A 50% Drop is Completely Plausible

A frequent claim I used to hear from Realtors® at open houses was that real estate prices never go down. Although I don’t hear this myth much any more, you can still see remnants of the claim on websites that haven’t been updated for a while. For instance here is a quote from a Miami-based mortgage broker, Richard Barnett:

“The Florida Real Estate Market is not going bust! Prices have stabilized but they are not in decline, nor will they ever be in decline. You see Florida is not like the rest of the country. Florida is Paradise. Taxes are low, the climate is perfect year round, people are friendly, energy is plentiful and there is always something to do and enjoy. If you don't believe that then stay in New York or Ohio or Columbia or wherever you came from, we don't need you here. But if you want to be a Floridian then there is a price to pay and you will pay it for Real Estate. Don't worry, mortgage rates are going down and you can probably afford a lot more house than you thought, and remember since Real Estate prices do not go down in Florida, you will never loose [sic] money on your investment of property. So buy now before the next big increase predicted for early 2007 happens and you loose [sic] the dream of living in paradise.”

These outrageous claims are not limited to solo practitioners trying to peddle risky subprime ARMs. Recently, Lawrence Yun, the Senior Economist for the National Association of Realtors® said, “Our experience says prices do not go down when there's job creation in the local economy," said Yun. "In local markets where they are flat on jobs, they could see prices decline. But we're projecting 2.3 million new jobs this year. The job market is providing a buffer. It's a counter force to rising rates."

To be fair, we have not seen significant price drops in South Florida in recent history. The South Florida Business Journal explains:

“How often does the price of a used home fall? In Miami-Dade, for example the price of the average used home has fallen in only once since 1960 ­ in 1984 and only by 0.1 percent. That was due to the 15 percent interest rate-induced market collapse in 1982 and its aftermath.”

However, there are problems with that statement. While there has only been one nominal drop in home prices since 1960, when adjusted with inflation, there have been sustained, albeit small, drops in real terms. Regardless, it is unfair to compare recent history to our current situation. Consider the following graph that shows Florida home prices after being adjusted for inflation (Sources: Florida home prices from OFHEO.gov and “CPI less Shelter” data from BLS.gov):

This graph does show the sustained price drops when adjusted for inflation that experienced for much of the early 1990s. It also shows that home prices typically ran relatively even with inflation. Most importantly, it shows that our current market is nowhere near normal. Since 2000, Florida has experienced home price increase far beyond normal sustainable levels. In fact, in less than five years it has more than doubled after adjusting for inflation.

It is this rapid and massive price increase that leads me to believe that we can expect a similar rapid and massive decrease. As discussed in a previous post and as shown in anecdotal evidence in the daily “Today's F-cked Buyer” posts, we have seen a drop of approximately 15% to 20% since the peak in late 2005. However, in order to return to normal sustainable levels, we need to drop at least another 30%. I fully expect that to happen.

Realtors® and others who make a living in the real estate industry argue that this will not happen while providing little or no rationale for their assertion. Often they justify the nearly 100% inflation-adjusted appreciation as being completely rational, but claim a subsequent 50% decrease as irrational.

However, the graph above is impossible to refute. Florida’s real estate market followed a predictable, normal path for 32 years (since the beginning of OFHEO’s statistics). In four, short years, home prices doubled in price for no apparent, rational reason other than irrational speculation fueled by the most liberal credit markets in the United States since 1929.

It is completely conceivable that we will once again return to normal sustainable level and follow a normal path just like we did before especially when we consider the recent tightening of the credit markets.