Buyers

East Bay Real Estate Crisis Is Over!

The Wall Street Journal article from May 6 is the most well thoughout explanation on the status of the current housing market.

By CYRIL MOULLE-BERTEAUX –
May 6, 2008; Page A23

The dire headlines coming fast and furious in the financial and popular press suggest that the housing crisis is intensifying. Yet it is very likely that April 2008 will mark the bottom of the U.S. housing market. Yes, the housing market is bottoming right now.

How can this be? For starters, a bottom does not mean that prices are about to return to the heady days of 2005. That probably won’t happen for another 15 years. It just means that the trend is no longer getting worse, which is the critical factor.

Most people forget that the current housing bust is nearly three years old. Home sales peaked in July 2005. New home sales are down a staggering 63% from peak levels of 1.4 million. Housing starts have fallen more than 50% and, adjusted for population growth, are back to the trough levels of 1982.

Furthermore, residential construction is close to 15-year lows at 3.8% of GDP; by the fourth quarter of this year, it will probably hit the lowest level ever. So what’s going to stop the housing decline? Very simply, the same thing that caused the bust: affordability.

The boom made housing unaffordable for many American families, especially first-time home buyers. During the 1990s and early 2000s, it took 19% of average monthly income to service a conforming mortgage on the average home purchased. By 2005 and 2006, it was absorbing 25% of monthly income. For first time buyers, it went from 29% of income to 37%. That just proved to be too much.

Prices got so high that people who intended to actually live in the houses they purchased (as opposed to speculators) stopped buying. This caused the bubble to burst.

Since then, house prices have fallen 10%-15%, while incomes have kept growing (albeit more slowly recently) and mortgage rates have come down 70 basis points from their highs. As a result, it now takes 19% of monthly income for the average home buyer, and 31% of monthly income for the first-time home buyer, to purchase a house. In other words, homes on average are back to being as affordable as during the best of times in the 1990s. Numerous households that had been priced out of the market can now afford to get in.

The next question is: Even if home sales pick up, how can home prices stop falling with so many houses vacant and unsold? The flip but true answer: because they always do.

In the past five major housing market corrections (and there were some big ones, such as in the early 1980s when home sales also fell by 50%-60% and prices fell 12%-15% in real terms), every time home sales bottomed, the pace of house-price declines halved within one or two months.

The explanation is that by the time home sales stop declining, inventories of unsold homes have usually already started falling in absolute terms and begin to peak out in “months of supply” terms. That’s the case right now: New home inventories peaked at 598,000 homes in July 2006, and stand at 482,000 homes as of the end of March. This inventory is equivalent to 11 months of supply, a 25-year high – but it is similar to 1974, 1982 and 1991 levels, which saw a subsequent slowing in home-price declines within the next six months.

Inventories are declining because construction activity has been falling for such a long time that home completions are now just about undershooting new home sales. In a few months, completions of new homes for sale could be undershooting new home sales by 50,000-100,000 annually.

Inventories will drop even faster to 400,000 – or seven months of supply – by the end of 2008. This shift in inventories will have a significant impact on prices, although house prices won’t stop falling entirely until inventories reach five months of supply sometime in 2009. A five-month supply has historically signaled tightness in the housing market.

Many pundits claim that house prices need to fall another 30% to bring them back in line with where they’ve been historically. This is usually based on an analysis of house prices adjusted for inflation: Real house prices are 30% above their 40-year, inflation-adjusted average, so they must fall 30%. This simplistic analysis is appealing on the surface, but is flawed for a variety of reasons.

Most importantly, it neglects the fact that a great majority of Americans buy their houses with mortgages. And if one buys a house with a mortgage, the most important factor in deciding what to pay for the house is how much of one’s income is required to be able to make the mortgage payments on the house. Today the rate on a 30-year, fixed-rate mortgage is 5.7%. Back in 1981, the rate hit 18.5%. Comparing today’s house prices to the 1970s or 1980s, when mortgage rates were stratospheric, is misguided and misleading.

This is all good news for the broader economy. The housing bust has been subtracting a full percentage point from GDP for almost two years now, which is very large for a sector that represents less than 5% of economic activity.

