People will always need to buy and sell homes and property. These transactions are complicated, often extremely so, and thus, a broker is almost always needed. The demand for a broker’s services, then, is fairly inelastic. However, a reduction in the number of transactions that take place could severely impact a broker’s or brokerage firm’s bottom line. The recession that began in 2006 with the economic downturn and credit crisis, and in some respects, hasn’t yet ended has had as a result a sharp reduction in the number of real estate transactions due to the tightening of credit and overall economic malaise. This author’s prediction is that absent some major unforeseen revitalizing event affecting the U.S. economy, the real estate brokerage industry will continue to contract.
While it is difficult to trace the global recession of recent years to any one cause, popular culture and opinion point toward banks and the real estate industry as co-villains and architects of the disaster. This simplistic point of view does have some truth to it. The true causal factor, however, may have been the extremely low cost of money during the boom years of 2000-2006. “Cost of money” refers not only to interest rates but also the qualification process for borrowing. Banks traditionally had made real estate loan applicants jump through hoops, then charged them fees (over and above the interest they would pay) for the privilege of borrowing money. Suddenly, however, interest rates had dropped to a 40-year low. By 2002, mortgage rates for the most qualified buyers were dipping below 4% APR. The yield on debt securities had concurrently reached new lows as well; money was cheap. This meant that a huge quantity of cash was all dressed up with no place to go; investors disliked the idea of buying debt securities whose yield was in the 1% range. The traditional refuge for investors in such times is equities, but the recent dot-com driven market crash, when many investors lost half of their portfolios’ values, served as a strong deterrent. Thus, there was only one place for all that cash: real estate development and its comrade-in-arms, real estate lending.
Americans, for the most part, want to own their own homes; it is considered a fundamental part of the “American Dream.” Banks realized that in order to generate enough loan business, they would have to loosen their loan qualification requirements. Suddenly, the qualifications for getting a home loan changed from “must have a 720 credit score and stable income of at least three times the monthly mortgage payment” to “must be a carbon-based life form.” Even the necessity for a down payment went out the window, as subprime lenders offered zero-down mortgages as long as the borrower was willing to pay for mortgage insurance. And to inflate the bottom line and make lending at low interest rates be even more profitable, banks slathered on myriad upfront costs, including origination fees and “points,” where a borrower pays 1% or more of the total loan value because, well, because the bank charges it. Borrowers, however, were happy, especially those millions for whom the reaction of a bank officer, if they had asked for a homebuyer loan, would have been to burst out laughing. To make sure that the loans were as attractive as possible, the numbers were often tweaked to make the monthly payment—at least for the time being—as low as possible. This also helped buyers to qualify.
The real estate gold rush occurred in part because people were unrealistic in their expectations. The boom in mortgage lending led to a run on real property, with which new building could not keep pace. Suddenly, a host of people were screaming and waving money at potential home sellers. It was a euphoric time in the real estate industry. House prices were going up by ten percent a year! Or twelve! Or twenty! Get them while they’re hot! Verick and Iyanatul, discussing overall economic conditions during this time, noted that “There was a general euphoria about the conditions in the global economy and with many commentators claiming that ‘this time is different’. As argued by this study, there are, however, many similarities between the US sub-prime crisis and previous banking crises such as the massive surge in housing and equity prices, the growing current account deficit and rising level of (private) debt” (Verick and Iyanatul 12). This irrational euphoria and, most importantly, the perception that basic economic realities had somehow become no longer true infected the U.S. real estate industry. Buyers were blithe about the risks of default. After all, if your house increases in value by ten percent a year, and you’re paying eight percent a year interest, you’re making money!
What buyers didn’t realize, and real estate brokers probably realized but didn’t bother to tell the buyers, was that real property hadn’t increased in value just because it had increased in price. Furthermore, that price increase wasn’t etched in stone, as everyone learned in 2006-2008 when real estate prices (not values) dropped by more than half in some markets. Suddenly, borrowers found that they had negative equity in their properties: they owed more than the properties were worth. This effect was exacerbated when their “adjustable” mortgage payments increased, either automatically (after they had been offered an unrealistically low rate for the first year or two) or as a result of an increase in prevailing interest rates. The global recession also meant that many of these newly minted homeowners lost their jobs. As a result, many people either couldn’t make their house payments or decided they simply didn’t want to. The gigantic wave of foreclosures that followed is well known.
The real estate brokerage industry, some feel, is partly to blame for all this. Many new brokers had appeared, attracted by the seeming easy riches. After all, all you had to do was get a brokerage license, join a firm or put out your own shingle, and wait for the money to roll in. After all, sell a house for $300,000, collect your six percent, and boom! you’re $18,000 richer. What could be easier? Unfortunately, many of these new brokers—and far too many of the existing ones—didn’t tell the eager buyers waiting in their offices the truth: that even though they might have qualified for a loan, they still shouldn’t buy a house. After all, that wasn’t their job, or so they said. Obtaining financing was a separate activity, and many buyers arrived “pre-qualified.” Still, the protestations that it wasn’t the job of the broker to determine the fitness of a buyer seem a little hollow.
