This week Bruce Norris joined once again by Leslie Appleton-Young. Leslie is vice-president and chief economist for the California Association of Realtors, a statewide trade organization with over 150,000 members dedicated to advancement of professionalism in real estate. Leslie directs the activities of the association’s member information group. She oversees the analysis of the housing market and brokerage industry trends, member communication, and membership development activities. She also is closely involved in the association’s strategic planning efforts and is a well-known speaker in California.
One of the things Bruce has noticed that has been on the increase is the percentage of equity sellers. This is probably a very significant development because in a way that is an acknowledgement that they are not going to see 2006 prices any way soon. It is an embracing reality and also recognizing that whatever they are going to do next in real estate is a good time to do it. If you are selling today and trading up, you are going to be fine. If you are trading down and possibly dealing with some other investment property, there are a lot of things you can do to get the advantage of the positives in this market, even though you are selling at a price that a few years ago you would have been somewhat disappointed in. When you are buying in the same market, you might ask yourself what the big deal is. People have a lot of emotional attachment as was noted in last week’s radio segment. You have almost 30% of the mortgages in California underwater, so people are in distress and many stuck right now.
Bruce wondered how different the reasons are for people buying in 2012 than in 2006. Leslie said you have more first-time buyers, and you have a little bit more of the trade-up situation going on because those equity sellers have finally realized this is not such a bad time and are going to jump on it. If you look back in 2006 and 2007, it was really a market dominated by REO purchasers and larger and smaller investors. It was more of a situation where certain prices were so low they were going to buy as many as they could and do their business model that way. When you look at the market today, it is much more balanced. It depends on the area. If you look at the sales that closed escrow in April, 58% were equity sales, about 22+% were REO, and about 19.4% were short sales. Therefore, you have a little bit of a balance between short and REO; it is a little bit more on the REO side while the rest are equity sales. When we first started to come out of the bottom, the REO market was well over 50% in many areas and likely close to that statewide as well. We certainly have over the past several years whittled down on at least the available inventory of REOs to the extent that now you have a two month supply, even less in some areas, of REO inventory.
One of the things mentioned in the first segment was shadow inventory. FHA has approximately 41,000 REOs right now, but they have over 700,000 people that are 90 days late. Fannie and Freddie have similar stories, and the loan mods have similar percentages. Bruce wondered what will happen with this inventory, if they are just going to really dole it out over time or take it to the sidelines as rentals. Leslie said they will most likely keep doing what they have been doing, which is to dole it out over time since this is the only thing that really makes sense for them in terms of managing their balance sheet and recognizing the losses on those assets. What is interesting is that it seems like almost every year, not including the last year or two; people would have a date set. They would ask questions like if they heard that on September 15 all of the banks are going to dump all of the foreclosed properties in one day. This never happened, and it will not happen. However, we still cannot say that this problem will not be with us for quite some time, possible 4-5 years in some areas. There is no magic bullet here; it is really one property or loan at a time. The impact of various programs will ebb and flow, but it takes time for the lenders to work through each and every one of these, and it is going to define our market for a while. Every year the market seems to be a little bit different, and certainly this market with fairly robust sales for six months in a row is showing that people are able to be more responsive today to the advantages of the market.
Bruce wondered what percentage of these sales investors are buying. Leslie said the investor sales in California are probably over 20%. In some areas they are significantly higher. All cash purchases have been about 25%. NAR had a number that was in excess of 30% a couple months ago. There are non-investors who are paying all cash for homes, but it is a very significant part of the market. About 80% of them are investing to rent, and possibly the other 20 are reselling, flipping, fixing them up, and selling them. However, this will vary by market.
What is interesting is we have had a big recession, and if you look at household formation, it really didn’t happen. We are way behind on household formation, and at some point the echo boom generation is going to play catch-up. You will see an article from time to time talking about the coming housing boom. When you look at the lifestyle choices that the generation has had to make given how lackluster the job opportunities have been and the doubling and tripling of families, at some point they are going to have the income and the job market is going to be conducive for them to break through or break free and enter the housing market. New construction was just hit very hard and has started to come up the last couple years, but it is still well below the 200,000+ units we need a year to house everybody. Things will be changing, but as long as the economy is as challenged as it is with the euro zone and Japan and India slowing, there are a lot of global trends that will impact our economy and our financial environment.
