Slow decline or is a big chunk about to be ripped out?

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Submitted by sdrealtor on June 4, 2007 - 10:31am

On a couple threads there has been some back and forth about what is coming in the next few months. Admitting I am in the long and painful decline camp with SD R and a few others. On the other side we have those that believe a large chunk of pricing (10% or more) is about to be taken out of the market quickly (LS2008, Rustico etc.). I'm not married to my opinion but beleive what I do based upon what I see in the markets I generally follow. Here's my case:

Closed sales figures for the 1st 5 months of 2007 vs. prior years for Coastal SD from Point Loma through Carlsbad show that volume is not declining there.

2007-1241 (still more late reporters coming)

Here is the averages represented by these sales (i.e. average size, selling price and price/sq ft).

2004 2,684 sq ft $1,072,428 ($400/sq ft)
2005 2,624 sq ft $1,176,811 ($448/sq ft)
2006 2,703 sq ft $1,252,146 ($463/sq ft)
2007 2,696 sq ft $1,199,774 ($445/sq ft)

I only have inventory for a couple ZIP that I follow closely but it is way down vs. last year in these areas.

My problem stems from my inability to see how a pricing collapse would happen administratively. I just dont see people with equity dropping their acceptable prices form 850K to 750K or from 600K to 500K. I dont see the lenders doing it either with inventory levels where they are. I'm not saying it's can't happen, I would just like to here some theories as to how it could play out over the next 6 months so we can all kick them around.

Submitted by Bugs on June 4, 2007 - 10:48am.

We're patiently waiting for the end of the 3rd quarter this year, because by then the media will be harping on the effects of: the looming spike in ARM resets; the skyrocketing foreclosure rates; the reality that this has been a really horrible year for volumes and prices; and the normal downturn that occurs after the end of the summer.

I think the public's recognition of all those factors is going to converge at about the same time. When that happens, if there's any remaining doubt that now is NOT a great time to buy real estate, the tone of the reporting will be alarming enough to cause that tipping point that will push the market psychology firmly and decisively into negative territory. At that point the correction will take on a life of its own and nothing will stop that correction from playing out - not lowering interest rates, not bringing back free money, not even price reductions.

And don't kid yourself about the builders not cutting pricing. There's little difference between the builders' positions in Riverside County and San Diego County, except that in SD County they actually have more margin between costs and sales prices.

Submitted by JWM in SD on June 4, 2007 - 10:58am.

Hear, Hear. This is what I have been saying for over a year now. Once the MSM gets it's teeth into the story, then they will not let it a pit bull. It will make for too good a story and they won't be able to ignore it anymore. It's at that point that J6Pack will finally get it and start to really panic.

Submitted by sdrealtor on June 4, 2007 - 10:58am.

Sounds like The Perfect Storm of bad sales data, rising foreclosures and negative media heading into seasonal slowness. All a very realistic scenario. My difficulty, which SD R no doubt shares, is seeing homesellers actually radically adjust their expectations so quickly. People hate change and resist it at all costs. Would that perfect Storm be enough to get them to do so? I just cant see it.

As for the homebuilders, they would definitely be the first to jump ship!

Submitted by FormerSanDiegan on June 4, 2007 - 11:03am.

I believe that the seasonal strength remaining in some areas this Spring will be a faint memory by September.
I anticipate that for SD county the bulk of the price drops in the area-wide numbers (e.g. median and Case-Shiller) will take place in 2007 and 2008. Looking back to the last downturn, the largest price declines were a couple years after the peak. We are entering that period now in San Diego.

It will look like a sharp decline in terms of the numbers, but as many here have noted, the changes in median price in this cycle has lagged the changes in similar house comparisons. I view the next 2 years as the reports finally catching up.

Submitted by an on June 4, 2007 - 11:09am.

As for the homebuilders, they would definitely be the first to jump ship!

The question then would be, if the homebuilders jump ship, how long can the private seller hold out. If a person can buy new @ 20% less than resale, why wouldn't they? The seller who do not have to sell probably will not adjust price fast enough to make a sell. I think it's the marginal sellers and builders who will affect the prices.

Submitted by HereWeGo on June 4, 2007 - 11:14am.

Coastal SD will likely remain solid for a while. The outlying areas are taking a beating, though. Worse yet, the definition of "outlying" appears to be expanding.

Submitted by Troubled Loner on June 4, 2007 - 11:29am.

Too many people will not have the luxury of waiting this cycle out, as homeowners did in the early nineties. We are going to see a growing number of banks and homeowners that will have to sell, adding more to inventory, forcing prices downward, and spooking out potential buyers.

