Earlier this week I read an interesting article on the state of the real estate market. The author, David Lereah, SVP and Chief Economist for NAR®, focused on the nervousness of today’s Buyers and whether Sellers’ prices were grounded in reality. He did a great job boiling this market down to a few concepts that home sellers have been living with in 2006.

Lereah’s thesis is that Buyers are nervous (hence, less prone to action) because they lack the confidence that drove Buyers to purchase as rabidly as they did in the past two years. He claims that Buyer confidence eroded with:

1. The run-up in home prices in a relatively short period of time
2. The sharp increase in interest rates in all major products – 30 Year Fixed, conventional and Jumbo loans; 3, 5 and 7-year ARMs – the declining desire to use Interest Only loans.

Together, these two influences affected the perception of affordability. I think we would all agree: the increase in prices simply could not be sustained. Things got too far out of whack. Prior to the run up in prices, the Rule of Thumb was that a buyer could afford a home priced approximately three times his annual income. If Buyers used that convention today, someone interested in buying an "average" Winnetka home would have to have an annual income in excess of $450,000. In Wilmette, the buyer of an average home needs $303,000; and Kenilworth requires similar incomes.

In reality, there are few buyers who make the $400,000 annually and can afford the $1.2 million homes in our communities and even fewer who make $600,000 for the new construction priced at $1.6 million-plus. Because of the fast and furious run up in prices, the value propositions on the North Shore might appear to have gotten out of whack. As a consequence, Buyers are less prone to pull out the checkbook for a house. They search for a home that will satisfy a basic value proposition that they alone define. Hence the slowdown in purchasing.

Lereah’s second thesis is that Sellers need to match their expectations to the new reality of a slower, more deliberate buyer who is extremely value conscious. Most home owners have large equity gains in their homes. However, the market is not supporting prices as it did in late 2004 and early 2005. In the last 24 months, the median price of homes sold declined in Winnetka and Wilmette (32% and 12%, respectively). Interestingly, the same measure increased 8.3% in Evanston over the same period. In 2006, this same pattern holds true: the median price of homes sold in Wilmette was down 10.5% and in Winnetka, it was down 19%; Evanston had an increase of 17%.

Are Sellers reacting appropriately to this slowdown? It appears that answer is mixed. Over the last two years, Wilmette and Evanston saw the median price of New Listings increase (15% and 1% respectively) while Winnetka had a decline of 29%. In 2006 all three towns are showing declines in the median price of new listings: Evanston, down 10.7%; Wilmette, down 10.5%; and Winnetka, down 25%. In 2004 and part of 2005 it appears Sellers DID react appropriately and raised prices into the buying. Now, as buying slowed, prices are coming down ... hopefully to meet expectations. So, it looks like sellers are reacting appropriately.

Lereah nailed the dynamics at play in today’s real estate market. I would add that the slowdown in both buying and price appreciation may actually be good for the longer term market. It may instill a new value proposition that (a) more people can afford and (b) buyers can sustain. Most home sellers still have a large buildup of equity in their homes. It certainly is not as much as in past years. Looking forward, the consensus is the average appreciation in 2006 in each of these communities will probably only get to about 3%. Not exciting, but perhaps more realistic.

More to come …

DS