The Lake Team

Real Estate Industry News

 Why the Value of Homes Will Keep Falling

The housing collapse led the stock market and the economy into the cellar.  And this crucial sector is headed deeper still, along with the value of your home.  How low?  One measure suggests a further 14.5% drop.

“The problem we have right now is that our animal spirits are beaten down, and this is a fundamental problem,” says economist Robert Shiller, the foremost expert on the U.S. housing market.  And, he adds, the feds aren’t helping.  ”The Obama stimulus plan has a good chance of not fixing that,” he says.

Though it’s the largest such government initiative since the Great Depression, the announced stimulus certainly hasn’t changed the psychological tone on Wall Street.  Confidence in the Troubled Asset Relief Program and its ability to save banks from bad mortgage assets may be even lower.  News circulated of proposed relief for some homeowners in default, but it would have little benefit for the majority of creditworthy Americans.

And psychology is going to play the determining role in ending the housing crisis, as well as everything that has flowed from it.  If Washington doesn’t dispel the gloom, Americans will remain depressed.  That means a depression rather than a recession becomes increasingly likely — and increasingly likely to spur more action in Washington. How all this will turn out is impossible to predict.

As an investor, I would not put my foot into these circles of doubt.  If I had a home to buy or sell, I would not be in a hurry to pack my bags.

The decline still ahead

How low will prices go?  The ups and downs of home prices are heavily dependent on regional economies, so it’s hard to give one answer.  But the S&P/Case-Shiller index of home values nationwide has plunged 19.1% in the past year and 26.6% from its peak in June 2006, as of data for November that were released late last month.

Futures contracts that trade on the Chicago Mercantile Exchange forecast a further decline of 14.5% by November 2010, after which home prices likely will begin to revive.

“Homebuyers have access to these futures’ prices — they’re publicly available — and if you see the market is going to go down another 15%, you bet I’ll be guided by that,” says Fritz Siebel, a trader in property derivative securities for Tradition Financial Services.  ”I’m going to fulfill the prophecy of the index by not buying. It will be self-fulfilling.”

Indeed.  Forecasts like that help keep buyers off the market, waiting for lower prices.  Meanwhile, many owners with mortgages can’t afford to sell.  That, coupled with tougher lending standards and despite low mortgage rates, will keep the freeze on.

Are the feds helping?

Shiller rose to prominence in the 1990s with his book “Irrational Exuberance,” which anticipated the bubbles that have blasted stocks in the past decade.  His newest book, co-authored with George Akerlof, is “Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism.”

The title is drawn from John Maynard Keynes, who in 1936 wrote: “Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as the result of animal spirits — a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.”

Shiller says the financial stimulus package hammered out in Washington does very little to offset pessimism in property markets.  First-time homebuyers will be eligible for a tax credit of $8,000, but it will be spread out over several years.  ”I can’t believe that’s going to have a huge effect on this massive housing market,” Shiller says.

Joseph Davis, the chief economist of Vanguard Group, agrees.  Even if the tax break were immediate, “it’s not going to be very effective,” he says.  ”It’s a down-payment issue.  The credit door has closed shut for many households.  And negative home-price psychology has them on the sidelines.”

A subsidy to help buyers meet down-payment thresholds “would have been the biggest bang for the buck in housing stimulus,” Davis says.

Overall, Davis judges the massive steps the federal government is making to address the current economic malaise to be “necessary but not a sufficient condition for economic stabilization.  And the reason is they do not directly address the two sources of considerable stress in the economy.  One is the issue of solvency in the banking sector, and the second front is housing, and they’re both related.”

Stocks cratered recently when Treasury Secretary Timothy Geithner unveiled a bank bailout that was vague on most points but pointedly ignored the “mark to market” issue, which is what makes mortgage assets so toxic.  The market is marking prices at rock bottom because nobody knows what these assets are really worth.  Almost certainly, however, those assets are worth significantly more than the current prices.  If banks have to sell them off at market prices, they’ll lose a ton more money.

The solution favored by most economists is to allow banks to assign a “fair” value, rather than a “market” value, to mortgage-based assets.

Investors spy change in the distance

Real-estate companies have been hammered in this bear market.  Homebuilders Pulte Homes (PHM, news, msgs) and Toll Bros. (TOL, news, msgs), for example, are down 60% and 40%, respectively, over the past two years.

But a few hardy value investors have begun dabbling in property stocks, and that is the most promising development that Vanguard Group’s Davis says he’s seen since the downturn began.

“When value investors start to come in and see opportunity, psychology switches from fear of loss to fear of losing the possibility of profit,” he says.  ”That’s how bear markets have ended in the past.”

One such investor, Jerome Dodson, the manager of the Parnassus Fund (PARNX), notes that stocks turn up long before the fundamentals do, and he has taken positions in several homebuilders.  He envisions an end to the crunch — but in the distance.

“The first uptick in fundamentals will be people buying homes again,” Dodson says.  ”I think that will probably be sometime between the end of this year into 2010.  So if I’m correct and we’re somewhere between 10 and 12 months away, then sometime in the next three months stock prices of the homebuilders are going to move higher.”

 By: Tim Middleton, www.moneycentral.msn.com