My opinion is that we see an accelerated downturn in prices towards the end of this year, bottoming out (getting to rational fundamental prices) by the end of 2008, and then hanging out on that bottom for 5 or 6 years. I don't think we will see todays prices for at least 10 years, unless wages and inflation rise significantly.

It hasn't gotten bad yet, there are still people who think that homes are really worth what they're selling for in SD. There are people who think now is a good time to buy before prices start going up again. The psychology hasn't shifted yet, when it does, it will be ugly. How many of us remember what it was like in the early-mid 90's? The last thing anyone wanted to do then was buy a home.

Submitted by gn on June 4, 2007 - 11:30am.

"My difficulty, which SD R no doubt shares, is seeing homesellers actually radically adjust their expectations so quickly. People hate change and resist it at all costs"

It's true that sellers are stubborn & unlikely to lower prices. But if they can't deal with the ballooning ARMs, they'll face foreclosure & their houses will end up being sold by the lenders at reduced prices.

Submitted by sdrealtor on June 4, 2007 - 11:40am.

That is exactly what has been happeing the last few years with builders undercutting resales. I cant speak for other parts of the County but there is alot less new product on the market now. I believe this is one of the reasons my area has held up as well as it has. In the Coastal areas there just isnt enough new building going on rigth now to really haev amajor impact on pricing.

Submitted by sdrealtor on June 4, 2007 - 11:46am.

I agree that many homes will end up back with the banks. The whole foreclosure process spans many months and frequently more than 1 year from the time a missed payment turns into an REO on the market. The banks are rational sellers but are always looking behind at past market conditions rather than ahead at what might be coming. Throw in relatively low inventory and it could be some time before they fell the need to radically reduce prices.

I dont disagree with you or any of the other posters that it s coming but all I keep hearing "It's coming". I would really like to see someone lay out a realistic assumption as to how it could play out on the street level.

Submitted by SD Realtor on June 4, 2007 - 11:54am.

Pretty much agreed with sdr... There is NO DOUBT that many people will be forced to sell. They WILL have to sell at whatever the market dictates. However I see people with equity that are not in risky loan vehicles simply shutting it down and sitting tight. Whether they are wise to do that is not the point of the post, the point is that there is a very large number of people, with equity, with relatively safe financing vehicles, that will simply sit tight.

Will that support the market? No I doubt it. Will there still be alot of inventory, alot of REO, alot of distressed sales? Of course.

I think sometimes people may obscure the fact that there was alot of housing market activity before 2003.

Finally there are other people who also have horrid financing vehicles but who put alot of cash down. They are refinancing and sitting tight. Yes they lost equity but no they are not bailing out. There was a recent withdrawn listing on Sunset Ridge in Scripps that I was tracking that did this.

Agreed again with sdr on the REO pricing. That has been one of the most frustrating things of all this year and 06 was that the REO properties really are not priced that least not yet....

SD Realtor

Submitted by gn on June 4, 2007 - 12:08pm.

Like the last bubble, we know that when a bubble pops, it's not pretty.

Unlike the last bubble, this time around, the amount of the credit extended to investors was unprecedented. This means that the number of properties being held by "specuvestors" is also unprecendented. So, it'll probably be uglier than the early 90s.

It's like watching a horror movie. 15 minutes into the movie, there's some scary part, but that's just to warm things up. We haven't gotten to the REALLY scary part yet.

Submitted by DaCounselor on June 4, 2007 - 12:07pm.

"How many of us remember what it was like in the early-mid 90's? The last thing anyone wanted to do then was buy a home."

I honestly don't recall a widespread anti home ownership sentiment in SD during that time period. My recollection is that we were in the midst of a recession and most people I knew were under-employed and/or struggling to make a buck and/or concerned about career prospects in SD. The local economy seemed pretty narrow in scope and the phrase "sunshine wages" got tossed around quite a bit. I know a number of those in the "young professional" category who packed up and moved away, looking for greener pastures. But I just don't recall anyone saying they didn't want to buy a home or that a home in SD would be a terrible investment. In fact, my recollection is just the opposite - but the problem was no one was making the money or felt secure enough in their job to take the plunge. Of course, this is just my recollection.

