Resale Numbers and the Success of HAMP

Resale Numbers Dissappoint – but…  HAMP was a Success!

NAR released the July home resale numbers, and as predicted, they fell significantly.  The fell far below analysts expectations, and even farther that I predicted in my Coffee on Monday.  Here are two graphs that illustrate the results (once again taken from www.CaluclatedRiskBlog.com)

This first one shows home sales by month (resale homes only):

Existing Home Sales Slump in July

You can see the trend was clearly down until early 2009 when the administration stimulated the housing market with the tax credit.  Sales spiked in November of 2009 with the scheduled expiration of the tax credit and then again early this year with the real end of the tax credit.  Now, we have resumed the downard trend.  Based on August numbers in the San Diego market so far (I know, small sample size), it looks like things may get a little worse (July sales were down in San Diego 20% from a year ago and I think August will be down about 24%), I will look at the numbers more closely in next week’s Coffee. 

With the combination of slower sales and more homes being put on the market by builders (new construction spurred by the short term rise in demand), banks (more aggressively processing foreclosures), and individuals (summer season sees more homes offered for sale), inventory as measured by months of sales, spiked:

Nationwide Inventory Jumps to over 12 months

Ouch, that’s a big jump.  Inventory rising that quickly in one month is a bad indicator.  Plus, as foreclosures will continue to be put on the market, this number could grow to 14-15 months.  Inventory levels over 6-7 months usually result in lower prices.  Fortunately, we are in much better shape here in San Diego with inventory levels still under 5 months.  However, significantly lower sales levels in August will drive that number up.

I found an interesting article about a meeting at the Treasury between top players there (including Geitner) and several prominent bloggers.  You can see the article here.  The blog this is taken from is www.interfluidity.com.  The interesting part was when they addressed HAMP, you know, the Home Affordable Modification Program.  While it has been considered by most to be a failure, the Treasury thinks it was a success because it basically pushed the foreclosure problem down the road 3-6 months so the banks could recover.  The argument was that if all the homes had been foreclosed on instead of going through the delay, the system might have failed:

The conversation next turned to housing and HAMP. On HAMP, officials were surprisingly candid. The program has gotten a lot of bad press in terms of its Kafka-esque qualification process and its limited success in generating mortgage modifications under which families become able and willing to pay their debt. Officials pointed out that what may have been an agonizing process for individuals was a useful palliative for the system as a whole. Even if most HAMP applicants ultimately default, the program prevented an outbreak of foreclosures exactly when the system could have handled it least. There were murmurs among the bloggers of “extend and pretend”, but I don’t think that’s quite right. This was extend-and-don’t-even-bother-to-pretend. The program was successful in the sense that it kept the patient alive until it had begun to heal. And the patient of this metaphor was not a struggling homeowner, but the financial system, a.k.a. the banks. Policymakers openly judged HAMP to be a qualified success because it helped banks muddle through what might have been a fatal shock. I believe these policymakers conflate, in full sincerity, incumbent financial institutions with “the system”, “the economy”, and “ordinary Americans”. Treasury officials are not cruel people. I’m sure they would have preferred if the program had worked out better for homeowners as well. But they have larger concerns, and from their perspective, HAMP has helped to address those.

It’s an interesting take, and correct from the standpoint that it helped the system.  Isn’t it interesting that when the politicians sold it to us, they emphasized the saving of people’s homes rather than saving the system.  Also a sidelight to watch is  now that the stimulus is over, we are seeing the foreclosures that were delayed by HAMP start to be processed just as demand is falling.

Small Investment Opportunity

Front of Condo

Fallbrook Short Sale condo

For those of you looking for a small real estate investment, try this one:

• 2 Bedroom (dual master) condo on Gird Rd that sold in June of 2005 for $355,000 owner then re-did the kitchen with granite counters and new appliances.
• Will rent for $1,300 – $1,400 – the rear entrance to Camp Pendleton is nearby.
• HOA is $200/mo and there are no Mello-Roos.
• It is a short sale and I think I can get it approved between $170k and $180k. 
• With 25% down, it looks like worse case it is break even cash flow and best case it is a 4% return on invested cash

No, it’s not the perfect unit.   Yes, there is road noise.  No, you are not going to want to retire into it.

It’s an investment.  With cash flow.  And upside.

