By Ken Roberts
BIM Publisher's Note: This column appeared in Business Insider Magazine's "Selling the South Bay" issue, 3rd quarter, 2006.
BIM Publisher's Note: This column appeared in Business Insider Magazine's "Selling the South Bay" issue, 3rd quarter, 2006.
You can’t turn on the TV, the radio or pick up a newspaper without being barraged with news about the housing bubble. And if you think about it, the media has been banging the drum about the pending gloom and doom in the housing market for the past three years. If you are currently a homeowner or want to be, it’s certainly difficult to determine where our local real estate market is going and when. Part of the problem is that the South Bay doesn’t always go the same way at the same time as the rest of Southern California, let alone the rest of the country. Certainly, the San Diego or San Francisco marketplaces have very different local forces at play. So exactly where does the South Bay fit in the grand scheme of the housing slowdown? Will there be a gentle touchdown or a big crash in local real estate values?
Everyone likes to compare the housing price correction of the ‘90s to today. Home prices in 1989, like today, hit historic highs. South Bay real estate values had almost doubled from ’86-’89. Today’s prices have certainly reached epic proportions. But that’s where the similarities end. In 1990, California fully participated in an economic recession. Because of the end of the Cold War, there were huge cutbacks in defense spending and aerospace, resulting in the loss of thousands of local jobs. Today, we are coming out of a recession and jobs are being created. Historically, almost every housing correction was preceded by an economic disaster-- i.e., recession, high unemployment, skyrocketing interest rates, runaway inflation, etc. We currently have low unemployment, higher but historically low mortgage rates, an expanding economy, and moderate inflation. Yet prices are starting to decline. In 1989, according to the Federal Home Loan Bank Board’s Monthly Interest Rate Survey, 30-year fixed mortgage rates averaged 10%. In 1998 when the housing market started to rebound, those same 30-year fixed rates had declined to about 7%, substantially higher than today’s low to upper 6% range!
The most recent numbers from the National Association of Realtors show the national median price of a home nationally in August was $225,000; down 2.2% from $230,000 in July and down 1.7% from $229,000 a year ago. This was the first month-to-month decline since April of 1995. Inventories grew to a 7.5 month’s supply--the biggest since April of 1993. Yet 2006 will be the third best year ever in terms of number of homes sold. On a year-to-year basis, the number of sales dropped 22% in the West. So how does that compare to the South Bay? It’s plain to see the large increase of for-sale signs around town. Homes are sitting on the market longer. Gone are the days of multiple offers with sales over full price in a matter of hours. Price reductions are now exceedingly common. Additionally, properties are staying on the market longer. But how does the South Bay stack up against the rest of the country?
To conduct the analysis, I broke the South Bay into three segments: (1) Torrance (includes Torrance High, South High, West High and North High areas.) (2) The Beach (includes Manhattan, Hermosa and South Redondo) and (3) Palos Verdes (includes PVE, RPV, RH, RHE). I looked at the number of sales from January through August of ’05 and ’06 and the number of properties currently listed. I took the average number of sales occurring now divided by the total number of homes for sale to determine how many months inventory exist currently. Here are the numbers from data received from the Greater South Bay Regional Multiple Listing Service:
(1) Torrance
# sales avg./mo days/mkt $ volume___ avg. sales price
01/01/05-08/31/05 - 678 85 15 $ 470,600,000 $ 697,000
# sales avg./mo days/mkt $ volume___ avg. sales price
06/01/06-08/31/06 - 571 71 29 $ 425,500,000 $ 745,000
Current homes for sale - 313 Avg # sales/month - 71 No. months inventory - 4.41
(2) Palos Verdes
# sales avg./mo days/mkt $ volume___ avg. sales price
01/01/05-08/31/05 - 544 68 15 $ 760,750,000 $ 1,4000,000
# sales avg./mo days/mkt $ volume___ avg. sales price
06/01/06-08/31/06 - 399 50 36 $ 583,500,000 $ 1,462,000
Current homes for sale - 293 Avg # sales/month - 50 No. months inventory - 5.86
(3) The Beach
# sales avg./mo days/mkt $ volume___ avg. sales price
01/01/05-08/31/05 - 1358 170 17 $1,425,000,000 $ 1,050,000
# sales avg./mo days/mkt $ volume___ avg. sales price
06/01/06-08/31/06 - 1096 137 31 $1,322,000,000 $ 1,227,000
Current homes for sale - 690 Avg # sales/month - 137 No. months inventory - 5.04
Torrance - 16% drop in # of sales, 10% drop in sales volume, # days on the market doubled
6.5% increase in average sales price, 4.4 months unsold inventory
Palos Verdes - 27% drop in # of sales, 23% drop in sales volume, # days on the market doubled
4% increase in average sales price, 5.9 months unsold inventory
The Beach - 19% drop in # of sales, 7% drop in sales volume, # days on the market almost doubled
14% increase in average sales price, 5.0 months
This gives us some rudimentary numbers. I suggest we not read too much into them other than to say our local real estate market is holding up better than the rest of the country so far. This doesn’t mean the local market won’t get worse through the holidays, a typically slower time, or next year. We will have to wait and see.
