As everyone knows by now, the inevitable fall-off of the  real estate sales market is now well-entrenched. This is the second time in my 24-year practice when such a fall-off has occurred. The last time was from 1990 through 1995. However, unlike the drop in the 1990s, this drop off is being driven by massive banking mismanagement and unsound lending practices (the source of which, regrettably, is greed).

In the short-term (over the next three years), the Washington DC area real estate market is likely to experience a relatively mild recovery from the current drop.  The primary and secondary indicators of that recovery are clearly operating.  One of the most significant indicators is an increase in the number of new purchase home insurance applications.  As one of my sources from inside the insurance industry observed, "the first-time homebuyer is back in the market.  They realize that prices have come down somewhat and are stable, that there is not as much competition for a given home, and that sellers are more willing to negotiate the sale price now then in the recent past."   Also, FHA loan rates are more favorable now then at any time during the past several years of rapidly rising home prices. 

But caution, intelligent shopping and careful decsionmaking are still needed.   At th national level, an even greater and more widespread drop in the real estate market is likely to follow any such recovery.  This second drop in the market is far more significant since it will be driven by larger forces – specifically, the wave produced by the boomer generation. Bear in mind that it is this population group and the related demand for housing that they have been responsible for which has led to the huge run-up in prices during the past 12 years.

The unprecedented and lengthy period of growth in real estate values we are just coming out of is directly attributable to the purchasing decisions and spending power commanded by the boomers. For many years now, starting in the late 1960s, they have been leading the crest of the house buying wave. Beginning in their mid-twenties and up through the present time, they have been buying their way up through the property sales market – leading the way and establishing the upper limits of home prices throughout the productive years of their lives. The oldest segment of this bulging population group turned 60 in 2006 – which means that a very large retirement cycle in this group is just now beginning and will continue for approximately 10-12 years.

It is this inevitable wave of retirement in this very large population group that will produce a natural counterbalancing change in average home values nationwide. As this group enters this phase of life, an equally inevitable second drop-off in real estate values will be a natural outcome. Once this large-scale retirement cycle gets solidly underway (in about 2 ½-3 years), a national declining market will result that is likely to last for approx. 12 years. It will be determined almost exclusively by the boomers selling their primary homes in order to retire into their "final" smaller home.

Unfortunately, the fact is that there is no sizable population group following immediately behind the boomers who can buy their homes. In other words, as the boomers prepare to retire, there will be more homes to sell than there are buyers – and a long-term buyers’ market will become the norm. Of course, all of the homes will get sold – but at a very significant price reduction – possibly declining by 15-20% in outlying areas (i.e., not inside or near the Beltway and/or not convenient to a METRO station).  The decline could be as much as 25-30% in other major metropolitan areas throughout the country.

The DC metro area has definite insulating factors to offset this, but these can only temper, not eliminate the trend. Homes that are located inside the Beltway and/or near a METRO station should hold value fairly well, but the values of houses that do not meet these criteria could well take a beating.

The bottom line on all of this is that if one holds property that is not near the METRO and/or is not close-in to Downtown that one is thinking about cashing out in the next 15 years, it would be a good idea to weigh a sale in the next three years rather than waiting until one is forced to sell in a seriously declining long-term market. If your home fits this "less desirable" description and you're wondering what one might do with funds that become available from a real estate sale, the most astute and experienced financial planner I know does not see any safety in transferring significant holdings into stocks as these are likely to suffer in concert with a downturn in the real estate market (as we have just witnessed).  Instead, with the idea of shepherding one’s assets over a period of decline, he is recommending that funds be put in protected investments such as bonds where one can be sure of an annual return of around 5%. As far as real estate investing is concerned, the prudent investor needs to think much more cautiously about the wisdom of such an investment.  For the time being, for a financially safe and successful real estate purchase, both investors and owner-occupants should focus on homes that are located inside or near the Beltway, convenient to a METRO station, and ideally, close to community amenities such as shopping, restaurants and theaters.

Boom, Fizzle, Crash?  Yes -- the DC area market is generally flat to slightly positive -- and the speculative boom is over.  This is the second time in my real estate prcatice that I've seen this happen.  All economic markets are cyclical -- and we are now in the phase referred to in the adage, "what goes up, must come down."  However, the market in the Washington Metro Area inside the Beltway and/or near a METRO station is still experienceing a postive -- albeit attentuated -- growth trend which is not like the national trend as seen in many other major metropolitan areas.

