By Tal Ben Zur
It is hard to remain indifferent in face of events occurring presently in the U.S. Real Estate and the Credit markets. We are seeing a string of negative reports, accompanied by comments about the “real estate bubble that popped.”
“The popped bubble” is a term widely used by the numerous specialists relative to the current state of the real estate market.
Comprehension of the term “bubble,” as it pertains to the real estate market, will not transform you overnight into specialists, yet it will certainly clarify the reasons that caused the current crisis.
Thus, a real estate bubble is a type of an economic bubble (or a financial bubble) that happens when the market value of a fiscal property (as merchandise, stock, or real estate) rises to the level significantly exceeding the objective economic value of the property. (Economic value is comprised of the future value of the property, along with the cash flow it is projected to generate for its owners.)
The bubble phenomenon is cyclical. It reoccurs every few years in different geographical locations, with variations in its extent and in the type of the property. And yet, the way it ends is almost invariable: the bubble “bursts,” and the downfall in the commodity prices causes an economic crisis (see current crisis), and the loss of financial resources for many.
One of the focal factors in the creation of the bubble is the availability of cheap credit, and the willingness of the banks to provide to questionable borrowers who would be considered unfit for such credit in regular times. In such ridiculous circumstances the investors could purchase the “bubble” property, not only with the money they had, but also with the money they did not have, as well as inflate the price of such property, etc., etc.
A vicious circle develops when the investors are able to obtain a loan against the property itself (i.e. to purchase a house for $500,000 as well as to obtain a loan in a similar amount, all while the house is serving as collateral). Such conditions propel property values higher and higher.
Another important factor in the creation of the financial bubble is human nature. A well-known trait of such bubbles is that they begin with initial price increases generated by relatively experienced investors and followed by a herd of less experienced investors attracted to the revenues advertised in the media or by word-of-mouth.
Many of such investors purchase the property intending to sell it to other investors that will follow them. At the final stage we see the last investor who is holding a property with an inordinately inflated value, and in order to unload it, he is forced to take a loss. By this stage most of the more experienced investors managed to realize large profits from their holdings, and to avoid the pitfalls.
Usually the bubble becomes transparent when the prices start falling. This is the onset of the “correction” period when the prices are coming down gradually until such time that the market stabilizes and comes to a normal and healthy condition.
The present bubble began in approximately 2001 (immediately after the dot-com bubble burst), and it is found throughout the US real estate market (or, as many believe, throughout the world) in densely populated areas and in the major cities (Los Angeles, New York, Miami). The bubble reached its peak after sharp price increases in 2005–2006, after which we have witnessed a gradual decline in real estate prices, primarily in the private sector. It should be noted that the price declines vary from one area to another and from one state to another. Some areas can boast a relative stability in housing prices.
The present real estate bubble is a regrettable result for the unfortunate combination of loans provided at ridiculous terms without the appropriate supervision and the insane drive to purchase a house. The fact that the Federal Reserve dropped the bank interest by 0.5% doesn’t really help to fix the problem—namely, the voluminous credit provided to problematic borrowers against securities (primarily single family houses) that cannot be materialized.
In the next few months we may witness the rise in interest on loans that have already been granted. In other words, these loans were given at a low interest rate, which is constantly raised over time.
This condition will lead to the increased volume of loans lost to the banks, as well as to the increased number of bank foreclosures. No one knows the extent of this problem. What we do know is that banks, along with numerous financial institutions, have collapsed under the burden of debt and foreclosed homes, while the surviving banks will do everything possible in order to get rid of the foreclosed properties—including greater flexibility as to the price of the foreclosed property relative to the potential buyer.
This is the right time to search for properties the bank wants to get rid of at any price—even at a loss. It is important to choose to work with real estate professionals, capable of identifying the true value of the property in this bubble market.
The daily media information raises one of the major questions, which will affect all of our lives in the next several years—namely, what will the landscape of the American economy be, apparently the greatest and the strongest, once the dust settles.
Tal Ben Zur is a Highland Park resident, a real-estate consultant and the owner of BZPros.com.
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LA County median home prices rose 2.6% while nearby counties declined according to this LA Times article. Some see a troubled market ahead...some see opportunity.
