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It's an unsettling time to be shopping for a home. Home values have yet to stabilize in three-quarters of U.S. metropolitan areas. Alarm about so-called robo-signing of foreclosure paperwork has raised fundamental questions about who owns a property's title. And, while unlikely, two bipartisan commissions have suggested capping or killing the previously sacrosanct tax deductibility of mortgage interest.
As a result, home shoppers are being forced to accept a more traditional view of a real estate purchase: seeing their new home more as a savings account than as an investment. That represents a switch from how many owners thought during the go-go years of surging home prices and easy money, says Stan Humphries, chief economist of real estate information and listings website Zillow. "It's essentially a forced savings plan, putting aside a percentage of your income into a savings account that is a non-depreciating asset in typical times," he says.
Of course, that's not necessarily a bad thing. From the 1950s through the mid-1990s, home values appreciated 2 percent to 4 percent a year, on average, just beating the rate of inflation. The challenge is that Humphries also thinks home values won't bottom nationally until June 2011 at the earliest. Even when home values bottom out, Humphries expects an L-shaped bottom. His grim outlook is based on the fact that 23.2 percent of single-family homes across the U.S. had negative equity in the third quarter—which means high foreclosure rates will likely persist, while underlying demand for housing remains weaker due to high unemployment. The Obama Administration doesn't expect unemployment to return to a normal range, below 6 percent, until 2015, according to the Office of Management and Budget's mid-session review released in July.
Certainly, few now expect to sit on a property for a couple years and then get rich off the equity. Real estate agents complain that even record-low mortgage rates—which hit 4.07 percent on Nov. 9 for a 30-year fixed-rate loan, according to Zillow—won't budge many potential buyers, given the tough outlook for price appreciation. "If prices are falling, and rates are falling, and the news is more of the same, why would you buy a home right now?" says Alicia Trevino, a broker in Dallas.
Even some professional real estate "flippers," or the people who work with them to buy and rapidly sell property, are having second thoughts. "I tell clients, 'Don't buy this as an investment,'" says Sheldon F. Margolis, a real estate lawyer in Jersey City, N.J. "It will increase in value, but it will take a lot longer than it did in the past." Large inventories of unsold units have made it no longer possible to buy an apartment in a high-rise on Jersey City's high-priced waterfront in the construction stage and make a quick $30,000 to $50,000 by flipping it, he says. Similar new developments throughout the U.S. are sitting mostly empty, with values, in many cases, under water. That has left their developers stuck. Flippers are akin to day traders in the stock market—high risk, high return, but in a challenging market, most wind up losing money.
A few markets showed renewed life earlier this year, but mostly due to the federal first-time home buyer tax credit, which finally expired in September. First-time home buyers accounted for a record 50 percent of all home sales in a 2009 study from the National Association of Realtors, up from 47 percent the prior year. (The data go back as far as 1981.) Home values in five major California markets, including Los Angeles and San Francisco, turned negative again in the third quarter after climbing for five consecutive quarters, according to Zillow. Despite an average 3.6 percent year-over-year gain in single-family home prices nationally in the second quarter, prices fell in 70 percent of the 384 metro areas, and many markets experienced double-digit drops, compared with the 2009 second quarter, Fiserv-Case Shiller said in its November home price insights report. Fiserv-Case Shiller expects double-digit declines to continue until the end of the summer of 2011.
Prospective home buyers are happy now if their purchase simply holds its value, says Patrick "Bud" O'Hagan, a broker at Terry O'Connor Realtors in Allendale, N.J. Buyers "want to make sure that a year or two from now the house is still worth more than what their mortgage is," says O'Hagan. "They're looking at what happened to houses bought two years ago that are under water."
Seeing so many foreclosures hit the market, and watching what has happened with prices, has ingrained a bargain-basement mentality in many buyers, say agents. It's also drawing in longtime renters who see opportunities. Donny Epp, a graphic designer in Fayetteville, Ark., and his wife have been paying $700 a month to rent an apartment and decided they could buy a place for not much more in monthly costs—even while paying close to the listed price. On Nov. 23, they signed a contract for a three-bedroom house listed for $115,000, for which the seller is offering to pay closing costs (that will lower the Epps' total costs by 3 percent). Although Epp has seen several friends lose money on homes they've bought, he says he isn't worried. Epp can't imagine the house being sold for much less than what he'll be paying, and it is close enough to the local university that he's confident he could rent it if he wanted to.
"It wasn't about finding the best steal of a deal," Epp says. "We saved our money and wanted to find a place we'll feel comfortable in. I'm not interested in low-balling anyone."
Any proposal to take away the tax deductibility of mortgage interest is a long shot. Given the power of the real estate lobby, they would face an uphill battle in Congress. One option suggested by former Wyoming Senator Alan Simpson and former White House Chief of Staff Erskine Bowles proposes abolishing the deduction entirely, while a second option would eliminate it for second homes, home equity mortgages, and mortgages or more than $500,000. An alternate plan from a Bipartisan Policy Center task force headed by Alice Rivlin, former director of the Office of Management and Budget, and former New Mexico Senator Pete Domenici would convert the itemized deduction to a flat 15 percent tax credit up to $25,000 for all taxpayers on a principal residence, making it beneficial for lower-income taxpayers who don't itemize.
Kyle Wissel, a principal in the real estate group at New York City accounting firm Weiser Mazars, says he doubts a major curtailment of the deduction would curb people's desire to buy a home. "At [a price cap of] half a million dollars, what you're excluding is a fairly small minority of purchasers," he says of the second Simpson-Bowles plan. "It won't [affect] a lot of those people who, in some cases, weren't itemizing anyway, so it won't make a difference to them."
Some real estate brokers believe it's just a matter of time before excess inventory is worked off and the employment outlook improves to the point where home prices start to rise again. Markets that already have stabilized tend to have large government, educational, or military facilities nearby, says Humphries. For exampled, the steady presence of more than 200,000 Marines and their families at Camp Lejeune, N.C., provides a higher comfort level for would-be buyers in Jacksonville. On Nov. 19, Matt Abercrombie, a Marine sergeant and mechanical engineer, and his wife Megan closed on a four-bedroom house in what she describes as "an upscale, boutique neighborhood with good-size acreage." It's the third house they've owned in the six years Matt has been stationed there. Their thinking "wasn't so much 'this is a fantastic investment' as 'this house really suits our needs, and we see ourselves staying here over the long term,'" says Megan. It was a bonus that the appraisal for the mortgage came in $20,000 higher than the purchase price.
Charles Moore, owner of McGuire Real Estate in San Francisco and a third-generation broker, sees the psychological reset among prospective home buyers as a return to attitudes that prevailed before the 1970s, when inflation drove up home prices in California and other hot markets. He doesn't fault people for hesitating to jump in now; he sees them as simply exercising all the diligence that home buyers largely abandoned earlier in the decade.
"Not only am I not overly alarmed by it, but in a way I'd say this was necessary for the market to adjust from this bubble effect to [more realistic] value," Moore says. "'Ozzie and Harriet' buyers didn't expect any return on investment."