Bruce Norris is joined this week by Leslie Appleton-Young. Leslie is vice-president and chief economist for the California Association of Realtors, a statewide trade organization with 155,000 members dedicated to the 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.
For someone like Leslie who really heads up a lot of the talks in front of realtors, it must be quite a relief for her to say some pleasant things about the market. Leslie said what is particularly interesting is to go back just twelve months and be right at the cusp of the acceleration that we saw in 2012, then look back and see how quickly things changed. Bruce said in the January 15th report that really covered the final numbers for the year, the median price was $366. This was a change of 27% year-over-year and an unbelievable price change. It begs the question if the inventory mix was different or if the prices have really moved that much. Leslie said it is really a combination of both. We have had a really significant shift in the last year in what is selling. If we go back to December of 2011, 27% of the closings in California were REO. A year later in December 2012, it was only 11%. In one year you went from over a quarter of a market to about 10-11% of the market.
Equity sales or traditional sales that were not distressed went in the same twelve month period from 48% to 64%. Short sales stayed about flat at 24% a year ago and 25% now. You can see that you had a big drop in the available supply and hence sale of REO property, which tended to be at the lower end of the price scale and a lot more sales at the upper end. It was the same in 2012, at least for California, which is leading the rest of the country in the housing recovery since we led the downturn. We have seen a very significant shift back towards a traditional non-distressed market.
Bruce said what is interesting about this is we are at 64% traditional sales. Bruce wondered if it was ever really this low during the 90s. 64% is an improvement from where we were, but Bruce does not know if we have ever had 64% traditional sales in our history. Leslie said she thinks he is right and this is a point that gets to the whole issue of negative equity. You go back to the 90s, and the percent of people who were underwater was less than the 29% that we have today in California. It is a whole different ballgame.
One of Leslie’s quotes from this cycle that we have just been through, as painful as it was, was the quote, “If you do not have equity in your home, you’re not a homeowner.” This is relevant on so many levels. If you look at the 90s and see how people behaved in a market where prices went down but they still had equity in their home, they hung in there. This time around, prices came down, people went into foreclosure, and they walked away because there was nothing left to save. This has likely been what has made this cycle so painful and drawn out.
Bruce said we went down in the 90s very gradually over a period of 5-6 years. It seemed like it was a repetitive 5% a year, whereas this time we dropped off a cliff and sometimes it seems like we are going down 3-4% a month in some counties. There was no way to catch that falling knife. It solves very quickly when there is nothing left to save. On top of that, we had a hard macro picture in terms of job losses and job opportunities, which exacerbated the declining price situation for many people.
Leslie mentioned the REOs becoming a smaller percentage. In one of her presentations, she took a look at the REO sales as a per dollars per square foot. For example, if you have it down as $116 a square foot and you have equity sales at $243 a foot, that is definitely not the same inventory. As an investor, there is virtually no discount in the marketplace for an REO, so it is a significantly different house. It is almost apples and oranges except when you are reporting on state as a whole with aggregate data. Then everything gets put in the same pot. Slicing and dicing this data in a meaningful way is the only way you can figure out what is going on. As Bruce noted earlier, the median home price in California increased 27% in December. It was buffeted around as an example by such a change in the composition of what was selling.
What is interesting is that the composition could be changing for two reasons. One would be if the jumbo loan market improved. However, we also could just have more houses turning to be expensive because of price appreciation. This is something that is being seen in Corona. Right now we see almost a 4% price movement per month. You are seeing this in areas where prices sell dramatically and were extremely attractive to first-time buyers and particularly investors. This was the canary in the coal mine investor that was looking to buy as early as 2008. Bruce said they did not have a lot of company when they were doing this, and a lot of people were talking about the pending shadow inventory and the extra price decline it would bring. At this point Bruce thinks most people would have to either believe they were mistaken or things are not going to happen because of policy changes.
Leslie said it is often hard for people to look ahead because the reality of today is so real. The question is how many people in our industry thought we would be in this situation today where we have a market that is really the strongest individual sector in the entire economy. Bruce said when you try to make decisions based on current emotions, that is dangerous. Bruce is thankful he has charts he can look at and see what is inevitable. For instance, regarding the inventory decline we have, a report came out saying that at the beginning of 2012 there was 4.3 months, and now there is about 2.6 months. It really does not feel like there is 2.6 months of available inventory somehow. It seems like half of it is pending because it seems like every time there is a house, it goes pending unless there is something radically wrong with it. This could be if it is so overpriced it’s ridiculous or it is missing a kitchen. Things are going into escrow very quickly.