Kitchen

So, if you are looking for an investment in San Diego that you can get with 25% down as a small investor and get it for about 50% of the price paid in  2005 (with a kitchen re-model thrown in since then), give me a call.

Coming Loan Mods and Foreclosures

This is a re-print of a Monday Morning Coffee from 3 weeks ago.  Someone asked me to post it on the blog, so here it is.

I spent a lot of time going through data this week with the goal being to look at all types of mortgages that are currently out there and see what the delinquency rate is and when they are due for interest rate adjustments.  We know from historical data that the following has been true:

• Once a loan is 60 days late, there is a 98% chance that it will be liquidated through a foreclosure, short sale or a loan modification will take place.
• Over the past 2 years, it appears that for every 1 foreclosure or short sale there have been 3 loan modifications.
• Within one year, 58% of all loan modification are 90 days late and since the banks do not do 2 loan modifications on the same loan, at least 58% of the 75% delinquents that were modified the first time around will be liquidated within between 12 and 24 months of first going delinquent.
• Taking those together, once a loan is 60 days late, about 25% of the homes will be liquidated within a year (that’s the longest they are generally taking to process) and 44% (58% x 75%) will be liquidated in the second year.  (I could not find data on the second year after loan modification, most likely because there isn’t enough yet).
• This means that the effects of the mortgage defaults are felt over an extended period.
• These numbers will likely improve over the next couple of years as the Home Affordable modifications do more to reduce principle and payment that previous modifications.  However, there are many that don’t think it will make much difference.  The Home Affordable modifications allow for 5 years before the new loan adjusts towards market interest rates.

With the above track record, I was hoping to look at all loans that are out there and overlay loan types with when they are adjusting and the forecasted foreclosure/modification rates to get an idea how long until we work through the distressed inventory of homes (and who said I’m not a fun guy to hang out with on a Friday night.)

Unfortunately, I cannot get my hands on all the data.  Those who have it are not giving it up without a lot of dollars and frankly, I think we can get a rough idea with what I did find. 

What I found is available on the Federal Reserve Bank of New York’s Web site (if you want to get really depressed, they have a map showing every county in the country with mortgage, auto, credit and student loan delinquencies).  I was able to download the data for Sub-Prime and Alt-A loans as of June 30 of this year.

Quick note – Alt-A borrowers have better credit scores than Sub-Prime borrowers and typically longer time periods before adjustable loans re-set which is why you see lower delinquencies.  

So, the first wave of foreclosures that started last year was in the sub-prime market and the next (possibly this summer) is the Alt-A market.  But look at the number in bottom that is bolded – even after the loan mods and foreclosures of the past year 50% of the people in the country with sub-prime loans are delinquent!

I know this is getting long, but a couple more pieces of information on both types of loans, focusing on CA:

Sub-Prime:

• Of the 326,521 sub-prime loans in existence, about 208,000 are adjustable.
• 172,359 of those have already re-set (the introductory interest rate is over).
• There are only about 36,000 homes left to re-set.

Alt-A:

• Of the 613,650 Alt-A loans in existence, about 428,000 are adjustable.
• 181,898 of those have already re-set.
• There are 246,000 homes left to re-set (most of them more than 2 years out)
• Because of better credit scores, more Alt-A homeowners were offered negative ammortization loans which will be harder to modify because they have no equity.

At least in California there is likely to be more damage in the second wave as the Sub-prime loans that were modified the first time default again combined with a larger pool of Alt-A loans that are re-setting over the next 3 years.

However, I don’t think this means a 20% drop in market prices.  I think we are likely to see another drop during 2010 and an extended period of up and down (the Alt-A loans will re-set through the next 3-4 years and then we will have the Home Affordable loans re-setting starting in year 5 which should be a smaller number (if the market stabilizes) but will still be a negative influence). I think we are mostly through the painful devaluation phase and moving into what I can best call (someone else’s term) an extended “muddle through” period.

In summary as I have said before, we have oversold housing as an investment over the past 10 years and undersold it as “home”.  We don’t have a choice anymore but to look at our homes as places we raise our families and with the help of 30 year fixed mortgages, slowly pay off so that our true  “investments” don’t have to pay for our mortgage when we retire.

