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started. Inventories are still going up, standing at the highest levels since World War 2, and banks are just now gearing up for repossessions. With 4.5 million unsold homes, builders continuing to add new homes at the rate of 1.5 million a year, and the number of buyers shrinking to less than 6 million this year, there is no reason to think that prices will appreciate again any time soon. We have to work through the supply and demand imbalance, and this will take years, many years, as it always does.

What factors affect real estate and create demand?

1. A growing employment base. It is logical that new jobs cause people to move into the area, and create demand for housing. Regional real estate booms are closely tied to employment in the area. It is no coincidence that the Southern California real estate downturn took place when the aerospace industry , the area's largest employer at the time, shed 100,000 jobs between 1989 and 1995, unemployment climbed to 10% in Los Angeles county, and real estate plummeted. It took several years for the booming entertainment industry to fill the void, become the region's largest employer, and add enough new employment to fill the jobs and buildings left behind by the aerospace companies.

2. Interest rates. The single biggest factor affecting your house payment is the interest rate on the note. In 1990, an 11% interest fixed rate mortgage would set you back $3,335 a month for the principal and interest on a $350,000 mortgage. 14 years later in 2004, you could obtain an interest-only loan at 4%, borrow $1,000,000, and the same $3,335 a month would cover the minimum interest payment. So assuming a $100,000 downpayment, you now have the ability to buy a $1.1 million house for the same monthly payment that would have paid for a $450,000 house 17 years earlier. It is interesting to note that a house worth $450,000 in 1990 is now coincidently going for $1.1 million, illustrating what impact the rate reductions had on inflation during that time!

3. Availability of land for new construction. Some regions are completely built up and no longer react to the simple forces of employment and interest rates. For example, when the dot.com bubble burst, the 200,000 jobs lost in the Silicon valley did not contribute to a major real estate decline because the housing supply was already extremely tight. The demand softened slightly for a few years until the new Google millionaires started the next wave. The same conditions are in place in Manhattan, Beverly Hills, Malibu, and Santa Barbara where normal market forces do not apply.

Summary:

Unless you think 4.5 million aliens are about to invade the planet and snap up the entire inventory of homes available for sale, or the fed is no longer worried about inflation and wants to drastically lower rates, then housing is probably in the tanks for years to come.

Learn more about this author, Rene Pharisien.
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