Why The Real Estate Market Isn’t a Free Market

The folks at Redfin got into real estate to make the industry more efficient. But if anything, the market has just gotten less and less efficient. And most of it isn’t the Realtors’ fault but the banks. Banks selling a home don’t trust one another’s credit. They reject appraisals for a price that a buyer is willing to pay. They’re slow to put homes on the market, but aggressive about pricing other sellers out of the market, even as buyers are frantic to strike before the tax credit expires.  The California economy is in the tank but we only have 4.2 months’ supply of listings.

I am not trying to talk the market up. (After years of saying that prices were too high, I was virtually crucified for saying, when no one else would, that prices in Southern California may be nearing a bottom; three months later, prices began to increase). And my point in writing this is not to blame the banks, who have good reason for an abundance of caution. My point is just to state the obvious:  the market has become distorted so much that it is ridiculous to pretend that it is a free market. It is instead an oligarchy, controlled by the government and the banks to limit price drops, which in turn frustrates consumers and limits price recoveries.

Human nature being what it is, there are some folks who have already figured out how to profit from this skewed-up system in interesting and not entirely ethical ways. Here are just three phenomena in the real estate market that only make sense if it isn’t really a market at all:

1. Banks are hoarding listings to avoid writing down their losses: individual home-owners who want to sell can’t compete with the banks on price, and so hold their properties off the market. As a result, banks have effectively become the sole supplier of homes for sale in many distressed areas. We routinely see bank-listed homes with 30, 50 sometimes more than 100 offers. And yet even as sales volume in California is up 35%, prices are down 30% over last year, despite modest recent gains. Supply and demand have been slow to find a new balance because there is an enormous backlog of homes that could be sold, and most are not being put on the market. Banks have good reasons to withhold inventory: staff reductions, the need for repairs, concern about flooding the market. But another reason banks withhold inventory is that they can avoid acknowledging the  loss on their books until someone puts a new price on the listing. Dribbling out the inventory may prolong the banks’ survival, but it means a recovery will take longer, too. The major source of uncertainy in today’s market is that nobody knows how much of the inventory iceberg is under the water.

2. Real estate agents may be hoarding listings to save them for their own buyers, doubling their commissions: the shortage of listings in a market where asking prices have not significantly increased distorts the incentives for real estate agents, too. In multiple Redfin Forums posts,  several eagle-eyed consumers recently noticed that listing agents are accepting an offer on a listing literally one minute after it debuts on the the market. Then a month later, the listing agent returns the property to the market saying the previous sale fell through,  and again immediately acccepts a new offer before anyone else can strike. The second time around, the offer is from a buyer represented by the listing agent, so she stands to earn double the commission. The concern is that the listing agent is hiding a listing from other buyers until he or she can find her own buyer. The fact that we’re even having these skirmishes over inventory suggests that the market is not doing its work; normally when there is a shortage of supply and an excess of demand, prices increase and supply increases.

3. Banks refuse to accept what the market tells them is a fair price for a home: for a long time, banks have aggressively priced their own listings to create a bidding war between buyers that results in final prices hundreds of thousands of dollars over the asking price. That was strange enough, but now in the Inland Empire our partner agents are seeing banks refusing to take the highest offer, for fear that the home won’t appraise for the value offered by the buyer. Rather than risking that a loan will fail because of the appraisal, the banks take a lower offer from an all-cash buyer.  What this means is that the market establishes a price for the property and the banks on both sides of the deal — the one selling the property, and the other lending money to a would-be buyer — refuse to believe it. Now cash has always trumped other offers at nearly the same prices, but when we see a bank reject offers 10% or 20% higher it means that the credit markets are still hindering a recovery. Perhaps soon people will be offering two chickens and a goat for a house.

So what’s the solution? The government could require that banks receiving federal assistance put real estate up for sale within nine months of taking ownership, or at least mark the assets to market using the Case Shiller index where available; failing that, we should at least extend the home-buyer tax credit so that we don’t create demand exactly when the foreclosure moratorium reduced supply.

And banks themselves obviously need to require listing agents to keep a listing on the market for a minimum length of time — say three days — so the market can do its work. But as for banks that refuse to accept a price for fear it won’t be supported by the appraisal, we shouldn’t worry. We’ve all had enough of banks being pressured to make deals they’re not comfy with. If we get the inventory on the market when the buyers are ready to buy it, the market can start to do its work again.