Things are either a lot more confusing than Bruce ever acknowledged, or it is more confusing than it ever has been. Leslie said she believes it is the latter and recognition of the impact of all these forces outside of our control is more heightened than ever. Mark Zhandi came out with an article that said the GDP is really dependent on the end result of Greece. Some people when hearing this might think that Greece is the size of Rhode Island, so how would it have that big of an impact. It is a little frustrating for Bruce as a local investor in Riverside that he has to pay attention to a lot of things outside of real estate and outside of our country. The financial community is a global community, and everyone is a player. Everyone is exposed to Greek debt and the Euro Zone. With all of that the financial crisis was a real wakeup call that it is not just about me in my little area, but you are directly impacted by what goes on overseas. It really is overwhelming.
Mark Zhandi also said we sometimes have the tendency to create today’s policy to solve yesterday’s crisis. Leslie said she heard him speak in D.C. a couple weeks ago, and he was right on target with comments like this. We are dealing with Dodd-Frank and qualified residential mortgage as if that is going to really be a game changer, and it is not. A lot of requirements for that loan is not necessary. Leslie said it will be a game changer in a very negative direction. One of the things Leslie said she has been concerned about is in order for a mortgage to qualify, the loan needs to have 20% down. You look at the last ten years of what the GSEs have purchased, and less than 15% would have qualified as a QRM under this definition. It is very restrictive, and the data shows that the difference the delinquencies and foreclosures for 10%, 15%, and 20% down are not that different. To focus on 20% is really going to be a burden for a lot of first-time home buyers.
There are a lot of policy implications tied up into what was most likely a real attempt to not let that happen again. However, the pendulum always swings too far in either direction. The timing of this is really not the best, and we don’t need to have the most restrictive lending policy when we have the affordability that is at all-time highs. When you can actually buy something and reduce your cost as opposed to rent, you would think that would be good idea to be more aggressive as a lender than less. There are so many people who, if they could, would just a straight refi that would take them down from 7% to 4%. They would then be able to stay in their home, so Leslie does not understand why this would not be a doable thing. There is really no difference since you are already in the position of 140% LTV, so you might as well be at a 140% LTV with a loan that somebody is going to make a payment on that you can afford. We saw in the San Fernando Valley in the ‘90s that people stayed in their communities even when they were underwater. It is not a completely rational profit utility maximizing decision when people look at their home in their community.
Bruce asked Leslie if she thinks Fannie and Freddie will not exist in ten years. This was the impression the GSEs gave Bruce and Sean O’Toole when they spoke in front of them in D.C. Leslie thinks this message has been sent loud and clear. If you looked at the white paper that the FHFA came out with earlier, you would see that this year they essentially said as much. However, the question is if it is a new entity or a combined entity, and what does it do if it is backstops. There are a lot of unanswered questions that have just not been fleshed out yet, and it is going to take a couple of years for them to do that. However, there is enough possibility of major change in which we all need to be involved. If you look at the mortgage market today, you see that last year well over 90% of the loans originated in United States for home were Fannie Mae, Freddie Mac, or FHA. That is just the way the market is, so the first-pass argument is that whatever you are going to do, don’t do it now. We have an industry and economy that is trying to get back on its feet. Looking longer term, Leslie did not think there was any doubt that there are changes that should, could, and will be made. The point is to do it in a reasoned fashion so that you avoid as much as you can, both pitfalls and distress, that is going to take the economy back where we don’t want it to go.
Bruce thinks one of the things that is going to happen in 2013 is we are going to have to get serious about generating some revenue and increasing taxes. Bruce wondered if Leslie fears that real estate would be one of the obvious targets for some of the policy changes. Leslie said she had the opportunity to go back with her leadership team a couple months ago, walk the halls, and go in and talk to the California Congressional Delegation. Without a doubt there is support for the mortgage interest deduction and a general feeling that this is not a time to mess with housing since it needs to get back on its feet. If and when a major effort at tax reform begins, likely after the election, everything is going to need to be on the table. Leslie said they were told this a couple of times by people who were very sympathetic. The thought was if we take the mortgage interest off, then somebody else is going to their thing off while another is going to take their thing off until pretty soon nothing is going to be on the table. Being realistic about it, everything is going to be on the table, and we will just have to see how things go.
