Market Showing Signs of a Bottom

 Recap – Last Year – A sharp correction

In the 2nd half of 2007 market activity and prices fell off a cliff. (see www.LBRE.com for previous newsletters). The correction was so abrupt and dramatic, it ranked as the largest year over year price drop in California real estate history. (See Case-Shiller S&P Stats next page)

But as quickly as the market dropped, it has shown signs that the worst may be over, and a bottom may be in place. At least for single family homes in some Long Beach neighborhoods.

Market uncertainty and the media

With the recent volatility, buyers don’t know what to believe. If you listened to the media, you might conclude it was the end of the world for the real estate market. But the media these days is more about sensationalism than balanced reporting, so the average consumer may think the market is weak. In Long Beach, where we focus, this is definitely NOT the case.

Economic health – It’s a matter of perspective

An appropriate quote, “When your neighbor loses his job, it is a recession, when you lose YOUR job it is a depression”. Certainly the credit crunch and the resulting drop in values has devastated some while others remained unaffected.

Feeling stress are those owners that bought in 2004, 2005 or 2006 with little down or marginal income, or owners that refinanced at the market’s peak and used the proceeds to support a lifestyle beyond their means.

But the majority of homeowners that didn’t use their home as an ATM will remain unaffected. Many were in disbelief at the markets final ascent. So the recent adjustment wasn’t too big of a shock.

Related industries may also feel some pain

The contraction in the real estate market has also devastated those counting on a high volume of real estate transactions, or those benefiting from consumers flush with home equity.

Real estate related services (sales, escrow, title, termite and lending) expanded dramatically during the last 10 years to serve the needs of a hyper active market. The volume of activity is way down (although picking up in the last two months). There has been overcapacity of people in these industries, many of whom will not survive the downturn. Also affected are industries that benefited from increased home equity, such as home remodeling, residential construction, auto and RV sales.

Depending upon who you listen to, your outlook would vary widely. Rather than listen to the media or individual market participants, let’s listen to the market.

Locally supply is low & demand is strong

Putting aside all of the negative media hype and acknowledging that some will be dramatically affected, current supply & demand figures point to a market that is bottoming.

12 month supply of homes, now only 4 months

The market has shifted dramatically from a 10 month supply to a 4 month supply of homes for sale, in just the last two months. Two months does NOT make a trend. But this shift is HUGE and warrants attention. (see charts next page for monthly supply and demand).

Supply remains low & is lower than it appears after short sales are removed

If you look at the chart “Unsold SFR Inventory” on the next page, May & June’s inventory shows two numbers. About 2 months ago the SoCal MLS started tracking short sales (when loans are in excess of the sales price and sellers can’t sell without the lender agreeing to lose money). While the total number of unsold homes is 1,100, there are only 800 homes for sale, not counting the 300 questionable short sales.

Demand has Come Back – And is likely to Stay Strong.

While the market has been quiet. There still seem to be more buyers than sellers. Albeit these buyers have been cautious, they have to be. Banks will no longer just throw money at anyone with a pulse. Buyers must document their income and have a down payment, just like in the good old days.

There also has been quite a few buyers that have decided to wait until next year when they think prices will be lower. These buyers will provide future demand. If the market is currently bottoming, even with tight underwriting guidelines, and a reduced number of cautious buyers, it may only get better if some of these buyers get off the fence. So it is likely the market may have some staying power and not get weaker.

Anecdotal arguements for a bottom – 17 offers

Penny recently wrote an offer on a listing that was slightly under priced. It was a 1,210sf, 3/1.5 bath home in the Carson Park area of Lakewood. Homes like this have been selling for around $430,000 – $450,000. It was listed for $399,000. A total of 17 offers piled up on the property and the home sold for around $450,000.

This is not the kind of price action of a market that is going down in value.

I have personally had other transactions where there have been multiple offers, and have spoken to several agents that work in the East Long Beach areas that have had bidding frenzies when a listing is under priced.

Bidding wars on very well priced listings indicates price support and confirm a potential bottom in home values.

But don’t expect the market to come roaring back

While the market has shown very strong signs of bottoming, don’t expect prices to just bounce back. It will take a while to work through the overhang of future foreclosures that will be trickling or flooding onto the market over the next several years.

