Housing Woes Hit High End Too

The subprime mortgage collapse isn't just threatening the market for low-end homes; it's also afflicting luxury homes, reports Fortune's Jon Birger.

By Jon Birger

September 21, 2007

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Increased rates on big home loans translate to a substantial decline in buying power. Two years ago a $6,000 monthly payment would support a $1 million, 30-year mortgage at 6%. Today that same $6,000 payment covers only an $870,000 mortgage at 7.35%.

In other words, higher rates have trimmed the buying power of luxury-home buyers by 10% to 15%. Throw in the fact that some buyers can't get a mortgage at any rate right now, and you've got all the makings for a national price correction for luxury homes.

"Eventually it's going to take its toll on the higher end of the market," says Karl Case, a Wellesley College economics professor and a co-founder of real estate consulting firm Fiserv CSW.

The only question is whether sellers will hold out–which they're prone to do when the economy is strong. For example, the Stiers, who are empty nesters looking to downsize, say they'd rather stay put than go below their revised asking price.

Those inflated numbers on oversized home loans may be here to stay for at least a year. One top mortgage fund manager says he's sworn off investing in jumbos because he doesn't trust the rating agencies to distinguish the good credit from the bad.

"I just don't see the light at the end of the tunnel," the fund manager says.

The jumbo mortgage woes will probably have a national effect on real estate. Up to now, the slowdown has been quite localized. Areas like metropolitan New York had been exempt, while parts of California and Florida were notoriously affected.

According to the second-quarter survey of the National Association of Realtors, home prices are now falling in many once-hot areas such as Sacramento (6% year-to-year decline) and Tampa-St. Petersburg (down 4%). The Las Vegas market, once more scorching than the desert sun, has cooled.

Those regional slowdowns are a byproduct of the oversupply created during the bubble years–basically too many speculators looking to make a quick buck and too many developers and lenders willing to help them try.

It's a story that has been told endlessly, yet contrary to popular belief, rampant speculation was never a national phenomenon. The same can be said about the fallout from that speculation. The NAR data show second-quarter home price increases in 97 of the 149 metropolitan areas surveyed. Some of the better markets include Salt Lake City (up 22%), Seattle (up 9%), and Charlotte (up 8%).

Until now sellers like the Stiers could take comfort in the fact that what was happening in Vegas was staying in Vegas. And there is little precedent for a real estate downturn occurring in the absence of an economic one. But the woes of the mortgage market are now threatening to metastasize, and the segment most at risk is luxury homes.

The shakeout has already begun, maintains Diane Saatchi, a real estate agent who specializes in multimillion-dollar vacation homes. The head of the East Hampton, N.Y., office of the Corcoran Group, Saatchi says it's no coincidence that several of her sellers agreed to lop hundreds of thousands of dollars off their asking prices the same week that jumbo rates pushed past 7%.

She's now predicting a 20% price decline for all but the most expensive Hamptons homes (the superrich don't care about mortgages). Says Saatchi: "More and more, this feels like a correction."

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