If one wants to zero in on the primary cause of borrower default, however, one must look at the way banks handled loan transactions during the boom period. Many borrowers were genuinely surprised when their monthly payments skyrocketed. Many of those persons accused the banks that had loaned them their mortgage funds of not disclosing to what degree their payments might increase under certain contingencies. Indeed, especially in the case of “teaser” (artificially low temporary rates) and adjustable mortgages, many lenders did not do so or glossed over the information. As a response to this, the U.S. Truth in Lending Act (TILA) was substantially strengthened by the addition of the Mortgage Disclosure Improvement Act (MDIA). Further additions included the Credit CARD Act and the Dodd-Frank Act (Consumer Finance Protection Bureau). These additions to the TILA were a reaction, some say quite belated and overdue, to complaints that mortgage lenders hadn’t used full disclosure. In any event, this was to some extent closing the barn door well after the horse had gone, because banks after the crises of 2008-2009 drastically restricted their lending criteria; when almost anyone could formerly have gotten a mortgage loan, now almost no one could.
The stock market crashes of 2001 and 2008-2009 caused many people to swear off buying stocks ever again. They also had the effect of destroying many people’s savings. In between, the mortgage and credit crises shook the faith of Americans in the cherished institution of home buying and ownership. Even today, several years later, the economy is affected. Gigantic government debt and the seeming reluctance of Congress to agree on anything have made people fear for the future. This is not, in short, a time when people want to make commitments—and buying a house is often the largest financial commitment a person will ever make.
There is also the element of “once burned, twice shy.” Many people feel that they were “had” by the various crises, whether they lost money in a home-buying transaction, had their stock portfolios gutted by the two recent crashes, or saw the yields on their bonds and savings plummet to a fraction of a percent. It’s not the sort of zeitgeist that makes people want to invest, or, more crucially, to assume the risk. Ten years ago, the nation was risk-approving (or perhaps, risk-ignoring). Now, it’s risk-averse. This is in part a good thing, as people are paying down debt and increasing savings for the first time in a decade or more, but it also slows down the economy. Transactions need to occur for both the brokerage profession and the economy in general to flourish. Unfortunately, many of those burned by the mortgage crisis and the resulting dive in home values blame their realtors as well as their lenders and “the man” in general.
In addition, whatever confidence U.S. investors and the general public may have regained has recently been shaken by the recent government shutdown, financial turmoil in Europe, and question arising from stubbornly persistent unemployment and the uncertainty over the effects of Obamacare. In a joint report, the Real Estate Research Corporation (RERC), Deloitte (one of the “Big Eight” accounting firms), and the National Association of Realtors noted the recent challenges to the economy and to the real estate brokerage industry, but were cautiously optimistic:
The outlook is for a continued slow recovery, with modest economic growth over the next few years and for slow job growth to continue. It is expected that once businesses get used to the new tax increases, that business spending (including hiring) may increase. In addition, it appears that the residential real estate market is finally starting to stabilize, and we may finally begin to see positive growth in this sector.
This optimism, if it exists at all in the general public, must certainly be fragile. It isn’t difficult to imagine the markets freaking out over any one of a number of possible events, such as Iran starting to shake its fist again or a European country going into default.
What, then, should real estate brokers do to restore confidence in the industry? For starters, ethical behavior is an absolute must. This includes not only behaving in a completely scrupulous manner towards all parties but also to engage in full disclosure. It must of necessity mean that if an agent perceives a transaction to be not in the best interests of a buyer or seller, that agent has a fiduciary and moral duty to advise the client. The brokerage industry absolutely must not adopt a condescending or superior attitude toward its clients. At no time should the message sent or implied be, “You need us more than we need you.” Like it or not, popular sentiment has lumped together banks, realtors, and government in assigning blame for the mortgage and credit crises. The primary job of the industry, then, is to regain people’s trust.
It’s now time to haul out the crystal ball. It seems that the U.S. economy and therefore the real estate market will continue to grow sluggishly, absent some major game-changing event (RERC, Deloitte, NAR). As mentioned at the beginning of this paper, there will always be a need for realtors with a penchant for real estate sales. However, the boom times of easy credit and instant qualifying will probably never come back. For one thing, the consequences of that time are seared into the public consciousness. People will be cautious for quite some time, and that caution will seep into the real estate market.
It is to be expected that the real estate brokerage industry will contract. Many brokers have retired or changed professions, and there has been only a relative trickle of new ones. In order to survive, many brokers will have to accept reduced commissions or share revenues. It can also be expected, due to both increased regulation and protraction of the mortgage lending process, that closings will take longer than they used to. Some markets will remain “hot,” but far more will remain cool or cold. In many markets that were hit hardest by the housing crisis, a decade or more’s worth of housing inventory remains. Banks continue to own far more foreclosed properties than they wish to, and the presence of those properties is a downward pull on prices in those areas.
Still, there is some reason for optimism. The economy is, in fact, improving. The national debt and the federal deficit are shrinking. It may well be that despite conservative rhetoric, Obamacare will turn out to be a boon for the economy. It might also be expected that our elected representatives, reacting to massive public disapproval at their recent antics, will learn to work with one another and actually get something done. This author’s opinion is in line with that of the “2013-Turn the Page” report, that a cautious optimism is warranted. People will still need to buy and sell real property, and the process, if anything, has become more involved and complicated, so there will be a continuing marketplace need for real estate professionals.
Consumer Financial Protection Bureau (CFPB). Consumerfinance.gov. “CPFB Consumer Laws and Regulations.” 2013. Web. 14 Nov 2013.
Real Estate Research Corporation (RERC), Deloitte, and National Association of Realtors (NAR). “Turn the Page.” 2013. Web. 14 Nov 2013.
Verick, Sher, and Iyanatul Islam. "The great recession of 2008-2009: causes, consequences and policy responses." (2010).