For the past several years, residential real estate has been a seller's market.  With low interest rates and not enough houses to go around, sellers could expect to receive top dollar for their homes and could turn their homes around fairly quickly once they put their homes on the market.  In early January, the National Association of Realtors projected that existing home sales would fall this year by 4.4%, but as of early September, that forecast has dramatically decreased, with existing home sales for 2006 projected to fall 7.6% below sales in 2005. [1]  The market looks even worse for new home sales, with a 16% fall expected this year.  [2]  Indeed, it is a buyer's market, and if the bubble really has burst, the economic implications could be far-reaching.   

The market surge, which was initially brought on in the late 1990s by low interest rates and easily obtainable mortgages with favorable terms, has been replaced in the tighter economy of 2006 by higher interest rates which makes mortgages unaffordable for many potential buyers.  [3]  In the past three years, the interest rates on some long-term adjustable mortgages have tripled, causing many owners to attempt to sell their homes or be foreclosed upon.  [4]  The current number of homes for sale on the market is the highest it has been since the early 1990s [5], with 3.86 million homes currently for sale, the equivalent of a 7.3 month housing supply. [6] 

Because of the current decline in home sales, the U.S. Senate Committee on Banking, Housing, and Urban Affairs, Subcommittee on Housing and Transportation and the Subcommittee on Economic Policy held a hearing on September 13, 2006, in which testimony was heard and members discussed "The Housing Bubble and Its Implications for the Economy." [7]  Reports indicate that in some markets there will be a negative impact on the economy due to "market psychology" and the fact that in recently hot markets such as Arizona, Nevada, and California where residential sales and sale prices are declining, investors are no longer sinking their money into the real estate market.  [8]  This is causing an economic downturn in these once hot locations.  Investors previously bought residential property within minutes of it being put on the market, but are now either investing their capital elsewhere or not investing their excess capital at all.  An economic impact is also being felt by investors who purchased large amounts of residential real estate in these hot locations and are now forced to place it on the market at prices below what they initially paid for the property. [9]  Thus, these investors will lose money on their transactions and as a result will have less capital to invest in other areas of the economy.

Another significant economic impact can be seen in the fact that existing homes are not appreciating as much as they have been in the past. [10]  This means that in the near future, the downturn in housing sales will have a general economic impact on consumer spending ability both for people who are able to sell their homes at a lower price than they expected to receive, and for people who are locked in to an adjustable mortgage who are paying an increased amount to the mortgage company.  [11] Both sellers and owners paying a higher rate will be left with less disposable income which would normally be invested in various areas of the economy.

Thus, although it is a buyer's market due to the surplus of housing and decline in home price, high interest rates dictate that fewer people will actually be able to purchase homes.  Other downturns in the economy due to lack of investment and lack of disposable income will only worsen as interest rates rise and the housing market swells in number of homes available.

Sources:

[1] Noelle Knox, Realtors Forecast What Home Builders Know:  Home Sales This Year Will Tumble, USA Today, Sept. 7, 2006, http://www.usatoday.com/money/economy/housing/2006-09-07-homes-forecast_x.htm

[2] Id.

[3]  Robert Z. Aliber, Real Estate Recession Coming, N.Y. Sun, Sept. 12, 2006,http://www.nysun.com/article/39480?page_no=2&access=320298

[4] Id.

[5] Id.

[6] Knox, supra note 1.

[7]  The Housing Bubble and Its Implications for the Economy: Hearing before the S. Comm. on Banking, Housing, and Urban Affairs Subcomm. on Housing and Transportation and the Subcomm. on Economic Policy, 109th Cong. (2006) (panel statements), http://banking.senate.gov/index.cfm?Fuseaction=Hearings.Detail&HearingID=236

[8] See generally Id. (statement of Patrick Lawler, Chief Economist, Office of Fed. Housing Expertise Oversight).

[9] Aliber, supra note 3.

[10] See supra note 7 (statement of David F. Seiders, Chief Economist, National Association of Homebuilders).

[11] Id.