Psychology on the buy-side is of course most relevant in a situation where someone has the means to get into the market but may choose not to. This is where things get interesting. En masse, how long will those who are able to stifle the seemingly inherent urge to own their own home be able to hold off on buying? How long will they wait? I have absolutely no idea. How will the general psychological make-up of many Americans - I want what I want and I want it now - factor in? Will MSM reporting "real estate = bad" trigger a sheep mentality that will over-ride what I see as a pre-existing and inherent desire to own and the "I want it now" mentality? Who knows - I sure don't. But it's going to be interesting to see how it plays out.

Submitted by sdrealtor on June 4, 2007 - 12:19pm.

I dont know the exact figure but I believe the actual number of "specuvestors" in SD county was relatively low.

That is not to say that there wasnt rampant speculation in SD County. Several months ago Rich (our host) put together a great series about people speculating with their primary residences. That is the real problem we face as I see it. People bought homes they really couldnt afford with the false expectation that RE always goes up. However, these primary residence speculators will be prone to hang on longer than pure specuvestors. Just another thing that has me stuck on a slow painful ecline rather than a short and steep one.

Submitted by Tone on June 4, 2007 - 12:38pm.

I think it all depends on the lenders.

For example, because of rumblings from the sub-prime market during the past couple of months, lenders have recently put the screws on 100% financing. What will happen once the bulk of foreclosures hit later this year and into next? Lenders could really tighten up standards in response. Furthermore, if investors are not willing to take on the risk of packaged mortgages, this could further push lenders back to the lending standards of yesteryear (20% down anyone?)

A change in lending standards could seriously dry up the pool of buyers and crash the market quickly as REOs and those who must sell race to the bottom to attract a shrunken pool of buyers. At least that's a scenario I could see play out.

Submitted by Troubled Loaner on June 4, 2007 - 1:12pm.

Tone, I agree, what allowed this bubble to inflate beyond historical proportions was the loosening of lending standards.

I believe eventually we'll get back to the traditional standards of 30 years, fixed rate, good credit, having to qualify according to your income, etc. Once that happens, how many people can really afford a home for $500,000? As more lenders get burned, they will tighten standards, further decreasing the buying pool. It's happening now, and will continue.

Years from now people will look back on all of this, at no doc, stated income, teaser rates, neg am, to anyone (yes, ANYONE!) getting a loan, and ask what the hell were we thinking?

Submitted by NotCranky on June 4, 2007 - 1:24pm.

You guys actually have me on the fence more than you know. I still think the macaroni is about to hit the fan.
The myth of the spring bounce is pretty much shattered. Latent downside tension from seller's who believed the spring bounce theory and price accordingly.Inventory likely to go up. I don't need to repeat everything else being said.
I don't expect sustained good news, on interest rates, jobs or any of the other potential economic drivers.

My sales pitch to buyer's is still the same. Wait six months and if things look better, for buying, wait another six months. Time is on your side. That said , I think there will soon be deals out there for the right kind of bargain hunter. The Temecula guys are having their day more or less. I think they are just getting the chain reaction going that will drive down comps but they arent idiots either. Maybe the first bargains will be the best? I think the chain reacton is coming to a zip code near us soon. However, the deals may be the exception and in the eye of the beholder and all. Maybe the real trend will move slower and more real than nominal.I am not clarvoyant nor do I know how to spell it.

Am I backtracking ? No! I am just trying to debate reasonably. If I understand bugs, he is in the big chunk camp. As a very good appraiser who has shown detachment from the debate and even his own opinion, I think he has the best perpective to analyze the question. In any case to paraphrase him...since the appreciation happend in big chunks especially 2003-2004 I don't see why it can't be taken off in big chunks. Do we need a similiar but opposite catalyst to the easy lending of those days? Or can the precarious way the cards are stacked be enough? I think either will do. In shaky times the probability that the catalyst surfaces is too high for yours truly to recommend anything but caution in our local market.

Submitted by sdrealtor on June 4, 2007 - 1:44pm.

You are not backtracking, you are taking a look at your opinions and it is healthy to challenge them. That is something I constantly do. I'm still stuck on this slow and steady thing. Regarding the big chunks of gains and consequently big chunks of losses, my feeling is that greed is a much more powerful and actionable emotion than fear. IMHO, greed compells people to chase risky opportunities while fear paralyzes them from making good decisions. I think you are onto something with the idea of a catalyst. Something that we dont see coming could certainly send the system in disarray.


Submitted by JWM in SD on June 4, 2007 - 1:52pm.


Do you know Todd Lackner?? The appraiser noted in the NC Times article who cooperating with the FBI on cash back mortgage schemes in SD??

Submitted by NotCranky on June 4, 2007 - 2:13pm.

