Will Boston real estate market crash in 2008? Will the regional and national economy go into a recession in 2008? The field of risk assessment encompasses studies that estimate the chances of a specific set of events occurring and/or their potential consequences. However, even experts tend to differ on any given subject. One "expert" might take a risk more seriously than a second expert and so on....each basing his/her assessment on the body of their respective work and analyses done.  Barring the construction of an exceedance probability (EP) curve which attempts to capture what experts know and do not know about particular risks, most of us attempt to form our own ideas about a particular situation through anecdotal experiences, newspapers, journals, seminars and other publications.
 
In recent weeks,  Many of you have have asked me about the direction of the real estate market given recent news articles like the ones below:
 
Housing market slump likely to continue into 2009 - and that's without a recession (Boston Globe)

Housing prices are projected to bottom out midway through 2008    (Boston Globe, 11/14/2007 )

Foreclosures: Filings rise, more on the horizon as int. rates jump on a record no. of adjustable mortgages (CNNMoney.com)

Bernanke warns on economic growth: Says he remains concerned about credit crunch and oil prices (CNNMoney.com)
 
After my last commentary titled: "Buying In A Soft Market:  Adjustable Rates, Interest Rate Cut, Stubborn Sellers, Mortgage Constraints", as always,  I received many responses. However, there were two comments from readers that were completely bearish on the real estate market. Being open to a spirited debate, I wrote back to explore their comments further and promised to share my thoughts through this monthly medium.
 
One reader, who is a money manager, wrote: "Convincing a buyer that this is still a great market only to have him buy and get his entire equity position wiped out does nothing for your business 10 years later when he goes to sell." When I asked him why had he bought a house last year given his own doom and gloom scenario for the Boston market, he said, "actually if you can hold a home for 10 years you would not lose money in almost any real estate market environment." With the latter statement, he negated his earlier stance that buyers purchasing a property now would lose their entire equity position in 10 years. Furthermore, this reader proceeded to inform me that " In the 1989 downturn, most buyers who bought in '89 got whole again on their investment by 1995. So that was a (5)- 6 year decline.". ......With this second statement he negated his earlier comment about holding a property for a minimum of 10 years to avoid equity loss....now it was down to 5-6 years.
 
REASONS TO BUY IN A SOFT MARKET: He further informed me that, he bought in April (2006) because he and his wife wanted to "buy a house from which we would not ever need to move from. Not the starter home but more the end home. We purchased a 6,000 sq ft place so plenty of room for more kids...and we won't be forced to sell in 2-3 years (because of a need for more space)." In other words, taken literally, this individual bought an expensive place with the intent to keep it long term and not have to sell it within 2-3 years. He bought his place because, in all likelihood, he wanted to avail of the following:
 
a) plentiful inventory on the market (He bought a place he: loved, could live in forever and did not have to stretch financially as he might have had to in 2004-2005)
b) attractive home prices ( he would not have bought the place unless he felt he paid a competitive price consistent with his bearish outlook)
c) absence of multiple bids on the same house (a common occurance just a couple of years ago)
d) better negotiating environment
e) tax sheltor (primary residence continues to be the foremost tax sheltor for an individual)
f) medium to long term investment opportunities OR  to avail of a house as a "store of value"
 
The reader further commented, " I think stretching yourself in real estate is a great idea if you have stability in your job and income stream etc. That is because the inflation rate allows you to effectively inflate away your mortage payment and you also have the ability to deduct interest. RE is a wonderful long-term store of value (because) real estate prices have appreciated at around 1% over the rate of inflation (over the past 100 years)." Practically speaking, I dont invest in real estate with a 100 year time frame. ..and when I calculate a return on my investment, I base it on my specific investment in a specific area and dont use national averages to gauge performance. In the past 27 years Boston prices have gone up over 600% and that works for me...despite the fact that during this period, the nation witnessed two severe down cycles in real estate.   
 
