10 Questions…on the Softening Real Estate Market for Prakash Dheeriya
Two years ago in The Report, real estate market expert Prakash Dheeriya, professor of accounting and finance, debunked the idea that Los Angeles County was in the midst of a real estate bubble. Still, the market has undeniably softened and with his continued eye on the market and home financing trends, he explains here how you can take advantage of the current conditions and how creative loan financing may send the market into a tailspin in the years to come.

Is any of this talk of a softened real estate market fueled by the media?
I don’t think it’s media-driven at all. They’re trends coming from data and statistics compiled from reputable sources like the National Association of Realtors. The L.A. Times and ABC may report on the softening of the market, but they’re not driving it. No one’s talking about a crash, but I think it’s accepted all over the country that we’re seeing a slowdown.

Are you surprised by this softening of the market?
Not really. Mathematically, it’s impossible for prices to continue to grow year after year and it comes to a point where eventually something has to give. The raising of interest rates by the Federal Reserve has slowed the market by making it more difficult for some buyers to get loans. So they can’t be purchasers and thus houses stay on the market. The ultimate end is that there are more houses on the market than there were before.

We’ve seen an increase in supply then, but why not a drop in prices?
In a slowing market, research has shown home sellers still approach the situation as if it’s a hot market. They aren’t willing to budge on price despite more competition – in the form of more houses on the market – and their own decision to stick it out doesn’t help matters. Some new homebuilders are also offering incentives like vacations and paying for closing costs on new homes. Basically, it’s a way of lowering the price without broadcasting that prices are going down.

So what should homeowners who are thinking of selling do? Sell now or wait?
I would get out right now. I’d try to sell at a little below the market price to make sure I can get out, because I think it’s going to continue to soften. The creative financing tactics used by lenders is going to loom large if interest rates continue to rise.

How will creative financing on previous loans affect things?
Lenders have reduced the eligibility standards for loans, and they’ve also offered adjustable rate mortgages like interest-only loans, negative amortization loans, and option arms that may really affect the market. If interest rates stay low, these adjustable rate mortgages won’t affect things because people will just be able to refinance when the rates jump. But if the interest rate continues to rise, we’re going to see a lot of people who can no longer afford their monthly payments and they’ll have to default, thus putting many more houses onto the market. Then it’s simple supply and demand as we’re seeing now – more supply means prices will have to come down.

Won’t it hurt lenders if lots of people default?
Absolutely. But there’s also nothing to stop lenders from offering even more creative financing, such as 40- or 50-year fixed loans at the slightest sign of trouble next year when interest rates are expected to be higher. This may delay massive defaults on home loans and any decline in house prices.

Still, why have lenders offered such creative financing if it could come back to haunt them?
The main thing is intense competition. They make their money off the fees involved in closing and so it’s been the pressure to sell loans that has led them to be more aggressive and offer these types of loans to people who might not be able to afford them when the rates increase. They also probably think they’ll be able to resell these defaulted properties right away should that happen, but I don’t think it will be that easy – they’re in the business of buying and selling loans, not buying and selling real estate.

When will we see the adjustable rates start to become a factor, and thus, potentially see a lot of people defaulting?
I expect it will really start in eight months to a year, because most of these loans have a three-year adjustable term and we really saw them come on the scene two to three years ago. In one to two years, we’ll be in the thick of it. Remember though, if interest rates stay low or they come up with new creative financing options, none of this will happen.

So would you buy now?
If I had to buy a house right now, I’d negotiate pretty hard because it’s becoming a buyer’s market. But if I could wait, I definitely would. Again, this all depends on whether interest rates continue to rise, but it could get pretty volatile soon so if I had a choice as a buyer, I’d just watch the market very closely right now. I’d probably wait a year or two and then buy and that’s particularly true here in Los Angeles.

You said you weren’t surprised by the slow down, but has anything else surprised you?
I’m surprised that the Fed didn’t stop raising interest rates earlier as I think that’s the primary reason for the slow-down, and even more than that, I’m surprised that federal agencies involved in housing financing haven’t taken a look at the legality of some of these loan practices. They really could have some negative affects on people who can no longer pay their monthly payments and the lenders who are giving such financing.
 

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