By Brian Simon
Note: This was the lead article in Business Insider Magazine's "Selling the South Bay" issue, 3rd quarter, 2006.
Note: This was the lead article in Business Insider Magazine's "Selling the South Bay" issue, 3rd quarter, 2006.
While the consensus is we are indeed in the midst of a real estate pricing correction both nationwide and regionally, it is not yet known how deeply the market’s cooling might impact jobs and the economy. In the South Bay, where housing values have more than doubled over the past five years, opinions on the matter are mixed. Recent data indicates that borrowing and spending have slowed, thanks to rising interest rates and prohibitive home pricing. Area real estate agents report that houses are staying on the market considerably longer—an average of more than two months for single family homes in some communities. Median prices on sales also dropped significantly in several cities—double digit decreases were reported in El Segundo, Palos Verdes and Hermosa Beach in July 2006 as compared to one year earlier. While the news was considerably better for most of the South Bay in August (e.g. El Segundo single family home sales prices were up by 17.9 percent from August 2005), the National Association of Realtors announced that median home prices across the country had declined by 1.7 percent that month—the first slip of any sort in more than 10 years.
This comes on the heels of the NAR’s report that total sales transactions for previously owned homes fell 4.1 percent across the country in July, reaching a 2 ½ year low that exceeded projections. Analysts said the increase in mortgage rates coupled with uncertainty about the economy and job creation, have scared off prospective homeowners.
After 17 consecutive ¼ percent increases, the Federal Reserve decided not to raise interest rates at its last two sessions, the most recent taking place on September 20.
The group’s goal has been to boost rates enough to stave off inflation while at the same time maintaining a healthy economy. Though some are concerned about a looming recession and impending real estate crash, others believe we are experiencing a gentle housing slowdown that is normal and even necessary.
“I think it’s appropriate that after 40 percent growth the last two years there is a correction,” said Virginia Butler, a Palos Verdes-based Coldwell Banker agent who has been in the business for over 25 years and sits on the California Association of Realtors (CAR) strategic planning and finance committee. “That level of growth was an anomaly. Even though interest rates are still low by historical standards, they went up enough to cause payments to go up and make buyers pause. Also, articles about supposed real estate bubbles got into buyers’ heads and slumped consumer confidence.”
Yet according to CAR’s latest figures, the economics don’t support a gloom and doom scenario. “The flattening we are experiencing now is different from any previous ones because all economic factors are sound right now,” Butler reported. “Jobs are not part of the story in this market right now. There’s nothing that’s showing in the economy of the South Bay that there are jobs lost.”
In fact, CAR’s updated economic forecast for California indicates a decrease in unemployment statewide from 5.3 percent last year to 5.0 percent in 2006 as well as 1.6 percent growth in non-farm jobs. Real personal income is also projected up 3.3 percent.
El Segundo Re/Max Beach Cities broker Jim Marak believes that despite the housing downturn, the strength of the South Bay’s business climate will continue to fuel residential home values in the South Bay over the long haul. He warned that an occasional hiccup is part of the process. “Obviously, prices can only go up to a point where eventually they must pause to allow consumers’ incomes to justify the purchase of a home,” he explained. “When this point comes, prices adjust downward or hold still for an indeterminate period of time. However, the long-term trend in any area where business is good is upward.”
Cool Downs are not new to the South Bay real estate market. In the late ‘80s, home prices doubled in the area. A correction brought those values down by the mid-‘90s. Since that point, prices have increased by another 250 percent. “We’re at an adjustment/holding phase right now, but the very strong business climate leads all parties to believe that any price decreases at this point won’t be radical in nature,” Marak said. “The South Bay and Westside business climates are highly diversified and for that reason in-elastic in their anticipation of future increases in business and production volume. The same area in the late ‘80s was over 85 percent focused in the military/aerospace sector. Currently, it is only approximately 16 percent military/aerospace and is not heavily weighted in any other business sectors. This strong diversification is the crux of the anticipation of fairly in-elastic home values.”
