House values sued off

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Just over a week ago, further fueling speculation of a sharp downturn in the housing market, the National Association of Realtors trimmed its home sales forecast for the fifth consecutive month, while simultaneously predicting continued decline in future home sales.

Federal regulators and Congress are looking to stop the downward spiral by targeting companies that engage in so-called “predatory lending” — the supposed root cause of all of this. The irony is, of course, that in so doing, they are overlooking the issue of lawsuit abuse — almost certainly a contributor to the current decline in property values and home sales, if not a particularly easy-to-understand or headline-grabbing one.

Recent years have seen a spike in the number of class-action lawsuits filed by property owners in respect of defective or incomplete construction, particularly in the Sunbelt region of the United States: Nevada, California and Florida. Yet contrary to popular belief, excessive litigation is turning out to be the enemy, not the friend, of homeowners.

Data compiled by the California Building Industry Association indicate housing affordability in that state declined 44 percent in the last five years — a period when the pursuit of class-action lawsuits by property owners was rising steadily. In 2006, the average price of a home in California was more than $500,000 — meaning one would have to earn more than twice the state’s median income to buy an average house — and that, in large part, because homebuilders have been setting prices artificially high to bring in more money from sales upfront, in many cases to cover the cost of future frivolous litigation.

The problem? Artificially high prices eventually mean a declining pool of would-be purchasers, buyers taking on too much debt, and, ultimately, a need to sharply bring down prices to sell, and an uptick in foreclosures as those with hefty mortgages fail to make payments.

More to the point, when a housing development becomes the subject of a lawsuit, it makes would-be buyers wary of investing there — which drives housing prices down further.

Take for example the case of Salinas, Calif., home to many housing developments, including one where a class-action lawsuit was initiated in 2004, by 220 homeowners, fewer than half of whom actually experienced the plumbing problems that caused the suit. Housing prices in the vicinity of that development currently run as low as $375,000 — significantly below the California average. And property values in Salinas are on a steep decline, too. A Global Insight and National City Corp. study found in just one-quarter a downward “correction” in property prices of nearly 2½ percent in Salinas.

To be sure, Salinas’ property market suffers from extreme overvaluation (in 2006, it was rated the second most overvalued locale in the entire country). However, well-publicized lawsuits, in which plaintiffs state for the public record that they have had to carry out hundreds of thousands of dollars worth of repairs, do not seem to be helping the cause.

Naples, Fla., is another area where the proliferation of lawsuits against developers seems to contribute to the decline in property values. Recently, a number of lawsuits have been initiated against developers for failure to deliver condos to owners in fully complete condition. And, though, as of first-quarter 2006, Naples was the area of the country with the most property overvaluation (in August 2006, prices averaged around $500,000 and had increased 140 percent since 2001), prices have been declining just as lawsuits against developers gain more publicity. In June 2006 alone, the average price for an already-built home in Naples fell 8 percent.

But it’s not just California and Florida where a connection is drawn between lawsuit proliferation and declining property values. In Clark County, Nev., a large number of high-profile lawsuits affecting developments sprang up just a few years ago. In the aftermath, property prices in the area have taken a nosedive. One property owner, reluctant to sell at a $9,000 loss last year, was facing a $40,000 loss as of June, and prices are falling month after month.

Judges in Nevada have begun to put the kibosh on class-action lawsuits where numerous property owners who have suffered no damage form part of the plaintiff pool. However, the decline in the housing market continues.

Quantifying the effect of heightened legal action on property prices is difficult. But, the examples of Salinas, Naples and Clark County certainly indicate that increased litigation in the property sphere is an integral part of the deadly cocktail bringing prices plummeting in markets that were once overvalued, and where property was in high demand.

Federal regulators and Congress would do well to consider that as they move to counter practices said to be contributing to the burst of the housing bubble.

Liz Mair is an author, political commentator and consultant in Arlington, Va. She writes daily at www.lizmair.com and regularly at the New York Sun.

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