Reflections on the Real Estate Market

I have been engaging in a bit of reflection on the state of affairs over the last year. My thoughts center on what happened, who it happened to and the implications of these events on the future activity in the real estate market in New York City.

The Seller
There is a saying that the pain of a loss hurts twice as much as the joy of a gain. There is no question that a lot of sellers are having a tough time accepting that the sale price they hope to achieve is no longer possible. Sellers tend to take the following steps in coming to terms with a declining market:

Stage 1: Denial – The seller evaluates past sales in the building and perceives the value of his home in reference to those properties. The seller feels that the recession is happening to someone else and not to him. Brokers are evaluated based on how much they agree with his position.

Stage 2: Shock – There is limited buyer activity on the property. Then offers appear, which are unacceptably low. The seller becomes frustrated and angry with real estate brokers. Finally the seller begins to recognize that the property will not sell at the price hoped for.

Stage 3: Pain – The seller tries to figure out what to do. He begins to listen to brokers and friends who tell him he has to adjust his price. He tries to reconcile the impact of the lower price against his future financial position.

Stage 4: Confusion – The seller continues to seek advice from others. Even though he has altered his price he still is not getting reasonable offers. He starts to evaluate whether he should bailout for the best he can get or hold on in the hope that there will be future improvement in prices.

Stage 5: Reinvigoration – The seller begins getting offers that are in line with his adjusted expectations. He fights hard against buyer demands for further concessions. He becomes empowered by the chance to create a deal and get the transaction behind him.

The Buyer
The buyer is seeking to find an opportunity. She has long felt that prices were too high. Now that there is a decline in prices she is seeking to take advantage of the market to find an apartment that she views as “fairly” priced. She is well informed and monitors the Internet and classified advertisements regularly. Here are the stages in the buyer’s final decision to go forward with a deal:

Stage 1: Inquisitiveness — The buyer is aware that the market has declined and curious to see if the price adjustments are significant enough to warrant serious consideration for making a purchase. In addition to browsing Internet sites and reading the classified section of newspapers, she goes to open houses.

Stage 2: Caution – The buyer begins to see a chance to purchase a property that was previously unavailable at an affordable price. However, she is hesitant to make offers and does not feel she is under time pressure. She believes that the current price decline is not over and that there is more bad news to come that will affect prices. Bad news is good news to the buyer.

Stage 3: Opportunism – The buyer identifies a property which meets her needs and decides that she should make a bid. The bid is low, reflecting her desire to negotiate a good deal.

Stage 4: Reconciliation – The buyer recognizes that the seller is not going to accept the price she bids and that she has to improve the offer in order to obtain the seller’s serious interest.

Stage 5: Acceptance — The buyer agrees to a number higher than she originally intended, but still affordable. She accepts that this is the best that she can achieve under the circumstances.

The Banks
Banks make money by lending, of which home mortgages have been a huge area of profitability. When the economy soured, many banks found that some of the riskier loans they owned stopped paying and profits turned to losses. In this case, the government mandates that banks increase their reserves to ensure the availability of adequate funds to deal with the difficult economic environment. The need to generate greater reserves and anxiety about the economic environment causes banks to dramatically reduce lending and to make demand that many borrowers they repay their loans rather than seek to extend or renew them. This results in a credit squeeze – borrowing becomes difficult and lending terms more onerous.

Stage 1: Generous Lending – The banks have substantial amounts of cash and considerable profits. Their business clients are doing well and requesting loans to operate and expand the business. In addition, the housing market is vibrant and many borrowers are submitting applications for loans for new homes or for equity credit lines. Banks are finding that many borrowers are financially qualified and they are lending substantial sums and earning considerable profits.

Stage 2: Knee-Jerk Response – The economic news turns negative. The stock market declines. Banks realize that the economic environment has changed and policy directives are sent to all departments to refrain from issuing loans to all but the highest quality clients. In addition, banks direct that loans maturing should not be renewed.

Stage 3: Work Outs, Defaults and Foreclosures – With the change in bank lending policies and a negative business climate, many clients are incapable of paying back their loans. A portion of the mortgage loans start to show delinquency. Delinquency notices are issued, mortgage delinquencies get legal letters and foreclosure proceedings commence. In some instances, banks accept short sales, receiving less that the full amount due on the sale of a property. In other instances banks agree to “recasting” the loan at altered terms with lesser interest or lower amortization.

Stage 4: Restrained Lending – Borrowing terms are tightened and review procedures are intensified. Many business clients are showing poor financial reports as a result of the bad economic environment so qualifying for loans isn’t possible. In addition, many applicants for mortgages have poor credit scores because they had to deal with economic difficulties and cannot qualify for mortgages as a result of heightened credit score requirements.

Stage 5: Repositioning – New financial institutions appear as a result of mergers with weaker banks. Banks reposition themselves to provide new and creative ways to finance businesses with greater collateral requirements or guarantees. Loan terms become extended and mortgage financing programs become more actively marketed on a more conservative basis.

Real Estate Brokers
Real Estate Brokers are dependent on velocity; whether prices go up or down is not as critical as the number of deals performed since commissions are earned successful transactions. In the current environment, brokers retrench and reinvent themselves. There is considerable retrenchment as weak firms either fold or merge into stronger ones. Brokers become more flexible, going into areas previously ignored and handling rental transactions more aggressively. In this market we have seen:

Stage 1: Denial – Real estate brokers initially believe that the decline in market activity does not include their area of the business. Thus, when buyer calls slow down they view it as a temporary condition. When they start seeing deals fall apart because buyers and sellers can’t agree on price, they view it as the buyer’s fault for being intransigent.
Stage 2: Frustration – There is a continuation of slow buyer calls. Sellers become frustrated because brokers are not “working” their properties. Deals continue to fall with a “10%” gap that just doesn’t seem to go away. Agents start to get angry at buyers for refusing to be “realistic.” Some sellers remove their apartments from the market.

Stage 3: Confusion – Agents find themselves with less and less to do. Personal bills have to be paid and commission income from closed deals is falling. Buyers are not calling or are increasingly demanding. They see themselves as more informed than brokers because they scrutinize every Internet site for possible opportunities. Brokers call sellers to advise them to adjust their prices downward to accommodate new market realities. However, even with price adjustments buyers are still not responding. Brokers don’t know what to do.

Stage 4: Reinvention – Real estate agents begin to redefine their selling strategy. They become more attentive to buyers. They start looking at redefining how they spend their time in order to build a base of business from new resources.

Stage 5: Rededication – Transaction activity starts to resurface. The level of dedication to servicing buyers and sellers knows no bounds. As a salesperson said, “Before I was an amateur psychologist, now I’m qualified for a degree.” Everyone is empathetic and struggling to understand what reality of the situation. Will the board approve the lower price? Will the bank accept the financial condition of the buyer? Will the buyer stay committed? Every deal is a juggling act.

Going Forward
The year 2011 presents a new market dynamic. The past few years have been challenging, yet have resulted in a new way of looking at ourselves and how we can best operate in a vastly different, evolving environment. Many economists look at recessions like a wave, washing away the old and revealing new vibrancy. We are now climbing a new mountain and the landscape is bright and exciting. There will be considerable effort; however, the path is clear.

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