The spring of 2009 has been profound for the dramatic change we’ve witnessed in the real estate market. Before diving in and taking a detailed look at the local market, let’s explore some of the broader based dynamics that are influencing it.
The recession that started around the 3rd quarter of 2007 will most likely run well through 2010, with more favorable economic performance anticipated as we get into the latter part of this year. Our Gross Domestic Product (GDP) is running around -2% and the California unemployment numbers were just announced at around 11.5%. The official numbers don’t reflect the very significant number of people who have lost their businesses, aren’t drawing unemployment, job-seekers who have just graduated college, or those who have earned money in the “shadow” economy… gardeners, housekeepers, nannies, etc. The “real” unemployment number is thought to be more in the 16-17% range.
Although the media would like us to believe otherwise, there is NO national real estate market. Statistics about the “US housing market” are meaningless and have often been used to sensationalize the news. Unfortunately, the California market really doesn’t need any sensationalizing. Prices in San Francisco’s residential market are down approximately 45% since May of 2005; Los Angeles is down about 40%; while cities that never experienced the big real estate run-up, like Charlotte, NC, are only down a few percentage points. We’ll get into the reasons for this in just a bit.
If one keeps in mind the simple “law” of supply and demand, it’s much easier to understand the present market. With the end to the moratorium on March 31st that allowed banks to hold back their inventories of foreclosures, we’re expecting a glut of them to roll into the marketplace this summer. Most are found in the east county areas, but there are a significant number expected to find their way into the local “Lamorinda” market.
While in 2008, it seemed like most people “hated “real estate, 2009 has provided opportunities for investors and long-term holders of real estate to get into the market with very favorable terms and expected asset performance. Foreclosed homes are now finding their way back into the rental pool as they get scooped up by anxious investors who are seeing them produce positive cash flow with low down payments. Those who were sitting on the sidelines, or who never thought they could afford our local markets, are now finding them affordable with the combination of dramatically reduced prices and historically low interest rates. Those interest rates will not stay low forever, and are already headed up in concert with the 10-year Treasury rates.
The high-end markets have been particularly stressed this year; not just locally, but on a worldwide basis. From Sydney to New York to San Francisco, the formerly “protected” markets have been severely impacted… quite frankly, in ways that many thought they’d never see. Regardless of how one defines our local “upper end” market, the picture will be unsettling for sellers. Based upon closed sales through the end of May, homes in Lafayette and Orinda priced at $1.5M and above had an inventory with 40 months of supply… measured by dividing available inventory by the number of homes that have actually closed escrow in a given month! If we define the “upper end” market as being comprised of homes $2M and above, we’re looking at about 28 months of inventory based upon the expected closings by the time you read this market letter!!
In fact, as of this writing, there are 56 homes on the market in Lafayette and Orinda at $2M+, and only 4 homes pending in escrow. Only 2 homes have closed escrow in this price range all year. The most recent of those homes entered escrow in early February. One of the four homes pending in escrow was purchased for $3.85M two years ago, and it sat on the market for months before the price was lowered to $2.995M where it finally garnered an acceptable offer.
So, why are we having problems in the upper end? Well, there are numerous factors that are far beyond the scope of this publication. However, we no longer live in a world where “the rich always have money.” In fact, we really need to look at where the money came from to buy all of these $2M+ homes over the last 5-7 years. Based upon anecdotal information from lender sources, much of it came from large performance bonuses, including from the now heavily impacted financial services industry. Those dollars are now gone, as are many of the jobs held by some of the present homeowners in this market segment. Replacement jobs are few and far between, and most aren’t at their prior compensation levels. Another large source of capital for these home purchase dollars came from stock option cash-outs. Those dollars are substantially gone now, too.
We should also add that the availability of loans for luxury homes has been extremely challenging. Whereas lenders were once giving loans to anyone who could fog a mirror, they now are making it extraordinarily difficult for some of our most financially qualified buyers. For the most part, the federal conforming loan programs don’t help the majority of buyers in our market, due to their upper limit of $729K. As a result, local buyers are largely dependent upon the handful of lenders who have extremely conservative “jumbo” loan programs available. This further constrains the supply of buyers and exacerbates upper end market woes. Recent upticks in mortgage rates, keyed off of increasing 10-year Treasury rates, could put further pressure on prices.