Additionally, money managers forget that real estate is a leveraged asset. Therefore, when a $100,000 house appreciates by 1%  (4-5% or higher with inflation) or $1000, the actual return on investment would be 5 to 10% (depending on whether the buyer put 10 or 20% down). Also, what my money manager friends may not know is that the equity markets have given an annual average return of only 0.9% between 1974-2006 ( Alliance Bernstein).......see how law of averages minimize the success of many investors who may have made zillions investing in stocks of companies like Oracle, Microsoft, Intel etc.
 
SOFT MARKET...LOCAL OR NATIONAL PHENOMENON?    My friend, the reader,  then summarized his argument with, "(The good time in real estate) has come to an end Rajiv. Don't assume it is a local issue or a miami or las vegas issue. This is a national issue. And the fed dropping the rate 50 bps won't do much. Look at the 30 year jumbo rate 3 years ago and look at it right now. Big difference. Look at who will even write jumbo mortgages now? 50-100 underwriters have gone bankrupt in the past 8 months."
 
OK, so let's assume that good time in the real estate market has come to an end in ever nook and cranny of the nation...every geographic region, every state, every city  and that the "bust" began in July 2005 (widely regarded as the peak of the last "hot market"). Real estate market is cyclical and, historically, has had "up and down" cycles in 5 year intervals. If we were to think of 2007 as the second year into the "down" cycle then we have another three years to go before the market picks up...that would take us into the beginning of 2011. Most real estate gurus, economists, think-tanks, investment banks are of the opinion that the market will improve anytime between mid to late 2008 and early 2011....all time frames within the realm of a 5 year down (soft or bust..take your pick) cycle.  The point is everyone has an opinion about the timing of the market and rarely has anyone been able to predict it accurately.......in the meantime, we all make decisions based on our perspective, our understanding of the market, our risk profile and our lifestyle needs.
 
Having said the above, I will reiterate what I have said in my previous commentaries: While the softening market is real, the extent of the CORRECTION has VARIED from region to region and city to city. The slow down in the real estate market manifested itself in Palo Alto, CA as a decline in the multiple offers received by sellers on their houses (from 8-12+ offers to about 4 offers now). Although, on my last visit to Palo Alto 2 weeks ago, million dollar homes ($1 - $1.5 Million) were still receiving 12- 13 multiple bids.  In Boston, MA, the correction has brought about a reduction in prices of about 3.5 %  (average for the city) thus far with neighborhoods like Back Bay and Beacon Hill holding up better than Dorchester and East Boston. Will prices drop 20% in Boston, as two of my money manager readers predict? I will leave the answer up to you. As for myself, I have bought real estate in Boston after July 2005 (post peak) and have not liquidated any of my real estate holdings in the city...and of those two money managers, one bought a house last year (as narrated above)  and the other continues to own a luxurious home in a town abutting Boston.
 
HOME COSTS REMAIN HIGH: Even with the downturn in the real estate market, houses in the Boston area will continue to be remain high, according to a new report from Harvard University's Joint Center for Housing Studies (2007). The median price of a single-family home in Greater Boston has dropped 3.5 percent in the current slowdown (through July 2007). At that price, a house costs 5.4 times the median household income. The standard for affordability is 3 to 3 1/2 times median household income, according to the Harvard center.

"House prices would have to fall a spectacular 35 to 44 percent -- to the $224,000-to-$262,000 range -- before being affordable to a broad segment of the population, as they were in the mid-1990s in the aftermath of the previous housing-market correction."

That downturn had a much greater effect on improving housing affordability than the current one. For example, at the peak of the recent real estate boom, in 2005, the median home price in the area was 5.6 times median household income, and has since fallen only to 5.4 times median income. In the late 1980s, house prices peaked at 4.5 times household income, and then plunged to 3.2 times income in 1994.