Despite the optimism of some real estate professionals, the outlook isn’t so rosy on the banking side. Julie Souverielle, Vice President/Manager Residential Lending of the Long Beach-based Farmer’s and Merchants Bank warned that the national financial obligations ratio (the total debt consumers owe benchmarked against recession troughs and peaks) has reached its highest level since data started being collected in 1988. “Every time the national obligations ratio has peaked, it has been followed by a recession,” she noted.
Meanwhile, statistics show that employment in housing and related industries accounted for 43 percent of private sector industry payrolls from November 2001 through April 2005 and primarily fueled the country’s economic recovery. Yet when the Fed began to raise interest rates in 2004, real estate related job creation subsequently fell by nearly 70 percent. “If the housing slowdown is similar in magnitude to the early '90s bust, then the U.S. economy would lose approximately 1.2 million housing related jobs in just these fields: construction, real estate agents and mortgage brokers,” it was noted in an article in The Big Picture in May 2005. “These job losses would probably occur over a multi-year period.” Global investment banker Goldman Sachs projected an even harsher scenario-- that as many as two million jobs could be lost in the residential real estate sector over the next few years. That’s about 20 percent of the 10.1 million jobs tied to the housing market.
While Marak agreed that real estate-related jobs have comprised the fastest sector of employment growth nationwide, it is not so much the case in the South Bay. Though he expects more than half of the real estate licenses to leave the business as a result of the current adjustment period, most of the departing agents would not be considered industry mainstays to begin with. “In the ‘80s, 20 percent of the agents were doing 80 percent of the real estate transactions,” he said. “Presently, 10 percent of the agents are doing 90 percent of the transactions.” Butler agreed. “In terms of real estate agents, there is always a shake-up,” she said. “A lot of people jump in when the market seems easy and those people tend to slough off when it gets more difficult. They tend to come from other sales or entrepreneurial posts and tend to return to those positions.”
While the South Bay’s economic diversity may serve it well in the long run, some believe consumer spending may plummet due to mortgages being overextended. According to the Mortgage Bankers Association, since the first quarter of 2000, residential mortgage debt has increased 88.1 percent ($4.3 trillion) to its current level of $9.15 trillion. “People have either tapped out their equity or they can’t tap it again because they are fully leveraged in debt to income ratio, said Souverielle. “As rates continue to rise, they’re going to stop borrowing. The effect of cessation of mortgage withdrawal will be huge. I’m not sure the government realizes how much money was being pumped into the economy over the last five years. (The slowdown) may have a ripple effect to the building industry—the Home Depots, home goods stores, laborers, suppliers, retail store people that supply the building industry.” There is some evidence the ripple has already begun. According to a recent Associated Press report, the National Association of Home Builders declared that confidence among home builders has sunk to a 15-year low.
To further bolster her point, Souverielle noted that adjustable rate mortgages (ARMs) make up 34.3 percent of loans in California, 11 percent above the national average. “Over $1 trillion of hybrid loans (five-year or three-year) are due to hit their first interest rate reset date in 2007. If someone got an ARM at 5 percent, based on today’s rates, that interest rate could rise to 7.625 percent, or $597, on a $400,000 balance. Also, you’re going to have to have more income to qualify for that kind of increase. Some people used these loans to buy their house. A lot of people stretched too far to get their house in the first place and now they’re not going to be able to qualify to refinance.”
Souverielle has also noticed that some people have begun to move out of the area altogether in order to land a house they can afford, find a new job and have better disposable income in areas with lower costs of living. Housing costs may also at times deter potential employees from moving to the area from out of town. Marak, who counsels executives and engineers being recruited by local Fortune 500 firms, said the cost of housing can weigh significantly on the final decision of whether to accept a job and relocate to the South Bay. “I assist them in their housing search and educate them as to the cost of local housing so that they can ask for commensurate pay and signing bonuses to accommodate the going prices,” he said. “Most of these transferees and new hires have found that if they specifically ask for salary and compensation to enable their move that their new employer will work with them. In some cases the employer will not work with them and the transferee or new hire will turn down the job.”
