You might think there's little to be negative about with the $8,000 First Time Homebuyer Tax Credit. After all, I've already shown how it boosted sales and housing starts in the Billings area. The credit proved to be so "popular" that it was extended for an additional 7 months (but as one commentator wryly noted, it's hard to find a government giveaway that's not "popular!").

While we're still on the temporary credit-induced high, I'm going to argue that this program will eventually hurt the Billings market more than it has helped it. Here are the four reasons why:

1. The tax credit delayed a necessary downturn

In early 2009, I presented evidence that prices were already falling significantly in Billings. Some sellers were desperately trying to unload at 10% or more below what they paid a few years earlier. Then the homebuyer credit kicked in and changed things. Sales improved, and prices seemed to stabilize.

Propping a market up using a temporary subsidy can work, but only for awhile. The unintended consequences that follow may be worse than the original downturn would have been.

Since 2006, I have been cautioning that the Billings housing market seemed overheated and overpriced for the current income levels. If it needs to come down as I suspect, then it would have been better to allow home prices to take their natural course and come down gradually. Tampering with a market to postpone an inevitable correction only makes that correction sharper when it finally comes.

2. The tax credit encouraged marginally-qualified buyers to jump in

This is not a new phenomenon, but I think the tax credit made it worse. Increasingly over the last decade, the government has encouraged anyone and everyone to buy a house. But the "ownership society" idea missed the simple (and to some, uncomfortable) fact that many people are not in a position to buy a house. Some don't have any money saved, and some don't have the income to support the kind of house they want. People were encouraged to buy anyway instead of working to get into a better position.

5+ years of easy money drew in many people who shouldn't have bought a house when they did, or shouldn't have bought as much as they did. Unfortunately, the tax credit just provided another incentive for people to get themselves in trouble. With interest rates unbelievably low, a free $8,000 just for buying a house, and almost zero cash required, who wouldn't be tempted?

Thanks to this policy, we'll probably see increasing defaults and foreclosure problems in Billings in the coming years.

3. The tax credit spurred homebuilding when we already had too many houses

In early 2009, I presented supply and demand graphs showing how home inventory was rising at the same time that sales were falling. These market forces were driving prices down.

Then the homebuyer credit threw a wrench into things. Sales rose almost immediately as buyers took advantage of the money. These buyers particularly demanded houses in the $100k-$200k range. Local home builders ramped up construction efforts to fill this need.



Above you can see a street in the Riverfront Pointe subdivision. Wells Built Homes filled this street with houses in a matter of months, thanks to the tax credit. These newer, entry-level homes (most of them $180k-$200k) were in high demand by first time home buyers.

In this whirlwind of activity, a few important points may have been overlooked. I'm not sure that the fundamentals in place a year ago really changed. We probably still have too many houses, but that fact was temporarily hidden by the frenzy of sales from the tax credit. Builders built and built (and are still building) during a time that we already had high inventory. When the credit goes away, we may find we are in even worse shape than before-- falling sales, and even higher inventory.

4. The tax credit pulled demand forward even further

Just a generation ago, it was quite common for a married couple to save for years and be well into their 30's before buying a house. The housing boom changed that. Suddenly, it's become quite common to own a house in your mid-20's. For young newlyweds, it's almost expected. We've even seen college students buying houses to get in on the appreciation.

This is known as "pulling demand forward." During the last decade or so, new demographic groups of buyers entered the market as never before. All the normal buyers plus these newer, younger buyers combined to help fuel the housing boom of the last 10 years.

And now this tax credit for new home buyers has pulled demand forward yet again. Anyone who was even thinking about buying recently now has a great incentive-- grab the $8,000 before it goes away in June. Every person who could possibly want a house should have one by this spring.

At the end of this tax credit-- who's left to buy? Sure, we have new workers coming from the college and high school ranks (if they can find good-paying jobs, that is). But we've been so busy selling houses that our metrics for "normal" home sales have been skewed for years. All of those new buying demographic groups have been used up nearly all at once.

Conclusion

This is a tricky issue. We all know people locally who can thank this tax credit (directly or indirectly) for keeping busy or even keeping their job. The homebuilders and Realtors, of course, think Max, Jon, and Denny have really helped Montana by supporting this. Nothing's free in economics, however, and I believe that market manipulation tends to have undesirable side effects. By seeking a temporary fix to a fundamental problem (overpriced and overbuilt housing), we may instead see a longer and deeper downturn in the future.

A previous post of mine discussed the apparently positive effect the $8k tax credit has had on the Billings market. Now it's time to look at some not-so-positive market dynamics this has resulted in.