WHAT WILL HAPPEN TO THE MARKET BETWEEN 2008 AND 2015?  According to Harvard Joint Center for Housing Studies, the market(s) will eventually recover. "Once excess inventories and credit problems are worked out and balance is restored, ongoing demand for new and improved homes promises to lift the value of new construction and remodeling to new highs. Greater productivity will help raise real incomes for many while record wealth will allow households to spend more on housing. And, house prices will continue to move up. The influx of immigrants and their children has and should continue to drive household growth between 2005 and 2015 and, with the enormous increase in household wealth over the past 20 years, healthy income growth will help propel residential spending to new heights." The area's foreign-born population makes up 17 percent of all homebuyers, more than the nation as a whole, and  puts upward pressure on prices.
 
To give you another view point,
Ivy Zelman, a veteran Wall Street analyst, chief executive of research firm Zelman & Associates, says it's unlikely the housing market will recover before 2009, adding there's a "50 to 60 percent chance of a recession," as the housing slump curbs consumer spending. Zelman's outlook is in contrast to Federal Reserve chairman Ben Bernanke's prediction, who said last week that housing will be a "significant drag" on the economy into next year but will not plunge the nation into a recession. Like my  two  money manager friends, Zelman believes that SHOULD the economy go into a recession (50-60 percent chance), home-price decline COULD range from 16 percent to 22 percent ...this would be an average percentage decline nationwide and not Boston specific number.
 
"Not every market will get pummeled, though. Manhattan seems to be holding up for certain kinds of housing. Prices of co-op apartments with four bedrooms or more, for example, rose 19 percent in the third quarter from a year earlier. Major markets with the lowest level of housing distress include Boston-Cambridge and Manchester and Rockingham, New Hampshire", according to HomeSmartReports, a service that tracks six variables of home-market risk. "Boston is pretty moderate in terms of risk," says Mike Ela, president of the service. Is this where we pit Ivy Zellman, Mike Ela and couple of my money manager friends against each other. Both my money manager friends are sure that the Boston reall estate prices will drop by upto 20 percent. They are certain of it....defintely more than Ivy, Mike....and John Hancock. Go on, keep reading...John Hancock is next.

IS THERE ANOTHER VIEWPOINT BESIDES IVY ZELMAN'S? YES THERE IS.  According to John Hancock US Economic Outlook report, Fall 2007, "the deepening troubles of the housing sector and the latest employment report suggest that the US economy was losing momentum even before the credit crunch raised market angst. To counter the threat of a more severe economic slowdown, the Federal Reserve cut the funds rate by 50 bps in September and may well cut once more before the end of the year."

"The macroeconomic bottom line remains guarded optimism. Leveraged deal-makers are in trouble, and many sub-prime adjustable rate mortgage borrowers will lose their homes. But to the extent that the economy is being pushed towards a downturn, either by a financial crunch or by real economic trends emanating from the housing slump, the Federal Reserve has ample ammunition to cut rates and restore both confidence and real demand. Only if the Fed mis-judges completely is there reason to fear a recession, and while such a mistake is always possible, predicting it will be not easy."

"The housing market could still take another leg down, bringing a sharp and unprecedented drop in home prices. If consumers pull back in shock, we could be well into a recession before the Fed can stop the slide. It would take another anemic year to recover, with bad times for equity and credit markets in the mean time. Higher borrowing costs and tighter credit conditions versus current levels could lower growth an additional 0.5 to 2% over 2008." John Hancock believes that the likelihood of a recession is 30%, for Ivy Zellman it is 60% .....and for my two money manager friends, it seems to be 100% ........and one of them bought a high -end home last year despite his bearish outlook.

WHO IS RIGHT AND WHO IS WRONG? SHOULD I BUY NOW?  Most economists believe that the economy will be able to weather this storm.  Standard and Poor's chief economist, David Wyss, and Moody's Economy.com's chief economist, Mark Zandi, have forecast  8 percent price drop in the housing market, peak to trough. As discussed in previous commentaries, local factors will ultimately determine the extent of price drop in each town and neighborhood.  

