Buyer Beware! Seller Beware, Too!

If you’re confused about the direction the housing market is taking, you are most certainly not alone. There are stories of sellers slashing prices and offering new incentives to attract buyers, but at the same time, home prices nationally have risen more than 10 percent over the past year. Even as inventories of unsold homes are on the rise, homebuilders such as Lennar Corp. are reporting huge jumps in earnings. The much anticipated rise in 30-year Florida home loan rates has been tepid, if that.

The most recent issue of Business Week takes a look at the situation, and what should you do whether you’re on the buying end or trying to sell. Cut your price now, or hold out for more? Rent while you wait the market out, or buy while you can still snare a low-interest Florida home loan? Get a bigger house or downsize? Across the nation, confusion reigns.

“Buyers are complaining that prices are astronomical, but sellers are still thinking they’ll get what they saw their neighbors get last year,” said Carol Higgins, a realtor in the New York City suburb of Larchmont.

No one can predict which way home prices will go in the next nine months or so, and perhaps longer. Over the past several years almost every pundit who has attempted to forecast the market has been markedly off. You can avoid critical psychological and financial mistakes in today’s anxious Florida housing market by following some pretty basic advice. however. No matter how smart you are, it’s easy to fall into certain traps. Costly traps.

“So much of what drives the housing market is human interpersonal dynamics,” said Yale University economist Robert J. Shiller.

Instead of concentrating on fundamentals, people tend to be ruled by their feelings and by comparisons to their neighbors. If your brother-in-law made a killing in real estate, you’re determined to do the same. If your buddy’s house sold for 40 percent more than he paid for it, you’re convinced yours will reap the same reward, even if the market has shifted.

Below are a set of guidelines crafted by behavioral economists. Look at some bad decisions people make, so as to avoid following in their footsteps. You can also see which geographical areas are more susceptible to a drop in median prices and which are less at risk.

CONTRARIAN IS COOL
A first rule of thumb is to avoid herd behavior, which is what lures a lot of people into some of the more overpriced markets in the first place. Millions of eager buyers can’t all be wrong. Can they? Expectations of rising prices become a self-fulfilling prophecy as everyone and their mother tries to leapfrog each other. People simply believe that prices will not go down. Ever.

“You see people who aren’t particularly talented, who aren’t hard-working, who buy a house with nothing down, and they’ve been getting rich doing it. If they’re getting richer, then you’re falling behind,” Robert H. Frank, a Cornell University economist, said.

Herd behavior is taking the easy way out. Thinking independently can be more rewarding. Richard X. Bove, a financial analyst at Punk, Ziegel & Co., concluded that Florida real estate was overpriced and bailed out earlier this year. He sold his 5,600-square-foot St. Petersburg home for $1.2 million, twice what he paid for it a decade ago. His plan was to rent while he waited out the housing decline, but when he couldn’t find a good rental, Bove lowballed a four-bedroom house in Tampa and got it at $740,000 — 30 percent below the asking price.

In a softening South Florida housing market, it’s a dangerous mental mistake to commit to “loss aversion,” or the determination to avoid recording a loss at all cost. Some sellers gamble the market will bounce back rather than cut their prices. Florida real estate agents, in general, have a much clearer idea than sellers that demand has softened. Even owners who stand to make a big profit on a sale even after a reduction will often set the price too high.

Sellers set their listing prices, in part, based on data that’s 6-9 months old. If you don’t pay attention, you may underprice in a rising market and overprice in a falling one.

GETTING STUNG ON BOTH ENDS
Joe and JoAnn Watson, a neurosurgeon and Ph.D. in genetics, respectively, recently relocated from New Rochelle, N.Y., to McLean, Va. They planned to come out even by selling and buying at roughly $1.2 million, but are being burned on both ends of the transaction. The Virginia house is costing them significantly more than $1.2 million, while they can’t get what they want for their suburban New York residence.

“We were advised by two brokers to price it initially at $999,999, but my husband and I wanted to start at $1.19 million because we thought we could get it,” said JoAnn Watson, who has since dropped the price $1.09 million and still hasn’t received an offer. “It’s a great house. Why doesn’t anyone realize it?”

The danger of lagging on price cuts in a sinking market is that you follow the market, failing to sell because the price is always a little high. In recent research, Christopher J. Mayer of a Columbia Business School and David Genesove of Hebrew University in Jerusalem found that when prices were falling in Boston in the early 1990s, two-thirds of the houses that came on the market were eventually withdrawn without a sale.

In parts of the country where the market is still strong, such as South Florida, a common blunder continues to be overconfidence. Owners typically don’t seriously consider a wide enough range of potential housing market outcomes, including the possibility of a steep decline. That leads people to take more risks than they should.

