Skip to content, or skip to search.

Skip to content, or skip to search.

Is Your Apartment Like a Dot-Com Stock?

ShareThis

On a macro level, what all this boils down to is that despite record-low interest rates and surging house prices, we are spending more of our incomes on mortgage payments and owning less equity in our houses than ever before. We are richer than ever, but most of our wealth is the result of stock and real-estate appreciation, not savings, and, therefore, is exposed to declines in these assets. And for the first time since the forties, we are also spending more than we earn.

What’s more, our financial system is now highly dependent on us making good on our debts. According to Paul Kasriel of Northern Trust, mortgage-related assets now make up nearly 60 percent of all commercial-bank assets, versus about 15 percent in the sixties and 40 percent in the late eighties. As long as we can keep making our payments, we’ll be okay. If we can’t, we may take the banking system down with us.

So what might Chicken Little expect to see in the near future? Barring a terrorist attack, you’re not likely to wake up tomorrow to find your apartment worth half of what it is today. Real-estate markets don’t tend to crash as violently as stock markets. Instead, one day, prices just stop going up and properties sit on the market. Low offers come in, but sellers hold out or wait to sell until prices recover, which they don’t. Eventually, those who have to sell—because of payment shock, relocation, or job loss—take what they can get and prices recalibrate.

One of today’s optimistic arguments is that hordes of buyers will jump in when prices dip—an argument common in the 1999 stock market, as well. What this ignores is how quickly psychology changes when prices begin to fall. People are desperate to buy today, in part, because they fear that prices will be higher tomorrow. In a declining market, the reverse is true: Buyers have an incentive to wait. Furthermore, when guaranteed gains disappear, Johnny-come-lately speculators rush off to the next hot market, further dampening demand. Owners whose equity has been depleted feel poorer and start saving instead of spending, weakening the local economy. Real-estate brokers, mortgage brokers, appraisers, inspectors, architects, engineers, movers, contractors, appliance vendors, and other industry participants make less, and their reduced incomes and buying power further lessen demand. And so on. In the stock market, the saying goes, you don’t want to try to “catch a falling knife.”

For homeowners who haven’t taken on high payments or exposed themselves to rate shocks, a real-estate crash should be tolerable: You can just live in your bad investment and avoid taking a loss. However, if you have banked on further price appreciation to offset a lack of savings, or rapid salary growth to take the sting out of payments, then you may get screwed.

If so, in your misery, you’ll have company. American homeowners have grown so accustomed to raiding their home-equity piggy banks that many have already factored gains and cash-outs into their spending and retirement plans. This, combined with negligible savings and huge debts, could lead to a truly nasty scenario. If home-equity wealth and income drop, the financial squeeze might curtail other spending. This, in turn, would slow the economy, kneecapping the other American wealth repository—the stock market. Although stock performance has stunk for five years, the market is still expensive: It could fall by half and not reach the level at which other bear markets have bottomed. If real estate and stocks collapse, rising unemployment could trigger more defaults and, ultimately, another S&L-style bailout.

Even if a change in the price trend doesn’t result in disaster, it will likely reverberate through the local and national economies. In New York, real-estate taxes represent about a quarter of the city’s revenue. A decline in prices would not dent revenue immediately, but it would slow future growth. And with the city’s budget forecast already in deficit, this might force spending cuts, increased taxes, or both.

One thing we know from the stock bubble: If the real-estate boom ends badly, there will be hell to pay, and it won’t be directed at buyers who overstretched. As in the stock market, such folks will be portrayed as innocent victims duped by a constellation of professional shysters: brokers, appraisers, lenders, et al. One can already imagine the outraged sound bites emanating from televised congressional hearings: “You knew rates would rise, didn’t you? And you knew what would happen when they did.”

Regulatory backlashes are as much a part of market cycles as booms, and in the midst of them, practices once viewed as business-as-usual are suddenly deemed sleazy or criminal. Conflicts of interest in the real-estate industry can make Wall Street look saintly. The entire real-estate-brokerage complex—from agents to mortgage brokers to appraisers to lenders to tax collectors—is wired to benefit not just from homeownership but transaction volume, so even when it is in a buyer’s or seller’s interest to do nothing (often), the pressure is to transact. In a rising market, no one sees this as a problem. But in a declining market, established practices can seem evidence of an industry rotten to the core.

One New York–specific “dirty little secret,” for example, is the “negative pledge” co-op loan. Co-op boards often restrict the amount of mortgage debt a resident can carry, usually to between zero and 50 percent of the purchase price. As the Website of one mortgage broker makes clear, however, with help, these rules can be ignored: “Negative Pledge financing is offered by a select group of lenders that understand the New York marketplace. They don’t advertise their services, but we know who they are.”

How does a negative-pledge loan work? The lender gets in on the game. The borrower gets two commitment letters—one for the permitted financing, the other for the rest—and the co-op gets a resident secretly leveraged to the hilt. New York co-op boards are the last organizations most people have sympathy for, but this may not be a defense for misleading them.

Bear markets for assets are bull markets for politicians and lawyers. In the wake of a real-estate bust, many enterprising regulators will no doubt seek to follow in Eliot Spitzer’s footsteps.

For practical purposes, the bubble debate is academic: You can afford what you can afford, and no one knows what the market is going to do. As Keynes observed, prices can stay irrational longer than you can stay solvent.

The great error made in the nineties was not the failure to recognize that the stock boom might be a bubble: By 1999, in fact, most professionals thought that it might be a bubble but kept buying anyway, because they didn’t know when it would end. The great error was the belief that before the bubble burst, something would change that would tell everyone to get out—that somewhere, a light would turn from green to red.

Having lived through that bubble, and looked hard for the signal, I would respectfully suggest that this is wishful thinking. Lights were flashing yellow, of course—and had been for years—but conditions just kept getting better. Eventually, by the end of the decade, life had been so good for so long that almost no analyst or strategist on Wall Street saw anything that would bring the party to a halt. And in New York real estate, life has been good for quite a while.


Related:

Advertising
Current Issue
Subscribe to New York
Subscribe

Give a Gift

Advertising