Greed is actually self preservation gone awry. I think it is just as possible that self preservation is going to lead sellers to go more in the CYA direction. If there truly is a scarcity of buyers willing to bail them out and they are also also playing CYA , which seems apparent, there is the potential "Rush for the exits" right there. Add any other catalyst, maybe even just foreclosures finally getting priced like foreclosure and we got a stampede. Of course an unforseen catalyst could work the other way too. The only one really being considered seriously at all is a bail out. I think that could help the market find support earlier but that still might be after some serious depreciation?

Submitted by SD Realtor on June 4, 2007 - 2:26pm.

I think the catalyst could be the treasury yield. If we do not see any bond market rally and the yield keeps creeping up then we certainly may see the catalyst that will result in a depreciation notch down rather then a slow slide. Right now we are near 5 and the selloff has been going on for 2 months give or take. If the 10 year hits 6 or 7? Then yep for sure we will see the housing market get pounded good and hard and it will be fast.

SD Realtor

Submitted by PerryChase on June 4, 2007 - 2:34pm.

I'm a bugs fan. His posts are always to the point in a "big picture" way.

Now, lenders and the MSM are talking about giving homeowners reprieve by developing new "affordability" products.

I don't see how payments can be reduced anymore than Interest Only and Option ARM loans (which are forever loans). They're saying that owners with exotic loans should refinance into fixed rates loans. Yeah, sure! How are buyers who can't afford payments on Interest Only and Option ARMs going to afford payments with fully amortized 30 year loans?

The existing loan products have stretched out repayment as much as possible already. There's no way they can make the monthly nut anymore "affordable."

The can can't be kicked down the road any further. Even a stagnant or slightly declining market in 2007 will cause sellers to go under water (with selling costs and carrying costs). That will feed on itself and cause further depreciation in 2008.

Submitted by NotCranky on June 4, 2007 - 2:43pm.

Hello SD Realtor,
You are basically saying increased mortgage interest rates?

Submitted by SD Realtor on June 4, 2007 - 3:26pm.

Yep I am... I am always surprised that most people are not aware of what drives long term mortgage interest rates.

SD Realtor

Submitted by drunkle on June 4, 2007 - 3:34pm.

who pays the interest on tbills? the taxpayers, i presume.

who collects the interest on fed rates? private banks.

why are tbills and mortgage rates connected?

how are americans not getting screwed 6 ways to sunday?

Submitted by SD Realtor on June 4, 2007 - 3:36pm.

drunkle - aye caramba... nevermind...

Submitted by NotCranky on June 4, 2007 - 3:45pm.

Treasury Market and Mortgage Rates(link)

This is suppose to be a link to an informative page on the topic of the bond market and mortgage rates.

Edit: didn't work .."bond market and mortgage rates" is what I searched.

I'll try again.

Submitted by drunkle on June 4, 2007 - 3:55pm.

got it. given a choice between a tbill and a home loan, investors want the better return. especially considering the risk.

something seems screwed up about it anyway. like, the commoditization of ownership. but i can't put my finger on it.

Submitted by Bugs on June 4, 2007 - 5:18pm.

Truth to tell, I doubt the correction will include a big chunk, although I think the pace of correction might move relatively quickly for a couple years, starting at beginning of the year.

Looking at past swings, the pace of decreasing markets tends to be a little slower than that of the gains that preceded them. If we look at the slope of our recent spike we can see it went almost vertical between 2003 - 2005. Obviously it won't track down at the same pace but I think it's very possible that the pace of decline could move a bit faster than it is doing right now. A 10% or 12% decline in nominal prices doesn't sound like a whole lot, but if you multiply it by 3 years it starts to add up.

As a number of people have already commented, any home owner who is at all able to hold on to their home will do so. At any rate, they are not the ones for whom we should be fearful. It is the people who cannot hold on who are sitting on a must-sell transaction, whether they realize it now or not.

I think it will eventually come down to the size of the must-sell inventory vs. the size of the pool of buyers. We can see that these two numbers are moving ever closer towards each other every month. I highly doubt they'll actually meet, but I don't doubt that the number of must-sells will eventually comprise enough of the listings to drive the pricing for the remainder of the listings.

Submitted by waiting hawk on June 4, 2007 - 6:16pm.

The big declines most are hoping for will come once a recession comes in. If we do not see one by the end of this year I have told the wife I have to rethink 2 years worth of plans, but I am only watching land in an area that is not as popular so I have more faith. Watch the long rates and economy. You need one of those to go to get what you really want. You want to buy when most cannot and that my friends is why it gets cheap.

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