Deciding whether to rent or buy is a perfect example of what the housing market can learn from behavioral economics. If financial efficiency were all that mattered, many more people would be renting nice houses instead of buying them, even with the mortgage interest deduction. But something about owning the place where you lay your head on the pillow each night gives people comfort.

“It’s worked out so phenomenal,” exults first-time buyer Obrey M. Minor, a 27-year-old special education teacher and first-time home buyer who recently settled into a house in the Houston suburb of Katy.

Social pressure to buy is intense, particularly in upscale communities. On the other end of the spectrum, you have individuals like Annapolis, Md., renter April McKinley, a health care consultant who recently moved with her husband from Pittsburgh to the Washington, D.C., area and ran smack into a wall of high prices.

“Here I am, a productive citizen, and I can’t afford to own a piece of it,” McKinley said.

Jonathan Miller, CEO of real estate appraiser Miller Samuel Inc., recalls that when he and his family moved to posh Darien, Conn., 15 years ago and rented for a year, “we were absolutely second-class citizens. It was very unpleasant.”

The notion that a home is a fortress is perfectly defensible, but it is not necessarily financially sound. In many markets the total monthly costs of renting are far below the total monthly costs (taking PITI into account) of owning the same property. Housing is 62 percent cheaper in San Diego, for example, according to Boston-based Torto Wheaton Research. So you owe it to yourself to consider the implications of buying your little piece of this world.

CONTROLLING THE CRAVINGS
In order to avoid home-buying mistakes in the Florida housing market, more people should be aware of the human tendency toward status-seeking. You can probably channel that desire more productively, if nothing else. If getting your kids into a good school district is a priority, for example, you may be able satisfy your lust for status by buying a smaller house in a prime school district — rather than a mansion in a less-desirable place.

A common foible that helps account for Americans’ obsession with real estate is what you might call the “tangibility fallacy.”

It’s the tendency to regard tangible things, like houses, as more stable than intangible ones like stocks and bonds. While a house provides more comfort than stockbroking account, it doesn’t make it a better investment. In fact, a comparison of stocks and real estate might surprise you. Except for the past few years, house prices have risen only about 1 percent faster than the rate of inflation. But not everyone sees it that way.

“We all went through the crash of the market. I lost $150,000. You never get that money back. I think the stock market is going to go down. I’d rather put the money we have in hard assets like property,” said 68-year old Ron DeLucia of Jacksonville, Fla., who is trying to by a bigger place across town.

It’s easy to lose your head over housing if you aren’t disciplined. To find your way, focus on the fundamental factors that determine value. With that in mind, it’s reassuring to realize that prices in the U.S., though high, are not out of line with other major countries. And remember that over the long run, real estate values rise at a pretty dependable clip.

BEWARE THE RED FLAGS
Prices in some U.S. housing markets do raise red flags, and a good starting point is to look at the affordability of homes for ordinary families. That measurement ranks Los Angeles dead last, with only 2 percent of homes sold there considered affordable by families earning the area’s median income, according to the National Association of Home Builders.

Other cities that don’t fare much better:

• New York — 6 percent.
• San Francisco — 7 percent.
• Miami — 14 percent.
• Boston — 24 percent.
• Washington, D.C. — 27 percent.

Of course, unaffordability is a chronic condition in places like New York, so it’s not necessarily a sign that a correction is coming soon. But in some cases, the median price is not too lofty. Tops in affordability among big cities were places like Dallas, with 60 percent of homes sold affordable by median-income families. San Antonio and Houston came in at 57 percent, while Chicago offers a respectable 48 percent.

Economists at Global Insight Inc. and National City Corp. conclude that in the fourth quarter of 2005, 42 percent of the top 299 metro markets were “extremely overvalued and at risk for a price correction.” The California and South Florida real estate markets dominate this list. Boston and New York look more reasonable by this measure, and San Francisco appears a bit less bubbly. Texas real estate still comes out looking like a bargain.

Another way to identify a problem area is to compare rents to sales prices, with the idea that if people’s monthly payments to own a house are much higher than what they would spend to rent the same place (real estate tax deductions and considerations included), then they must be banking on prices going up so they can sell for a profit someday — which leaves them exposed if prices don’t rise. By this measure, San Diego is one of the frothiest areas of the country, while Tampa and Orlando real estate aren’t nearly as costly.

The bottom line? Millions of households will buy a home this year. Locally, thousands of people will apply for Florida home loans. The process will always be lengthy and it is always big deal. Whether you are a buyer or seller, you don’t have to feel quite so lost. Or alone.