Why Higher Prices are a Bad Sign
In the San Francisco Chronicle this week there was an article that tried to find a positive sign of a housing recovery from the fact that house listing prices had started to rise. The article did point out that this was strange given that all other stats (selling price, # of sales, and price per square foot) had been falling at the same time. Still the general consensus was that a good thing was happening and I quote “this optimism is a trend for the area…” Try again…
What is really going on here is quite a bad sign and represents the last ditch efforts of sellers to deal with increasing buyer negotiating power (and proof that they finally accept the switch to a “buyers market”). Specifically sellers now know they will be forced to negotiate A LOT more than they thought up until now. In fact they all have in their heads a percentage (much larger than before they adopted this strategy) of how much they will have to lower the price of their house to get the deal done and they believe that is an absolute. As a result the only way to combat that is to raise the price so when the required and large discount happens you still can capture some upside.
Here is an example from the recession of 1980. My father sold window coverings to bring in some money above his teaching salary. Typically they are priced with 50% margin (so window blinds he lists for $100 cost him $50). He carried sheets that had these list prices on them and his customers all knew what the margin was (most people assume 50% for most products regardless of the truth). Then one day his distributor, during the economic downturn of the early 80s, offered him some “60% markup sheets”. Simply put these were the same list price sheets but they had a 60% margin built in. So now the same blinds had a list price of $125.
The result? Well without saying anything (because of the common market belief in a 50% margin) he could offer his customers 50% off (in theory offering the blinds “at cost”) making them extremely happy and more willing to buy even during that recession. In reality he still got to pocket 10% ($12.50) margin and no one argued. Afterall you can’t get something below cost can you? This was also very believable to the customer because it was a recession so my father should just be happy to sell at cost just to keep his business around, if not profitable.
So that is what is going on here. Sellers are increasing the implicit markup knowing they have to sell “at cost”. In this case the “cost” is the minimum price at which the seller is willing to offload the house. The “markup” is actually the percentage that they know they will have to reduce the price to move the sale given current market conditions. Like the story above they just pad the “markup” so when that percentage comes off they get to preserve some margin. Assuming this works.
Don’t get me wrong, when the market does truly recover of course listing prices will rise, justifiably. The difference here, however, is that none of the “true” stats (those that represent actual buyer behavior as opposed to seller aspirations and packaging) show this upward momentum. Remember listing prices don’t actually mean anything. In the world of economics (as opposed to the world of real estate fantasy) the true “market clearing price” of an object is what the buyer is willing to pay (and actually close the transaction) NOT at what price the seller is initially willing to sell.
So in the end this strategy is a form of seller capitulation and not market improvement. Sellers now know they must discount heavily (not just a token amount) and are trying to preserve some minimal upside. Strap in because this ride is a lot longer than most wish to believe. To the 5 year old real estate optimists in the back seat “no honey, we’re not there yet, why don’t you nap some more.”
October 13, 2009 at 8:19 pm
” To the 5 year old real estate optimists in the back seat “no honey, we’re not there yet, why don’t you nap some more.”
Well said.
Again.
October 13, 2009 at 12:25 pm
I had some relatives buy near the peak, with a 10-year Interest Only mortgage, in San Carlos, and are either 1) naive or 2) in denial about their situation.
Here’s a home that is 2.4 miles from their place, built 50 years+ ago like theirs, and is about equidistant to the 280 and 101:
http://www.redfin.com/CA/San-Carlos/2335-Saint-Francis-Way-94070/home/799850
It is a 3 / 3.5 with 2,070 sq feet. There are two ways to use this home as a comparable to come up with an approx. value for my relatives’ house:
1) Using dollars per square feet: (generously) assuming they get their asking price of $948,500, that is $458 per sq ft. Using that value my relatives’ would now be worth $760,632 (they paid $960,000!! in Oct 06).
2) Using Zillow’s crazy numbers, but factor in a relative adjustment: Zillow has the above house’s value at $1,108,000. Gee, that’s funny, it is “worth” $1,108,000, but the sellers are selling it for $948,500! Something’s wrong with this picture. Hint: Zillow is on Kool-Aid. Anyway, take Zillow’s number and subtract how much they are really asking (the true value, assuming they get it!), and you can come up with a “percentage that Zillow is too high.” That percentage happens to be 14.39%, so then look up Zillow’s estimate value on my relatives’ house and subtract 14.39% from that value….that number is: $817,500.
So by these two rather quantitative, no-b.s. comparison methods, my relatives are down somewhere between $142,500 – $199,000 on their original purchase price.
October 13, 2009 at 10:37 am
If it is Option ARM recast-ers rushing to the exit, a lot of them are still in denial about how much value their house has lost. I think that’s a big reason real-estate/the-economy are going to be bad for a while to come. Despite the gloom and doom in the news, I think a lot of people are in denial, and/or expecting prices to roar back any time now.
Marcitz, Is it more apartments you are seeing for rent? We are looking for a small house/duplex on the peninsula and not finding much. As far as for sale, I agree, houses going on market and either sitting or being pulled off.
October 13, 2009 at 10:54 am
Its a mixture of subdivided houses, houses, and apts for rent. Its more than I’ve ever seen but Palo Alto never has a lot of rentals so a small amount is noteworthy. Sometime the best strategy (especially in the downtown areas) is just to walk up-and-down the downtown streets and look for signs. Good luck. Rents are falling as well.
October 13, 2009 at 8:55 am
Mathcheck… $100 for something that cost $50 is a 100% profit margin, not 50%
October 13, 2009 at 9:33 am
Definition check – its a 100% MARKUP but a 50 % margin. See http://en.wikipedia.org/wiki/Profit_margin.
Also basic common sense. If you had a 100% profit margin that would mean you have NO costs.
October 13, 2009 at 7:34 am
Its more than that, listing prices are up because people with Option ARM loans are
Finally being hit with recasts. Even those whose loans haven’t recast are now in a
Rush to the exit. Result is more high priced homes on the market and an increased
Listing price.
Its obvious on the ground here in SF, many more for sale than for rent signs, very few
Of them vanishing. Its also obvious that the city is full of empty homes, these are not on
The rental market and are almost certainly in the hands of flippers who wished to make
A quick buck on TIC conversions.
October 13, 2009 at 8:20 am
Down here on the Peninsula I’ve actually noticed a LOT more for sale AND for rent signs which is extremely strange. I guess people must be, on net, leaving the area because, technically, you are either a renter, owner, or homeless. The homeless level appears to be the same.