Drop in Inventory – Another Factor

With the end of the second quarter, we are now a couple of weeks away from the press talking about how inventory levels are down.  This will be substantiated by reports from the San Diego MLS or SANDICOR that inventory of available homes fell from about 15,900 at the end of March to about 9,400 at the end of June (these numbers are approximate as I do not track manufactured house or time shares).   Now, this looks like a huge drop and would signal that there is not enough inventory to meet demand, prices are going to shoot up, etc. (see the post below for a discussion on the dual markets we are seeing and the reasons for them).  The problem is, these numbers are not accurate.
In April, the SANDICOR added a new listing category called “Contingent”.  This is supposed to be used for homes that are short sales where the seller has accepted the offer and it has been sent to the bank, and Bank Owned Homes where the offer has been submitted to the bank but there has not been formal acceptance.  These homes are homes that previously were left in the “Active” state.  The new classification is important because it paints a more realistic picture of the homes that are currenty available.  The problem is, there is no way to go back to March and determine how many of the “Active” homes would be “Contingent” today.  What we do know is that there are over 3,800 “Contingent” homes in the MLS right now.  If you add that number to the Active listings, you get a result over 13,200.  While this is still a 17% drop in inventory, it is not the 41% that it looks like on the surface.

A Tale of Two Markets

It was the best of times, it was the worst of times.  Ok, I couldn’t resist.    Ever since I told my investor clients to get out of the market in May of 2005, I have pointed to the end of this year as being the bottom for San Diego housing prices.  I felt really good about that until the end of last year when Fannie Mae put a moratorium on foreclosure activity.  I thought that could delay the bottom of the market to the end of 2010.  Now, all the news we hear has a positive spin and has made me wonder if I was wrong then or if I am wrong now.  There are a couple of sectors of this market that are sending mixed signals and need a little digging into to understand.
First, homes priced under $700k have been selling like crazy with multiple offers while the higher priced homes are not moving nearly as quickly.  In fact, two of the last three homes we have sold around $700k have received offers for more than we were able to get the home appraised for.
Second, while the press is reporting that the end of the recession is near, banks are telling us to get ready for a large wave of foreclosures that should start in the next month.  This second wave could be enough to send the market back into a dive.  In truth, we are starting to see a few, but nowhere near a significant number.  To try and figure it out, I spent some time going through some numbers.
First of all, as many of you know, I do not like the statistic of the Average, or Median, Sales Price (rather than go into detail, if you scroll through the posts for an entry titled The Problem with the Median Price, you will get the idea), so I am not going to talk about specifically about price levels.  But, I will look at a couple of other interesting statistics.  First of all, let’s look at the inventory of homes for sale over the last year and a half.

This chart shows we have gone from a high of almost a year of inventory down to just four months of inventory in one year (inventory is calculated as total homes on the market divided by homes sold in previous 12 months times 12).  That is a very remarkable reduction in inventory and shows that in fact the market may be turning around.  However, four months of inventory is not the level at which we should see multiple offers and homes selling over appraisal, that happens when inventory is under two or three months.  So, I wanted to see if the inventory levels were similar across all price ranges.  Guess what?  It’s not.

This data is as of June, 5, 2009 from the SANDICOR MLS.  A couple of things to note.  First of all, below $600k inventory is severely constrained.  In fact, if you look at the numbers in red, there are more homes in escrow under $600k than there are on the market – hence the frantic pace of offers we are seeing below that price level.  However, look at homes over $1M and you can measure inventory in Years not Months.   There are simple and complex reasons for this.  The simple is that there are still loans available with 3.5% down up to FHA limits while at higher price points, you need to have 20% down.  The complex reasons require a different forum and someone a little more advanced in global economics.  So, while interest rates may not be as low as they have been, the fact that at lower price levels money is still available is helping those homes sell.

Next I wanted to see if the inventory drop is due more because people are buying more houses or there are fewer houses for sale.  The news reports will have us believe that it is because more people are buying houses.  Let’s look.

First, notice that the home sales have been fairly steady over the last 12 months with the exception of the holiday period.  The reports of increase sales for the past few months have been because of the drop you see from September 2007 to May of 2008 when the mortgage crises first hit.  The Real Estate industry reports sales compared to a the same period 12 months previous, and since sales were so low a year ago, sales now are reported as high despite being farily normal.  This chart clearly shows that the drop in inventory the last year is not due to increasing demand, but from a supply that has gone from 20,000 homes to 10,000 homes for sale in about seven months.  So, the recent reduction in inventory (as measured by homes-for-sale divided by sales-per-month) is because there are fewer homes for sale, not because there are more homes being sold (within the last twelve months).

