Real estate is the greatest indicator of the health of the economy. By its very nature, it actually is the physical area in which one lives or works. In a previous life, I was a Real Estate salesperson and separately a Real Estate Research Associate, but this was before the time when mortgage backed securities and sub-prime mortgages became the buzz words of the year - similar to ‘chad’ and ‘WMD’ in years past. The truth is the real weapons of mass destruction are ignorance and naivety.
The initial rash of foreclosures in 2008 was the fault of both the lender and the consumer. How could a consumer making $50,000 a year, think that he or she could possibly own a $500,000 home? Caveat Emptor! If it looks too good to be true…it probably is. This consumer was mesmerized by, say, the 2% Adjustable Rate Mortgage they received but either blissfully naïve or simply ignorant to the “A” of the term ARM. This resulted in the vaulted residential real estate bubble of the mid-2000s.
Although I was young, it was during this move toward peak home prices that my mother sold the house I grew up in Rhode Island. A year later our former neighbour sold their house for about $100,000 more. Neither one made the wrong decision, the poor decision was made by the purchaser who believed the homes were nominally worth $250-350k. I don’t want to fathom what they’re worth now.
The blame cannot be solely rested on the lendee. The lender had an obligation to fully educate the lendee, but in their own right mind had to have known this person could not pay the mortgage once the rate jumped. I’m sure this lender was being pressured by their company to pump out as many mortgages as possible, and then these mortgages were packaged and sold to another party. This is one of the main factors that led to the demise of Lehman Brothers and the ridiculous amount of money that the US Government lent out in the TARP program.
Taking this into consideration, the stock market fell due to lack of confidence, negativity and the simple fact that people were pulling their money out of everything they could (and can) to cover their commitments. Economics is as much a statistical science as it is a psychological one. With the market plummeting, consumers stopped consuming. This led to companies shutting down, downsizing or restructuring. This resulted in mass layoffs across the country. Those people with sub-prime mortgages could now definitely not afford their mortgage payments and their homes were either sold for a loss or foreclosed by the banks. Since people still need a place to live, cohabitation – living with roommates or parents or children – became a necessity for survival. This resulted in an abundance of houses for sale – a buyers market. But a buyers market with few to no buyers is not market, so now Banks are no in real estate business, they are in the money business!
So, we have less employed, a poor performing market, low interest rates (as a result of trying to stimulate spending), an abundance of residential real estate for sale and companies downsizing or closing. The result of the latter is that commercial real estate begins to suffer. Already, manufacturing has been shifted to other countries so factories and warehousing demand has diminished. This has been accepted, although resulting in a serious export/import imbalance. However, the service and retail aspect of American business affected the commercial real estate sector. A prime example of this is the greater San Francisco area on the late 1990s.During the .com bubble, internet businesses, although often minimally staffed, needed office space. So, much more office space was built and refurbished in the area. When this burst, the microcosm of San Francisco and Silicon Valley, experienced a serious commercial real estate down turn. There were not enough businesses to occupy the office space. This example has now spread national.
As consumers spent less, the retail companies began to close as there were fewer consumers to purchase their products. One of the best examples of this is Circuit City. I currently live in Hoboken, NJ and work in Midtown Manhattan. I pass a defunct Washington Mutual bank in Hoboken and a defunct Circuit City in New York everyday. These retail outlets have not been leased. Moreover, the 7,000 square feet of retail space in my old office building has not been leased in over three years, with one exception. That exception was a Pret a Manger that lasted less than seven months. How many cranes do you see in American cities? How many new buildings are being built? Few. Very few. On a practical and psychological level – new buildings are a sign of prosperity. However, this is not a result of, ”if you build it, they will come.” Because, now, there is no one to come…at least for the moment.
It will only be when these retail stores become stocked with goods, that people continually purchase, will this recession end. How can we have jobs, when few people are buying? How can people have homes if they have no jobs? This leads to the Paradox of Thrift. “I need to save, but need you to spend.” With so many houses and commercial space available, we must accept the fact that unless we become self perpetuating and let the market sort itself out (by hitting rock bottom), these properties will remain vacant and under-occupied.