Friday, May 05, 2006
Buying In A Cooling Market
A few professional observations that market participants may want to consider when operating in a slower real estate market.
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Depending on where you are, the real estate market may not have cooled off at all. The general trend in North America, however, is for markets to slow down from the frantic pace of these past few years to more normal levels – which fact one would hardly define as a problem. Quite away from being caused by the bursting of the mythological ‘real estate bubble’ that doomsayers have been so fond of prospecting to the general public, slower demand for real estate products, particularly residential, has to do with the monetary policies of the Central Banks. By reducing the money stock, the cost to the banks for using the available capital is raised and passed on to consumers with a mark-up factor. This, in turn, discourages consumer spending on goods and services and, conversely, stimulates consumer saving. As interest rates slowly ooze upwards, demand lowers and markets cool off.
The effects are widespread and reverberate throughout the economic basket of goods and services including, of course, real estate. But unlike a real estate bubble, which occurs when speculation causes prices to increase so much and so fast, that the bubble ultimately bursts when prices of goods are so absurdly high that consumers either refuse or cannot afford to purchase, thus sending demand tumbling down, a cooling-off trend through higher interest rates has the beneficial effect of consolidating market wealth achieved thus far. This is so, specifically because a slowdown in capital appreciation allows real wages to catch up and it does, therefore, regenerate the pool of buyers. Higher interest rates, moreover, promote domestic saving and attract foreign capitals thus reinforcing both the intrinsic and nominal value of the currency, another beneficial factor in finance albeit not in trade.
Because of this, the National Association of Realtors (NAR) estimates that in 2006, overall new and existing home sales will decline by an average six percent, meaning that about 400,000 fewer people will purchase homes compared with 2005. And yet, home prices will continue to increase, albeit at a milder pace than in previous years, with a real capital appreciation ranging from 5 percent to 10 percent, depending on the location.
A slower market has unquestionably beneficial effects for savvy homebuyers, since missing is the sense of urgency so characteristic of these past few years. This means that Buyers can now take a longer time to look and select the product they want – both the real estate product and the financing that goes with it. In fact, it is important for consumers to realize that profitability in real estate comes not only from a lower purchase price, but also from the overall savings received with lower interests paid to institutional lenders. In the highly competitive lending industry, as interest rates increase lenders typically begin to offer over-the-counter products to lure borrowers and mortgagors. This combination of lower price and lesser cost is what maximizes the return on investment in real estate.
Buyers should also come to terms with the realization that in a cooler market, just like in any other market, the so called low-ball offers will get them nowhere, more often than not. This is so, because the vast majority of Sellers invariably have the alternative of not selling at all for overly discounted prices. Real Estate Boards across Canada and the United States report that inventory levels are ‘seasonally normal’ – an indication that the anticipated glut of housing due to the inability of homeowners to meet mortgage payments has failed to materialize, thus far. And, furthermore, the vast majority of mortgagors with adjustable-rate mortgages have locked already into fixed-rate products, which are not at all influenced by the present upward trend in interest rates. Which means, therefore, that it is not true that Sellers who choose to sell now must do so because the only alternative they have is to face foreclosure.
Of course, this is not to say that ‘super deals’ cannot be found: they certainly can be, now as in any other time. But it is not going to be this slower market that will make super deals more common or more accessible. The best strategy for Buyers is to ask their agents to run a check on homes in the area they have selected, that have recently sold and on those that are still up for sale, so as to price offers accordingly. Likewise, in sizzling real estate markets, desperate buyers occasionally have gone to such extremes as to forego home inspections in order to snatch a home as fast as possible. This is no longer the case, though, and wise home purchasers should do their homework entirely, so as to avoid unpleasant surprises later on.
Finally, Buyers need not to procrastinate a purchase for fears that home values will abate further. Market stabilization and softening prices do not equate to capital depreciation. Not only economic forecasts anticipate capital appreciation ranging from five percent to ten percent in 2006 as aforesaid but, moreover, there is a very sound economic reason to invest and to continue to invest in real estate: consumers confidence, which remains high in all sectors of the economy. Historically, a strong income-employment factor generates consumption, since when people acquire income they tend to invest it, and it is the correlation between employment and spending which, ultimately, generates economic growth – also in real estate.
Luigi Frascati
Real Estate Chronicle
