It's official. The New York Times has reported that the Denver real estate market has slowed.
"Sellers continue to profit," says the paper, but "houses are sitting on the market longer, buyers are negotiating harder, and some owners, particularly young buyers who may have been counting on rapid appreciation, are postponing dreams of renovations, moves to larger homes and big savings for their families." (See: Housing Goes Frothy to Flat in Denver Area, July 17, 2005)
The Denver results are neither shocking nor horrifying. What they show is that real estate is simply a localized commodity and that commodity prices can rise and fall.
"Denver's circumstances," explains the Times, "are in some ways particular to the area, driven largely by job losses in the telecom sector, but they illustrate how a moderate slowdown could play out for homeowners in other parts of the country and stand as a potent reminder that galloping price appreciation is not the norm."
The National Association of Realtors says that Denver homes in the first quarter of this year were priced at $236,000 versus $231,800 a year earlier -- that's an increase of "just" 1.77 percent.
Let's take a look at that 1.77 percent price gain. It's not much in the context of the huge price increases seen recently in Washington, West Palm Beach, Las Vegas and Los Angeles. However, 1.77 percent is surprisingly good when one considers the Denver job market. It is a gain, after all, and not an outright loss.
"Of the 75,000 jobs lost in Colorado during the past two years," says the Metro Denver Economic Development Corporation, "69,000 of the job losses were in metro Denver. Metro Denver job losses totaled 40,300 in 2002 and 28,700 in 2003."
These are immense numbers. Few other metro areas have seen comparable job reductions and so in one sense the Denver slowdown is unlikely to be repeated elsewhere. The great miracle of Denver is not that home values rose 1.77 percent, it's that they didn't sink in the face of massive job losses.
Also, because real estate has value as both an investment and as shelter, that 1.77 percent increase is larger than it seems.
Imagine that a buyer put down 10 percent on a Denver home in the first quarter of 2004 and that the property appreciated 1.77 percent. In the Denver example, the investment would be $23,180 and the increase in value in year one would be $4,200 -- a return of 18.1 percent on the actual cash investment. (Obviously, with a fuller analysis there would also be closing costs, tax benefits and other matters to consider, as well as the fact that a lot of folks buy with far less down.)
What about the monthly mortgage payment, utilities and other expenses? Those are the costs of shelter. If you didn't live in the house, you'd have to live somewhere -- and pay rent.
Could you really get $4,200 out of the house if you sold after a year? Not likely after the costs of marketing and closing are considered, but then how many people sell within a year?
Here's a key question: Given a tough local job market, why didn't prices fall further?
Owners like to see rising property values -- and so do local taxing authorities. If values increase, we have more equity and a greater store of wealth against which we can borrow. If we sell, we leave the settlement table with a bigger check.
But if the price of homes fell tomorrow, the result would be minimal for most of us -- but not for everyone.
- If you recently bought and were forced to sell, lower prices would be a problem.
- If you wanted to get a massive home equity loan, with lower home values you would not be able to borrow as much.
- If you financed with an interest-only loan, ARM or with little down then falling home prices would make it difficult if not impossible to fully refinance.
However, if you bought a few years ago, a price downturn would likely mean less profit rather than no profit. And if you're not selling or refinancing, the whole issue is somewhat moot.
Denver teaches us three things:
First, it's impossible to believe that home prices will always rise. It's simply more logical to assume that home prices in most areas will -- at least at some point -- level off or perhaps even drop. The reality of the marketplace, the fact that commodity prices both rise and fall, suggests that consumers should avoid excess borrowing and loans with changing terms.
Second, there's no need to panic. The overwhelming majority of homeowners -- especially those with fixed-rate mortgages -- are able to ride out a slower market. The reason the Denver experience was so mild in the face of serious job losses is that most people simply stayed put. In effect, inventory contracted to offset reduced demand.
Third, consider the alternatives.
For instance, shares for the The New York Times Company (NYSE: NYT) closed at $42.39 on July 19, 2004. A year later the same shares were priced at $31.54 -- a loss of $10.85 per share or 25.59 percent.
Ironic, isn't it? For all the worries about flat and frothy real estate markets, if you bought both a Denver home and 100 shares of The New York Times Company a year ago, look where you'd be today.