U.S. Real Estate Prices to Fall an Additional 25% by 2010

According to Goldman Sachs economist Jan Hatzius the number of unsold homes on the U.S. market is so large that prices could easily fall by an additional 20 percent to 25 percent by mid-2010. Half of the foreclosures in the U.S. in 2008 took place in four key states: California, Florida, Nevada, and Arizona. Other foreclosure hotbeds include Washington D.C., Detroit, Cleveland, and Minneapolis.

Some of the most irresponsible subprime lenders, including IndyMac, Countrywide, and Golden West Financial (all of which have been shut down or sold to other institutions) were located in California. Real estate prices in the worst bubble states became so inflated at the height of the bubble that the only way most people could get into the red hot market was by taking out ‘creative’ mortgages like 5-year interest only loans, or subprime mortgage loans combined with subprime home equity loans.

Many buyers in the western metropolitan areas took 100% financing on subprime terms that actually created instant negative amortization—in other words, the amount owed began to increase as soon as the papers were signed, and continued to increase even when regular payments were made. The reasons buyers took these insane loans were that: 1) they could, 2) the buyers and the lenders assumed the properties would appreciate rapidly into the indefinite future, and that therefore the buyers would be able refinance in a year or two on better terms and actually take cash out at refi, and 3) the homes were so incredibly overpriced that few could buy them without entering into questionable financing agreements.

Us foreclosures will force prices down another 25%

In some parts of California and Nevada, during the most frenzied part of the boom, a small (under 1,000 square foot) bungalow built in the 40s or 50s was going for nearly a million dollars, and buyers were competing to buy at that price. In Indiana or Michigan the same home, even at its most inflated, would have gone for $40,000 to $60,000.

Buyers in California were so drawn to these subprime vehicles, and real estate prices have plummeted so quickly, that the foreclosure rate is becoming truly alarming. In California alone the rate of foreclosure increased 82% between 2007 and 2008, and it is expected to go even higher in 2009.

What does this mean for the foreign investor? While there is not reason to avoid the four top foreclosure states when it comes to property shopping, there is reason for caution. Most analysts believe prices still have a long way to fall before hitting bottom, with the most bearish among them forecasting falling values for another two years or more.

When negotiating a deal on a foreclosed property, foreign investors therefore will want to build this 25% depreciation right into their initial offer and then go even lower than that. Many banks will not consider a short sale of less than 75% of the amount mortgaged, but his will not be a sufficient discount in most cases, since most of these foreclosed properties were 100% financed at insanely inflated values. It is not even possible to over-prepare when considering a short sale offer. Make sure you are dealing with a broker experienced in short sales and make sure the bank is indeed willing to negotiate. Get that in writing and then aggressively prepare your case as if you were going into a murder trial.

For some tips on how to increase the likelihood that your short sale offer will be accepted, read our post on short sale negotiation tips, Short Sale Pitfalls, When to Punt and When to Pass.

Some states, like Vermont and North Dakota, have lower than average foreclosure rates and property in some parts of these states is actually still appreciating. For more tips on which parts of the U.S. are hot and which are not, visit our  articles on United States Real Estate Prospects for 2009.