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Real-Estate Bubble Losing Air


By Robin Goldwyn Blumenthal
From Barron's

It would seem to have it all: four bedrooms, a guest house, a pool and a rock waterfall. But the vacation home in Naples, Fla., hasn't been drawing much interest from buyers, so the seller recently threw in that most modern of amenities: the $1 million price cut. That's brought the asking price down a full 25%. "If you want to sell, you've got to go back to '04 prices," says Chip Harris of Coldwell Banker Previews International, which is handling the property.

The market for second homes could use a second wind. After a long string of double-digit annual price increases, a number of second-home meccas across the country are suddenly suffering from plunging sales volume and burgeoning inventories of unsold homes. Result: Naples-style discounting is starting to spread. It hit the town of Pocasset, on Massachusetts' Cape Cod, just as retired executive Jack Reen was trying to sell his four-acre, six-bedroom beachfront home. He cut the price several times, for a total of 42% off the listing price, before striking a deal at $3.95 million. Reen takes a philosophical view of the experience, noting that the original price was set at the top of the market. "Calling the tops and bottoms is impossible," he says.

Though the official figures on sales prices have yet to reflect the current round of cuts, interviews with real- estate pros and others strongly suggest that the averages are deteriorating in a number of key markets. Just look at green and hilly Litchfield, Conn., about a two-hour drive from New York City. It was a magnet for Wall Streeters during the past five years, and prices climbed accordingly. But in the past 10 months, prices in the lower end of Litchfield's market -- homes of $300,000 to $600,000 -- are down 12%-14%, and volume is falling at the next level up, says Stephen Drezen of the local Portfolio Properties Group.

It's all a big change from the seemingly endless rises in prices. For more than a decade, baby boomers have been flocking to the second-homes market and lifting prices, just as they'd earlier lifted the market for primary residences. The market barreled ahead during the past few years, and the demographics -- 75 million boomers -- still bode well for long-term growth. But first, the market has some correcting to tend to.

While pundits debate when the bubble might burst in the primary-housing market, the air already is whooshing out of parts of the second-homes market. Naples, on the sun-drenched edge of the Gulf of Mexico in Southwest Florida, is perhaps the most striking example.

Vacationers long have been attracted to Naples' proximity to water, the Everglades and shopping at the likes of Saks Fifth Avenue. Last year alone, buyers bid up the area's median price by 30%, to $482,400. Charles Ashby, president of Naples' VIP Realtors, recalls that one of his sales associates was able to go down to a local bar and sell 26 units in a nearby Fort Myers high-rise the first night contracts were being accepted.

Today, about the most visible activity in that area is the 400 or so daily additions on the multiple listing service -- and price reductions by the dozens. In the 35 years that Ashby has been in the business, this is the first downturn he's seen, even counting recessions. "The mule died," he says.

With mortgage rates rising and home-price appreciation slowing or vanishing, buyers in Naples have pulled back in a big way. The area's sales of homes costing less than $1 million declined 45% in unit volume in the first four months of this year. More expensive homes fared somewhat better, falling 34%. But pressures at the higher end clearly are mounting. All along the pricey Gulf shore, builders still are tearing down old ranch houses and replacing them with two-story mansions, pushing the market toward a classic glut.

The Naples experience is being repeated, to one degree or another, in a variety of other vacation hot spots -- from Palm Desert, Calif., to Phoenix, Ariz., to Ocean City, N.J. Phoenix in recent years has been overrun by property flippers from California, says Mike Messenger, president of Russ Lyon Realty in Scottsdale. But unit sales now are down by 40%-42%, and the city's inventory of unsold homes has shot up more than five-fold, to 39,000.

Likewise, the number of homes for sale on the Multiple Listings Service for the Falmouth area of Cape Cod is up about 65% from a year ago, says Lynette Helms of the local Real Estate Associates. With numbers like that, more price cuts can't be far behind. In fact, the Cape Cod town of Barnstable is among the first of the second-home meccas to show a decline in median prices in the figures tallied by the National Association of Realtors. The price was down 1% in the first quarter, to $385,000.

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It's true that the total second-homes market nationwide has managed to keep posting gains over the past two years. Some 3.34 million second homes were sold in 2005, up 16% from 2004, according to the realty trade group. The median price of a vacation home was up 7.4%, to $204,100, and prices have continued to rise in many markets.

