Publication Date: Friday, October 9, 2009
After self-fulfilling prophecies become fact
Local real estate market is poised for strong recovery
Real estate this year has been the mirror to our economy. The usually boring world of deeds and mortgages has been in our news daily for the past 12 months as all the pundits look to real estate as the barometer of economic health.
There were dire predictions of a total collapse of the real estate market and in the midst of the first quarter of 2009 the buyers and sellers made that a reality. Sales were about 50 percent below normal in Palo Alto, which was a lot better than it actually felt for those in the business.
A feeling of impending doom does not make someone want to invest lots of money and take on lots of debt, both of which are generally required to buy a home on the Peninsula. Foreclosure data is still making the front page of the newspaper at least a couple of times a month, but real estate is no longer the only whipping boy of the economy. Now we have consumers, autos, banks, health care and unemployment.
No doubt real estate was caught up in "irrational exuberance" to quote Alan Greenspan, former chairman of the Federal Reserve, resulting in a general fear that if asset values are unduly inflated then they may suffer an unexpected and prolonged contraction.
We definitely experienced the "unexpected" aspect and are now into the "prolonged" part. We now know -- because the economy is best viewed in hindsight -- that the real estate market peaked sometime in the latter half of 2007. We didn't realize it until other events in the market pointed it out to us, like the collapse of Lehman Brothers, AIG and others, all of which would still be alive and kicking if the irrational exuberance of real estate had continued to flourish.
How are things different now?
1.) Some statistics are surprising because they are not in the news. For instance, the number of homes on the market in San Jose in an "active" status (not in contract) is 1,077. The number of pending sales (homes in contract) in San Jose is 2,019. The number of closed sales of homes in San Jose for the last 30 days was 633. This surprised me when I saw this trend several months ago, but it has persisted. Lower inventories and increased sales activity generally point to price stabilization and not falling prices.
2.) Mortgage rates are well below where they were in 2006 and 2007. Conforming rates are at least 1 percent lower. Jumbo-loan rates are also down. As opposed to 2006 when anyone with a pulse and a credit score could get a loan, the main issue here is that you now have to qualify based on your documented income, assets and credit score. This may seem onerous, but actually it was the way banks used to do business about 10 years ago.
Current buyers are opting for longer-term, fixed-rate mortgages in lieu of short-term fixed or adjustable mortgages. The home mortgage interest deduction is alive and well and with interest at historically low rates this creates further stability in the market.
These factors combine to give the current crop of buyers more incentive to ride the wave of price instability in comparison with the crop of buyers from 2004-07 that had little or no hard money invested and adjustable mortgages that were based on terms that required refinancing every few years. Those buyers had to rely on the market increasing since refinancing a 90-100 percent mortgage is impossible. Those buyers were lied to by their lenders and brokers who failed to warn them that their loans could not be refinanced unless the market continued to inflate by 10 to 20 percent a year. Today's buyer has been forewarned by the current crisis that markets do not always go up and the loans cannot easily be refinanced.
3.) New home construction by the developer/speculator is at a standstill. From 2002-07 these projects sprang up like Krispy Kreme's, but now are either mothballed or sitting vacant. Construction lenders scarcely exist or want so much security that the typical developer cannot afford to meet their terms.
Santa Clara County is projected to continue its growth in population as San Jose has now reached a population of more than 1 million. Growth in population causes demand for housing. With little or no housing projects being planned or built, the inventory of available housing could shrink.
4.) Construction costs are down by 10 to 20 percent since their peak in 2006-07. This trend encourages homeowners and buyers to improve their property. The more money people invest in their homes the more equity build-up and price stability is attained.
5.) Properties valued at $2 million or more in Palo Alto continue to be difficult to sell. The markets within markets require careful study. Homes under $2 million are generally selling rapidly and that market segment appears to have price stability.
Homes over that price are more difficult to sell and fewer sales create an uncertainty for pricing where valuation is based on comparable sales. Major lack of "super-jumbo" financing (loan more than $1.1 million) in the marketplace will continue to cause uncertainty and price instability in this market until a financing channel is created by the marketplace.
Obviously, in other markets the brackets where price instability still exists may be significantly lower than in Palo Alto. For instance in the City of San Jose, homes priced over $750,000 make up 40 percent of the active listings today but only 10 percent of the pending sales, and only about 15 percent of the closed sales in the last 30 days.
Is today the ideal time to invest in real estate? One can unequivocally say that today is a much better time than it was in the previous three years to purchase with lower prices and lower mortgage costs.
People should invest in homes for other reasons than an expectation of rapid appreciation. A home becomes the core feature of a respite from instability, uncertainty and privacy, which cannot be attained as long as the place you live is owned by someone else. The desire for ownership must be coupled with a sensible financial strategy that does not defeat the purpose of owning your own home in the first place.
J. Robert Taylor, J. D., a real estate attorney and broker for more than 20 years, has served as an expert witness and mediator and is on the judicial arbitration panel for Santa Clara County Superior Court. Send questions to Taylor c/o Palo Alto Weekly, P.O. Box 1610, Palo Alto, CA, or via e-mail at firstname.lastname@example.org.