So, why are there fewer homes for sale?  With more research – and a guess or two, I came up with three reasons.  First of all, there are typically three sources of home sales:

1. Individuals selling their homes.
2. Builders selling homes.
3. Banks selling foreclosures.

The number of individuals selling their homes has been the largest segment of San Diego’s home sales (at least as measured by the MLS data above) over the past several years.   However, with values down significantly, people are not selling unless they need to due to job loss, bad loans, job transfer, divorce, etc.  In fact, almost 50% of the homes for sale by individuals are short sales right now, showing that it is truly “need based”.  I do not expect the number of sales by individuals to rise that significantly until values rise again – people are staying put, and unless the number of short sales increases or prices rise significantly, I do not expect that substantial additional inventory will come from individuals selling their homes (there will be a seasonal rise due to summer, but nothing that will have a long term effect on the market).

Builders represent a substantial part of the market that goes untracked by the MLS.  It is pretty easy to tell that builders have dramatically slowed down their construction and sales.  Builders are releasing and selling homes on the order of 2-3 a month per project rather than 2-3 a week (those that have not closed down completetly).   I have spoken with a couple of builders in the last week, and they are seeing the same increase the rest of the market is.  The issue with builders is that from the time they decide to ramp up production, the first homes hit the market in 7-10 months.  So, even though they will start to increase production, we will not likely see the homes available before the first of next year.

That takes us to the banks selling foreclosures.  The following chart shows the number of NODs (Notice of Defaults) and Trustee Sales scheduled in San Diego over the last year-and-a-half.

This chart is very revealing and shows a lot of why the market seems to be overheated.  Notice that in September of last year when the banking meltdown occured, the number of NODs filed fell by almost 2,000 a month for three months.  Correspondingly, the number of Trustee Sales scheduled fell.  If we look at the number of homes affected in the eight months since the meltdown (shown by the area in pink under the 2,500 line between September and May) the total is slightly over 5,000.  This would put inventory levels at 15,000 homes today instead of 10,000.  Add to this the fact that NODs jumped over 3,000 in March while the Fannie Mae moratorium was still in effect (the moratorium is on loans issued between 2003 and 2007 on owner occupied homes with Fannie loan – a significant number) and we can anticipate the possiblity that those numbers will go higher.   The other thing about the homes scheduled for Trustee Sale is that most of them get postponed, either because of the moratorium or because the banks are trying to work out a resolution (short sale) with the owner.  For example, even through there are only  1500 -2000 homes that have been initially scheduled in any month, enough have been put off and re-scheduled that there are about 1600 a week currently scheduled for the next three weeks.  When the banks start pushing forward with those, inventory will start to rise about a month later.

Ok, so what does this foretell for the market?  Good question.  My thoughts are that the San Diego market is going to develop along two different paths.

In the sub-$600k market prices are going to rise through the summer as it will be later this summer before the foreclosures start to hit the market in significant volume.  Then, once the summer season is over the foreclosures will start to increase the inventory and the builders will start adding homes to the market late in the fourth quarter.   I am looking for a 5-8% increase from May’s prices to pricing we will see in September/October closes and then an easing into next year.  Where it goes after that depends on how many homes are forced into foreclosure and what goes on with the broader economy.

Above $1M, the market is going to stay soft.  When you look at the number of homes on the market and realize that to buy a $1M home now, a buyer needs good credit, $200,000 cash, an income around $180,000 (assuming $1k a month in auto/credit card debt),  not own a home they need to sell and believe that the market is not going to fall anymore.  Considering that we have over 2200 homes priced over $1M on the market and are only closing about 100 a month, I expect another 10-15% slide over the balance of the year in this segment.  The main wild card here is if loans become easier to get for the higher price range.  If that happens and you open up the $1M+ segment to people with $50k or $100k to put dowh, then this segment should do better.

In between, you have those homes priced in the $700k to $1M range.  They will be caught in an interesting position where the homes below them are pushing up towards the $700k point and the homes above are coming down.  I think in this area, performance will be dictated by neighborhood although the critical factor is going to be the ease of getting loans.

Since the Fed Lowered Rates to 0%, Why Haven't Mortgage Rates Fallen Farther?