One of the possible reasons for a pullback in prices is supply and demand. When supply increases and demand decreases, prices decrease. Potential buyers, believing the media’s message of the pending crash of the real estate market, don’t want to buy at “the peak” only to see their home’s value fall dramatically. So many are waiting to see when prices decline and by how much. The demand to buy exists. It is simply sitting on the sidelines. There is a natural ebb and flow in all markets. The stock market has bull markets and then corrections. The market consolidates before moving up again. Over time, it has always moved higher. Although certainly more volatile than the real estate market, it isn’t much different. Let’s put this in perspective. If you were one of the unfortunate souls who bought a home at the end of December 1989--the absolute peak of the real estate market then--you would have seen your home’s value decline by some 30-40% by 1997. If you would have simply held on until today, everyone would congratulate you because you bought at “just the right time” since your home has appreciated so much in value!
The message is: Prices may correct, a little or a lot. It only matters if you have to sell into that market. Just make sure you have the ability to weather a storm by not overextending yourself. Some experts believe our downturn in prices resembles the recent real estate corrections in Australia and Great Britain. Median home prices doubled in Australia and tripled in the United Kingdom. Their economies swooned briefly, avoiding a recession, even though rising interest rates affect consumer spending more there than here because more homeowners there use adjustable rate mortgages. Home prices suffered short periods of decline and are on the rise again; about six percent in both countries over the past year.
A substantial national real estate downturn would seriously hurt our economy. Residential construction represents 6% of our gross domestic product. That, coupled with new Fed Chairman Ben Bernanke’s wanting to err on the conservative side to contain inflation, has led some experts to conclude that the Fed may have already raised rates too high, inevitably triggering a recession. Historically, after the Fed has finished raising rates in succession, it begins lowering short-term rates within six months. The Fed controls the Federal Funds Rate--not mortgage rates. So mortgage rates do not follow directly what the Fed does with short-term rates. Mortgage rates are determined by the Bond market. The most accurate gauge is the Fannie Mae 30-Year Bond. The next best gauge for mortgage rates is the 10-Year Treasury Note. Right now the 10-Year T- Note yield is priced at about 4.50% and the Federal Funds Rate is at 5.25%. That 0.75% differential means the Bond market believes we could see a 0.75% to 1% drop in mortgage rates in 2007. Lower mortgage rates could help keep the housing market correction a shallow one. It all depends on how the economy fares moving forward.