But the Realtors' chief economist, David Lereah, expects the volume of second-home sales to decline at least somewhat this year. And there's every reason to think that some markets could be hit hard.

For starters, many second homes have been sold not to serious vacationers but to speculative investors hoping to cash on the national real-estate craze. How else to explain why six out of 10 second-home owners surveyed by the Realtors group own two or more homes in addition to their main residences?

The danger is that if enough of those investors decide the market has peaked, they could trigger a selling frenzy throughout the second-homes market. That, in turn, could add to the pressures in the main housing market. After all, second homes now account for a full 40% of all homes sold in America.

Statistics compiled for Barron's by The Local Market Monitor, a Wellesley, Mass.-based consulting firm, show just how big a role can be played by investors. In Myrtle Beach, S.C., long a favorite vacation and retirement destination, investors owned a full 58% of properties in 2004, the last year with available data. Though Florida communities accounted for eight of the top 10 investor-owned hot spots, Wilmington, N.C., clocked in at 38%, Las Vegas at 26%, and Honolulu at 23%. The normal level is closer to 14%. (See table nearby.)

Says Ingo Winzer, president of The Local Market Monitor: "This makes me very worried because it implies that the price increases have been driven more by speculators than by people who are going to hold onto these properties, and indicates to me that there's a speculative boom."

The price runups of the past several years are reason enough for concern. A report from Cleveland-based National City, a top banking and mortgage concern, points to serious overvaluation in a number of second-home hot spots in Florida, California and elsewhere.

Tucson, Prescott and Phoenix in Arizona are estimated to be as much as 52% overvalued based on income levels, population densities and historical prices. Also high on the list: Bend, Ore., and New Jersey's Ocean City and Atlantic City, where homes are deemed overvalued by 50% and 60%, respectively.

Behind all this is a fervor eerily reminiscent of the late 1990s on Wall Street. Some 65% of second-home owners surveyed by the National Association of Realtors said they considered their second homes better investments than stocks, and 29% said they planned to buy additional properties within two years. An eye-popping 64% of investors with four or more properties planned to buy another property within two years.

But those high rollers could lose their nerve quickly if prices continue to weaken.

"People don't believe in the laws of supply and demand anymore," says Alan Skrainka, chief market strategist at Edward Jones. "We're not saying it's a bubble, but we're saying prices are overstated and will likely correct 20% to 25% over four or five years."

He rejects a notion advanced by housing bulls that shore communities in Florida and California will be protected because of the limited supply of coastline. "Japanese real estate and land prices went down for 15 years and Japan is an island," Skrainka says.

Southern Florida has shaped up as the epicenter of the looming glut. In Palm Beach County, inventories of unsold homes have more than tripled in the past three years, to more than 25,000. Some brokers in South Florida are reporting a quadrupling of inventories over the past year. In what some see as a sign of the times, Coldwell Banker Residential Real Estate recently closed four of its 31 offices in the Palm Beach region; the company calls it an anticipated consolidation.

There's little doubt, however, that the market is starting to run out of buyers.

"The homeowner that absolutely has to sell will take a hit," says Paul Boomsma, executive vice president of Chicago-based Luxury Portfolio Fine Property, a unit of Leading Real Estate Cos. of the World. The problems are worsened, he points out, by the continued acceleration of development in overheated areas.

Investors hoping to sell luxury condos that they bought over the past couple of years could be in for some special trouble. A recent report by San Francisco-based JMP Securities analyzing the Florida condo market estimated that 25%-40% of the of condo units now for sale in Florida belong to such investors. "Flippers are already listing units for sale in buildings that are near completion this year but are not closed yet," hurting an already weak market, the report says.

Florida condo sales are down 20%-50% year over year in most markets, JMP says. And the report cites estimates of 50,000 new condo units announced for Miami-Dade County alone, adding to the 50,000 either under construction or ready to begin. That compares with the 10,000 total that have been built in the area in the past 10 years.

Some northern parts of Florida are also taking a beating. On a recent drive around Amelia Island, off the coast of Jacksonville, David Hehman of EscapeHomes.com, a resort and second-home marketplace, counted 50 properties for sale on the water or side streets along a three mile stretch.