A friend was over on Sunday and asked this question.  I tried to explain, but don’t think I did a very good job.  But, it is a good question and one that I hear a lot, so I am going to try to explain it here (within the limits of my understanding).
First of all, let’s define a couple terms:

• Fed Funds Rate – This is the rate set by the Fed.  It is currently targeted to be between 0% and 0.25%.  This is the rate that the Fed uses to provide short term loans to banks.
• Prime Rate – This is the interest rate that commercial banks offer to their most valued and credit worthy customers.  It has tracked at 3% over the Fed Funds Rate over the last several years.  This 3% is the spread that banks make.  Think about it this way; if the bank borrows at 1% from the Fed, they will loan to their best clients at 4% and to others at more than that.  That difference is their profit and how banks typically make money. Note that their profit is a lot more than 3% because with $1,000 of assets, they can borrow $10,000 to loan out a total of $11,000.  So, in that case, they pay your grandmother 2% for her deposit of $1,000 and the Fed 1% on their $10,000 for a total of $120 cost a year and earn $440 (4% on $11,000) for a profit of 367% (ok, they had operating costs, but who can’t cover operating costs on a 367% gross margin?)
• US Treasury Bonds -Bonds issued by the US Government paying the buyer interest payments every 6 months.  They usually have a maturity rate of 30 years.  The payments are set by the government, but when the bonds are issued, they are done so in an auction and they are in $100 increments.  The amount paid in the auction determines the Yield, or actual rate the holder will receive.  For simplicity, lets say the bond is going to pay 5% a year for 30 years.  If people think that is too low, they will bid less than $100.  If they bid $90, they are still going to get $5 a year, plus their $100 back in 30 years, so the effective interest, or Yield, would be closer to 5.7%.  Likewise, if they think 5% is a great rate, people may bid the bonds up over $100, lowering the yield.  This is why when bonds go up, it is the same as saying the yield, or interest rate is coming down.  Since US Treasury Bonds are guaranteed by the US Government, they have historically been considered the safest investment and offer the lowest yield.

It is important realize that your bank does not keep your loan.  (Remember from above that every $1 your bank has in deposits allows it to borrow $10 to loan out.  Once they loan out $11, they are done.  To get around this, the bank sells your loan (hopefully for more than $11) takes the profit and loans it out again).  Your bank sells these mortgages to investors such as insurance companies, foreign governments, pension funds, Bill Gates, etc.  (from here on out, we will call this group Pwtom for People With Tons of Money).  This buying and selling of mortgages is what is called the Secondary Mortgage Market.  Here is the important part.  Your bank does not set the price on the secondary market – the buyers do, by insisting on a yield.  So, what determines the yield the investors want?

Treasury Bonds.  Treasury Bonds are (historically) the safest 30 year investment because they are backed by the US Government and everybody knows the US Government is safe (isn’t it?).  So, if Pwtom has a choice between buying Bonds from the government or a mortgage from your bank, what is going to determine which he buys?  Basically, the difference in the yield, or interest rate, between Tresuries and mortgages.  If the difference (or spread) is too small, Pwtom buys Treasuries and to get him to buy mortgages, the rate on mortgages needs to go up (remember that if Pwtom doesn’t buy mortgages, your bank has to hold onto them and can not lend out anymore money).

Let’s look at today.  Treasury Bonds are currently trading at historically low rates.  So, why aren’t mortgages falling as far as Treasuries?  It’s the risk involved in mortgages.

Imagine that you are Pwtom and you are trying to decide where to put your money.  You have always bought Treasuries and in the past several years have bought US backed mortgages.  You were willing to buy the mortgages because they were guaranteed by Fannie Mae and Freddie Mac – basically by the US Government, not so different from Treasuries.  However, now the administration is talking about requireing banks who are going to get government aid to “modify mortgages”.  While mortgage modification sounds great to those of us with a mortgage, what about Pwtom?  He basically bought a bond in the form of a mortgage that he thought was guaranteed by the United States Government and now he is being asked to accept a lower interest rate or less money at the end when the mortgage is paid back.   Now, we don’t have to be smart like Pwtom to realize he is getting screwed in this deal.

The important thing to realize is that if Pwtom thinks that there is a chance the mortgage he is buying will be re-negotiated or go into foreclosure, he is going to require a much higher interest rate on all the mortgages he invests in to cover the ones that go bad.  So, the exact thing we are hoping will help, mortgage modifications, is creating uncertainty for buyers of mortgages and causing mortgage rates to stay higher than they otherwise would.

How Far Have We Fallen? Downtown San Diego

How Far Have We Fallen?

