Housing: Basic Supply and Demand


The news reported the ongoing lack of progress in the building construction industry. The problem is easy to understand, when applying basic supply and demand economics.

The supply of housing increased due to foreclosures. Buildings that a few years ago would have been owner-occupied are empty now, because of defaults on mortgage notes. One cause of the problem was the easing of regulation, and the promotion of adjustable-rate mortgages (ARM) that allow payments to be increased during the life of the loan. In the old days, fixed-rate mortgages were the norm, and borrowers made monthly payments, without worrying about increases.

The demand for purchasing homes simultaneously declined, as fewer people now qualify for mortgages. In the old days, a potential buyer needed a substantial down-payment, which generally stopped them from simply walking away upon default. The easing of regulation allowed the financially unqualified to buy, and as they defaulted, they simply stopped paying, and allowed the bank to foreclosure without trying to redeem, since they had no skin in the game. During the period of easy credit, too many buyers entered the market, and now that they no longer qualify for loans, due to a return to traditional lending standards, such as the requirement of a down-payment, there are too few qualified people available to purchase too many buildings.

With the supply of homes exceeding the number of qualified buyers on the demand side, prices have dropped, or at best stayed flat. This is simple economics. So until the oversupply of homes is removed from the equation, there will not be any real growth in the construction industry. Only when new construction is no longer competing against the oversupply of existing foreclosed properties, will the situation improve.

The flat-line growth in the value of homes has also affected those who could bring cash to the table, or who could qualify for loans. This is true despite the availability of relatively low interest rates. In my case, for example, we moved from Wisconsin to Florida 2½ years ago and intended to buy, but as we examined the market, several factors caused us to continue renting for the time being.

First, housing values are not increasing, and in some areas they are actually declining. If after just a few years, we wanted to sell again, any sale, after paying the sales agent, would result in a loss.

Second, the cost of Florida condo generally includes relatively large monthly dues, twice as much as one would pay in the Midwest. It appears a lot of profit-taking is built into them that could be cut out. Dues are like taxes, as they cannot be recouped.

Third, the cost of insurance in Pinellas County is too high, based largely on unfounded fears of a direct hit by a hurricane. Once again, these payments are not recoverable in any future resale.

Fourth, since wealthy Floridians enjoy no state income tax, much of the burden of running local government is based on a relatively high real estate tax, which is not offset by state revenue-sharing.

Fifth, when looking for a condo, one has to consider the number of neighboring tenant-occupied or vacant units in foreclosure, since owner-occupied units are generally better maintained. In this regard, the number of foreclosed units was a factor.

To comfortably buy, purchasers need to know their investment is more likely to grow than decline; the dues, insurance and real estate taxes must be minimal; and the vast majority of the units in any condo project must be financially above water. Given the current situation, at least for now, we will continue renting.

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