One needs to be discerning when mterpreting published indicators of declines in pricing.  For example, a recent report from Zillow.com indicated that in the last quarter of 2007, Silver Spring home sale prices dropped by more than 9% when compared with the same period a year earlier.  However, it is important to note that the "Silver Spring" refererd to in the Zillow report is an unincorporated area that occupies more than 25% of Montgomery County -- the bulk of which is outside of the Beltway and not near a METRO station.   When one examines sold prices for Silver Spring homes that are located inside or just outside the Beltway, in fact, prices increased -- and were in line with the increases reported for Takoma Park, Kensington and Bethesda.  These communities, like close-in Silver Spring, are located in an equivalent distance relationship to Downtown Washington -- and the economic forces that are operating in the Washington Metro Area remain positive, strong, and unchanged (see my previous reports below for a detailed view of these forces and their likely long-term impact on the area economy -- and home values).

When drop-offs have occurred previously (the last time was 1990-1995), in the first year or so after the changeover, some homes lost value, but those that were close-in to the city and to the city's amenities (including METRO access) depreciated (if at all) minimally -- perhaps 2-3% below their peak appreciation.  For example, homes in close-in Takoma Park lost no value and Silver Spring dropped about 2%, whereas some of the most expensive homes in farther out communities (such as Potomac) lost upwards of 20%.

The essential context to remember now is that between 1995 and 2006, most of the entry-level homes in close-in communities such as Silver Spring and Takoma Park tripled in value -- more than 300% appreciation!  In fact, appreciation was so significant that there are no longer any entry level homes available in these close-in markets.  While no one could have predicted the amount of appreciation that would occur in those 11 years; anyone who follows real estate trends seriously knew - with certainty - that over the long term (5-10 years) the value of property in the Washington Metro Area was destined to appreciate significantly!  And, anyone who is willing to attend to the forces that remain in place in the Washingotn area knows that signifcant appreciation continues to be certain.  (SEE SECTION BELOW: "2006 1st Quarter Update," the paragraph that begins,  But, aren't these things signs that the Washington real estate boom is ending?).

"But the word on the street now is that sales have come to almost a complete standstill?" 

Yes, the rate of sales (i.e , the number of properties that are actually going under contract each week) has slowed considerably.  There are fewer buyers who are actively shopping right now -- many fewer than the number of properties that are on the market.  Even if every active buyer were to purchase a property this week, the rate of sales would still be much lower than in the same period during the boom.  It is this reduced rate of sales that is the fundamental measure; all other indicators of market condition are secondary to or derivative of this one.

State of the current  Washington DC area real estate housing market.  In a word: "soft."  Rapidly accelerating prices have halted.  There are far fewer buyers looking right now.  Homes are staying on the market longer before going under contract.  Marketing time has gone from days to weeks; it is not unusual to see a particular home on the market now for more than a month or two.  Only well-located homes in great condition are selling quickly.  All of which spells "relief" for buyers who, up until recently, were faced with tremendous pressure to act quickly when they found a house they liked -- and often with little time and opportunity to deliberate carefully.  The slowing of the market is especially beneficial to "first-time" buyers who, quite naturally, come into the market with a degree of uncertainty due to being somewhat unfamiliar with the entire real estate purchasing process.  Right now (and this is likely to last at least into the Spring market), there is little chance that a buyer will have to compete with several others who are trying to buy the same house. Still, an exceptional house in good condition in a convenient neighborhood that is priced appropriately could still be sold conceivably in a multiple-offer scenario.

Will prices drop?  Not very likely for the most desirable properties -- but the period of steady price increases (12-15% per year) has ended for the time being.  Up until this past Spring (2006), there was still a tendency for new listings to come on the market priced above the sold price of a comparable house in the same neighborhood that settled a week earlier.  Now, list prices are being kept very close to the amount of the last comparable sale.  And, for the more recently listed properties that have not sold yet, we can expect to see a slow roll-back to the pricing levels that were established last Spring.  And, we are now seeing sellers willing to offer (or willing to accept a buyer's request for) seller concessions such as:  contributing funds to the buyer at settlement to offset the area's generally high closing costs, and the more obvious one of being willing to accept a less than full- price offer.

Doesn't this mean that the Washington DC Area real estate boom is over?  Not necessarily, because the fundamentals that have driven the overall trend in home prices in the area remain solidly in place.  For a review of those fundamentals, please see my answer to this question in the third paragraph of the Update for the 1st Quarter of 2006, below.

