Second Quarter New Home Sales

The Gregory Group, has their corporate headquarters in Folsom. They are an information service company. They collect data from the building industry and then sell it back to the individual builders. Builders use the information to make decisions about the number of homes to build, how their competition is doing and even design features. Last Friday the Gregory Group reported home builders had sold 1,788 new homes in the Capital region during the second quarter of this year. The number was a 33 percent decline from the first quarter of this year and 1,336 fewer new unit sales than were sold during the same quarter in 2006.

The average selling price of a new home sale in the region during the third quarter was $444,233 or 11 percent below last year and about the same as it was for the second quarter of 2004.

El Dorado County reported only 29 new home sales for the period. The average price was $768,000 and 2 percent higher than a year earlier. Placer County had 515 for the three- month period with an average price tag of $512,000 declining 5% from last year. Sacramento County reported 868 new home sales averaging $414,000 and an 11% decline in price.

Greg Paquin, President of the Gregory Group said about the low sales and high inventory “I think the expectation or hope now is that 2009 or late 2008, is when we’re going to come out of this thing.”

One reason it is a little slow out there for builders is all the existing homes for sale. The region currently has 14,700 existing homes on the market. “I honestly think it’s more than 50 percent psychological,” said Dean Wehril a research executive with Sullivan Group Real Estate Advisors. “People are thinking, Why not see if I can get a better deal in six months. It’s almost a cliché, but it’s a lack of urgency. “

Opportunities in a down cycle market

At the end of the day we will probably regret more things we didn’t do in life than the things we did. Recognizing opportunities is difficult when caught up in life’s immediate realities but history can provide us a window to the future, keeping events in perspective including real estate cycles.

This is my fourth real estate correction in my 34-year practice. Each was the result of different economic or political forces and each resulted in declining property values. Not surprisingly each downturn was followed by a strong rebound.

Oil and gasoline or the lack of suitable supplies fueled (forgive the pun) the real estate recession in the 1970’s. The 1973 oil embargo by OAPEC resulted in government gasoline rationing and price controls. The cost of a barrel of oil quadrupled within a year. The shock plunged the New York Stock Exchange 97 billion in six weeks and the country entered a period of high inflation and an economic recession. Real estate values declined, as did the migration to the developing suburbs. Realtors who could afford to pay the high cost of fuel couldn’t buy any because their license plate didn’t end in the correct number. I was previewing neighborhood properties on a bicycle.

In the early 1980’s, inflation resulted in mortgage interest rates soaring above 14 percent. The higher mortgage rates prevented most homebuyers from qualifying for a loan even if they were willing to pay the high interest. Sellers offered buyers the benefit of assuming their existing lower rate mortgage with the balance of the seller’s equity paid over a period of time or when financing became available. Creative seller financing included: seller carried second and third deeds of trusts, contracts of sale, wrap-around mortgages, balloon payments and lease-options. Then making matters worse, the courts stopped creative financing, preventing buyers from assuming a seller’s lower interest loans. The monetary/inflation crises of the early 1980’s prevented many from considering homeownership.

My third real estate recession beginning in 1991 was the result of job looses primarily due to defense industry cutbacks. California had been the beneficiary of the military industrial build-up during much of the 1980’s under President Regan. At the end of the Cold War, the Clinton administration and bi-partisan Base Realignment and Closure Commission closed military installations all over the state including three in Sacramento. Between 1991 and 1995 a million Californian workers were displaced by defense industry curtailments. Families who are unemployed don’t buy houses.

It’s probably too early to call the exact cause of our current real estate downturn. The flippers and investors have taken much of the blame but they have always been a factor in any market. Builders did what they do best. Overbuilding has led to declining property values but is overbuilding the direct cause of the market’s decline or were builders the recipient of other market factors? Subprime lenders will face increased federal and state regulations for their role in the problem. The reality is, subprime lending has helped far more families into their first home than it has harmed. More people own a home today and will tomorrow because a lender took a big risk making a loan to a credit-challenged borrower. The media, politicians and consumer advocates continue to look for easy high profile targets to blame for our current predicament. This market correction, unlike the other three, is occurring during an expanding economy, historically low interest rates and a plethora of financing options. What’s up with that?

One thing that all our past economic and real estate down cycles have in common is they all bounced back. The Arab oil embargo in 1973 led to increased domestic exploration and new emphasis on alternative energy sources and conservation. The out of control of mortgage interest rates of the 1980’s led to a tighter monetary policy by the Federal Reserve, which was ultimately responsible for ratcheting down the interest rates to historically low levels. Displaced defense industry workers in the early 1990’s found employment in the emerging technology sector and the more recent availability of easy financing and low interest rates has resulted in the highest percentage of homeowners ever. Despite affordability critics, more Californians own their own home today than ever before.