A recent article in Barron’s Online discussed the fact that we don’t have a housing bubble, but rather a lending bubble. A combination of loose lending guidelines, 100% financing, negative amortization loans, interest-only loans, and no income or asset verification have allowed borrowers to buy more house than they can reasonably afford and thus put themselves and their homes at risk in the face of a real estate downturn. Evaluate with a qualified mortgage expert your current mortgage or the mortgage product you are contemplating. Make sure you are fully apprised of the real risks and rewards. The Pay Option ARM (Adjustable Rate Mortgage) loan product that so many borrowers are either choosing or more likely, being sold today, is certainly a big part of the problem. It was designed for well-heeled borrowers to manage their cash flow to create some arbitrage with their assets. Unfortunately, there are “salespeople” who may have been peddling cars six months ago “selling” the low monthly payment to everyone without fully disclosing the downside risk. Too many people are tempted by 1 to 2% teaser rates without fully comprehending the ramifications. You get to pay 1 to 2% now, but you may owe 7.5% or higher when all is said and done. It doesn’t take a rocket scientist to figure out that if you’re not paying 5 to 6% of what is owed, you will have to “pay the piper” eventually. It’s called negative amortization (neg-am). The shortage amount is added to your loan amount each month. So if you only pay the low teaser rate amount, your loan is actually getting bigger each month. Banks haven’t helped matters. When they fund a Pay Option ARM loan, they get to show the fully amortized payment as received income on their books while the borrowers are making the minimum payment. That makes their financial statements look better. And if the margin added to the index the loan is tied to is high enough, this product becomes highly commissioned for the loan officer. Not a good combination... Too often, borrowers are shocked that in as little as three to five years of making the minimum payment, their loan hits its neg-am cap and becomes a fully amortized loan at 7.5% or higher. That can cause their monthly payments to double or even triple! This is unlike a fixed period ARM that has the payments and interest rate fixed for five, seven or 10 years with the option to make interest-only payments. This can be a very powerful financial planning tool when coupled with a sound financial strategy. The neg-am Pay Option ARM certainly isn’t a one-size-fits-all proposition. Controversial mortgage products are tools to be used judiciously depending on your circumstances and only after all the risks have been assessed.
At the other end of the spectrum is buying 30 years worth of mortgage in a 30-year fixed rate loan and only using it for three, five or seven years before selling the property or having the opportunity to refinance into a lower rate. Then you have wasted thousands of dollars for security that you didn’t need. Contrary to popular belief, interest rates are not going to go up and stay there forever. In other words, if you didn’t get locked into a 30-year fixed rate in the last few years, you haven’t missed your once in a lifetime chance! As long as the Fed keeps inflation well-contained, the possibility of really high mortgage rates is very slim. And every time we have a recession, short-term rates and mortgage rates will roll back down again. Just like you should meet with your investment advisor at least annually to make sure your investment objectives are being met, it’s wise to meet with a mortgage planning professional for an annual mortgage review. The right loan product coupled with safe, proven equity repositioning techniques can be the difference between retiring sooner with more money and simply not being able to retire!
With our landing gear down, we are approaching the runway. The fire trucks and emergency crews are on hand with sirens wailing along with the onslaught of TV cameras and reporters, in morbid anticipation of the imminent real estate crash. Be it a rough landing or soft one, the important thing to remember is, it’s only temporary. The local real estate market will fly again, higher and farther than before.
Everyone likes to compare the housing price correction of the ‘90s to today. Home prices in 1989, like today, hit historic highs. South Bay real estate values had almost doubled from ’86-’89. Today’s prices have certainly reached epic proportions. But that’s where the similarities end. In 1990, California fully participated in an economic recession. Because of the end of the Cold War, there were huge cutbacks in defense spending and aerospace, resulting in the loss of thousands of local jobs. Today, we are coming out of a recession and jobs are being created. Historically, almost every housing correction was preceded by an economic disaster-- i.e., recession, high unemployment, skyrocketing interest rates, runaway inflation, etc. We currently have low unemployment, higher but historically low mortgage rates, an expanding economy, and moderate inflation. Yet prices are starting to decline. In 1989, according to the Federal Home Loan Bank Board’s Monthly Interest Rate Survey, 30-year fixed mortgage rates averaged 10%. In 1998 when the housing market started to rebound, those same 30-year fixed rates had declined to about 7%, substantially higher than today’s low to upper 6% range!
The most recent numbers from the National Association of Realtors show the national median price of a home nationally in August was $225,000; down 2.2% from $230,000 in July and down 1.7% from $229,000 a year ago. This was the first month-to-month decline since April of 1995. Inventories grew to a 7.5 month’s supply--the biggest since April of 1993. Yet 2006 will be the third best year ever in terms of number of homes sold. On a year-to-year basis, the number of sales dropped 22% in the West. So how does that compare to the South Bay? It’s plain to see the large increase of for-sale signs around town. Homes are sitting on the market longer. Gone are the days of multiple offers with sales over full price in a matter of hours. Price reductions are now exceedingly common. Additionally, properties are staying on the market longer. But how does the South Bay stack up against the rest of the country?
