Real Estate Corner: Catch a Falling Knife? Not Yet...

There are several indices that aim to measure the value of residential real estate in this country. The most accurate and least biased is the S&P 500/Case Shiller Home Price Index. I decided to test the accuracy of this index by comparing it to my own purchases of homes in the Washington DC area.

I purchased my first home, a townhouse near Fair Oaks Hospital, in Fairfax, VA in October of 1989. My timing was impeccable. When I compared it to the Index, the value of Washington single family homes was at an all time high. The Index peaked just 4 months later before falling like a rock until it reached the bottom in February of 1992. It was at this point I abruptly sold the house at the bottom of the market. According to the index value my home should have dropped about 5%. In reality, the property had dropped 10% and after selling commissions I owed more than it was worth.

The 10% I had put down was gone and I was now underwater by about $10,000. The index, which peaked in the Washington area in April of 1990, did not reach that peak again until February of 1999, nearly 10 years later.

I was recently in Tampa, Florida visiting a client when the S&P 500/Case-Schiller Home Price Index for July of 2007 was released. The report showed that the worst real estate markets in the country were Detroit, Tampa, and Washington. I asked my client about the local market to check to see if this rang true. He told me about two completed condo projects with no owners and one large condo project with just one family living in it. The scariest thing about this is that the Index does not include condos!!!!

Most people consider the value of their homes to be whatever the highest value ever paid in the neighborhood. Nationwide, I believe home prices have now moved down to their October 2005 values. In Washington, these values are down to the May 2005 values. The index shows a drop of 4% year over year nationally and a drop of 7.2% in the Washington MSA.

In my April 2005 Newsletter, I predicted a 10% market drop nationwide. It appears as of July of this year, we are nearly halfway there on a national basis and 75% there in the Washington MSA. Let’s take a look at the housing data to see just how bad it might get. Most of this data comes from Greg Weldon’s website http://www.weldononline.com/ and John Mouldin’s Weekly E-Letter.

Existing home inventories have increased by more than 1,000,000 homes since March 2007 and have doubled since 2005. In January of this year, there was a supply of homes for sale of about 6.6 months on the market. This figure has moved up to 10 months. There are now over 500,000 homes in the process of foreclosure and this number is increasing at an alarming rate. New home sales in August saw the largest decline in 30 years. Mean new home prices are down 11% in the last five months. Expensive homes, those above $750,000 are down over 35% from last year.

Many of the loan products, which helped people buy homes the last few years, are now gone. This includes not only sub-prime and Alt-A loan products, but the every day jumbo variety as well. The impact of this mortgage credit crunch will not be felt until the forth quarter of this year. As a result, I still believe we have a significant drop ahead. Washington MSA may experience a 15% drop from the 2006 high; nationwide I am still sticking to my 10% drop prediction.

While this may seem bearish, the market will bounce back. There will be some terrific buying opportunities in 2008. A significant amount of patience, however, will be required.