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Unless you’ve been asleep for the past year, you are more than aware of the slump in the housing market. You might be someone who is adversely affected by the downturn in housing, or maybe you are waiting for the downturn to continue because you are looking to buy your own property. My wife and I are in the second situation. We don’t own a house. We are renting and waiting until the best time to buy. Many people are saying that now is the time to buy; housing prices are at their lowest for the past few years, and interest rates are dropping. I disagree. I don’t believe we’ve reached bottom yet. In fact I am unsure that we will even reach bottom in 2008. We may, but it is no sure thing. I’d like to talk about two of the reasons that we are having this downturn in the first place, which will (hopefully) teach us a few lessons about what NOT to do when looking to purchase a house.

A Little Bit of Recent History

The median home price during the year 2000 (this is a national median price) was $119,600. By the fourth quarter 2005 the national median price was $213,900. This is an increase in the national median home price of roughly 178%. The Arizona median home price in 2000 was $121,300. By the end of year 2005 in Arizona the median home price had accelerated to $286,825. This is a 236% price increase. Why are these increases so large? What was going on with the rest of the economy at this time? Most of you will recall the market downturn and the “recession” at the turn of the century. The so-called dot-com bubble burst losing investors billions of dollars and pushing our economy into a soft recession. The federal reserve (public enemy number one, IMO) “fought” the recession (which by the definition of recession wasn’t even a true recession) by lowering their federal funds rate (the rate at which financial institutions lend one another money) 11 times from 6.5% to 1.75% over the course of a few years. These extremely low interest rates are what enabled banks and other financial institutions to lend businesses and individuals money at subsequently low rates.

The Next Pie in the Sky.

Where do investors put their money when their “sure” investment loses them money, and they are forced to pull out? In the next “sure thing,” of course. After the fall of the dot-com bubble and as the fed (aka the federal reserve) lowered their federal funds rate to a ludicrously low amount, investors decided that real-estate was a “sure thing,” and they pumped their money into the real estate market. Of course with this hefty increase in demand homeowners and homebuilders started rapidly increasing their selling prices. Simple economics right? Truly it is. What these investors (and even regular old Joe homeowners) did not think about is that the demand they were creating for homes was unsustainable. What goes up must come down. It’s a law… one which people tend to forget about every single time the next big investment comes around. “It won’t happen to this one,” they say. It always does.

Buying on Expectations

Foreclosures on homes happen. People lose their jobs and can’t afford their home payment anymore and so they end up foreclosing on their home. It is inevitable to a small degree. The level of foreclosures nowadays though is much larger than that small inevitable percentage. Another problem with today’s housing market is that consumers bought their houses on expectations. Expectations that the loan rates would stay low, expectations that they would get that raise next year, even expectations that housing prices would continue to accelerate at the level of growth that they experienced in the early part of this decade. These expectations are foolish to depend on. Purchasing a home will most likely be the largest, most expensive and most important purchase that one will ever make. Making such a large decision while making so many assumptions about the future is foolish, and it is primarily the cause of the increase in foreclosures we’ve been experiencing lately.

I mean no harm and no offense. There are many people out there who are suffering due to the events in the housing market over the past six or seven years. I do not mean to promote that suffering. I only wish to educate those who have not yet made these mistakes, so that they will be able to avoid them. Everyone makes mistakes. We grow by learning from (and not repeating) these mistakes.

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