The majority of the California Congressional Delegation has signed on to a resolution that has been passed around for the last two years supporting the mortgage interest deduction as it currently exists. However, if you recall what happened in 1986, you had a midnight deadline for a 3,000 page bill, and there is a timeline where people sign on and you see the mortgage interest deduction get capped at $1 million. It is hard to updo an affordable housing argument against that kind of cap, but it does also leave open the door for further reductions down the line. Leslie said they will be watching this and participating in these discussions with great interest.
When it comes to topics such as Proposition 13, Leslie said she cannot imagine a time that this will be looked at in a realistic fashion to change. It is too much a part of the landscape, and the lore. The public support for Prop 13 is quite strong, and we have a budget in Sacramento that does not hold together for this year or for the foreseeable future. There are commitments made in terms of pensions and medical support that are going to require an increase in taxes, higher revenue, or a reduction in those benefits. It is not going to be for the faint of heart to watch that process going forward because everybody has something to protect. The bottom line is we are going to have to keep cutting back until we can afford what we are doing. Fiscal responsibility is extremely important.
One thing the real estate boom did was provide a lot of revenue that did not exist prior. It looks like we figured out that more revenue does not necessarily solve the problems. We now have a dearth of revenue, but if we are trying to get new revenue sources then this is not really the solution. We really have to go to where the cuts are, which is happening. You are seeing cuts, and you will continue to see more and more cuts. There is a structural issue with respect to the commitments the state has made and what it is legally required to do since it cannot file for bankruptcy. The local municipalities can though, which is what makes Chapter 9 bankruptcy an interesting study. We have seen this in Vallejo and a few other cities. Michael Lewis released a book titled Boomerang in which the last chapter is actually about San Jose and what they are facing with expenditures that were related to an economy that disappeared and that promises that were made to public sector employees are now the bulk of their budget. Hopefully some lessons have been learned, but we are going to have to find our way out of it. This will most likely come with a mixture of cuts and revenue, but it is going to have to be primarily cuts. This is why Bruce believes real estate will not leave the table unscathed. Hopefully they will leave some things that are important. We had quite a price decline, so possibly a reduction in the amount of interest as far as up to a certain dollar amount would not be the end of the world at this point.
Another interesting topic is mortgage settlement for the California market. Bruce wondered which would be likely to occur: $12 billion for write-downs or short sales. Are people looking at reductions with this $12 billion? Leslie said she does not really know since she has not been following this that closely over the last month or two. She has not really seen much in the press about what they are doing. The initial reaction was it was great, but in California it really is a drop in the bucket. She has not read anything that has been an update on where it is all going. Bruce said he thinks he knows where it is earmarked to go, but Leslie said it is probably too early in the game and the process to have really seen an outcome yet. On the city of Riverside’s foreclosure task force, it is anticipating knowing what kinds of funds are going to be available and for what purpose. As of now, they really don’t know. Leslie said it is hard to get even a little cynical after the last five years when you hear about a new program that is going to do one thing, but only ends up doing a tiny part of it. This is not very successful.
Bruce wondered what percentage of the market now is first-time home buyers. He knew it got down to about 37%, although Leslie said it is at about 40%. She said they were going to have their annual market survey in the field next month, and this is really the data that she looks at the most and has the longest time trend on. They recently just completed a homebuyer survey, and about 47% of the people in that example were first-time buyers. Therefore, this is probably the general ballpark. If we had more inventory, it would probably be higher.
Bruce also wondered how the membership is holding up and what the mood is like. Leslie said membership peaked in 2006 at 211,000 realtors this year. She said they are going to come in at about 158,000, which is awfully good considering what has gone on in the market and the percentage of the business done by a smaller subset of agents. All that being said, they really are very busy, very engaged, and they are encouraged by the market fundamentals. This is to say after 4-5 years, there is definitely a new mood of positivity.
To find out more about Leslie’s business and any updates, go to www.car.org.
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