Downtown San Diego

This is the first article I am writing comparing sales data in specific areas of San Diego over time. The reason for this is that I am not satisfied with the simple “averages” that are put out by industry groups and wanted to see if we get different numbers when we look at it different ways. I apologize ahead of time that this is quite long, but I did not know another way to present the information.

The first area I look at is Downtown San Diego. For this article, I used all closings in the 92101 zip code. I looked at the fourth quarter of each of the last four years (I used a quarter’s worth of data so that the sample size was large enough that a couple of unusual sales would not overly influence the numbers the way it would if I only looked at one month).

The first thing I looked at was the average sales price and number of sales. They broke out like this:

Q4 – 2005
Q4 – 2006
Q4 – 2007
Q4 – 2008

# of sales
210
143
142
166

$ per Sf
$625
$562
$504
$421

Ave sf
1,159
1,185
1,083
1,163

% change from previous year

-10%
-10%
-16%

% change from 2005

-10%
-19%
-33%

From these numbers, it looks like the drop in prices accelerated in 2008, and this makes sense. I wanted to look a little closer at specifics to see if things were changing; when I did this analysis for a client late in 2007, we discovered that there were three different markets:

The Entry Level was taking the hardest hit.

The Mid Level (priced above $500k) was holding firm.

The Upper Level (priced above $1M) was actually increasing.

To determine if this was still the case, I looked at units that sold in the fourth quarter of 2008 that had also sold sometime in the previous 4 years.

Lower Level Units (Valuation Wise)

Address
Price sold Q4 2008
Price Previously Sold
Previous Sale Date
% Change
% Change per year.
Notes

1643 6th Ave #214
$185,000
$344,000
Q1 2006
-46%
-16%
REO

1642 7th Ave #422
$200,000
$401,500
Q1 2005
-50%
-12%
REO

1465 C St #3417
$223,500
$259,000
Q3 2004
-14%
-3%

425 W Beech St #333
$235,500
$500,000
Q1 2007
-53%
-28%
REO

702 Ash St #405
$209,000
$690,000
Q3 2006
-70%
-27%
REO

425 W Beech St #538
$240,000
$499,000
Q1 2007
-52%
-27%
REO

425 W Beech St #808
$225,000
$342,000
Q1 2005
-34%
-8%

1435 India St #502
$201,500
$360,000
Q4 2005
-44%
-13%
REO

515 17th St
$184,500
$425,000
Q3 2004
-57%
-11%
REO

1150 J St #503
$190,000
$293,000
Q3 2005
-35%
-10%
Short Sale

Middle Market Units

Address
Price sold Q4 2008
Price Previously Sold
Previous Sale Date
% Change
% Change per year.
Notes

801 Ash #1101
$460,000
$579,000
Q4 2006
-21%
-10%

950 6th #542
$435,000
$698,000
Q3 2006
-38%
-15%
REO

1240 India St #1112
$440,000
$735,000
Q4 2006
-40%
-18%
REO

1465 C St. #3505
341,500
$464,500
Q4 2004
-27%
-6%
REO

801 W Hawthorn St #204
$360,000
$515,000
Q2 2004
-30%
-6%
REO

445 Island #317
$465,000
$700,500
Q3 2006
-34%
-14%

877 Island #218
$385,000
$665,000
Q3 2005
-42%
-11%

High End Units

Address
Price sold Q4 2008
Price Previously Sold
Previous Sale Date
% Change
% Change per year.
Notes

1199 Pacific Hwy #3304
$865,000
$869,000
Q4 2004
-1%
0

1199 Pacific Hwy #2205
$953,000
$1,185,000
Q2 2005
-20%
-5%

1205 Pacific Hwy #1902
$935,000
$1,100,000
Q2 2006
-15%
-6%

700 West E St #3703
$1,000,000
$1,230,000
Q1 2008
-19%
-26%

550 Front St #801
$1,075,000
$775,000
Q4 2005
39%
11%
Seller was original owner.

550 Front St #1104
$1,100,000
$725,000
Q4 2005
52%
15%
Seller was original owner.

100 Harbor Dr. #3002
$1,500,000
$1,537,000
Q3 2005
-2%
0

550 Front St #2301
$1,950,000
$1,934,500
Q1 2006
1%
0
Prev owner made 79% in 2 mos.

Ok, what does this mean? Well, if you look at each segment of the market, it looks like the bottom end has fallen an average of 15.5% a year, the middle at 10.0% a year, and the top, or exclusive properties have fallen only 1% a year. However, the number for the exclusive properties is a bit deceiving as three of the units were in Pinnacle, and two of the sellers had bought from the builder prior to construction. So, they took advantage of 2-3 years of appreciation before the closed on their units. If you take the Pinnacle units out, the fall averages 7%.