While there are many real problems with our current market such as: poor mortgage choices by some borrowers, over-building by some builders, predatory lending on the part of a few lenders and inflated home prices, I believe much of the malaise in the housing market is based upon a lack of confidence in its return to some normalcy. Although past performance is no guarantee of future results the odds are favorable that it will.

Booming California

Our current real estate market malaise can be attributed in part to an oversupply of homes currently for sale and a lack of demand. That condition will not last forever. According to a study, recently released by the state’s Department of Finance demographers, the state’s current population of 35 million will expand to 39 million by 2010, 44 million by 2020, 49 million by 2030, 50 million by 2032 and hit 60 million by 2060. Expanding population is not the problem keeping up with the demand for housing is.

Current land use policies, infrastructure and the cost of construction will not allow new construction to keep pace with current growth projections. So what will happen when demand exceeds supply? Right! Prices will rise.

Sutter, Yuba and Placer counties are predicted to be the fastest growing counties in the state during the next few decades while Sacramento County is expected to nearly double from its current 1.3 million people. El Dorado County is expected to grow from its current 175,000 to 315,000, Amador from 36,000 to 68,000 and Nevada County from 95,000 to 136,000.

If you’re looking to escape this growth in population, move to Sierra County above Yuba and Nevada. It’s the only California County expected to decline from its current population.

When bank compete........

Lending Tree is a large Internet lender who has a television ad campaign that talks about banks competing for a customer’s mortgage business. One of the lines in the commercial is “When banks compete… you win.” Well, that probably depends upon your perspective. What if a number of banks were in competition with individual homeowners trying to sell their properties? Do sellers win? How does that affect the market value and equity of other neighborhood property owners?

Sandra is an attorney in San Jose who I helped purchase an investment property in a nice new development in Rancho Cordova in 2005. Her intent was to rent the property for two years and then sell for a profit. Last week her tenant called to say he was leaving at the end of his 2-year lease. Sandra then called me to ask about selling the property. As with many other clients this year, I counseled Sandra not to sell her property. As Kenny Rogers said, “You need to know when to hold ‘em and know when to fold ‘em” and this wasn’t the year to fold ‘em. Sandra understood the market but did not want a negative cash flow from her rental. She could off-set the capital loss on her sale by some other capital gain she had on another property she sold earlier this year. I still encouraged her to hold off on selling but promised to check out her local neighborhood values and calculate her loss after selling costs. Maybe she could break even.

After checking on the neighborhood listings and sales I was more convinced that Sandra should postpone the sale of the rental. Sandra purchased the new home at the top of the market in July of 2005 and her neighborhood values have been declining since. The local builder, in a close-out special in 2006, lowered his prices on the same model home, dropping Sandra’s value $25,000 and the only recent sales and listings were short-sales and a bank repo dropping her value even further. The property history on the short sales and bank foreclosures revealed that the banks were competing with each other. Each time one lender would lower their listing price the others would follow. “When banks compete……

My job was to show Sandra some alternatives to selling her property at this time. She could not afford to compete with financial institutions that were currently influencing the southward direction of the market. The first thing I did was to analyze the sale of the property. After deductions for all selling expenses and the cost of a vacancy while the property was for sale, she would lose $50,000. That would be a firm loss with no chance of recovery.

Next we calculated her yearly loss on the property. When she purchased, she put 20 percent downpayment but the negative difference between her mortgage, taxes, insurance and property expense and the market rent would still be $500 a month. As a rental with a negative cash flow, Sandra would receive some relief in the form of deductions from her other income and Sandra could afford to take the $500 a month hit with some adjustments to her 401K contribution. The question was for how long? We looked at a five-year scenario.

According to the California Association of Realtors, since 1982, the year over year price of a single family detached home in Northern California has declined in only 5 of the last twenty-five years. The most severe decline of property values was in 1991 with a 6.1 percent drop from the previous year. By contrast, twenty years have shown increases. The highest year-over year increase was in 1990 with a 25 percent jump in property values, followed by a 24 percent bump in 2004. The median price of a home since 1982 has increased 367 percent for an average of 14 percent a year. Although past performance doesn’t guarantee future results, it’s likely that property values will appreciate in the future by a minimum yearly average of 5 percent. That’s what we used to calculate a future sale.

Based upon no rental increases in the next 5 years and no vacancies, Sandra was scheduled to put $30,000 into her property. Then we figured, with a 5 percent compounded appreciation rate, what her property would be worth in five years. After subtracting her mortgage and selling expenses her profit would be $50,000 after returning her initial downpayment and the $30,000 that she invested over the five-year period. By using historical averages, conservative economic projections and know costs, we were able to calculate the return on Sandra’s investment.

Too often we make emotional decisions based upon short-term pain or gain. Real estate as an investment is subject to the current market fluctuation but consistent long-term appreciation.