False Bottoms - Or When the Tail Wags the Dog

For the last 18 months real estate investors, market analysts and other experts have speculated as to when the long awaited bottom for the beleaguered real estate market would finally arrive. Rather than offering guesses as to how long the down market would last, I have tried to focus on identifying the signs of a bottom approaching, so that myself and my investors would be able to identify this buying opportunity as it arrived.

If you have followed my articles and blog posts, you have noted that I consistently advocate using a three step process to identify the coming of the real estate market “bottom” and the possible beginnings of a recovery. This process involves analyzing three sets of variables: First, the standing inventory of homes for sale; second, the volume of existing home sales; and third, the median home price for a particular area. A few weeks ago, I confidently announced the arrival of the real estate market “bottom” in my local area: Las Vegas. I cited as evidence for this claim data from each of the three areas listed above.

First, the inventory of available single family homes in Las Vegas has decreased rapidly in the last few months after remaining relatively stable at around 22,000 homes through much of 2008. This inventory is now at a level of just under 12,000 homes. Inventory is nearly ½ of its 2008 levels. Homes under $200,000 have less than 4 months standing inventory. Homes under $100,000 have less than 3 months inventory. A normal healthy inventory is considered a 6 month supply of homes. This decrease in standing inventory was our first indicator that the Las Vegas real estate market was bottoming.

Second, the volume of existing home sales has exploded in Las Vegas in the last few months. In fact, sales of residential homes reached record highs in June. According to data published by the Greater Las Vegas Association of Realtors, sales of single-family homes and condos rose 87 percent in June from a year ago…to a total of 4,702 sales. This total breaks the previous record high set in June of 2004, during the peak of the housing bubble.

Finally, we must also consider median home prices, which after falling for over a year and a half in the Las Vegas valley have finally stabilized near $140K in the last three months.

I used all of this data to arrive at the conclusion that we have hit bottom in Las Vegas (and many other areas of the country as well.) And I stand by that assertion. However, unfortunately for many American home owners, we are beginning to witness the fact that real estate markets may create bubbles, but they don’t operate within them.

Two years ago, home prices cooled across the United States and as the real estate bubble began to burst it triggered the freezing of the credit markets, which in turn brought on the greatest recession this country has seen since the Great Depression. Since then, the general economic downturn has rolled on independently of the struggling housing markets. It has grown to encompass the stock market, the job market, the banking industry, and all other major economic areas. All the while, there has been no doubt that the catalyst which provoked this whole mess was the rapid decline of housing prices, accelerating foreclosures, bad loans and the accompanying problems surrounding the burst of the real estate bubble. Unfortunately, the cause cannot now bring the remedy.

In fact, the general economic malaise now threatens, in fact almost promises, to thwart the recovery of the housing market. Economists warn that rising unemployment rates will bring a fresh round of foreclosures as home owners, even those not burdened by questionable loans or upside down property values, lose the ability to stay in their homes. Also, to spite consistently low interest rates and government incentive programs for new home buyers, banks still seem reluctant to loan money. Instead of thawing, credit markets continue to tighten in many areas as banks raise rates and cut limits on unsecured credit lines and charge cards…even to good customers with perfect payment records.

These factors conspire to throw a bucket of cold water on the hot housing market that we are now observing. As the economy continues to decline, I would not be surprised to see our newly found real estate bottom begin to give way once again. Although I do not think that we will see declines that come anywhere close to the plummeting prices of a year ago, I do believe that rising unemployment and the continuing credit crunch may prompt home prices to begin another, more gradual, downward slide.

This doesn’t mean that the current market is not still a great time for investors to begin loading up on properties. Cash flow is always king when it comes to real estate investments, and the cash flow opportunities in Las Vegas and across the country are more promising than they have been in decades. But, as always, investors should proceed with caution and look to purchase for the long term. Naked appreciation plays are risky under the best of conditions, and they have no place what-so-ever in a volatile market such as this.