This makes sense. The lower end units had the shakier financing and were likely to feel the crunch sooner, while the high end units benefit from both the fact that their owners have deeper pockets and better financing, and the fact that there is more demand for large ocean view units than small, street level units. So, the lower end units fall first and faster, highlighted by the fact that many of those sales are after the lender has foreclosed and is “dumping” the unit below market to free up cash.

So, are we at the bottom here? No. But we could be close. I believe that a lot of the recovery will be from investors. It is going to be pretty hard to absorb all the inventory that is coming in the next 6 months unless investors step in and buy a lot of them. I just don’t think there are enough individual buyers who can qualify for a loan with the new standards to absorb all the inventory. For investors to enter the market, most of them want to generate decent cash flow (under the condition of putting 25% down).

Let’s look at the property at 1150 J #503.

<!–[if !supportLists]–>· <!–[endif]–>This unit sold as an REO (Real Estate Owned by the bank) for $190,000.

<!–[if !supportLists]–>· <!–[endif]–>25% down would be $47,500, leaving a loan of $142,500.

<!–[if !supportLists]–>· <!–[endif]–>For an investor, let’s be conservative and say the payment is about $950 a month.

<!–[if !supportLists]–>· <!–[endif]–>The HOA is $300 a month.

<!–[if !supportLists]–>· <!–[endif]–>Taxes would be about $200 a month for a total of $1,450 a month.

<!–[if !supportLists]–>· <!–[endif]–>The unit one floor above (#603), is currently listed for rent at $1,500.

<!–[if !supportLists]–>· <!–[endif]–>So, if the investor is paying the standard 10% management fee, they would be losing $100 a month.

So, an investor would have to put $47,500 down, repair the unit and then rent it at a loss of about $1,200 a year while the value is still going down. I don’t think too many investors will sign up for this until they are confident we have reached the bottom and the market has turned upwards. So, I think we still have about 10% to fall in the low end of the market (as long as rents do not keep falling). I expect the middle and high ends to be closer to a 5% drop in the next year. However, if rents keep falling, look for the lower end to drop up to 20% more. The high end, which is not as dependent on rental income will fluctuate more based on the overall economy and the stock market as major investors owning downtown units as a second or third home, may be forced to liquidate to free cash if their other investments decline.

Now, I am not bashing downtown at all. I think it is a great area and believe it will be one of the strongest in the recovery. I have several investors waiting to purchase downtown. But, as a Realtor who only makes money when clients buy or sell a property, I am telling my investors to wait. I still love downtown as an investment and think it will be one of the leaders in the recovery – just not yet.

Median Price – Overstating the Problem

I was preparing my market update email and was looking at the early statistics for December sales (San Diego County) and was reminded of something that many people do not understand. That is the Median Price. People assume that median is the same as average, and while it is an average, it is not the average that most of us are used to. The average we are most used to seeing is fairly simple, you take all the numbers, add them up and divide by the number of numbers. While the median is the value of the middle number (ok, it’s really simpler than it sounds). For example:

Let’s look at a neighborhood with 1/2 the homes being detached and 1/2 being mobile homes. The sales prices in a period are:

Home 1 – $100,000
Home 2 – $100,000
Home 3 – $500,000
Home 4 – $500,000
Home 5 – $500,000

The average price of these homes is $340,000 ($100,000 + $100,000 + $500,000 + $500,000 + $500,000) divided by 5.
The median price of these homes is $500,000 (the price of Home 3).

This is important because of what happens the next period when the sales look like this:

Home 1 – $100,000
Home 2 – $100,000
Home 3 – $100,000
Home 4 – $500,000
Home 5 – $500,000

You can see that prices did not change. The only difference is we sold one more mobile home and one less house. However, here is what the averages now look like:

The average price of the homes sold is now $260,000 ($100,000 + $100,000 + $100,000 + $500,000 + $500,000) divided by 5.
The median price of these homes is now $100,000 (the price of Home 3).

