In 2005, home sellers will have to price their properties judiciously instead of expecting offers beyond their wildest dreams on the first day of listing, according to Christopher Cagan’s market analysis and forecast. Buyers will look at many houses before placing a bid and will negotiate more with sellers.
In Cagan’s view, these are not signs of a crashing real estate market, but more of a raging fire returning to normal temperatures. Cagan, director of research and analytics at First American Real Estate Solutions, outlined his argument and supporting data in a new study, “Has the fire burned out? The return to a normal market.”
Housing price appreciation will slow down over the next few years, but Cagan sees no reason to worry about a bubble.
“This is basically the business cycle,” Cagan said. “This is not a stock market crash, there’s no reason to panic or run for the exits.”
In his study, Cagan charted, graphed and mapped internal data and numbers from the California Association of Realtors. He concludes that housing markets are returning to normal after a period of unsustainable price increases.
Cagan used the Southern California housing market as an example, but said his findings also apply to other markets.
Some real estate markets, such as Milwaukee, Wis., don’t fall into the same pattern and instead move smoothly without a cycle. Milwaukee’s market has been linear in character rather than cyclical, Cagan demonstrates through a graph. In contrast, the long-term California pattern is more cyclical, a fact even more obvious in a chart that factors out the effects of inflation.
Cagan notes that the psychology behind buying and selling often lags the reality of a situation. In other words, it takes time for people to become convinced of something. He argues that housing prices are leveling off as part of the normal business cycle, even if not everyone fully accepts that idea yet.
Cagan uses numerous color-coded maps of the greater Los Angeles area to prove the cyclical nature of that real estate market. The maps represent data from 1985 to 2003 and show a universal bull market in 1988-1989. The market suddenly dried up, however, in 1990. Between 1992 and 1993, the area hit its deepest drop in the cycle as foreclosures hit the market. Despite the general gloom of the market in 1995 and 1996, some buyers picked up bargains in affluent coastal areas.
About two years later, the bull market began to catch on and by 2002, the whole area was on fire once again. In the second quarter of last year, the market overall was sizzling and continued into this year. The second quarter of 2004 was the hottest part of the boom with prices rising at least 5 percent per month. Properties often had multiple offers on their first day of listing and often sold for above asking price.
The intensity “blew everyone away,” but it wasn’t sustainable, Cagan said. By the third quarter of this year, the market suddenly lost steam with inventory growing and price growth slowing down or even reversing. The market turn was most pronounced in affluent coastal areas with the more affordable inland areas continuing to do well as happened in the 1990 downturn.
The real estate boom also will end soon in those less expensive areas, Cagan said, primarily because of affordability issues. The price increases have become so great they are pricing out potential home buyers, including those who use adjustable-rate mortgages and other creative financing. The affordability concern is why that type of rapid increase simply isn’t sustainable, he said.
“Can you double in a year? You can. But can you double in a year indefinitely? No,” Cagan said.
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Cagan argues that high-end property activity leads the market, both in upturns and slowdowns. Bull markets usually start in high-end areas as people pick up bargains in those areas. Less expensive neighborhoods catch on later. As a market cools, that part of the cycle again begins in the high-end areas and less expensive neighborhoods follow.
Cagan predicts that in 2005 housing prices in affluent areas will be the same as they are now, or even slightly lower. In more affordable areas, prices will be higher than they are now since those markets have not yet reached their peaks.
Overall, he said, 2005 will likely be a sideways year with market rises and dips, but no huge movement in either direction. The market will not crash and there is no bubble to burst, he added. The market change is part of the business cycle and represents a return to normalcy.
“This is not apocalyptic. This is just going back to normal. This is what people have been doing for 100 years,” Cagan said. “This is not something incredible. This is not 1929. This is not Pearl Harbor.”
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