Without question, the housing cool down has caused some consumers to rethink their spending habits. Those who watched their homes appreciate annually in the double digits were more apt then to borrow against their home equity versus today. “Once upon a time there was a housing market that allowed homeowners to print money—those days are gone,” said Joel Naroff of Naroff Economic Advisors.
Meanwhile, Butler believes the next six months will tell the story on the current standoff between buyers and sellers. “Right now, sellers are resistant to the idea that things aren’t appreciating,” she said. “Prices are not going up anymore—the last two years, they were going up daily. When things flatten, it feels like they’re going down.”
According to some bankers, new home builders who have as a matter of course raised their prices weekly based upon the previous week’s sales activity have now had to lower their expectations. “Recent news has been very negative regarding lower new housing starts, building inventory of unsold new homes and sluggish sales of existing homes,” said Malaga Bank President John Polen. “Although I haven’t seen advertised lower prices, the builders are throwing in expensive upgrades or negotiating prices to make a sale in some cases. I would expect that this is a prelude to actually lowering prices in the near future.”
Much of the answer may come from the Fed itself. Though the board finally took a break from its quarterly rate hikes, it has not ruled out further increases at future meetings.
Some experts maintain the Fed must reverse its course at least slightly. ““These pauses seem to mark the top of the interest rate bumps,” said Polen. “Housing is going to further suffer unless the Fed provides a stimulus in the opposite direction. It has been said that the Fed always goes a little too far before it retreats. But the 17 increases did accomplish the goal of slowing down the runaway housing prices. The opinion on the street is that the Fed will lower the rate early next year. How much is the question. Encouraging—that should help the economy and housing prices all at the same time.”
Souverielle believes there is a psychological impact tied to the prime rate, which is now at 8.25 percent three years after hitting its bottom of four percent in June 2003. “People that could borrow even today are adverse to it because they feel rates are too high,” she said, adding that something about the eight percent mark prompted the warning bell to go off. “We have a lot of people trying to get out of their home equity lines of credit, pay them off and get to a fixed rate. As variable rates continue to rise, they’re going to stop borrowing.” If Souverielle is correct, a drop of just one-half percent--thereby pushing prime below eight once again--could provide a major boost.
Yet in the end, it may simply come down to one’s willingness to ride out the bumps. Marak continued to underscore the South Bay’s overall advantage by making a stock market analogy. “When your investment advisor puts you into a group of mutual funds that pretty much insure that you won’t lose your principal and have an excellent chance for future growth, you as the investor are a happy client,” he said. “The people who have purchased homes in the South Bay and Westside communities of Los Angeles should also be happy and satisfied consumers due to the long-term value of their investments. And once again, this is due to the excellent business climate of their communities.”
This comes on the heels of the NAR’s report that total sales transactions for previously owned homes fell 4.1 percent across the country in July, reaching a 2 ½ year low that exceeded projections. Analysts said the increase in mortgage rates coupled with uncertainty about the economy and job creation, have scared off prospective homeowners.
After 17 consecutive ¼ percent increases, the Federal Reserve decided not to raise interest rates at its last two sessions, the most recent taking place on September 20.
The group’s goal has been to boost rates enough to stave off inflation while at the same time maintaining a healthy economy. Though some are concerned about a looming recession and impending real estate crash, others believe we are experiencing a gentle housing slowdown that is normal and even necessary.
“I think it’s appropriate that after 40 percent growth the last two years there is a correction,” said Virginia Butler, a Palos Verdes-based Coldwell Banker agent who has been in the business for over 25 years and sits on the California Association of Realtors (CAR) strategic planning and finance committee. “That level of growth was an anomaly. Even though interest rates are still low by historical standards, they went up enough to cause payments to go up and make buyers pause. Also, articles about supposed real estate bubbles got into buyers’ heads and slumped consumer confidence.”
Yet according to CAR’s latest figures, the economics don’t support a gloom and doom scenario. “The flattening we are experiencing now is different from any previous ones because all economic factors are sound right now,” Butler reported. “Jobs are not part of the story in this market right now. There’s nothing that’s showing in the economy of the South Bay that there are jobs lost.”