Has the housing "bubble" burst in the Washington Metropolitan Area?  Most definitely not.  Prices in close-in heighborhoods are likely to keep rising for the foreseeable futre  However, consistent with my earlier reports (see sections below), the sales market has changed.  The feeding frenzy seems to have dissipated generally.  Nonetheless, a house in good condtion in a convenient neighborhood that is priced appropriately is still likely to be sold in a multiple-offer scenario.

Are prices in the area likely to drop?  Not in close-in neighborhoods, but they are not likely to continue rising at the accelerated pace experienced during the past five years.  Before the change in the market (which began in the late Summer, early Fall 2005), new listings tended to come on the market priced about 5% above the sold price of a comparable house in the same neighborhood that settled a week earlier.  Now, list prices are being kept very close to the amount of the last comparable sale.  And, the average house may be on the market for a month or longer before going under contract -- rather than being sold within 5 days or less of being listed.  Lastly, given the softening of the sellers' market that had been in place, we may begin to see the return of seller concessions, such as their willingness to contribute some funds to the buyer at settlement to offset the area's generally high closing costs.  This last has not happened generally, but it may.

But, aren't these things signs that the Washington real estate boom is ending?  Yes, the speculative boom is closing, but the fundamentals that drive the overall trend in home prices in the area are solidly in place.  These fundamentals are described in my earlier reports (below), but here is a current update.  The Metropolitan Washington Council of Governments recently projected growth trends in the area from the year 2000 through 2030. You can read the full report by clicking here, but here is the essence of what to expect over the next 25 years:

• A population increase of more than 2 million with an average annual increase of 69,000 -- and a half million more people than were added during the previous 30-year period;
• A 50% increase in employment -- with the greatest period of growth between now and 2015 ;
• Most of the new jobs (more than 60,000 new jobs per year) will be in Fairfax, Montgomery and Prince George's Counties;
• The inner suburbs (i.e., inside or just outside the Beltway) will add 691,000 new jobs by 2030; the outer suburbs of Maryland and Virginia will add 432,000 new jobs -- doubling the current number;
• Of the 821,000 new households to be formed during the period,  Fairfax and Montgomery Counties will have the largest share; and
• Current building patterns will leave a shortage of about 92,000 homes to meet the projected demand!

In short, these projections suggest that the pressure and demand on housing is likely to continue in the area for the foreseeable future.  A continuing and increasing demand for housing is the fundamental reason why prices rise.  However, most sellers (and buyers) make their sales and purchase decisions on gut-feelings rather than real world data.  So, at the moment before these real world facts dawn on everyone, the market is somewhat level and may continue in this mode for a while.

The Washington real estate market has been in an accelerated growth mode since 1995.  Simply put: the same house costs more every year (and, in fact, every month) that goes by.  The rise in the value of houses started in the District of Columbia and quickly spread to the surrounding communities.  Here are some examples:

In 1995, the average price of a single family house in Montgomery County was $216,084; in the District of Coumbia, it was $217,339.  By the year 2000, the average price of a single family house in Montgomery County had risen to $284,653; the average price in the District had become $291,641.  In the five years between 1995 and 2000, the average increase in value in both jurisdictions was a total of 33%, or just over 6% per year for each of those five years.

Now, over the next year (from 2000 to 2001), the average increase in value in both juridictions was nearly 15% -- in  only one year (that's more than 1% per month)!

From 2001 until 2002, the average increase was a little over 15% -- again in only one year.

From 2002 until 2003, the average increase slowed a little to just under 11% (with Montgomery County increasing at an annual rate of more than 12% that year).

In the next year (2003-2004), the average increase slowed a little more to just over 10% (Montgomery County increased at an annual rate of 7%; DC increased at greater than 13% in the same period).

Let's translate this into dollars.  In Montgomery County, a house that cost $200,000 in 1995, had risen to $266,000 by 2000, and last year (i.e., 2004) cost more than $366,000.  In the District, that same $200,000 house of 1995 had risen to more than $380,000 by 2004.

And these numbers are only a sweeping (albeit accurate) generalization.  In certain areas of the District and Montgomery County, the rate of increase has been much greater than the numbers just cited.

Except where indicated, all content is copyright © 2005, 2006, 2007, 2008 Jim Mulrooney. All rights reserved.