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.