In fact, CAR’s updated economic forecast for California indicates a decrease in unemployment statewide from 5.3 percent last year to 5.0 percent in 2006 as well as 1.6 percent growth in non-farm jobs. Real personal income is also projected up 3.3 percent.
El Segundo Re/Max Beach Cities broker Jim Marak believes that despite the housing downturn, the strength of the South Bay’s business climate will continue to fuel residential home values in the South Bay over the long haul. He warned that an occasional hiccup is part of the process. “Obviously, prices can only go up to a point where eventually they must pause to allow consumers’ incomes to justify the purchase of a home,” he explained. “When this point comes, prices adjust downward or hold still for an indeterminate period of time. However, the long-term trend in any area where business is good is upward.”
Cool Downs are not new to the South Bay real estate market. In the late ‘80s, home prices doubled in the area. A correction brought those values down by the mid-‘90s. Since that point, prices have increased by another 250 percent. “We’re at an adjustment/holding phase right now, but the very strong business climate leads all parties to believe that any price decreases at this point won’t be radical in nature,” Marak said. “The South Bay and Westside business climates are highly diversified and for that reason in-elastic in their anticipation of future increases in business and production volume. The same area in the late ‘80s was over 85 percent focused in the military/aerospace sector. Currently, it is only approximately 16 percent military/aerospace and is not heavily weighted in any other business sectors. This strong diversification is the crux of the anticipation of fairly in-elastic home values.”
Despite the optimism of some real estate professionals, the outlook isn’t so rosy on the banking side. Julie Souverielle, Vice President/Manager Residential Lending of the Long Beach-based Farmer’s and Merchants Bank warned that the national financial obligations ratio (the total debt consumers owe benchmarked against recession troughs and peaks) has reached its highest level since data started being collected in 1988. “Every time the national obligations ratio has peaked, it has been followed by a recession,” she noted.
Meanwhile, statistics show that employment in housing and related industries accounted for 43 percent of private sector industry payrolls from November 2001 through April 2005 and primarily fueled the country’s economic recovery. Yet when the Fed began to raise interest rates in 2004, real estate related job creation subsequently fell by nearly 70 percent. “If the housing slowdown is similar in magnitude to the early '90s bust, then the U.S. economy would lose approximately 1.2 million housing related jobs in just these fields: construction, real estate agents and mortgage brokers,” it was noted in an article in The Big Picture in May 2005. “These job losses would probably occur over a multi-year period.” Global investment banker Goldman Sachs projected an even harsher scenario-- that as many as two million jobs could be lost in the residential real estate sector over the next few years. That’s about 20 percent of the 10.1 million jobs tied to the housing market.
While Marak agreed that real estate-related jobs have comprised the fastest sector of employment growth nationwide, it is not so much the case in the South Bay. Though he expects more than half of the real estate licenses to leave the business as a result of the current adjustment period, most of the departing agents would not be considered industry mainstays to begin with. “In the ‘80s, 20 percent of the agents were doing 80 percent of the real estate transactions,” he said. “Presently, 10 percent of the agents are doing 90 percent of the transactions.” Butler agreed. “In terms of real estate agents, there is always a shake-up,” she said. “A lot of people jump in when the market seems easy and those people tend to slough off when it gets more difficult. They tend to come from other sales or entrepreneurial posts and tend to return to those positions.”
While the South Bay’s economic diversity may serve it well in the long run, some believe consumer spending may plummet due to mortgages being overextended. According to the Mortgage Bankers Association, since the first quarter of 2000, residential mortgage debt has increased 88.1 percent ($4.3 trillion) to its current level of $9.15 trillion. “People have either tapped out their equity or they can’t tap it again because they are fully leveraged in debt to income ratio, said Souverielle. “As rates continue to rise, they’re going to stop borrowing. The effect of cessation of mortgage withdrawal will be huge. I’m not sure the government realizes how much money was being pumped into the economy over the last five years. (The slowdown) may have a ripple effect to the building industry—the Home Depots, home goods stores, laborers, suppliers, retail store people that supply the building industry.” There is some evidence the ripple has already begun. According to a recent Associated Press report, the National Association of Home Builders declared that confidence among home builders has sunk to a 15-year low.