In  a survey of 60 private-sector economists, 60% said they felt that worst was over for the housing market (remember 40% feel that the worst is yet to come). And the economists raised their forecasts for the probability of recession over the next 12 months. It climbed to 28%, up from 23% in the June survey and the highest level in several years.....Ivy Zellman puts this number at 60%, John Hancock at 30% and my two money manager readers at 100%.

On average, economists expect growth at a 2.3% annual rate this quarter and 2.5% in the fourth quarter. For the year as a whole, they expect growth of 2.2% and for 2008 they put growth at 2.8%. Both annual forecasts were cut by one-tenth point from the prior survey in June. As long as employment stays strong and workers' earnings grow substantially (4 percent annually,  presently), confidence - and spending - will remain high and the economy will chug along....provided there is no recession and the probability of that happening is ...................yes 28% (60 Private sector economist), 30% (John Hancock), 60% (Ivy Zellman) and 100% ( two money manager readers). Take your pick.

WHAT ABOUT MASSACHUSETTS? HOW WILL ITS ECONOMY PERFORM FORWARD?  According to Moody's Economy.com (as of 11/14/2007), the region's economic outlook has deteriorated in the past six months, with New England states now projected to grow at an annual rate of 2.2 (vs. 2.7% -2.8% for the national economy) percent through 2011. Alan Clayton-Matthews, professor at the University of Massachusetts in Boston, said the state will experience a "tepid" expansion through 2012 with payroll employment growth edging up only 0.6 percent annually. Still, wages in Massachusetts are projected to remain about 22 percent above the national average, Clayton-Matthews said. Additionally, he stated, housing prices are projected to bottom out midway through 2008 (NOT 2009 or 2010 or 2011), falling about 10 percent ( statewide average) from their 2004(5) peak, before beginning to recover. But the increase in housing prices later in the decade is expected to be less than the growth in wages, making housing relatively more affordable.

According to New England Economic Partnership and the region's economists  (as of 11/14/2007) , New England  may escape a recession, defined as back-to-back quarterly declines in gross regional product - the output of goods and services across the six states  (what the probability is, they did not say unlike Zellman, John Hancock or my two reader friends) . In the other piece of good news for New England, the economists said they expect the fall in housing prices to end in the middle of next year  (not 2009 or 2010 or 2011....but remember economists, like my reader friends, are not clairvoyants ) .   

Mark Zandi, chief economist at Moody's Economy.com has indicated that housing downturn combined with its spillover effect on consumer spending may not pull the economy into recession but if oil remains at $100 oil through next spring then both the national and the regional economies will become vulnerable and very likley go into a recession. Another reason to focus on alternative energies and buy hybrid cars.....................

SHOULD I BUY NOW FOR THE MEDIUM TO LONG TERM?  My two money manager friends /readers who are predicting a 100% likelihood of prices falling in Boston and MA by upto 20% are home owners or have become home owners recently . A key to equity preservation in any market is tied to the purchase price....the question is how much do you expect prices to fall (or not)...2% or 10% (per majority of new England economists) or 20%  and based on your answer what would you offer to buy a property at?  I share data/facts with my clients, foster discussion similar to the one here, guide them and assist them in making a decision that meet their needs best . If people stopped buying or selling real estate and stocks when markets are soft/down or hot/up then markets would collapse..........buying and selling activity may slow down but it never stops. So then why do people believe that others should not buy when there are opportunities in the market to be availed of....opportunities identified through analyses and education.

I, for one, do not have the desire or the will to construct an EP curve to figure out what experts know or dont know. As always, I am happy to make an informed choice and make decisions based on it, for better or for worse, in sickness and in health.......oppssss..that appears to be a marriage vow.....marriage, a decision we all believe to be great until divorce comes knocking on our door...so much so for certainity in life. 

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