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Craig Allen: What Will the Bottom Mean in the Real Estate Dilemma?

Interest rates, home sales and a struggling economy combine to keep the bottom still frustratingly out of reach

Like most people who live in coastal California, I am very interested in owning a home. I have been waiting for the market to bottom out so I can get the best possible price, and I hope to see that bottom come soon. But I’m not expecting to see a bottom for at least another year or two, so I am in no hurry to buy. More important, I am not expecting real estate prices to rebound at a fast pace once we hit the bottom. For those hoping to see a quick bottom and a return to the days of double-digit price appreciation each year, I am afraid disappointment is on the horizon.

There are several key factors that I see holding prices down for some time to come, and that will likely result in a very slow price recovery once we go through the bottoming process. That process looks to be very slow and very long in duration, probably lasting at least five years.

Although some pundits feel we have already bottomed, or are at least close to a bottom, we are still receiving data that contradict this view. Just last week a report by RealtyTrac showed that 31 percent of home sales in the second quarter were on properties in some stage of foreclosure or sold by a bank — up from 24 percent at the same time last year. Homes in foreclosure or bank-owned had an average sales price of 32 percent below the average price for nonforeclosure homes.

Also reported last week, purchases of new homes fell 0.7 percent to 298,000 in July. This is the third-straight decline, and sales are at their slowest pace since February. Analysts had expected new home sales to rise by 1 percent, which underscores a core problem: The media and so-called experts have spoon-fed the public a steady diet of overly optimistic information to convince us that we are going to have a robust economic and real estate recovery that simply is not going to happen.

GDP was revised down for the second quarter to just 1 percent annualized growth. The economy is clearly growing at a very slow pace, and if that pace continues to slow, we could easily slip back into recession (a double-dip). In fact, another report last week suggested that the chances of another recession are 80 percent.

It seems that the economy is, at best, in a sluggish recovery, and unemployment remains very high at 9.1 percent. As long as people are worried about their jobs, they are going to be very reluctant to spend money, especially on major purchases such as a home, and especially in a declining home price environment.

Interest rates are another problem. While it is true that rates are at historic lows, including mortgage rates, home prices are still elevated in many areas, making affordability difficult for many. Banks are also reluctant to lend in a declining price environment, so they are requiring larger down payments. Appraisers are also being more conservative, and foreclosed properties within close proximity to other homes for sale cause even further reductions in appraised values.

If we add all of this up, I believe it paints a clear picture showing us that we have a long way to go — both in prices and in time — before we will see a bottom for real estate prices.

Another problem with interest rates is that there is nowhere for them to go but up. In the short term, it is possible that rates could fall a bit more, but we are just above 2 percent on the 10-year treasury. Short rates are at zero percent. With all of the stimulus spending, quantitative easing and the extended period of time that rates have been low, inflation is all but a certainty. The Fed will act swiftly and decisively once inflation begins to build. It will raise rates — and raise them aggressively — to fight inflation.

Real estate prices are directly, negatively affected by rising interest rates. It will be very difficult for real estate prices to rise, even at a slow pace, in a rising interest-rate environment. Rising rates will also act to slow the economy so unless it is growing at a strong pace, any increases in rates will cause pain in the economy, which is not good for real estate prices. The more rates rise, the more prices will need to come down to make mortgage payments affordable for potential buyers.

Buying real estate as a homeowner and not an investor/speculator is not just about making a good investment; it is about ownership, family, lifestyle and many other factors that do not directly relate to prices. For those looking for a home as opposed to an investment, the recent reduction in prices may provide the right opportunity to own. I certainly feel we are closer to a bottom than a top at this point. However, given the economy, interest rates, and the state of the real estate market and the banking industry, I believe we will not bottom-out for a year or longer, that the bottoming process will take several years, and that prices will not rebound quickly.

Craig Allen, CFA, CFP, CIMA, is president of Montecito Private Asset Management LLC and founder of Dump Your Debt. He has been managing assets for foundations, corporations and high-net worth individuals for more than 20 years and is a Chartered Financial Analyst (CFA charter holder), a Certified Financial Planner (CFP) and holds the Certified Investment Management Analyst (CIMA) certification. He blogs at Finance With Craig Allen and can be contacted at .(JavaScript must be enabled to view this email address) or 805.898.1400. Click here for previous Craig Allen columns. Follow Craig on Twitter: @MPAMCraig.

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