I guess this is old news now, but I thought I’d post it anyway to document history. This is the second cut in a row in an attempt by the Fed to get the current housing slump and oil price spike under control and prevent our economy from going into recession. I would be lying if I was to say that I have a full understanding of how this works and how the Fed’s adjustments effect all of us economically.
Click here for an article that spells it out the effects on the economy of lowering the interest rate.
I understand the basics. You lower the interest rate, the cost of borrowing money goes down, so people, businesses, etc. borrow more money/buy more product, real estate, etc. and the economy is given an injection of growth through financial movement. Unfortunately I think the present state of the real estate market as a whole (nationally) is a little more complicated.
What happened during that period of time many have come to call a “boom” is that the cost to borrow was little and people bought in the beginning because the lifestyle they desired was less expensive than it had ever been before. They wanted that second home, interest rates were so low it cost almost nothing to borrow for it, so they made the stretch to make the purchase. Tons of people did this, so many that there wasn’t the supply to meet the demand. The buyer noticed this and decided to become a seller to capitalize on this. He had something that he didn’t really need that someone else wanted and was willing to pay for it. The property sold for a profit. The buyer realized his quick profit and decided to do it again when he had the chance. Multiply this scenario by hundreds of thousands across the country and you have a “boom”.
I remember at one point a guy was telling me that he missed his opportunity on several preconstruction development deals because he never got a call back. At one point if you were not proactive in making sure you found out about and purchased the preconstruction, you missed out. I had a friend that worked on a big project in Vegas in the middle of the “boom”. He told me they were literally taking orders. When someone called, their story was basically “if you are interested, send me a $5k reservation check overnight with the signed reservation agreement and we’ll try our best to get you a condo, but I don’t have time to talk because I’ve got 30 more phone calls to return in the next two hours.” If my memory serves me correctly, this was a 900 plus unit resort that was sold out as soon as they brought the product to market.
ok, back on point. So, tons of buyers bought, and so many realized that they could “flip” out for a quick profit that buyers were no longer buying to use, but to resell. Buyers were buying to sell and developers were scurrying to keep up with the demand.
The good and the bad of all this is that nothing happens overnight. It took years for the market to heat up and it took years for the market to cool off. As prices started rising pretty sharply, and interest rates started to rise, the buying began to slow. In this particular case, the buying began to slow quicker than the developments could slow until it slowly flipped with there being slightly more supply than demand. As buyers began to realize this they started trying to sell so as to recover their costs, sharply increasing the inventory on the market and further increasing the gap between supply and demand. In addition all the buyers that bought – not because they could afford to buy and use, but to flip for a profit – are stuck with adjusting mortgages that they couldn’t afford in the first place.
So we’ve got a couple of pretty big problems that actually boil down to one huge problem: we have a great deal more supply than we have demand and there are tons of people that bought that could not afford to buy that are getting foreclosed upon, which will further increase the market inventory – creating even more supply than demand. The unfortunate thing about this is that we are just going to have to wait this out. Unless the Fed lowers the rates an astronomical amount (which he won’t do and shouldn’t because a total swing in the opposite direction would actually be worse for our economy in the long run) or, Heaven forbid, something tragic happens on US soil again, we won’t see any huge change in the market for a while with regards to shrinking the gap between the supply and the demand.
I know this may seem glum, but there is a positive side to all this. Those that can afford to hold will be fine. Real estate, as with most investments, is statistically strong over the long term. It is an exponential relationship: the longer the term, the lesser the risk, the lesser the term, the greater the risk. The buyers that bought to flip and couldn’t afford to hold took the risk that they would not be able to sell and get foreclosed upon.
Had I the knowledge in 2003 to be buying and flipping, I would have totally done so. I have friends that did very well during that period. I also have friends that are holding several houses right now not knowing how they are going to make their bills next month, hoping (and praying) for a sale.
Another upside? If you can buy and you like longer term investments, now is the time to buy. Existing homes are selling for pennies on the dollar if you look hard enough and in many cases these properties can cashflow for the buyer with great credit. In addition, developers are practically giving away new homes just to not carry the inventory. I hear stories of developers taking offers at cost just to get out. I wish we had that problem here (I’d love a new house), but this is mostly in larger metropolitan areas. Our development boom happened on the beach. Right now you can buy a condo on the beach for around $260 sqft. I could be wrong about this number, but I think right now it is costing somewhere between $250 and $300 a square foot to build. If you can buy right now, you should definately buy.
Ok, I’m done with my rant. I hope this all makes sense, it’s 1am and I’m going to bed. No more work today.