To conduct the analysis, I broke the South Bay into three segments: (1) Torrance (includes Torrance High, South High, West High and North High areas.) (2) The Beach (includes Manhattan, Hermosa and South Redondo) and (3) Palos Verdes (includes PVE, RPV, RH, RHE). I looked at the number of sales from January through August of ’05 and ’06 and the number of properties currently listed. I took the average number of sales occurring now divided by the total number of homes for sale to determine how many months inventory exist currently. Here are the numbers from data received from the Greater South Bay Regional Multiple Listing Service:
(1) Torrance
# sales avg./mo days/mkt $ volume___ avg. sales price
01/01/05-08/31/05 - 678 85 15 $ 470,600,000 $ 697,000
# sales avg./mo days/mkt $ volume___ avg. sales price
06/01/06-08/31/06 - 571 71 29 $ 425,500,000 $ 745,000
Current homes for sale - 313 Avg # sales/month - 71 No. months inventory - 4.41
(2) Palos Verdes
# sales avg./mo days/mkt $ volume___ avg. sales price
01/01/05-08/31/05 - 544 68 15 $ 760,750,000 $ 1,4000,000
# sales avg./mo days/mkt $ volume___ avg. sales price
06/01/06-08/31/06 - 399 50 36 $ 583,500,000 $ 1,462,000
Current homes for sale - 293 Avg # sales/month - 50 No. months inventory - 5.86
(3) The Beach
# sales avg./mo days/mkt $ volume___ avg. sales price
01/01/05-08/31/05 - 1358 170 17 $1,425,000,000 $ 1,050,000
# sales avg./mo days/mkt $ volume___ avg. sales price
06/01/06-08/31/06 - 1096 137 31 $1,322,000,000 $ 1,227,000
Current homes for sale - 690 Avg # sales/month - 137 No. months inventory - 5.04
Torrance - 16% drop in # of sales, 10% drop in sales volume, # days on the market doubled
6.5% increase in average sales price, 4.4 months unsold inventory
Palos Verdes - 27% drop in # of sales, 23% drop in sales volume, # days on the market doubled
4% increase in average sales price, 5.9 months unsold inventory
The Beach - 19% drop in # of sales, 7% drop in sales volume, # days on the market almost doubled
14% increase in average sales price, 5.0 months
This gives us some rudimentary numbers. I suggest we not read too much into them other than to say our local real estate market is holding up better than the rest of the country so far. This doesn’t mean the local market won’t get worse through the holidays, a typically slower time, or next year. We will have to wait and see.
One of the possible reasons for a pullback in prices is supply and demand. When supply increases and demand decreases, prices decrease. Potential buyers, believing the media’s message of the pending crash of the real estate market, don’t want to buy at “the peak” only to see their home’s value fall dramatically. So many are waiting to see when prices decline and by how much. The demand to buy exists. It is simply sitting on the sidelines. There is a natural ebb and flow in all markets. The stock market has bull markets and then corrections. The market consolidates before moving up again. Over time, it has always moved higher. Although certainly more volatile than the real estate market, it isn’t much different. Let’s put this in perspective. If you were one of the unfortunate souls who bought a home at the end of December 1989--the absolute peak of the real estate market then--you would have seen your home’s value decline by some 30-40% by 1997. If you would have simply held on until today, everyone would congratulate you because you bought at “just the right time” since your home has appreciated so much in value!
The message is: Prices may correct, a little or a lot. It only matters if you have to sell into that market. Just make sure you have the ability to weather a storm by not overextending yourself. Some experts believe our downturn in prices resembles the recent real estate corrections in Australia and Great Britain. Median home prices doubled in Australia and tripled in the United Kingdom. Their economies swooned briefly, avoiding a recession, even though rising interest rates affect consumer spending more there than here because more homeowners there use adjustable rate mortgages. Home prices suffered short periods of decline and are on the rise again; about six percent in both countries over the past year.