When the rate of house-price declines halves, there will be a wholesale shift in markets’ perceptions. All of a sudden, the expected value of the collateral (i.e. houses) for much of the lending that went on for the past decade will change. Right now, when valuing the collateral, market participants including banks are extrapolating the current pace of house price declines for another two to three years; this has a significant impact on the amount of delinquencies, foreclosures and credit losses that lenders are expected to face.

More home sales and smaller price declines means fewer homeowners will be underwater on their mortgages. They will thus have less incentive to walk away and opt for foreclosure.

A milder house-price decline scenario could lead to increases in the market value of a lot of the securitized mortgages that have been responsible for $300 billion of write-downs in the past year. Even if write-backs do not occur, stabilizing collateral values will have a huge impact on the markets’ perception of risk related to housing, the financial system, and the economy.

We are of course experiencing a serious housing bust, with serious economic consequences that are still unfolding. The odds are that the reverberations will lead to sub-trend growth for a couple of years. Nonetheless, housing led us into this credit crisis and this recession. It is likely to lead us out. And that process is underway, right now. I realize that many of you may have opinions about how the real estate markets are impacting you personally and I welcome your comments. Until next time…

Buyers

Sellers Need To Become Buyers NOW!

Since East Bay real estate is currently a Buyers market, become one NOW!

Here we are in the first week of February and there are still Sellers who are living in “pretend” that there has not been a price correction in the East Bay real estate market place. The price correction obviously varies from the Berkley side of the hills, Orinda to Pleasanton, central Contra Costa, southern Alameda county, and East county region. No matter what region it is, Buyers are the ones running the show this month. So, Sellers, pay attention! You need to become a Buyer ASAP! As long as you hang out as a Seller you will not be having the opportunities Buyers have today – unbelievable mortgage rates, a selection of great homes from which to chose, and awesome values!

Here is the dynamic that Sellers need to consider. In the hyper-appreciating market of 2003 to 2005, it was a Sellers market, and new price highs were set each month in almost all of East Bay real estate. The Sellers were “going to the bank”, however, once they sold their home, becoming a Buyer did not allow them the same advantages of being a Seller. Why? Because the price of the next home they were purchasing in the East Bay just appreciated another 2.5% since they sold their home. So, the Seller who just became a Buyer was now chasing a hyper-appreciating market and needed to pay top dollar for their next home, and typically they were in multiple offers with other very competitive Buyers who wanted the same home.

So, here we are today. The reason a Seller needs to become a Buyer immediately is because of the complete opposite market dynamic in the East Bay real estate environment. The Seller may not be happy about their eventual selling price, but once they get over current market realities, they will be in the drivers seat of this market as a Buyer. It is not a market that is hyper-appreciating. It is a market that has had over 18 months of price corrections, interest rates are at a three to four year low, and the government is working hard to create the needed mortgage money and debt assistance extremely favorable to California Buyers.

And, when I hear Buyers talking about waiting on their next purchases, “… until the market hits bottom”, my question back to them is, “What information sources are you using to determine when the market will hit bottom?” Almost 100% of the time they say they are using newspapers and the media to make that determination. You must be kidding! Remember, if it “bleeds it reads”! Here is the latest snap shot from DataQuick for January 2008, that provides the real stats on what is happening in each local real estate market;

• Current months of inventory are down 25% in most East Bay real estate markets compared to thirty days ago! This is a HUGE shift!
• The mini-markets continue with large variations between cities, with the San Ramon Valley at 7.04 months of inventory, and Lamorinda at 6.95 months of inventory. ( Months of inventory means how long would it take to sell the current number of homes for sale in a given city if no more listings came on the market.)
• Overall, for the twenty-six communities in the East Bay, there is 10.33 months of inventory which indicates it is still a very strong Buyer’s market, BUT it is starting to shift!

One other indicator to watch closely today is interest rates. As mortgage rates decline you will see an increase in sales, which will begin to stabilize home prices, which will begin a slow shift to a level playing field for both Buyers and Sellers. The window of opportunity for Buyers is starting to close before your very eyes. So, Sellers, become a Buyer ASAP and enjoy the buying experience of the current East Bay real estate markets. Until next time…your real estate and lifestyle detective remains on duty. I always welcome your comments and perspectives.