Is It Time To Buy Less?

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It has been a most-interesting few weeks in one of the nation’s hottest real estate markets, the area just outside my front door.

As someone now in the process of selling, I am elated by current market conditions: As long as the check clears I heartily approve of interest-only loans; I believe the availability of 100-percent financing is a Constitutional right and if lenders are content with drive-by appraisals it’s okay by me — even if the investment property I’m selling is barely visible from the road.

But I’m not a seller every day. When the property settles I will be a buyer and my view will quickly change. And regardless of which side of the transaction one is on, financial sanity on a national level is important to us all.

All of which brings us to Alan Greenspan, the chairman of the Federal Reserve. Despite all the yammering and mooing about a national real estate bubble, Greenspan has finally explained what readers of this column have long heard: There is no national real estate market. There are many local markets. A nationwide drop in average prices would have a modest economic impact in most areas and no impact at all for many owners.

“Although a ‘bubble’ in home prices for the nation as a whole does not appear likely,” says the Fed chairman, “there do appear to be, at a minimum, signs of froth in some local markets where home prices seem to have risen to unsustainable levels.”

“The housing market in the United States is quite heterogeneous, and it does not have the capacity to move excesses easily from one area to another. Instead, we have a collection of only loosely connected local markets. Thus, while investors can arbitrage the price of a commodity such as aluminum between Portland, Maine, and Portland, Oregon, they cannot do that with home prices because they cannot move the houses. As a consequence, unlike the behavior of commodity prices, which varies little from place to place, the behavior of home prices varies widely across the nation.”

In other words, as has been said here repeatedly, real estate is a localized commodity. Looking at national trends does not tell us what’s happening down the street or across town.

One of the realities which dampens real estate speculation is that homes actually have a “use” value, it’s a place to live in or rent. If you own a house and local price trends moderate or even fall, it’s not great news but the practical impact may be zero, especially if you have a fixed-rate loan and no urge to sell.

So why do we talk about the national real estate market? Because it’s an easy benchmark to watch. What we really need to talk about are sales in the neighborhood and sales in a ZIP code as we see with the Market Reports posted online by local brokers.

“Speculation in homes is largely local,” says Greenspan, “especially for owner-occupied residences. For homeowners to realize accumulated capital gains on a residence — a precondition of a speculative market — they must move.”

There is a different market for mortgage financing, however. That market is nationwide and growing numbers of high-risk loans should make us all nervous.

It is here that my thoughts as a seller differ from my thoughts as a citizen. Yes, I am elated to sell property to anyone with a check of the proper size, but I wonder why lenders make such risky loans and whether the economy is well-served by such financing.

“The dramatic increase in the prevalence of interest-only loans, as well as the introduction of other relatively exotic forms of adjustable-rate mortgages, are developments of particular concern,” according to Greenspan. “To be sure, these financing vehicles have their appropriate uses. But to the extent that some households may be employing these instruments to purchase a home that would otherwise be unaffordable, their use is beginning to add to the pressures in the marketplace.”

Lastly, in an oblique way, Greenspan touched on the matter of real estate commissions.

It is routinely said that real estate commissions should fall because commissions have dropped for stock brokers, travel agents and such. However, the electrons required to sell 100 shares at $2 each are no different than the impulses needed to sell 100,000 shares at $20 each — in both cases we merely have a few electronic blips moving from here to there.

But homes are not interchangeable — economic theory holds that real estate is a “nonhomogeneic” commodity — a fancy word meaning all properties are unique.

Greenspan says that “because of the degree of customization of homes, it is difficult to achieve significant productivity gains in residential building despite the ongoing technological advances in other areas of our economy. As a result, productivity gains in residential construction have lagged behind the average productivity increases in the United States for many decades. This shortfall has been one of the reasons that house prices have consistently outpaced the general price level for many decades.”

Uniqueness, of course, is why no one buys a home over the phone, sight unseen. It’s also the reason local brokers who physically exist in your ZIP code consistently have value while brokers far away in some distant galaxy are irrelevant.

Greenspan says, “Although we certainly cannot rule out home price declines, especially in some local markets, these declines, were they to occur, likely would not have substantial macroeconomic implications.”

If Greenspan’s comments had subtitles, they would say In English that even if home prices fall, they won’t fall everywhere and the overall impact is likely to be minimal on a national scale.

That said, do your part. If it requires interest-only financing, a stated-income loan or a 100-percent mortgage to buy property, if you can’t finance the home of your dreams with a fixed-rate loan, look toward the future: Buy small, buy less, save more and stop racking up credit card debt. You’ll be grateful if and when interest rates rise and home sales moderate on your street.

Written by Peter G. Miller

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