viable "strategy". Nor is "needs based" pricing.

The question underwater sellers *should* be asking themselves (but probably won't), is, "Which course of action will leave me worse off? Pricing competitively and selling now at a smaller loss, or, wishfully "holding out" and selling later, likely at a much larger loss --plus tens of thousands more good money thrown after bad in mortgage interest payments, taxes + upkeep?

Mental accounting and irrational loss aversion continue to reign supreme in the housing market.

[Real Estate Bystander]

I have been watching my area of 20878 North Potomac MD, and have seen prices budge slightly on some townhouse areas, but rarely on any single family homes. In fact, within the last few weeks, I have seen some new SFH listings that are priced at roughly what their peak value was in 2006. Prior sales on these in the late 90's at about 30% of what they are asking now. This strikes me as either A) totally in denial of current market conditions including inventory, lending standards, etc B) truly believing their house is "special" or that this area can support these ridiculous prices, or most likely C) that they saw their neighbors cashing in for huge profits in the past couple of years and theyre trying to cash in on it before its too late. Which is it? When I show all this data to my wife to get her opinion, she says: GREED.

[Hyman]

The reality is that eventually these homes will go back up in value, and almost all owners know this It could take 2, 5, 10 years or longer. It can be easier for people to just stay in their homes and wait out the bust, than to sell them at a depressed price. The only ones who are actually being hit head on by current market conditions are the ones who have to sell, whether it be because of a job transfer, divorce, or another "absolutely must relocate" situation.

[Malkiel]

It looks like there's as much reality denial going on among people who want to bash sellers as there is among sellers. Only a person who's never actually bought or sold a house can go on talking about sellers in the abstract as though they are people of unlimited resources who can just pull cash out of the air to cover the upside-down first mortgage when they're trying to buy a different house. I don't know how many transactions involve people who have a mortgage on an existing house who must sell that house in order to be permitted a mortgage on a different house, but it must be a sizeable portion of the market. Most homeowners in every income bracket will not be permitted by a mortgage company to close on a new house unless they are prepared to pay off the mortgage on the existing house as part of the transaction; if they're upside down on that first mortgage by a couple of year's income (say, $150,000 on a $650,000 house that can now only sell for $500,000), then they certainly won't have the savings to close. Their only strategy can be to market at a price which incurs the loss they can take. Railing about "hope not being a strategy" is deliberate denial of the issue in order to keep your hatefest going. And hate is no more rational than hope...

[Real Estate Bystander]

Malkiel - while it is true that there is an over abundance of zealotry amongst the housing Bears, there is also a justified exasperation over the "victimization" of sellers in a declining market. If a house is bought for 250K and is then listed for 750K 8 years later AND those sellers are underwater, then there has been a gross mismanagement of money--DEBT--something that is also so endemic of the US and is equally exasperating!

[HARM]

Malkiel,

Where is the "hate" in my previous post? I was talking about rational self-interest and the importance of removing emotion from what is, at the end of the day, a financial decision.

I'm not denying that underwater sellers have a tough decision to make, they do. However, their options are not as limited as you seem to think. For one thing, they can request a SHORT SALE, where the lender recognizes that house values have falles, and are willing to forgive the difference between what the seller owes on the house vs. what it can be sold for today.

Congress and the Bush Administration have also gotten into the act, and are now *encouraging* lenders to agree agree to CRAM-DOWNS of principal on houses that are worth less than what borrowers paid (and threatening legislation as well). They have already passed a law that ELIMINATES TAXES on "forgiven" debt from short sales.

Underwater sellers today *have options* other than simply feeding a hungry alligator, and draining their 401ks/IRAs/penions and life savings in the process. Recognizing this isn't "hate", it's reality.

[zuzu'spetals]

From what I've been reading on realtor's sites (a few seemingly honest ones) short sales are a scam. Most lenders will only agree to a short sale IF the seller stays current on the monthly payments, and -- key point!-- the lender does not tell the seller upfront "we'll only agree to accept XYZ amount less than you owe us." So in real life, the lender squeezes another couple of months payments out of the seller, so the lender is in no hurry to accept any lower offers-- where's the incentive for them to do so?-- and then the lenders go ahead & foreclose anyway!

Apparently, this has something to do with general accounting principles-- a foreclosure must be taken as a "loss", whereas a short sale is accounted for as a drop in earnings per share or something. It seems to be an issue of when its better for the lender to take a hit on its balance sheet. Some realtor in DC posted the statistics on short sales in the Washington area, and it was like of the hundreds and hundreds that were listed on the MLS as short sales, only a handful ever actually sold. He called them "fake listings"-- too often, just a waste of sellers, and potential buyers, time.