The policies that were in place for 2012 that took inventory down by about half have not changed. You have all this demand that is still potential, only it is chasing half of the inventory. There are some data issues, and one of the things that seems to be propping up in a lot of discussions around the state is the off-market listings that are not counted in the MLS. You have to get the property in within the first 48-72 hours after having had a proliferation of private groups that are keeping it off. This may be a factor in under counting. Right now we are in the process of seeing how big that is, but it may be a little bit of a data issue.
Another thing that has been discovered is in past cycles investors tended to buy, fix the property up, and get it back on the market ASAP. This time, eight out of ten plus are fixing them up and renting them because the economics of renting is attractive in a market with low rates, rental appreciation, and price appreciation. This is keeping homes off the market as well, so there is a variety of reasons why you have inventory as low as it is. All of these things are probably going to continue to be so in the future. You have a great demand for the product, and you have a good chance that you are going to balance two months of inventory for the entire year. The big question mark in terms of forecasting sales for 2013 is on the supply side, not the demand side. So the question is how much inventory are we going to have.
What you have to then look at is the CoreLogic data that has 20% of the mortgages in the state being underwater. This is a lot of people, over 2 million properties, that are not really doing anything yet. Some of them are going to become whole as price appreciation increases, or they may do a refi and stay, and they may list. Whatever they do is going to happen slowly, so there is not really any magic bullet. Your forecast ahead is always gradual, but you look backwards and things turn on a dime occasionally. This may happen with inventory, but Leslie said she is trying to get her head around what that could be. She does not see it, and neither does Bruce.
When we said there was going to be 20% price appreciation in 2013, a good part of it was Bruce said he could see the demand side of it being real. However, he cannot see the supply side changing radically since they are not going to do REOs in quantity. FHA is selling their notes that are delinquent, so that is not going to be a big HUD list like we used to have. Only about 70% of your equity sellers are capable of putting these on the market without it being a short sale. Therefore, you are just naturally drawing from a diminished pool for the moment. What is nice about that you only need about a 20% price increase to solve half of that list. Once we get there, it is game over and the rest of them will be encouraged to keep hanging in there. Bruce thinks anyone who is current is going to stay.
Leslie said the big question mark is how soon the economy will reach the 6.5% unemployment target and start giving some higher rate messages to the market. When rates start going up, you are going to get movement in terms of some of the investors. They will see higher yields in other areas of the economy. This will most likely not happen this year since this economy is still struggling. You could also have California react very differently from the rest of the country, and this is one of the things that encourages Bruce about California. It is going to fare much better than the nation, so you will probably get a national policy that stays at this low rate that will be given to a California that doesn’t really need it anymore. We could probably survive just fine with a 4 ½% mortgage rate, but we are going to have it at 3 ½% or less.
It would be an adjustment and would have an impact. It is not that it will not create a reallocation of capital. The idea that these low rates are going to be with us forever is not going to be the case. David Stockman, Reagan’s CBO director, talked about another bubble. His argument was you have so many properties owned by investors that if and when rates go up significantly or even not significantly enough to make a difference, they are going to list and sell and move onto something else. It is an argument you have to think about because we have not really been in this situation before where you have such a large segment of the market being purchased by investors.
Bruce said an investor by definition is the cash flow type where a lot of the people would ultimately like to pay off the property and own it free and clear. In that case, the property is not going to re-emerge. One of the things that could be done for the glut of these properties not to re-emerge is to give them financing that they can go along with. The unfortunate fact of this is you cannot. You can get ten loans, and then you have to go to a loan like Bruce provides. He is giving a 9.9% interest rate, and it still makes sense that it will cash flow and they will buy it and hold it for appreciation. That person will sell that property because the real gain is in the appreciation. We could have a market that would be very different if we could give financing to investors.
You have the large Wall Street companies coming into the marketplace, so Leslie asked Bruce what his take is on Blackstone and the hedge funds. They may be responding a little bit differently than the individual investor who wants to pay it off and own it forever. Their game plan would be very different, and Bruce thinks sometimes they will form a REIT. In this case the properties may just stay permanently rentals. There are other companies such as Carrington who probably have a goal price, and then they will exit.
