Trading Down Is the New Real Estate Reality

For many people who once only dreamed of a $1 million home, today a $500,000 home is looking pretty good

By Prashant Gopal

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Half a million dollars is, by almost any standard, a lot of money. But during the past few years, when credit was easy and regulations were loose, to many Americans it didn't seem like all that much.

That's because they were able to borrow huge amounts of money to buy new homes, often with little or nothing down. And while most homes sold in the U.S., even at the height of the housing bubble, were $500,000 or less, rising prices in most major cities and affluent suburbs around the country pushed the cost of a three-bedroom home well into seven figures or more.

In fact, in most parts of the country $500,000 has always bought plenty of house. But the gap between $500,000 and $1 million is more than monetary. It is also psychological. And during the recent boom years Americans became reckless consumers, buying cars, houses, clothes and much more that they couldn't really afford. The dream of a $1 million home, once so distant, became tantalizingly reachable.

Now that's all changed. While certain pockets, such as Manhattan, San Francisco, and Boston, remain high compared with the rest of the U.S., real estate prices around the country have fallen dramatically. The downside to this, of course, is that many people now owe more money on their homes than their homes are worth. The upside is that valuations are much more realistic—and affordable.

Pain is Spreading

That's because homes priced at the half-million mark—and higher—are now also beginning to shrink in value. Initially, the properties hit hard by the subprime crisis were lower-priced dwellings more often than not bought by people with poor credit. But now, as too many of us are experiencing, the pain is spreading even to people with good credit and higher incomes.

Until recently, sellers in wealthy neighborhoods were somewhat protected from the subprime credit crisis and were still drawing buyers with high salaries, good credit scores, and a cushion of savings. But the problems worsened after Lehman Brothers collapsed on Sept. 15 and credit markets froze, corporate giants laid off thousands of highly paid workers, and the stocks that padded the portfolios of the wealthy plummeted.

And even once seemingly impervious markets such as New York City, Florida, and California, which had attracted well-heeled international buyers looking to take advantage of a weak dollar, began to struggle as the global economic slowdown washed over Europe, Asia, and even the Middle East.

Luxury home asking prices nationwide have fallen 5.4% since Jan. 4, and homes now stay on the market for 148 days compared with 125 days at the beginning of the year, according to The Institute for Luxury Home Marketing's Luxury Market Report, which tracked prices through Nov. 7. The data—compiled by Altos Research—look at prices in the top 10 wealthiest Zip Codes in 30 large metro areas around the country.

Waiting Game

"The entry level of the upper tier—the $500,000 price point and up—has been softening for a while," said Laurie Moore-Moore, founder and CEO of the Institute for Luxury Home Marketing, a Dallas-based group that trains high-end agents. "What we've also seen in the last month is huge uncertainty at the very top of the market. People want to know where are we headed, how serious [the downturn] is going to be, and what is the duration. There are enough questions that at even at the top of the market people are waiting and watching."

BusinessWeek.com put together a sampling of homes in 17 of the most affluent communities across the nation selling for about $500,000. A few years ago those homes would have likely commanded much higher prices.

Art Tassaro, a Realtor with Friedberg Properties in the wealthy New York suburb of Cresskill, N.J., said buyers have all but disappeared in the past few months. Sellers who want their home to move quickly need to be aggressive about pricing. One method is to average the three lowest sales prices in a given neighborhood during the past year and then discount that price by another 5%, he said.

"If it was bad before, it's worse now," Tassaro said.

Buyers' Market

Of course, grim times for sellers can be full of opportunity for buyers, especially those with cash, he said.

John Marcell, president of Better Mortgage Brokers in Upland, Calif., in San Bernardino County, said sellers are having to discount prices significantly to make a sale. Most sales are so-called short sales, where the lender agrees to accept less than the outstanding loan amount to avoid a foreclosure.

High-end homes are just sitting on the market in his area, he said. Entry-level homes now make up the market's strongest segment because first-time purchasers can take advantage of low prices without having to worry about unloading their existing homes, he said.

"The only sales of million-dollar homes are foreclosures," Marcell said.

Click here to see what kind of home $500,000 can buy you around the country.

Gopal writes about real estate for BusinessWeek.com in New York.