[ericinNE]

As a R.E. investor for over 25 years, I can assure you that short sales have always been a lender scam. The only short sales lenders would even toy with considering were those properties that had a loan balance close to the market value of the property. Before the bust, lender's kept those properties going through the forclosure process that held any chance of being sold for more than the outstanding balance, and were listed at market value, not loan balance value. Post-bust, there is almost no incentive to short-sell, as the lending dollars that would be freed up by not having the forclosure on the books, are not being lent out anyway, due to so many fewer qualified borrowers, due to the tightened lending standards. Better for lenders to foreclose, collect on the mortgage insurance that was in place (on any loan w/ greater than 80% LTV,) and let the insurer deal with it. Dirty little fact not being talked about in all the subprime/CDO/everything-else-real-estate... debate. Smart lenders had their asses covered from the git-go on the high LTV loans. The write-downs any lender is taking is behind the structured investment products they hold (CDO's, etc.) Not the loss on the loan itself. Here's one for ya: Why hasn't the Fed demanded that all the mortgage insurance $ that get paid to these subprime lenders be applied to the foreclosure principle amount, and let the foreclosed-on owners finance just the remaining balance, if any? Because the lenders who didn't carry enough insuanace on the loans they made (because who cares if we have to foreclose, we'll just sell it for more than the outstanding balance and make mo' money, mo' money, mo' money!) would be in an even deeper hole. So we all get to watch as lots of properties come on the market at distressed prices, and suffer along with those who dug the hole, even though the vast majority of us had nothing to do with it. Gotta save those banks! Who else can keep creating the new money that keeps a debt driven economy afloat, if even for only a few more years.

[zuzu'spetals]

Hi ericinNE & thank you for your informative post! Fair warning-- I am truly a financial dolt-- just a frustrated wanna-be home buyer in Norfolk VA who has tried to buy an affordable home here every summer since 2004 but couldn't-- because over the past 5 years, home prices here have doubled-- across the board, and in all neighborhoods (even the totally crappy neighborhoods where the frontyard lawn decor includes a drug dealer or 2 lounging about...)

Each spring, we'd get pre-approved by our lender, Navy Federal Credit Union (bills itself as the world's largest). NFCU sells their own $0 down loan product-- "Veteran's Choice"-- to compete with the VA's $0 down loans. And on these "Veteran's Choice" loans, NFCU also charged what they called a "1.50% funding fee"-- making it sound similar to the VA's funding fee. But when I actually read the pre-approval loan papers (...yes, I'm the type who actually reads the papers-- don't bloody well understand them, but I read 'em!) this 1.50% "funding fee" actually turned out to be for something called LPMI-- 'Lender's Private Mortgage Insurance".

I'm trying to fit your info together with what I already know, so please walk me (slowly! :)) thru this, OK? Let's say we had a NFCU loan for $200K, and we'd made a year's worth of payments-- call it $1500 PITI. Let's just say, of that, $1000 was P+I, so after 12 months we've paid $12K. 200K-12K= $188K due NFCU, right? So let's say in the 13th month, we default & quit paying our monthly mortgage. If NFCU foreclosed on the loan, would they then get paid the remaining $188K by their mortgage insurer? Or would their mortgage insurer only pay them the difference between the sale price of the home at foreclosure (let's say it sells for $170K on the courthouse steps) and the full balance due of $188K? $188-$170= $18K loss to NFCU. Does their LPMI pay NFCU back just that full $18K?-- or does it also pay NFCU for its process costs in doing the foreclosure?

Did I understand you correctly?-- that many sub-prime lenders did not, (or were not *required* to carry) enough lender's PMI to cover their losses if their loans went into default? And you're suggesting that, of the lenders who *did* carry enough lender's PMI, that instead of foreclosing, those lenders could take the amount of dollars they'd be paid by their insurers if they did foreclose, and instead, apply that same amount to the principal balance owed? So, using the above example, if NFCU's insurer paid NFCU the $18 K shortfall, then NFCU could drop the loan amount by $18K, and re-finance the homeowners on a $170K new loan?

So, as far as the lender's mortgage insurance company is concerned, it'd have to pay NFCU the 18K anyway, if NFCU foreclosed. But what would the advantage be to NFCU in this re-financing arrangement? They'd still be making a new $170K loan to homeowners already in financial distress, right? So why would they want to do that?

Please explain further, & again, my apologies for my near-total ignorance of how finance works!

[Mallarde]

I wonder if an overabundance of real estate agents with nothing to do increases this phenomenon.

For example, I visited a place in Santa Monica that was listed at $720K but was worth about $600K. If you are a seller and an agent tells you she will try to sell if for $720K or thereabouts, why not let her try? Maybe you think that if she can sell it over-market it will more than offset the taxes, HOA fees you pay by sitting on the property a little longer.

If you are an agent, you might have harder choices to make. You might have to do more work to get listings -- such as wasting time trying to sell a property over-market. At least you get to try to poach buyer clients while you sit at open houses.