Deflation in the Real Estate Bubble
Problems with Vacation Homes

For Release April 6, 2006

By David Olson

It is our observation that the real estate bubble is starting to deflate and that the most vulnerable areas are vacation towns where there is a heavy preponderance of investor and vacation homes. Over the past several years, the National Association of Realtors has conducted surveys of the share of existing housing sales that were secondary residences. This share has risen in recent years. In 2005, the share of purchases by investors was 28% and the other 12% was bought as vacation homes. In 2004, the NAR survey showed 36% of all transactions of existing homes were secondary residences, of which 11% were vacation homes and 25% were investor homes. These figures have been steadily rising for the past several years. Data collected by LoanPerformance shows the figures to be lower but also steadily rising. We believe the LoanPerformance data is understated due to misreporting on the 1040 forms. We believe as housing prices flatten, the investor segment of the market will drop by at least half. Therefore, housing resales and mortgages will fall by a corresponding amount. This should accelerate the decline in home prices, especially in vacation markets such as along the ocean.

On a bicycle trip on April 1 from St. Michaels, MD, I counted 40 for sale signs in a 12 mile stretch. This was almost one in three homes for sale. When I returned, I checked on the home a friend has for sale for $1.15 million. He has had it on the market for 140 days with no bids. On his block are 8 other homes for sale with no contracts. Zillow.com estimates my friend’s home is worth $980,000 or 15% less than he is asking. It also states that home prices in Talbot County (where St. Michaels is located) have fallen 30% in the past year. This is the biggest decline I can find anywhere searching around the U.S. on Zillow.com. I believe most speculation has occurred in such areas. The average price here is very high and there is no employer in the area who pays enough salary to warrant such high prices. That suggests most of the people are retirees or investors. If speculation is indeed excessive, then prices should soften here first.

A friend, John Turner, reported he spent the winter at Marco Island. His rent was $2,000 for a property with a $5,000 debt service. Every third property was listed for sale. In such a situation, it makes more sense to rent than to buy.

A business associate, Ray Klingensmith, just came back from Sarasota, Florida and reported that the only topic everyone was discussing was how to get rich in real estate. Everyone was speculating in the market. But prices were beginning to soften. Homes that sold for $140k five years ago and then sold for $700k to $800k last year were now going for $500k. Buyers were accepting big discounts so as to be able to get their capital out of the property. There were for sale signs everywhere. There were lots of stories of high repair expenses from the several hurricanes last year.

A cousin, Steve Netherton, a 24 year real estate agent in Glen Arbor, MI reported that homes in his vacation area along the coast of Lake Michigan take six months to sell. The market is softening. He just sold his own home and a lot which he priced at the appraised value, but accepted a discount of 9% to sell it. He says sellers haven’t been willing to bring down their prices. The big selling season begins on Memorial Day. Until then, there isn’t enough business to be sure what is happening. He is hearing many stories of gloom from his buyers who mostly are auto industry executives in the Detroit area. He is selling fractional interests in a high rise luxury condominium building and sales are currently dead. The building is half sold after two years and sales are currently dead. He bought one of the large units for himself. The builder just raised the prices for the remaining units. Since he is getting no interest from buyers in Detroit which was the source of most of his sales in the past, he is thinking of focusing his ads on the Chicago market.

I checked on Zillow.com and found that they don’t have data on most rural areas where many second homes and investor homes are located, such as Maine and northern Michigan. This suggests their data set for the U.S. is understated. I believe the biggest declines in the real estate market will show up in those vacation home areas, such as St. Michaels, MD and Sarasota, FL. We shall have to keep our eyes on trends showing up in Zillow.com, which reports real estate trends for single homes, zip codes, towns, counties, states, and the nation. And it shows trends in these prices over the past five years. Zillow shows a decline in real estate nationwide in March and flatness over the past six months in many parts of the country. Mark Zandi of economy.com believes the market softness will first show up in California, Florida, and the DC market. We believe it will show up in the vacation areas within those markets.


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