Real Estate in the Spotlight: Waiting, Hoping, and Dreaming

It seems as if the whole planet is holding its breath while waiting to see what will happen to housing prices in the United States. Will they fall enough to cause a crisis in confidence that will turn the globe's biggest spenders into scared savers?

So far anyway, the markets are saying that this fall will only affect those directly involved in homebuilding and the lending industry. And although the world's stock markets have declined in the past two weeks, many are very close to all-time highs.

I've been warning that U.S. home prices peaked in the summer of 2005. And the difficulties in the subprime market and the homebuilders since then have not surprised me.

In times like these I try to put myself in the market's shoes. This means that I try to objectively look for evidence that maybe the real estate situation will not spill over into the general economy in either the U.S. or – by extension – the rest of the world.

I got a sort of direct education from "ground zero" recently. I grew up in Phoenix, which was one of the areas where house prices soared the most, and where people benefited the most. This has had an affect on the psychology of the average person there.

I recently spent time with one of these average persons. Until I was about 13, we lived close to a family. The parents at times were almost like second parents to me, the son a kind of brother.

We kept in touch over the years. The mother especially has some regard for my financial advice. I last gave it back in 2001 when I found that this 73-year-old widow's money was almost entirely in "aggressive growth" stock funds. Coming off of a high-tech bust that I thought was going to get worse, this was the worst place for a person like that to be. I put her money into a simple combination of Treasury notes and gold stocks.

Needless to say, she was very appreciative of how things worked out. She asked me to come out several months ago to help her with a new problem: her house. She'd owned it for 30 years. She's now 79. It is a two-story house, though, and she was worried that if her health deteriorated, it was smarter to move to a single-story house without stairs.

To keep a long story short, I convinced her she should sell her house and rent a nice one-story house in her same neighborhood. For her to buy another house now doesn't make much sense to me. We saw some houses for rent: The rents are so low that they'd take just a fraction of the monthly pension money she gets. In other words, she could sell her house, put the proceeds with all her other invested money, and not have to touch those assets at all.

Just with the money she'd save in property taxes and general homeowners costs, she'd be able to pay for several months a year of rent. And with her other regular pension payments, she'd have much more than enough money to meet her expenses: Indeed, she'd have a lot left over.

It all sounds simple. But I hadn't reckoned with one thing. For this to work in the least amount of time, she'd have to price her house to sell. As in many parts of the U.S. where house prices rose the fastest, houses for sale have soared in number. Many of them have been sitting on the market for months. She said she was ready to sell and move into a nice one-story house before she'd need to for health reasons.

But when it came to pricing her house, trouble began. "I'm not going to give it away" was her refrain. My advice to price the house at whatever it took to sell it quickly met with opposition from her son and herself. At the end, I only managed to get them to offer it at about 2.5% below the price they had first wanted.

Well, they've not received one offer. Who knows if they ever will?

The potential tragedy here is one of – dare I say it? – greed. This woman bought the house at a time when no one could have foreseen values going up as much as they have. At the price they're asking, with realtor fees taken out, they'd make nearly 450% on this home that has sheltered her for three decades. Moreover, as I explained, she really doesn't need to hold out for the last dollar. If the object is to get into a one-story house, then that should be the priority. So what if she lowers the asking price to one where she'd "only" end up making 350%? It's all gravy anyway. She wouldn't need to touch this money or the money she already has to make her expenses. By holding out for a higher price, she is risking having to stay in a house no longer suited to her at a time when that can be much less comfortable for her.

Of course, looking at it, there is really no way I can win giving advice here. Let's say I'd managed to talk them into lowering the asking price for it to sell fast at only a 350% profit. Let's say it sold fast. Then both mother and son would easily be angry with me for talking them into pricing it too low and "losing" all that extra money.

That's one reason why I don't like to give financial advice to family – or even "semi-family." Too many emotions are involved. The emotion of greed is the worst that an investor can have, except for panic.

The day I left the U.S. to fly back home, a friend told me another story. In the Washington DC area, he'd been house hunting. One house he was interested in was priced at $300,000. He offered $285,000. It was rejected. He got the "back-story": The owner, a Christian pastor, was ready to retire. They'd already bought a house in Nebraska, closer to their family. He'd wanted to sell the house originally for $325,000, but was talked into offering it for $300,000.

So in his mind he'd already taken a loss of $25,000 on his house. He didn't want to "lose" any more.

The money in the house was their retirement. He didn't want to jeopardize that. But that is exactly what he is doing, though getting him to see it that way would be impossible. By not accepting a very acceptable offer just 5% below their asking price, he is risking not ever being able to sell the house for anything close to what he otherwise could have gotten. And all the time, he's squeezed, having already bought his next house.

At this point in America's history, it is hard to escape the fact that too many people are being too greedy in what they want for their homes. As a result, more homes are sitting on the market unsold. Some are occupied, and some are not. Like that newly bought home in Nebraska that is not yet occupied, there are over 2 million homes in the U.S. now empty.

So far, the owners are able to carry them. They are waiting, hoping for things to turn around and for them to get the prices they want for their homes. All the while, more homes are being added to the market each month. Some are foreclosures. Some are people or estates that have to sell in the normal course of human events like death or divorce.

Some are new homes that were planned or built during the boom times only to be ready when the market has drastically changed.

Who do these sellers think the buyers will be for their homes that they want top dollar for? There is no rush to buy anymore. The house-hunter I talked to whose good offer was rejected is happy staying in his rented house. This house would sell for $200,000. He pays $850 a month in rent for it. That means that whoever owns the house is only getting a gross return of 5% a year on this house they rent out. After taxes, insurance, and upkeep expenses, they may not be making anything at all. They'd certainly be making more just sitting in T-bills.

But while it is not a great deal for the owner, it is certainly one for the renter. Why should he rush to better his offer to the pastor of $285,000? He instinctively knows that time is on his side.

And time is not on the side of those people trying to sell their homes in America today. Time is a powerful ally to have on your side. But you don't want it on the other side.

To my mind, most of the sellers today in the U.S. are living in a dream world. They are dreaming of prices that were seen at the peak. For the moment, they are ready to wait and keep dreaming. But people cannot do this forever. At some point, reality will hit home. Time catches up with us all: People age; they have to sell. Or they can no longer pay the price of having two homes. Or they watch their retirement money melting away each month and finally they panic.

I think that millions of people are going to realize that they simply don't have as much money as they thought they did. When this happens, they are going to cut back spending on all sorts of things. This will have global repercussions.

So I think the general markets are being too optimistic about the future. For me, this is an argument for being "underweight" in stocks and real estate and "overweight" in cash. Those sitting fat and happy in cash are going to have some great opportunities to buy homes in the next few years. But those too greedy will be sorry, as they nearly always have in the past.

Good investing,

Chris Weber