A Few Words on Potential Deflation and Real Estate

Deflation is a situation where wide spread decreases in price leads to lower production, which leads to cost cutting, which leads to less disposable income, which leads to less demand, which leads to lower costs in an attempt to spur demand... you get the point.

The scenario described above is not good for the economy-- just look at Japan during 1991 and beyond. Ben Bernanke of the Federal Reserve ("the Fed") recently provided commentary about the state of the US economy and touched on the potential for deflation. Although the Fed believes deflation for the US economy is possible, it does not think it's likely.

It seems like the US economy is and has been in a state of deflation during the period known as the "great recession." Let's take a look at the South Florida housing market as an example.

We have seen price reductions on homes in the South Florida market during the past several years. The over building that took place led to less production of new homes when the economy began to show signs of weakness. In turn, construction workers were laid off and those that were working took a cut in wages; this is a function of supply and demand. Less workers and lower wages led to less disposable income. Lenders responded to lower income and further home price reductions by tightening their lending requirements. Those who can afford homes are waiting on the sidelines for the "bottom"-- this lowers demand. The influx of distressed properties are increasing supply, demand has not increased and lower prices are ensuing.

Will the spiral ever end and what does this all mean to South Florida home buyers, sellers, renters, landlords and investors in real estate?

The distressed property situation needs to be "cleaned up" before we see a price rebound. Foreclosures and short sales have become more prevalent during the past several years. Even if the household members remain employed, wage cuts are causing problems. When you make less money and the mortgage remains the same, it means a larger percentage of household income is related to staying in your home. Loan modification may alleviate some of these problems; but we haven't seen success yet.

Consumer demand has to improve in order for home prices to appreciate. The depletion of goods and necessity for more services has to become apparent. When that happens, and people can no longer wait on the sidelines, we will see the economy pick up. More goods will be needed to be produced and more services provided-- this means hiring more workers. When a new person enters the workforce, they have more money to spend and current workers see potential for job stability. All will begin to spend more, increase demand and push up prices.

Confidence needs to be restored-- the system has to be deemed trustworthy and people have to feel like they know what the rules are and will be. Real estate professionals are essential to getting things back on track. With rules in place and a clear definition of the path going forward, the investment community should return. Investors will help deplete the housing inventory and home buyers will see "professionals" buying with confidence again. That should bring some of the homebuyers "off the fence" and spur more demand.

The Fed and government needs to help increase the transparency of the situation. The fear here is the Fed has shoft-term rates close to zero with no where to go. When people are so fearful about what might happen that they would rather take "0%" interest on their money instead of investing and seeing the assets lose value, more needs to be done to assuage those fears. If people believe the government entities understand the problem and offers potential solutions should the deflationary problem persist, more people might enter the real estate market now that are waiting to see if the "other shoe" will drop.

More deflation seems likely in the near-term. However, just as most people were caught by surprise about how quickly and severely the economy seemed to crash, it's very possible to wake up and find ourselves in an inflationary period. Locking in an historically low mortgage interest rate and buying a home now might turn out to be a very good idea.

Please feel free to contact me with any and all South Florida real estate needs/questions. I work well with buyers, sellers, renters, landlords and investors from all over the country and the world.

Michael Friedman
Realtor, Certified Distressed Property Expert (CDPE)
Lang Realty
561-989-2100