Back to reality in the real estate markets

Unless you live in cave it is hard not to hear something about the downtown in real estate markets across the nation. Newspapers, internet and the nightly news report about the troubled market on a daily basis. There is so much chatter that it reminds me of 2005 when everyone was a real estate expert. You could go into about any restaurant and overhear people talking about the pre-construction condo they bought or the home they just bought to fix up and flip. It was a case of tulip mania.

It has been over two years since that time and the real estate market in many areas of the country has dropped in value significantly. Sarasota real estate has dropped up to 30% in some segments of the market. The water front and other luxury markets have not been hit as hard but have still dropped in value.

If you bought in the boom times of 2005 there is a strong chance that your home is worth less than what you paid for it. In this case you have a few choices:

• Sell at a loss and chalk it up to a learning experience. Perhaps you can apply the loss to a gain somewhere else.
• Don't sell
• Wait for the market to return to 2005 values and then try to sell. It could be many years before we see this but no one knows for sure.
• If you can't afford the home you might explore a 'deed in lieu' which means signing over your home to the bank so they don't have to go through the foreclosure process. 
• Stop paying the mortgage and the bank will foreclose on you. This will obviously hurt your credit.

Those that held off from buying saved money. I can't speak for other real estate markets but in Sarasota a buyer would spend less in 2007 than 2005 for the same or equivalent home due to the market drop.

Below is a home that sold in March of 2005.

This home sold for $245,000. That is not a misprint - $245,000. This home was built in 1966, had 3 bedrooms, 2 baths and 1 car garage. The location is pretty good as it is a clean, safe neighborhood and convenient to many of the amenities that Sarasota, Florida has to offer.

It came on the market January 4th, 2005 and went under contract January 12, 2005, just 8 days later. It was listed for $245,000 and sold for full list price of $245,000. This was a sign of the times. This was not a one time event as this sort of thing happened on a daily basis. 

Assuming the buyer put 10% down, paid 1.25% of market value in property taxes, $150 a month for insurance and a 6% interest rate on the mortgage the total monthly payment comes to roughly $1,700 a month. If you are conservative and only want to spend 30% of your total gross income on housing that means you need to make $68,000 a year to afford for this home.

I was not involved with this transaction. My guess is that this was a speculative purchase for the buyer. I am not trying to belittle this home. My point is to show how out of whack the real estate market became back in 2005. It did not make sense. It was tulip mania.

The home above sold again in February of 2007 for $190,000.

This home sold recently for $207,000. It is a 2 bedroom, 2 bath pool home in the same area as the example home above. This sale makes more sense to me than the previous one. In fact, this seems like a really good deal.

The real estate markets have gone back to reality. Home buyers should only purchase if they can actually afford the home. So many people purchased in 2005 who really could not afford the property for the long haul. Their goal was to manage the expenses for a short time until they were able to sell the property. That is called speculating in the real estate market. When you speculate there is the chance of losing money. Real estate is not immune to price decreases.

This cleansing process has been underway for 2 years and might take longer to unwind. One interesting observation from a Realtor in the trenches is that the current market is very similar to the top of the market in 2005 only with the buyers having all of the leverage. Buyers are beating up the sellers pretty good.

If you are a buyer and trying to time the real estate bottom keep the methods of the contrarian investor in mind. They seek opportunities to profit from situations when the crowd mentality leads to unreasonable valuations for assets.

The real estate markets me may not have bottomed yet but we may be close to it and probably will scrape along the bottom for awhile when we get there. We will have to see what kind of impact the pending foreclosures have on the market.

If your time horizon for a property is long enough does it really matter if you buy it now or at a 5% lower price? Remember, homes are more than just investments.