To further bolster her point, Souverielle noted that adjustable rate mortgages (ARMs) make up 34.3 percent of loans in California, 11 percent above the national average. “Over $1 trillion of hybrid loans (five-year or three-year) are due to hit their first interest rate reset date in 2007. If someone got an ARM at 5 percent, based on today’s rates, that interest rate could rise to 7.625 percent, or $597, on a $400,000 balance. Also, you’re going to have to have more income to qualify for that kind of increase. Some people used these loans to buy their house. A lot of people stretched too far to get their house in the first place and now they’re not going to be able to qualify to refinance.”
Souverielle has also noticed that some people have begun to move out of the area altogether in order to land a house they can afford, find a new job and have better disposable income in areas with lower costs of living. Housing costs may also at times deter potential employees from moving to the area from out of town. Marak, who counsels executives and engineers being recruited by local Fortune 500 firms, said the cost of housing can weigh significantly on the final decision of whether to accept a job and relocate to the South Bay. “I assist them in their housing search and educate them as to the cost of local housing so that they can ask for commensurate pay and signing bonuses to accommodate the going prices,” he said. “Most of these transferees and new hires have found that if they specifically ask for salary and compensation to enable their move that their new employer will work with them. In some cases the employer will not work with them and the transferee or new hire will turn down the job.”
Without question, the housing cool down has caused some consumers to rethink their spending habits. Those who watched their homes appreciate annually in the double digits were more apt then to borrow against their home equity versus today. “Once upon a time there was a housing market that allowed homeowners to print money—those days are gone,” said Joel Naroff of Naroff Economic Advisors.
Meanwhile, Butler believes the next six months will tell the story on the current standoff between buyers and sellers. “Right now, sellers are resistant to the idea that things aren’t appreciating,” she said. “Prices are not going up anymore—the last two years, they were going up daily. When things flatten, it feels like they’re going down.”
According to some bankers, new home builders who have as a matter of course raised their prices weekly based upon the previous week’s sales activity have now had to lower their expectations. “Recent news has been very negative regarding lower new housing starts, building inventory of unsold new homes and sluggish sales of existing homes,” said Malaga Bank President John Polen. “Although I haven’t seen advertised lower prices, the builders are throwing in expensive upgrades or negotiating prices to make a sale in some cases. I would expect that this is a prelude to actually lowering prices in the near future.”
Much of the answer may come from the Fed itself. Though the board finally took a break from its quarterly rate hikes, it has not ruled out further increases at future meetings.
Some experts maintain the Fed must reverse its course at least slightly. ““These pauses seem to mark the top of the interest rate bumps,” said Polen. “Housing is going to further suffer unless the Fed provides a stimulus in the opposite direction. It has been said that the Fed always goes a little too far before it retreats. But the 17 increases did accomplish the goal of slowing down the runaway housing prices. The opinion on the street is that the Fed will lower the rate early next year. How much is the question. Encouraging—that should help the economy and housing prices all at the same time.”
Souverielle believes there is a psychological impact tied to the prime rate, which is now at 8.25 percent three years after hitting its bottom of four percent in June 2003. “People that could borrow even today are adverse to it because they feel rates are too high,” she said, adding that something about the eight percent mark prompted the warning bell to go off. “We have a lot of people trying to get out of their home equity lines of credit, pay them off and get to a fixed rate. As variable rates continue to rise, they’re going to stop borrowing.” If Souverielle is correct, a drop of just one-half percent--thereby pushing prime below eight once again--could provide a major boost.
Yet in the end, it may simply come down to one’s willingness to ride out the bumps. Marak continued to underscore the South Bay’s overall advantage by making a stock market analogy. “When your investment advisor puts you into a group of mutual funds that pretty much insure that you won’t lose your principal and have an excellent chance for future growth, you as the investor are a happy client,” he said. “The people who have purchased homes in the South Bay and Westside communities of Los Angeles should also be happy and satisfied consumers due to the long-term value of their investments. And once again, this is due to the excellent business climate of their communities.”
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