While it would seem that this credit cost taxpayers $8,000 per house, it's not so simple. Remember, many of those buyers would have purchased homes even without the credit. A better measure is to look at how many additional houses were purchased due to the credit, and divide the total cost of the program by that. Using the National Association of Realtors' numbers, we find that it cost about $43,000 per additional house sold. That seems like a steep price to pay for a temporary market bump.

And perhaps buyers haven't been getting as good a deal as they thought. Sure, it seems like a quick, free $8,000. But as a very perceptive real estate agent notes, funny things start happening when you subsidize a purchase. Buyers feel the thrill of getting a deal, and spend more than they would have otherwise. Here is how the aforementioned Realtor (Janet Guilbalt) puts it as she compares it with the Cash for Clunkers program:

Those handouts work every time, and succeed in making people lose their rational thinking. What is it about the word "FREE" that hooks us every time into short term thinking? Nothing is free..

Janet goes on to say that the "tax credit empowers the sellers more than the buyers." In reality, this credit was probably more of a giveaway to home sellers, Realtors, and homebuilders. Buyers were just used to facilitate it. And that $8,000? Well, any gain for the buyer was probably offset as buyers rushed in and houses were bid up.

The big question now is, what happens in the last half of this year? This tax credit ends in June, and it's quite possible that July and the rest of the year could see sales collapse after the incentive ends. And how will home prices react at that time? Once again, we'll have to wait and see.

I'll admit-- when I first heard about Twitter, I thought it was the silliest idea ever. Over time, I've slowly come around and can begin to see its usefulness. It is an interesting way to keep up on topics and people that interest you.

Twitter also has some interesting search applications. In fact, this one is kind of creepy: DemandSpot searches social media to find potential home buyers and sellers in a certain area. For example, someone in the Billings area posted the message "house hunting today :)" to their Twitter account, and this site picked it up. Presumably, twitter-connected realtors will now be stalking that potential homebuyer.

Anyway, you can now see a Twitter sidebar and you can find me under the username billingshousing. I'll use this to post quick links, articles, and other tidbits that don't warrant a full blog post. If you want to follow me on Twitter or just check it every now and then, feel free. And if you still think Twitter is the silliest idea ever, that's OK too!

In early 2009, new home construction in Billings had nearly ground to a halt. Single family building permits were down 70% from 2007 levels.

Then congress passed the $787 billion stimulus bill, which included an $8,000 First Time Homebuyer Tax Credit. It was a refundable tax credit (basically, free money) for any first time home owner. The credit was good for 10% of the home purchase price, up to $8,000 total.

This single act was a game-changer and affected the Billings market in a major way. Middle and lower segments of the housing market saw a surge in sales. Then homebuilders got into the act. New houses in the $150k-$200k range were in demand, and builders were happy to supply.

You can see how this played out in the last half of 2009:

Josephine Crossing and Riverfront Pointe (both off Mullowney Lane) are two subdivisions whose frenzied construction pace last year can be attributed to the tax credit. 17 of 30 homes sold in Josephine Crossing in 2009 went to first time homebuyers using the credit (see this article). Greg McCall even said that "Without that, we would be in trouble."

A recent Billings Gazette article also attributed the rise in sales to the "first-time homebuyer bailout." Howard Sumner put it this way:

The federal government’s existing first-time homebuyers credit, the new credit to encourage people to trade-up in housing and the Federal Reserve’s program to buy mortgages through this March provided a “fairly substantial push” to the local housing market, Sumner said.

Everything seems relatively cheery for now, but I think there's something that hasn't been mentioned. If the market was diving in early 2009, and then was supported by government intervention-- what happens when those supports are removed? The homebuyer tax credits will expire at the end of June, and Fed buying of MBS's is winding down this spring.

Foreclosures are a closely-watched statistic, and until recently Billings seemed to be escaping the national trend of rising defaults. Low foreclosure numbers have often been referenced as a sign that the Billings market is stable and healthy.

All that is changing. Here is an updated look at Yellowstone County Notices of Trustee's Sale figures for the decade:

The latter part of 2009 saw major spikes in mortgage defaults. My guess is that the ripple effects of the $8,000 tax credit may keep defaults from rising quite so much in 2010. However, if the local economy dives again or prices head downward, you can expect to see even higher foreclosure numbers in the coming years.

If you haven't seen them, here are two archived posts that explain foreclosures: My November 2008 post talks about what a Notice of Trustee's Sale is, and looks at some foreclosure trends in Billings. In April 2009, I discussed why we would probably see foreclosures rising significantly in 2009.

