Avoiding the Housing Market 'Dead Zone' Should you buy a home in a safe zone? Keep renting in a "danger zone?" Get into the market now, and start building equity? Shawn Tully of Fortune magazine examines the realities of some of the more volatile real estate markets in America with Farai Chideya.

Avoiding the Housing Market 'Dead Zone'

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FARAI CHIDEYA, host:

I'm Farai Chideya, and this is NEWS AND NOTES.

In places like Los Angeles, a two-bedroom/one bath bungalow, can cost more than half of a million dollars. That's due in part to a phenomenal real estate boom that's been going on for years.

Sellers in hot zones like Los Angeles, Miami, and San Francisco have profited from what is now being called an overpriced market. A cooling trend has all but extinguished many of these hot areas.

Fortune Magazine's senior writer Shawn Tully researched national real estate patterns and he joins me from New York with more. Welcome.

Mr. SHAWN TULLY (Senior Writer, Fortune Magazine): Yes. Hi.

CHIDEYA: You wrote an article that talked about safe zones, danger zones and dead zones. Can you give us a definition of each of these and an example of each of these?

Mr. TULLY: Well, the safe zones are the areas where the prices never ran up in the first place. Des Moines or Dallas, Houston, certainly a lot of the Midwest. Prices rose with inflation, perhaps a point faster. So you never really had the types of increases that we saw in what I call the bubble zones.

North of Washington, D.C., on the east coast, which would include New York, Boston, the whole Florida coast and the most of the west coast - San Francisco, Los Angeles, San Diego, as well as Sacramento; and then some internal cities, especially Sacramento and Las Vegas and Phoenix.

And those cities represent - or those zones represent about 60 percent of the market value of all housing in America. It's less than 50 percent of the houses, but it's well over 50 percent of the total value of houses, because the most luxurious, suburban housing is on the coast.

CHIDEYA: Why don't we just back up for a second and talk about what a bubble is. We're going to be using that term a lot this week as we talk about real estate. What is a bubble?

Mr. TULLY: A bubble occurs when a price of an asset completely diverges from the fundamentals that determine its value, personal incomes and rents. The multiple of housing prices to rents have skyrocketed and it's unsustainable. These ratios always come back to the historic norms and that's what we're going to see.

CHIDEYA: I read somewhere that in a city like L.A., it may - where I personally live - it may actually be smarter at this point to rent than buy. Is that true? And if so, how does that relate to what you're telling us?

Mr. TULLY: Well, that's definitely true. And this is taking in all the tax benefits of owning. You also have to add in property taxes. But if you take all of the costs and all the tax benefits into account, it is much cheaper to rent than to buy. And all of this overbuilding is simply feeding a glut in the rental market and the more that you have a glut in the rental market the more it pulls the price of houses.

CHIDEYA: Let me ask you this, though. If you're someone who, like me, has been a lifelong renter, yeah, maybe right now it's smarter for me to rent, but I'm not building any equity. Renting doesn't build equity. So aren't there other reasons besides value you get in terms of square footage to just go ahead and take the leap?

Mr. TULLY: Well, no. Because you can build substantial negative equity in a bad market. We saw this happen in the early 80s and the early 90s and it's happening again. In other words, if you buy a house for $400,000 and you put down $100,000 and the price drops, you're going to have a tremendous loss of equity. So if people who buy in now, could see a lot of that equity disappear.

It's a very wise time to sell. But anyone who is thinking about buying should take their time, low ball, throw in offers and low ball because the sellers are going to be desperate pretty soon. There's a tremendous amount of inventory on the market. So we've seldom seen anything like the numbers of properties that are for sale. There are not enough buyers to go around.

So for the first time in many years, probably about 10, we're going to see some bargains on the market.

CHIDEYA: Let's pretend that we have got a home seller in a dead zone. What does that person do?

Mr. TULLY: Well, it depends on how desperate they are to sell. There are a lot of people who are selling near the top of the market. You tend to get a tremendous amount of listings and people selling when they think that the market is about to go down. Whereas when they think the market's going to keep going on, they tend to hold on. Well, now no one thinks that anymore, practically. All you read about is the bubble, so people want to bail before the market goes down.

If you have to sell now, you're probably going to have to take a substantial discount, because there's so much stuff on the market that a lot of people really don't have to sell. And if they don't, it's probably wiser to ride this thing out than it is to take a big discount.

CHIDEYA: And finally, as one last example, what if you're a renter in a danger zone? Should you stay put or should you look for a house to buy?

Mr. TULLY: In the next two years you'll see probably a 20 percent drop in prices. It will become a good time to buy. It already is perhaps in certain areas where the cycle started earlier. But it will soon be a good time to buy in a lot of these markets. You're going to get big, big discounts and desperate sellers who are going to have to get used to taking big discounts.

CHIDEYA: Where are we talking about? Name me a city or two.

Mr. TULLY: Well, it's already happened in Boston. Prices are down at least 10 percent in Boston. It's already happening in, as I said, in San Diego prices are dropping. But they're going to drop more. So unless you can get a real steal and someone has to bail and you can get a great price, there's no reason to rush.

CHIDEYA: Well, caveat emptor, buyer beware. Shawn, thank you for sharing this information.

Mr. TULLY: Okay. My pleasure. Thank you.

CHIDEYA: Shawn Tully is a senior writer with Fortune Magazine. To hear an extended version of this interview, go to our Web site, npr.org.

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