Market Report: May 2007

Dear Friends;
 
After a robust spring rally the market appears to be cooling a bit. Although there are plenty of goblins lurking in the woods, I remain unconcerned about future prospects. Perhaps this is so because this is my fourth real estate recession. On another note, we finally have a good local project in Hillcrest available as a limited partnership. Call me for details.

--Jim

Real Estate's Dirty Bomb, Part II

Sub-prime loan defaults and conventional foreclosures have come to the forefront as the latest bits of evidence that the real estate market is far from recovery. There is more to the story as the rising tide of defaults is not the disease but a symptom. The putative value of the foreclosure data in shedding light on the state of affairs in real estate is marginal. The play we are witnessing has the same story line as before only with different actors. Markets are the same as Broadway; they love revivals and in fact cannot survive without them.

The question to ask is to what degree these foreclosures will exacerbate the real estate recession and perhaps affect the national economy. This would also include investment real estate as more often than not these markets are intertwined. A foreclosure must be viewed thusly; it is nothing more than an involuntary transfer of an asset from one person to another. Fees and jobs are created along the way. Housing is neither destroyed nor created. There are individual winners and losers. But in my view our community weal will benefit from the sub prime experiment, which is cast as the villain in this play.

As I noted in this space last month, "The debate about...sub-prime mortgages is also part of the larger discussion about density--or the expansion and democratization of the landowning classes." Sub prime mortgages can be seen as a great social experiment that did not totally succeed. But what effort to expand and democratize our national wealth has worked perfectly? Social Security has its flaws but who wants to toss it out? It could also be argued that the buyer of a foreclosed property is not all that different from its former owner. There will be an army of middlemen and banks along the way scooping up fees but the social and economic damage will not be as bad as it reads in the papers.

It is useful to speculate on the following: What if mortgage standards during the past five years were more rather than less restrictive? What if mortgage-underwriting guidelines required at least a twenty percent down payment? I posit that prices would probably be the same, if not lesser, had we had stricter lending standards over the past decade. The price run-up, which started in earnest in 1997, would not have been so expansive without a new class of buyers, formerly unqualified, entering the marketplace. And this also extends to people buying seven-figure homes with no payment as well as a clerical worker struggling with a no-documentation no-down payment loan.

I have no research to support my thesis. It seems patently true that reducing demand, by shrinking the pool of qualified buyers, would have tempered the price increases of the past decade. Real estate professionals will agree with this point. They saw the $300,000 condo seller move up to a $450,000 home that allowed that seller to buy a $700,000 house. The bulk of owners who just live in their homes and ride along with the cycles are probably no better or worse off even if the foreclosure situation gets worse. It only hurts to sell out; if you sell and buy in the same market you are really even.

On the Bubble

What prompted the article was a call from a friend. He purchased a Normal Heights home about two years ago in the high-400s enabled by a sub prime loan currently being loudly criticized by politicians of all stripes. Now that his loan payments have adjusted upward to reflect the true cost of money, my friend is in economic dire straights and is pondering his options. My friend's situation is not measured in the default statistics; this unknown does give me pause for concern. I do not think anyone has any idea of how many borrowers are on the bubble and pondering letting a property go.

Assuming flat prices for two or three years, the only way out of this potential disaster is going to come from the lenders. The lending community acted abruptly and without mercy in the 90s' and ended up with a huge and unwanted inventory of property. The inevitable losses led to a string of bank failures. Just like my friend, lenders will have to choose which path to take. Thus far it appears banks have learned a lesson from the past and are trying to save the borrowers. Greed, plus a nudge from the pols, will probably save the day. Or maybe inflation will, but more on that next month.

Click here to see Jim's past Market Reports. You can also download Jim's 26 page research paper on San Diego County apartments.

> Send me complementary, custom MLS listings
> Contact Jim Scott for more information or with comments at jimscott@sqre.com