You've probably seen a house or two for sale by a self-described "motivated seller." In this post, I'll take a closer look at one of those sellers to see what led to them being motivated. Here's what the current ad looks like (note that it's been listed for several months with no changes):



The current owner purchased this Laurel house in 2003, taking out $105,000 in loans. Had the owner simply continued to pay on his original mortgage, his loan balance today would be approximately $95,000.

And yet, he claims it is “REDUCED TO ROCK BOTTOM!” at $150,000. How can that be?



Welcome to the wonderful world of refinancing. This owner refinanced 4 times between 2004 and 2007. The latest refi from Avanta brought his loan amount to $151,650, or $56,650 higher than the initial loan. This resulted in a monthly payment of at least $1,300.

We don’t know whether the owner used the extra refinance cash to pay other debts, spent it on toys, medical bills, or something else. But in any case, he’s taken out $50,000+ of home equity during the course of 4 years of homeownership.

Increased debts come at a price. Unfortunately, the latest loan appears to be a bit much for the homeowner. Wherever the $50,000 went, it doesn’t appear to have helped his ability to make the new payments. He defaulted on the loan in February 2009, but was able to catch up on payments this past summer.



Now instead of having a $50,000+ cushion to lower the price and still have plenty left over, the owner is just trying to get out alive and has priced his house at what is now “ROCK BOTTOM.” The age-old advice still holds: Buy a modest house you can afford, pay it off quickly, and don’t take on new debts. It’s tempting to toss this advice out during the euphoria of a housing gold rush, but the consequences of doing so can be dire.

While this page is primarily about the Billings housing market, I try to keep track of the Red Lodge area as well. It's a low-income, high-priced vacation area that may be prone to the same downturn that Big Sky and other formerly high-flying resort areas have seen. In fact, stats from Gary Khatchikian show that prices are already down 18% from last year.

In my 2008 housing video, I highlighted the Spires at Red Lodge subdivision. Located on the hill northwest of Red Lodge, the Spires has room for 400 residential lots.



Construction on the first Spires home started in 2007. The subdivision received a fair amount of publicity and surrounded itself in hype. Here's an excerpt of a 2008 write-up by the developers:

People that purchased real estate in Jackson, Wyoming during the 1970s and 1980s are dancing a jig today. That is because this southern entry community to Yellowstone National Park has seen real estate prices rise twenty-fold or more, as some of the nation's wealthiest individuals purchased real estate in the area ... The charming Victorian mining-era town of Red Lodge, Montana may be just the type of real estate investment that Jackson, Vail, Aspen and Park City once were.

...

When asked why Red Lodge real estate is so inexpensive, architect Don McLaughlin says, "That is a good question and a question that we don't feel will be asked for many more years as we expect to see prices rise."

In March 2008, the subdivision was touted as "sustainable" in a Billings Gazette article, and the developer boasted that "the subdivision has sold $2 million worth of lots since September, making it the hottest-selling development in the Red Lodge area."

All the hype made it sound like a real estate no-brainer, but was it really? Now 2 1/2 years later, we can take a look and see.

First, a look at lot sales. By summer 2008, the developer had sold 15 lots in the first phase. Today? 17 lots sold. Which means 2 total lots sold in the last year and a half (for the record, that means 278 years' supply of lots in the subdivision). After the initial surge, sales have tanked. A new pricing sheet shows that lots have now been marked down 20-30%.

What about development on the lots that have been sold? You can see the grim reality in the photo below. The place is empty. On a visit last month, I saw only two houses and no signs of new construction. This means that only one additional house has been built since the initial one in 2007.

All the creek-side lots were sold two years ago, but they have not been developed at all. This suggests to me that these have been sold to lot speculators-- not people who want to build houses and live in a sustainable community.

As for the one new house that has been built, there's an interesting story behind it. You can read all about it in the Carbon County News. The lot was sold "below cost," and the house was built using a Montana Board of Housing HOME grant. Russ Squire of the Spires goes on to say that "I think most of Red Lodge qualifies for this. They can build a brand new home that in many instances cost less than what they are renting. We can do some good in the community and help Red Lodge working people get into homes they can own here."

Wanting to provide affordable housing is a noble cause, but I don't think this says much for the developer's hopes of Red Lodge prices taking off. Remember, in 2008 the developer hinted that Red Lodge would be like Jackson Hole where "some of the nation's wealthiest individuals purchased real estate."

The harsh reality is that one new house has been built at the Spires-- for a worker who makes under $35,000/year and relies on a subsidy to push the payment down to $600/month. This is a low-income state, and anyone building high-priced housing is taking a big risk.