What is interesting is we are asking ourselves if these people are really market makers and if they are changing the prices and rents right now. Bruce thinks this is one of the things that is going to start to happen. Bruce does not know if they have calibrated, but the big group of people foreclosed on in 2008 and 2009 can now save money going from renter to owner, which is unprecedented in California. It would seem if they are buying 500 rentals in an area like the Inland Empire, and at the same time the people who were foreclosed on in droves are trying to go from renter to owner, they may not get the yield they were thinking. It may be that they exited them earlier. There are already a couple companies that have exited their game plan. They thought they were going to do it, and then they found out it was not that easy to manage 500 scattered homes.
The people who are buying in bulk have to hold for five years. Fannie Mae most likely has a share in the appreciation of it, and it is almost like they are partners. This is a totally different game, and Bruce does not know how many Southern California properties are involved in this. It would seem like it would be a lot, but both Bruce and Leslie do not think it is. The situation involves more the 5-10 units individual investor. Bruce has met with several companies, and the reason they wanted the meeting was they wanted him to gather a group of investors who would flip them properties. They were having a hard time finding properties since they were not available. They were sitting there with a big check book, and they are spending a lot less of their money than they thought they were going to be able to spend.
Leslie said it is a much better market, but it is a frustrating market when you look at multiple offers and over bids. Some of the data Leslie has seen, particularly coming out of the Silicon Valley, is really disturbing in terms of how quickly that market is moving and the proportion of all cash transactions still happening. A lot of money on the sidelines is coming back into the market even today with a vengeance. Bruce said he is pretty republican politically, but this is the one time he has looked at a market and said he really does not think Wall Street is serving a purpose for the public for it to be here driving up prices and making inventory non-existent.
Bruce said when he buys and sells homes, they usually have 130-150 sales a year, but they sell none of them to the people even though they receive offers from them. They sell it to owner occupants because that is why they are here. Bruce has been on the other side, and they deal with realtors who deal with 50 buyers that have no income or sales. They are trying to buy a property, and they get beat out left and right by something that is easier to close, such as a cash sale. You cannot blame anybody since all cash rules. It is unfortunate. NAR just came out with data on housing affordability, and you look at this data and see how it has never been this positive. Rates are so low, but if you have to finance it all then you are at a disadvantage in this market.
Bruce looks at investors, and he sees a lot of people have it in their mind that foreigners are buying up everything. Looking at a chart they have, you see that they represent 5% of the market. It is small if you look at the whole state, but it is much more significant if you look at specific areas. If you take 5% of 500,000 sales, all of a sudden you are looking at 25,000 homes statewide. This is not a market maker in the sense that you are going to change the dynamics of a whole state if every one of those people decided to put up a house for sale. You know they are not all going to do this. Bruce said he does not know if the hedge funds own more than what the rest of the world is buying, although they are having a hard time buying their share. Bruce does not know the impact, although it really depends on how high they let prices go at these low interest rates. This is something they are both concerned about as they do not want to see a $600 median price with a 3% mortgage rate. Leslie thinks we will see rates come up way before this. Bruce said it depends since California may have a much brighter picture than the rest of the country.
Leslie thinks the long-term sustainable improvement in the housing market is directly tied to jobs. In California, Silicon Valley and the Bay Area is the best economy in the state, and we certainly have come down in terms of the unemployment rate being better than it was three years ago. We are making progress. One of the things Leslie likes to talk about is pent-up demand. This is all of the households that would have been formed that were not formed because college and high school graduates could not get jobs and had to move back in with their parents. The actual number of households that are invisible right now is between 375,000 and 575,000 depending on what kind of a growth rate you would have extrapolated with. This means you have people who just aren’t going to be able to make a market until they get jobs. California is doing a little better than the nation as a whole, but we need to do a lot better in order to really have this not be a financial phenomenon but rather an economic growth issue that is shared throughout the state by the population. This is what is still missing.
It is very powerful to talk about a state that sells 500,000 homes, and you have almost a year’s supply of pent-up demand due to unusual circumstances such as the recession. When that changes, you are going to have another group wanting to get into a fixed housing cost as opposed to a variable called rent. This is going to create a lot of demand.
To find out more information, you can visit CAR’s website at www.car.org. This site contains fantastic information to keep you updated on all of the current statistics on sales, price, and affordability.
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