What the Heck?

What the heck is going on with this real estate market anyway?

Back in the mid 80's, I was a young stock broker during the heyday of Wall Street. As a nation we had emerged from a time of high inflation and even higher mortgage rates and there was a feeling of abundance in the air. It was a time to make and spend lots of money and buying a home became something more than just a place to live. It became a way to build wealth. Our parents bought homes to shelter them but that investment turned into the goose that layed the golden egg. The next generation saw this and it fueled the false belief that real estate was your safest investment and would always go up in value.

Before the crash of 2007-2008 I had left Wall Street (and NYC) and was working as a real estate agent in Cleveland, Ohio with Keller Williams, which by the way was a fairly new agency in the area. I was separated from my husband and my son was around 10 years old so I was keenly aware of my precarious financial position as a single mother and a self-employed real estate agent. Most people believe realtors “work for” our brokerage but actually we pay them (through our commissions) they do not pay us. This means when commissions stop, so does my income! It can be pretty scary but having been an agent since the 90's I was good at putting aside money for a rainy day.

Back to the market. As early as 2004-2005 we agents began to notice something troubling. Because we work with our buyer clients directly we are often privy to the more personal aspects of their lives. We need to know their finances so that we can guide them toward a home that they can afford. Many buyers aren't aware of the additional expenses that homeownership brings. They look at the monthly mortgage payment only and rely on the banks to tell them what they can afford. But what they can afford was based on a formula that the banks would use to qualify you. It did not take in to account the vacations you might want to go on or the sick family member you had to care for. We realtors began to notice this but were so used to relying on banks and mortgage companies to make sound decisions we didn't question it. Not to mention the common belief was that home values would always go up. People took out home equity loans to go on vacation or buy fancy cars because they believed the rise in home value was money they could always bank on.

Then we began to notice loan products that required no documentation (not even income verification) with a very low (teaser) interest rate for the first year. Many new buyers didn't realize just how high their payment would go up each year. The other part of the problem was they also didn't require a down payment, sometimes even giving buyers 105% of the value of the home so they could afford the closing costs! Let me say that again, banks were giving loans for more that the appraised value so that people with not enough money to pay even the closing costs could buy a house. The thinking by the lenders was that the values were rising so fast that even if the buyer defaulted on the loan in the next few years (very likely because of the teaser rate) then they would foreclose on the loan and sell the house to make back their investment. Sounds risky right? It was but home prices continued to rise.

The banks and mortgage companies, not to mention title and closing services, were making money hand over fist. Of course this free for all created the perfect environment for unscrupulous behavior throughout the real estate industry. There were new mortgage, title and real estate companies popping up each week like weeds. And of course shady investors who saw lenders giving away money without documentation decided to take advantage as well. They created fictional buyers who never intended to live in the home buy them. They never never moved in or made one mortgage payment but walked away with the additional funds the bank gave them over the value of the home. Or they lived in the home for a year or more without making one payment until the bank foreclosed on the property.

Another component to this train wreck was new construction. At the time there was very little oversight on how builders would spend their money so they overbuilt in anticipation of future demand. They began building without having the funds to complete construction until more buyers gave them funds. They were borrowing from Peter to pay Paul as the saying goes. This is why when the market crashed there were so many half built communities where the builder simply ran out of money to complete the homes they started.

Of course it wouldn't be fair of me not to mention the real estate agents and mortgage brokers and appraisers who knew these people were using fake names and paperwork or could clearly see someone couldn't afford the home they were buying. But they turned a blind eye. So what happens next? By early 2007 there were so many homes that were either bought fraudulently or sold to homeowners who now could not afford the higher payments that delinquencies began. Foreclosures came next and the entire house of cards came tumbling down.

I think this shift from homeownership to investment changed the housing industry forever. Unfortunately many people who put their life savings into buying a house and now could not afford to make the large payments lost everything and got kicked out of their home. Folks who took out too much equity now found that their house was worth less than they owed. Imagine you had to move for work because you lost your job and now you cannot sell the home for enough to cover what you owe. It was devastating to many.

So that was the short/long version of the earlier crash. Of course there are many more aspects to it and my version is simplified but you get the gist. This brings us to today. Here are the primary differences I see. Firstly the home values going up have to do primarily with lack of inventory. This shortage has many factors but one of them is related to the changes made in home building after the crash. New regulations were put in place to prevent the same problems happening again. Builders are required to have more money in reserves and finish homes before starting on a new phase. So if the builder must finish one phase of development before starting on the next one it holds up production. Then add the supply chain issues we experienced during the pandemic and you see the problem.

Another difference today is the lending practices. This too was due to regulation put in place after the crash. Lenders are more stringent then ever that a buyer qualifies for the loan and the rules to ensure a buyer understands how their loan is structured and what payments will be in the coming years are strict as well. The “teaser rate” is no more.

Another change was in the appraisal industry. There were many unscrupulous appraisers who signed off on homes they never even saw. Banks relied on these appraisals for their loans so changes were made to ensure that appraisers were held accountable to the valuations. Banks will not lend above appraisal values which is why you have probably been hearing about buyers needed to fill the appraisal gap. This means they have to put more cash in to cover the difference. Do you see how this aspect is very different than before when people were buying houses with absolutely no money in. There was no incentive to stay in the home which fueled the foreclosure crisis. The final component to the rise in home values is the low interest rates we have had for years. Remember I said buyers were focused on monthly payments? Well the interest rate helps the monthly payment so yes interest rates going up will stabilize home values but it does not cause a crash.

Do bidding wars cause some people to overpay for a home, perhaps but when the person is buying it to live in for the next 10 years vs a speculative buy that chance of foreclosure is less. Also banks have changed many rules about foreclosure and because they did not lend with too small of a margin for loss they do not need to dump huge amounts of homes into the market in a panic like they did in 2008. Most buyers today are not buying because they want to cash in on the frenzy. They are buying because they need a place to live. The reasons I see as a realtor on the ground working with buyers every day aren't anything like I saw before the crash. They are buying because rents are high or they are moving to this country or to a new state. They are taking out equity to build the kitchen of their dreams or the home office because the pandemic has caused them to rethink what matters in life.

When the crash happened I was lucky. Because of what I had been seeing in the market I had sold my home before the crash and was renting. I had some money in the bank and was able to make changes in my life. I moved from Cleveland to Sarasota FL and bought a home in foreclosure at half the value from when it was built. I was lucky yes but in hindsight I see that my intuition based on what I had been seeing around me guided me. This time my intuition is to stay put.