Slow-motion finance: good housing starting to drop

Since I spent a lot of last year trying to understand real estate, friends now ask me things like, "Should I buy a house now? Prices are down in LA by half, right? And my realtor friend said a house sold last week for asking price."

Actually, I don't usually say whether or not anybody should buy anything. But if you want to know if desirable housing areas are near their bottom yet? With prices down almost 10% in nicer zipcodes? Nope, not close.

Housing is slow-motion finance. Frozen snails slow.

The first thing you should know is that houses don't sell for 20% or 30% below asking price. The vast majority of offers are just ignored. Most deals close at within 10% of asking, and the waiting game in the middle is where buyers don't buy and sellers don't sell. Some buyers buy, but a lot just wait.

So, what you see right before housing drops in price is that inventory goes up. The number of homes on the market goes way up. You should just figure out (homes for sale / homes sold) in a month, and if you see more than 6 months of inventory, things are slow. If you see 24 months of inventory, you're in free-fall. Prices are going to be on the way down for a while when you see this, and it doesn't matter what the median prices say right now.

Inventories in many LA Westside zipcodes have tripled in the last two years. It usually takes about a year of increasing inventory before the peak declines in prices happen. And that's the first of several of these years we're in right now.

And a quick review of how affordability is working on the high end:

1. Higher end homes are now facing a 7% financing rate, compared with conforming loans being offered around 4%
2. Temporary "conforming" limits are ended, so fewer loans are available at 4%
3. Banks now check your income when you apply for a loan
4. The top income tax rate is moving up to 39%, while the mortgage interest deduction is moving to 28%. (Previously both were 35%.) Did you notice this in the bailout bill?
5. Oh, there was a huge stock market crash
6. General acknowledgement that you're not going to get rich buying stuff you can't afford
7. Option ARMs and other adjustable-rate loans are starting to get more evil, fast

These factors are all causing downward pressure on housing prices, but the thing that is really fascinating about real estate is how long it takes to decline.

In stock-market-years, housing takes forever to fall (from a buyer's perspective).

If we had a housing market that reacted like the stock market you'd see things like this:

1. Interest rates for Jumbo loans move from 5 to 7%: prices go down by 20% tomorrow.
2. Income tax rate change: prices down by 10% tomorrow.
3. Market down by 40%: oh @#&...

But in the housing market, these things take years to play out. A change that reduces the affordability of housing by 10% will have no effect tomorrow or next week, and it will take multiple years to work its way into the market.

Despite current declines, my guess is that we won't see the full effect of price declines in "better" areas for 2-3 years.

Also, redfin has nice market data. For instance, they automatically make this page about Beverly Hills 90210, and you can swap in your own zipcode: http://www.redfin.com/zipcode/90210

Finally, one other interesting thing about the LA market. The median prices are being set by the massive foreclosures in the inland areas, not the areas where most people live. That seems silly, but right now it's true. So if you meet a realtor who tells you that prices are down 40% and you should buy, they're telling you a story about a place where you probably don't know anybody, and it's very very hot during the summer.