Loose lending practices allowed buyers with no or low down payments to purchase homes they could not afford.

To determine how long it might take for the market to come back, we simply need to estimate the volume of potential foreclosures and compare these with the typical number of sales the real estate market can handle.

How many over extended home owners are out there?

 Sub-prime lending really came into fashion in the second half of 2003 and lasted until the credit crunch, in July/August 2007. The bulk of these stupid loans were during this 3-4 years period, when as many as 50 percent of transactions used marginal sub-prime financing..

Currently home prices are back to 2004 prices, putting some other home owners potentially at risk:
1) Buyers that could afford their home when they bought, but have no equity. They might they be more likely to walk, especially when faced with financial hardship, a job transfer or relocation.
2) Homeowners that refinanced in the last several years and pulled out more money than the home is now worth.
How long will it take to purge the market of home owners that can just barely hold on. My guess is around 3-5 years.

It took 3-4 years of bad lending practices to create this mess, it could take at least this long to clean it up.
The number of sales will likely be greater from 2003 – 2007, than it will be in the next couple of years.

In addition to potential foreclosures, the markets also has to support normal sales from buyers trading up, relocation, divorce and death.

So going forward if 50% the of sales are sellers caught in the downdraft of lower prices that are stuck with payments the can’t afford and the other half are normals sales, and the market is a little slower, 3 years turns into 3-5 years.

January 2008 starts the process

While 2007 was slower, it really wasn’t until the last quarter of 07 that prices dropped and loan programs dried up. From this point forward we are now working in a different environment of lower prices and reduced access to credit. It is this combination that has really started the shake out.

Is 5 years too long for the market to return?

Honestly, I don’t know. If more buyers can hold on, or more properties sell, or if prices go up to provide some relief, or oil prices go down, maybe we can work through the potential foreclosures quicker. I simply don’t know the answer. There are to many variables and too many uncertainties. But history does offer some comparisons.

Historically 4.5 years would not be out of line.

Based upon the last cycle when the market peaked in 1990, prices didn’t start to go back up until 1996 and didn’t reach the previous peak values, reached in 1990, until late 1998. So based upon past cycles, 5 years sounds about right. But even if I am grossly wrong and it only takes 2-3 years to work through the inventory of potential foreclosures, it will still take another 2-3 years before prices climb 20-30 percent and help some owners recoup their losses. But that does indicate that it will be unlikely for the market to simply spring back and undo all the damage done.

While it is very difficult to predict the future, it is fair to say that 2 years will not be enough to make some home owners whole again.

National Housing News Doesn’t Matter, Only Pay Attention to Local Numbers Specfic to Your Property.

While we have been specifically talking about Long Beach. The health of particular markets vary greatly, even within Long Beach.

While Long Beach has been less affected than high growth areas, such as Riverside and San Bernadino, within Long Beach certain areas or types of properties are fairing better than others.

Here are some overall rules of thumb for what neighborhoods have seen greater price drops.

Areas that had more first time buyers from 2004-2007 are likely to have a greater correction. More homes sold to first time buyers in Lakewood and North Long Beach than in East Long Beach during the easy money period of 2003 – 2007. Consequently there are more potential buyers that may not have equity or be able to afford their home going forward.

Condos and high growth areas would also fall into this category. More first time buyers during 2003 -2007, will result in more potential foreclosures. I am certain that home owners in the inland empire and other high growth areas would love to have our relatively “Slow and Steady” real estate market.

Less desirable areas have been hit harder than more desirable areas. As prices headed out of most buyers reach, many first time buyers competed aggressively for second tier markets, pushing prices of Lakewood homes to right below those of Los Altos homes, and North Long Beach home prices, came in right under Lakewood home prices. As the credit market has crumbled, this compressed accordion has began to unwind, with the lower priced neighborhoods seeing a greater percentage drop.

Overall I would say today’s prices are between 15% – 30% off peak values, depending upon your area.

While overall the market has shown a 20% year over year drop in LA County, it is really dependent upon what area you live in and the price range of your home.

Should you have specific questions regarding your neighborhood, we invite your calls.
John Dumke