I have been asked my opinion by many clients as to why the market is so "bad" compared to recent years. Sellers are asking, "Where are all the buyers now that interest rates were lowered last week?" Although I am not an economist, I have been in the business long enough to see good & bad markets and witness what precedes each.
This is 1 of 2 entries in which I will be discussing my viewpoint on the recent slow down in sales.
Like many areas of the country, the Chicago area has seen a dramatic decrease in the number of home sales in the area. I have been tracking various towns in our area. In some cases we have seen almost half the number of sales compared with 2005 at the same time. (But, unlike many regions of the country, we still have appreciation in many of these same areas. I will touch on my theories for that in another entry.)
I have come up with my theory as to why we have seen such a slow down, which may echo a few analysts out there in one way or another and if it doesn't, it should.
Anyone who has taken an Economics course knows that supply & demand are key factors. Housing is not immune to this phenomenon. When there are few buyers, but large inventory, prices generally even out or can decrease. When there are many buyers with few choices, prices increase.
But why so many buyers from 2000-2005? Interest rates had something to do with it; however, the rates are still low (they were above 10% when I entered the business and had topped that beforehand). If rates are so low, where did all the buyers go taking advantage of them? Don't misunderstand, I see the interest rates as a major factor but not the key to the problem.
What I do see as a key factor is the availability of loans.
2-7 years ago, the "Sub Prime" lending market exploded enabling buyers to get loans that never before could have qualified. No Doc became as common as sliced bread. No Money Down, a "household word". 600 credit score - no problem. 550 - Yep that too. Lower - could be done. As a result, the number of people able to qualify for a loan increased dramatically. Multiple offers became a common occurrence - there were so many buyers. Buyers with little to nothing down not only had FHA to choose from, but several conventional options too. FHA became less frequently used, why deal with the appraisal & repair issue headaches when one could get a conventional loan, and more easily.
More Availability of Loans => More Buyers
More Buyers => More Competition when buying => Bidding Wars => Home Prices Rise
We saw the number of individuals owning a home increase to some of the highest levels in history. According to the US Census Bureau the Midwest saw a 73.8% homeownership rate for 2004. Compare that to 67.7% just 10 years earlier. 
But there was a dark side.
There were some predators taking advantage of buyers only to make money, advising buyers to go with a loan that they could never repay. And there were buyers who didn't understand that an adjustable rate can go up and usually will the first year or two - 2% can be a huge difference in payment, especially when you are spending beyond your means. Some buyers thought their home would easily be worth 15-20% higher in a year or two (sometimes the case) and they could easily refinance out of their less-than-desirable loan into a better one - but when the time came, they couldn't.
When these homeowners started defaulting on their loans, foreclosures increased. Lenders started going out of business. Someone stopped and said, "Why are we giving loans to people who cannot qualify to pay them back?" Someone else replied, "All 'sub prime' loans are bad. We should stop them all." And suddenly, the buyer who could get a loan 3 years ago cannot qualify to buy a cardboard box. (I'll get back on my soap box another day about the knee-jerk reaction our legislators are taking to this "crisis".)
Interest rates play a major role in the amount of funds available to lend. When the Fed lowers interest rates, generally more money is available to lend. More money to lend usually means lower interest rates for consumers. But we don't see all of the programs available that were before. Lenders are reluctant to bring back the lower lending standards (not a completely bad thing). Less buyers can get loans.
Fewer Loan Options => Fewer Buyers => Major Slow Down in the Housing Market
But there's more to it ... see my next entry.
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