A substantial national real estate downturn would seriously hurt our economy. Residential construction represents 6% of our gross domestic product. That, coupled with new Fed Chairman Ben Bernanke’s wanting to err on the conservative side to contain inflation, has led some experts to conclude that the Fed may have already raised rates too high, inevitably triggering a recession. Historically, after the Fed has finished raising rates in succession, it begins lowering short-term rates within six months. The Fed controls the Federal Funds Rate--not mortgage rates. So mortgage rates do not follow directly what the Fed does with short-term rates. Mortgage rates are determined by the Bond market. The most accurate gauge is the Fannie Mae 30-Year Bond. The next best gauge for mortgage rates is the 10-Year Treasury Note. Right now the 10-Year T- Note yield is priced at about 4.50% and the Federal Funds Rate is at 5.25%. That 0.75% differential means the Bond market believes we could see a 0.75% to 1% drop in mortgage rates in 2007. Lower mortgage rates could help keep the housing market correction a shallow one. It all depends on how the economy fares moving forward.
A recent article in Barron’s Online discussed the fact that we don’t have a housing bubble, but rather a lending bubble. A combination of loose lending guidelines, 100% financing, negative amortization loans, interest-only loans, and no income or asset verification have allowed borrowers to buy more house than they can reasonably afford and thus put themselves and their homes at risk in the face of a real estate downturn. Evaluate with a qualified mortgage expert your current mortgage or the mortgage product you are contemplating. Make sure you are fully apprised of the real risks and rewards. The Pay Option ARM (Adjustable Rate Mortgage) loan product that so many borrowers are either choosing or more likely, being sold today, is certainly a big part of the problem. It was designed for well-heeled borrowers to manage their cash flow to create some arbitrage with their assets. Unfortunately, there are “salespeople” who may have been peddling cars six months ago “selling” the low monthly payment to everyone without fully disclosing the downside risk. Too many people are tempted by 1 to 2% teaser rates without fully comprehending the ramifications. You get to pay 1 to 2% now, but you may owe 7.5% or higher when all is said and done. It doesn’t take a rocket scientist to figure out that if you’re not paying 5 to 6% of what is owed, you will have to “pay the piper” eventually. It’s called negative amortization (neg-am). The shortage amount is added to your loan amount each month. So if you only pay the low teaser rate amount, your loan is actually getting bigger each month. Banks haven’t helped matters. When they fund a Pay Option ARM loan, they get to show the fully amortized payment as received income on their books while the borrowers are making the minimum payment. That makes their financial statements look better. And if the margin added to the index the loan is tied to is high enough, this product becomes highly commissioned for the loan officer. Not a good combination... Too often, borrowers are shocked that in as little as three to five years of making the minimum payment, their loan hits its neg-am cap and becomes a fully amortized loan at 7.5% or higher. That can cause their monthly payments to double or even triple! This is unlike a fixed period ARM that has the payments and interest rate fixed for five, seven or 10 years with the option to make interest-only payments. This can be a very powerful financial planning tool when coupled with a sound financial strategy. The neg-am Pay Option ARM certainly isn’t a one-size-fits-all proposition. Controversial mortgage products are tools to be used judiciously depending on your circumstances and only after all the risks have been assessed.
At the other end of the spectrum is buying 30 years worth of mortgage in a 30-year fixed rate loan and only using it for three, five or seven years before selling the property or having the opportunity to refinance into a lower rate. Then you have wasted thousands of dollars for security that you didn’t need. Contrary to popular belief, interest rates are not going to go up and stay there forever. In other words, if you didn’t get locked into a 30-year fixed rate in the last few years, you haven’t missed your once in a lifetime chance! As long as the Fed keeps inflation well-contained, the possibility of really high mortgage rates is very slim. And every time we have a recession, short-term rates and mortgage rates will roll back down again. Just like you should meet with your investment advisor at least annually to make sure your investment objectives are being met, it’s wise to meet with a mortgage planning professional for an annual mortgage review. The right loan product coupled with safe, proven equity repositioning techniques can be the difference between retiring sooner with more money and simply not being able to retire!
With our landing gear down, we are approaching the runway. The fire trucks and emergency crews are on hand with sirens wailing along with the onslaught of TV cameras and reporters, in morbid anticipation of the imminent real estate crash. Be it a rough landing or soft one, the important thing to remember is, it’s only temporary. The local real estate market will fly again, higher and farther than before.
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