When will the distressed home sales stop so that the real estate market can get back to normal?
This is a question that many in the real estate business have been asking. It is a serious question, and various experts offer a wide range of answers: 2012, 2015, 2025. But all of these answers are wrong. It is a question based on a mistaken assumption. Distressed sales are not going away, and the real estate market wouldn’t be normal if they did.
Distressed sales have always been a significant part of the real estate market. There is a lot of emphasis now on foreclosure sales, and rightly so, as they are happening at the fastest pace in history. This is partly because of economic factors, such as unemployment and stagnant wages. But no one can claim that unemployment and stagnant wages will be going away. At the peak of the real estate bubble, unemployment was around 5 percent. Since 2009 it has been around 10 percent. There is some reason to hope that unemployment can fall to 5 percent again someday, even without a change in government policy in that area. But even then millions of homeowners will be unemployed, half as many as we have now. Similarly, even in the best of times, more than 5 percent of employed workers see no wage growth from one year to the next. An improvement in the economy could reduce some of the causes of foreclosure, but no one can claim that it will eliminate them.
Besides, many of the causes of distressed sales have relatively little to do with the economy. Often illness and the associated medical bills are what force a homeowner to sell. The timid health care reform measures that go into effect over the next decade will do little to take away the risk of illness or of catastrophic medical bills. Distressed home sales occur because a homeowner becomes disabled, dies, is incarcerated, or is called into active military service. We can attempt to reduce the frequency of these events, but that is quite a separate problem from the state of the economy.
There is also the issue of the underwater mortgages. In financial terms, you might look at these mortgages and conclude that the homeowner is stuck in the home they have for the rest of their lives — they may never be able to pay off the mortgage. But in practical terms, very few of these households will actually stay put for the next 25 years. Some will, of course, but it is a safe guess that more than four out of five will be forced to move for a new job or when their employer relocates. The steady stream of distressed sales from underwater mortgages will not last forever, but it can hardly go away until the underwater mortgages themselves go away, and that is a process that could take at least until 2040 to fully work itself out.
Even in 2006 at the peak of the real estate bubble, there were houses sold at auction every weekend. That was always considered a normal part of the real estate market. It is normal now. If you study real estate price trends over the last two years, every quarter you see real estate values go up in some regions of the United States and down in others. That was also what you saw before 1993. Pre-bubble, it was always considered normal for prices to go up and go down. It should be thought of as normal now.
The people who are waiting for a real estate market without distressed sales and with prices that go up and not down have been taken in by bubble thinking. So too, I am afraid, are most of the speculators who are buying so many of the distressed home sales this year. Bubble thinking is the mistaken idea that the pricing patterns that occurred during the bubble are normal. History tells us that a bubble is followed by a crash, and that what happens after the crash is closer to normal than what happens before. Based on this, for the U.S. real estate market, what we are seeing now is a reasonably good approximation of normal.