Some who have found themselves owning a luxury home, but without a job or with a lower paying one, have cut their superfluous expenses back and are doing everything they can to hold onto their homes. Many have already put their homes on the market, contributing to the build-up in inventory and it is expected that we’ll see others do so this summer and fall. For what it’s worth, the real estate economists who have studied our local markets don’t see improvement in this “upper end” segment until about 2011, when they forecast that it will stabilize and then return to “normal” real estate appreciation rates of 3-5% per year. In the meantime, they are forecasting further downside risk in the range of 5-15% over the next 18 months.
As further evidence of this, the banks are building this downside risk into their automated appraisal review process, and in some portions of Contra Costa County they are discounting “comparable sales” by 2% per month. We have heard of several recent sales where the banks have cut the appraisal by 10% upon review, even though the two parties to the transaction were contractually bound at a higher price. This leaves three alternatives… the buyer comes up with more cash to make-up the difference, the parties agree to a lower price, or the buyer backs out of the purchase.
The overwhelming majority of current activity is occurring in what has historically been considered the “lower end” of the local market. The average price of a home pending in escrow within Lafayette is around $1,070,000. On the positive side, this average “pending sale” price has increased over $100K above where it was about 3 months ago. In fact, the average price of sold homes in our area is up 3 months in a row, as astute buyers have jumped in to capture some of the outstanding purchase opportunities!
If you are a buyer in today’s market, you hold all of the power in the real estate transaction. Although there are plenty of homes that are still over-priced to today’s market, there are also many that represent excellent long-term values. Move-up buyers benefit in today’s market, whereas those who seek to downsize should consider waiting awhile, depending upon the type of market you would be moving into or what investment alternatives might be had with the sold home’s equity.
What do you do if you must sell? As painful as it might be, it’s best to be realistic about your market price. Only the homes that are compelling values are selling, and that’s across the board. In the upper end, being a compelling value in an “A+” location seem to be the key ingredients based upon homes that are presently pending in escrow. Don’t “test” the market at a high price, and then step your price down. “Testing” accomplishes nothing and only adds “Days on Market” to your listing in a soft market. If you insist upon “testing” at a high price, then be prepared to make a significant adjustment to market after no more than 30 days, otherwise you risk becoming a “stale” listing at an over-market price, and buyers will start to think that something is “wrong” with your home.
Unlike the latter half of 2008, we are seeing homes sell in 2009. All is not doom and gloom. As of this writing, there are 278 unsold homes on the market in Lafayette and Orinda, yet 69 of them are “pending sales” in escrow – almost 1 in 4 homes. The relative abundance of buyers in the lower end of the market, coupled with availability of lender capital in this price range, has caused the pending sales to be weighted at the lower end of the market. Therefore, if you have a home priced appropriately within this range, there is a strong chance that it will sell. Proper pricing is the key, since again, only compelling values are capturing buyer attention.
Remember that markets always cycle. This particular cycle is more unusual than most because it was coupled to and greatly exacerbated by the tremendous level of turmoil in the US economy, an unprecedented run-up in real estate prices fueled by lax lending practices, and finally the collapse of the lender’s “house of cards”. Nevertheless, it’s a cycle that will bottom out and turn back up. Specifically, we’ll most likely see the market cycle up in more affordable housing, followed by the upper end properties where the supply/demand relationship is most out of balance and where very constrained institutional financing has had the greatest impact.
We have always prided ourselves in conveying honest, fact-based information to our clients. We can’t change markets; we can only seek to understand them and to provide informed counsel to our clients – critically important in today’s complex, rapidly changing real estate market. We would be happy to help you navigate the current complexities of today’s real estate market in order to help you make the best decisions to achieve your personal financial objectives.