Beyond Florida, some second markets are holding up well and others clearly aren't.

"It's a very spotty market in all of the U.S.," says Robert Toll, CEO of luxury homebuilder Toll Brothers. In some of the markets where Toll builds golf-course and lake communities, like Palm Springs, Calif., Delaware and southwest Florida, demand has softened. The company, however, has had to offer incentives in only two resort communities out of the 15 it owns. "If you've got the right stuff, people still clamor for it," says the CEO.

Mike Messenger, the Scottsdale, Ariz., broker, sounds considerably more glum. He says this is the first time in 16 years that the lower end of the market -- always the driver for the area -- has weakened. The culprits? Mainly the flippers; Messenger figures investors account for 35% to 40% of the market.

Las Vegas is causing concern, too. It's "a classic example of an overheated market where there's too much proposed and the reality of the absorption isn't such that it could work in the near term," says David Wasserman, head of Wasserman Real Estate Capital, a developer. But Wasserman, who has luxury condominium projects under development in West Palm Beach, Pasadena, Calif., and Boston, figures that soaring construction prices should help to weed out some of the overzealous builders.

Already, several condo projects in Las Vegas have had to be canceled because they failed to presell enough units to get attractive financing, says Hehman of EscapeHomes.com.

On the East Coast, signs of a glut have been turning up all along the coastline of New Jersey. In an effort to move inventory, brokers in the upscale summer resort of Stone Harbor have been sending out postcards to vacation renters, proclaiming a three-bedroom condo to be "the perfect investment opportunity" at just $739,000. That's about what many of the would-be buyers might have paid for their first homes.

"The market is definitely in a correcting phase," says Timothy Richards of Ocean City, N.J., who recently retired as a realty broker and began a second career as a developer. He says buyers are waiting to see what happens with mortgage rates. "Whenever financial markets are in transition, we go into a holding pattern," he adds.

Real-estate pros in the Hamptons area of Long Island are keeping their fingers crossed. John Halsted of Allan Schneider Associates says he has seen some "price adjustments" -- usually around 3% to 5% downward, and usually in the mid-range of the market, of homes priced at $1.5 million to $4 million. He contends that there's still high demand at the super-high end. That belief will be put to the test by one of his firm's current listings, a $75 million spread in Bridgehampton with its own golf course.

Some would-be buyers appear to be sitting out this edgy period in the market and renting homes instead. That's one reason why the rental market in the Hamptons is considered very strong right now. The Halsted firm recently set its own record for a summer rental: $350,000 for a house in Sag Harbor.

Other home buyers, meanwhile, are seeking a measure of stability by venturing away from the traditional hot markets. But plenty of once-tranquil towns already have been discovered. "You're finding that smaller towns that 10 years ago were thought of as off the beaten track now have the rich and famous buying," says John McIlwain, a senior fellow for housing at the Urban Land Institute. He points to Rockland, Maine. "Twenty years ago you wouldn't go there at night because you would have gotten beaten up," he says. "Now, it's in international travel guides."

The tough conditions in the second-home market are no small matter for the people who own the homes. And the so-called mass affluent -- folks with investable assets of $100,000 to $1 million -- will probably take the brunt of any price declines. Spectrem Group, a Chicago-based consulting firm, says this group has more than one-third of its assets tied up in real estate. In general, these home owners are more vulnerable than the ultra-wealthy, both because they can ill afford to wait out a prolonged downturn and their losses can hurt if they're forced to sell into a glut.

All the same, many experts are cheering the current shifts in the markets. They call it an essential correction, a step that must be taken before the second-home market resumes its ascent. "In general this is a very good thing, because it got too far on the speculative side," says broker Ashby in Naples. "It needs to correct. If it didn't, it would burst."

Adds Mike McMurray, a broker with VIP on the Florida islands of Sanibel and Captiva. "It's not that the property is bad, but it's like Google. The value is there, but it may have gotten ahead of itself."

There's certainly hope for the long term. The baby- boom generation continues to amass both inherited and earned wealth. And many a boomer will buy a second home with an eye to eventually retiring to it. With any luck, they will see some nice financial returns. "Vacation homes have turned out to be one of the best housing investments, particularly on the coasts," says McIlwain.

The trouble is, home owners may have to wait quite some time before that happens again.

 

 

 

 

 

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