The Boom Is--Is Not!--Over: The Great Real Estate Debate

By Daren Fonda

When Holly Schiller bought a town house in Fort Lauderdale in the fall of 2004, she figured she would pocket a profit before the place was even finished. Schiller, 51, and her husband had already flipped several properties in Florida's sizzling market, and this one sounded sweet: three bedrooms, private elevator, designer appliances. Villa Medici, promised the builder, would be modeled after a "true Italian Tuscan village," featuring Mediterranean fac,ades and a resort-style pool. "As with any 'limited edition,'" the pitch stressed, "demand always exceeds the supply."

Well, maybe not always. The housing market in parts of South Florida is melting faster than a snow cone on Miami Beach. Schiller's town house has languished on the market for 18 months. She has slashed the price by $75,000, to $565,000, offered a $2,500 bonus to the selling agent and at one point threw in a $2,500 store credit for home furnishings--all to no avail. "Buyers are extremely hesitant," says her broker, Rob Rose, adding that hundreds of similar properties are for sale, with similar gimmicks--from free Caribbean cruises to gym memberships (personal trainer included). Schiller is nervous. She's renting out another property at a loss, while trying to sell that one too, and has a deposit down on a second town house under construction. "They keep telling me 1,000 people a day move to Florida," she says. "I don't know where they're going. They're not buying."

The house party had to end eventually, even if sellers refuse to believe it. Many remain defiant to the point of delusion, demanding one more drink at the housing bar. Real estate bulls point out that the nation's median home price is still up 0.9% this year, to $231,000. But that stat is misleading. There's a stalemate between buyers and sellers: property owners are reluctant to cut prices, and buyers are patrolling from the sidelines, hoping for fire sales. "We've had sellers' markets for the last five years, and they're transitioning to buyers' markets," says David Lereah, chief economist for the National Association of Realtors (NAR). "Sales go down and prices follow. Sellers are stubborn, so there's a standoff." Lereah says he'll probably cut his forecast for price growth from 5% to 4% this year. It could be worse, but in certain mid-tier markets--like Cincinnati, Ohio; Dallas; Milwaukee, Wis.; Salt Lake City, Utah--prices didn't appreciate as quickly as in the hot zones, and aren't likely to fall as fast. In places like Phoenix, Ariz., Las Vegas and Los Angeles, epicenters of the boom, look out below.

Sales of existing homes nationwide are down 8.9% this year, including a 17% free fall in the West, according to the NAR. A year ago, 2.6 million units were on the market. Now there are 3.7 million, a 39% spike. Home builders, whose stock prices have tumbled, were late to cut production, a bad sign for new-home inventories, especially with mortgage rates higher than last year's levels. KB Home, a national builder, says its cancellation rate shot up to 37% in the second quarter, from 25% a year earlier. "People are making arguably the most significant economic decision in their life," says CEO Bruce Karatz. "They want to feel like they're being smart, and in some markets it's unclear whether it's smart to buy a home."

If you live in Bubbleopolis, things certainly look scary. In Miami there's a 17-month supply of single-family homes for sale, according to the NAR. Some 75,000 condos are coming on the market in Miami--Dade County, many purchased by speculators with no plans to live in them. "There will be lots of foreclosures, lots of auctions," predicts real estate agent Rose.

The mood isn't any brighter in San Diego, another overheated market. In June the city's median home price fell 1% from a year earlier. That's the first decline in a decade. "$579,000--Getting Desperate!" reads an ad posted on Craigslist in the metro area. "There are three times as many houses on the market as there were a year ago," says Vikki Kuick, a broker who placed the ad.

Buyers are taking their time, leery of overpaying and taking on too much debt in a rising-interest-rate environment. Some sellers figure they're lucky to be getting out. Hewitt Hymas, a Navy commander reassigned from San Diego to Annapolis, Md., just sold his four-bedroom home for $476,000 (which he bought for $280,000 in 2002). It wasn't easy. Hymas relandscaped the yard, spent $7,000 on kitchen upgrades and eventually dropped the price by $18,000. "People around us still live with a heyday mentality," he says. "They got used to the boom and were asking ridiculous prices." He made a command decision not to be greedy and moved on.

Experts in market psychology say stubborn sellers have a classic case of denial. Richard Peterson, a San Francisco psychiatrist who specializes in financial decision-making behavior, points out that "people would rather gamble and hope prices come back. They ignore information suggesting that prices are dropping." It's the same mentality that leads blackjack players to double down in a losing streak.

Conversely, when investors see prices rising, they get overconfident--the hot-hand bias that leads folks to think a basketball player will sink his fourth shot after making the prior three, even though probability says the odds are the same for every shot. That explains sellers' reluctance to cut prices, Peterson says. Academic studies also suggest that frustrated sellers take their homes off the market rather than accept lowball offers. It happened in Boston in 1991, when condo prices tanked and two-thirds of the inventory was withdrawn for sale, says Chris Mayer, a Columbia Business School professor. Sellers then had to wait up to six years for prices to hit their previous peak. Robert Shiller, a Yale economist who has long warned of a bubble, thinks price stagnation (or worse) is here to stay but that Americans don't want to believe it. "People still expect double-digit gains," he says, citing surveys of homeowners.

Whether the eight-year boom was really a bubble remains a matter of debate among economists. No less a sage than Alan Greenspan started warning of "froth" in the market in May 2005--and the Fed has raised interest rates 17 times, at least partly to dampen speculative housing activity. Yet the party outlasted several years' worth of doomsday predictions. And for every bubble guy, there's one who thinks prices overall are about right, given mortgage rates that are still low by historic standards and other measures of affordability. "My view is that the run-up of home prices has been driven by the fundamentals," says Dick Peach, an economist with the Federal Reserve Bank of New York. He figures we'll have a soft landing.

Still, the slowdown seems certain to take a toll on the economy. Housing activity accounted for a full percentage point of last year's 3.5% GDP growth. Psychologically, rising home prices have made homeowners feel wealthier--just as stock prices did in the dotcom boom--boosting consumer confidence and spending on everything from cars to restaurant meals. Those rising prices, along with low borrowing costs, led homeowners to cash out a record $450 billion in home equity in 2005--money pumped into the economy. Rising interest rates have clogged that artery. And each month millions of homeowners have to write bigger checks to lenders as mortgages with adjustable rates move higher, another clamp on spending.

Perhaps most unsettling is that cracks are emerging in the Midwest, a region supposedly insulated from real estate madness. In Glen Ellyn, Ill., a suburb of Chicago, Deb and John Tritt have tried to unload their house for seven months. They've spruced up the place, knocked $58,000 off the price, to $739,000, and offered a week at their Hawaii time-share to an agent who delivers an offer. None of it has paid off, and two more houses in the neighborhood are for sale. "We're moving to a town home," says Deb, "and the only saving grace is that it's not finished yet."

Nonetheless, other buyers remain convinced that their nest is a good investment, not just a place to live. Mary Trujillo and her husband Jay just moved from a home in Houston to Naperville, Ill., where they bought a split-level ranch for $290,000. They're spending nearly twice as much on the new place and netted only $10,000 from the sale of their Houston home--after owning it for five years. "I think I have a better chance of making money off this house," says Mary. Call it the American dream.

With reporting by Elizabeth Coady/Chicago, Siobhan Morrissey/Miami, Jeffrey Ressner/Los Angeles