Real Estate Focus

A few years ago, we did something amazing and powerful, which has now come back to haunt the market. Namely, we created a disconnect between the price and the financing of residential real estate.

When the financial markets were able to provide EASY and CHEAP credit to all comers, the value of property was de-coupled from the underwriting of the loan. Buyers began to consider housing like any other consumer good such as a car or a refrigerator. The monthly payment was the issue; the price of the house became unimportant.

The market place responded. As long as the monthly payment was affordable, the market could increase prices. And as prices rose, mortgage loans became increasingly exotic to keep that monthly payment in reach, including deeply discounted starter interest rates. Continuing price inflation, mistakenly called appreciation, provided an escape hatch for anyone in need. Refinancing of mortgages provided access to the "equity" for spending purposes, but also kept the mortgagor from true market rates as he/she just refinanced at the new prevailing teaser rate for the new loan.

However, after these processes were firmly in place, the effects of taxes and insurance became issues. Taxes were based on market values, but did not immediately kick in due to the lag of the assessment process. Insurance costs skyrocketed in large measure due to two active hurricane seasons. As the markets turned, credit underwriting tightened at the same time interest rates started moving higher and house prices began to fall. The perfect confluence of events that created the real estate bubble became the perfect storm.

The cheap easy money to buy coupled with the low taxes and insurance is being replaced by its mirror image: more expensive less accessible money, high taxes and high insurance. The only moving part in the equation is the mortgage payment, which is tied to the price of the house. That now must move enough to compensate for the increases in all the other since throughout this whole process the income used to support the home purchase has remained essentially flat. This requires prices to fall. This process will require time to adjust prices to the new reality.