Now, it would be bad enough if the news reported that the average price had fallen from $340,000 to $260,000, a drop of 24%. However, they report the median which in this case is a drop from $500,000 to $100,000, or 80%.

Did the market fall 80%? No. In fact, the market did not fall at all in our example. Mobile homes still sold for $100,000 and houses for $500,000. What changed was the number of each type of home that sold. That is why in good times the reported gain is larger than the true gain (more houses sell) and in bad times the reported drop is larger than the true drop (more mobile homes sell). That brings me to the December numbers for San Diego.

The early December numbers for detached and attached homes (I actually exclude mobile homes) look like sales increased strongly to 2,334 from 1622 a year ago, an increase of 44% (this is great, but those of you who get my weekly update know the main reason for this). However, those same numbers show that the median price fell from $548,000 to $375,000 a drop of 32% in one year. If we were really seeing 32% drops in value across the board, a recession would be the least of our worries. But, what do we now know about the median price? It overstates both increases in good times and decreases in bad times. To show this for San Diego, let’s look at the median home sold in December of 2007 and December of 2008.

2007
The Median home in December sold for about $548,000. This is best represented by a home in Oceanside at 1180 Players Dr. that was purchased directly from the builder. This home has 5 bedrooms, 4.5 baths and is 3,352 square feet.

2008
The Median home in December sold for about $375,000. This is best represented by the home at 1853 Sheep Ranch Loop in Chula Vista. This home was purchased from the bank (as a foreclosure) and has 3 bedrooms, 3 baths and is 1,780 square feet.

The importance for you and me is that while the newspaper may report that the median price is down by 32%, the price of your home did not fall by 32%. Prices did fall, but a lot of that 32% is the difference in a 3,352 sf home sold by a builder and a 1,780 sf home sold by the bank.

The Dangerous Middle – Investment Horizons Should be Very Short or Very Long

The market is starting to get interesting from an investment point of view.  We are seeing some very good opportunities, but with one definite caveat:  You either need to be a very short term or a very long term investor.  The reasoning for this is that the market is going to go through a very rough patch and I think the stimulus packages are going to fall short. 

As Clinton was leaving office and Bush coming in, we were in the beginning of a recession.  However, at the same time mortgage lending rules were getting less restrictive which was pushing up housing prices and allowing people to pull money out of their homes to spend.  Without this, consumer spending would have fallen and we would have worked through a moderate recession and probably be in the early to middle stages of an expansion.  However, with access to easy money, we started buying everything in site.  In 2005 this had risen to ridiculous levels as $595B was taken out of homes through re-finances and pumped into the economy.  In 2006 it was $687B and 2007 it had fallen to $470B.  The important point is that this money was taken out of houses whose values had been inflated and put directly (tax free) into the economy to create demand for things like cars, pool, boats, etc. as well as creating numerous jobs.  Over that three year period, $1,752,000,000,000 was put into the economy tax free (unlike income which is taxes, a loan on your home is not) and spent on goods and services.

The effect of this money is magnified as every dollar I use to buy something from you allows you to buy something from somewhere else.  Therefore, each dollar into the economy results provides more jobs and services than just that dollar would reflect. 

Contrast that with the $750,000,000,000 that is being put into banks as part of the current bailout.  None of that market is earmarked to go into the economy, but rather to go into banks to help save the mortgages of the homes that drove the growth in the first place.  The easy way to look at it is that there is a hole in the ground that needs to be filled and although we don’t know how big it is, it is probably at least $1.7T big.  The government is pumping the first $.75T into that hole now.  I’m not an economist, but I don’t think that will solve the problem – and we haven’t even addressed the exploding credit card debt that has to be repaid before people spend more money.

Because of all of the above, I think that we are in for a rough three to five years (A newsletter I read called this last election “Electing the Janitor-in-Chief”).  Therefore, you have to have a really short time horizon (less than 4 months) or a really long time horizon (over 7 years) if you are going to invest in real estate.   If you jump into an investment with positive cash flow, but then find yourself needing to get out in 3 years, you could get hurt.

I want to be careful to point out that this is only of investors.  If you are looking for a family home and will be putting down roots and getting the tax benefits of home ownership vs renting, the picture is completely different.

Based on this, for my investor clients, we are either looking at making purchases at Trustee Sales with an eye to a quick fix and a flip, or looking at homes that show a positive cash flow with a reasonable (25%) down payment.  Fortunately, those deals are now out there.