To Buy or Not to Buy? Are we at the Bottom Yet?

I wanted to take this opportunity to educate people to the market conditions today. With all the news media predicting gloom and doom, it’s hard for buyers right now to get a grip on what is really going on. Whatever glimmer of truths lie in the articles written or news reports made they are well hidden behind the sensationalized headlines that sell their stories. So I want to take some time to present some facts and some history. I also want to look at trends to determine what is actually happening here. There is a lot of information here so take it slowly, don’t try to grasp it in one sitting. The reality is there are a lot of factors at bay. Trying to make sense out of them is not a simple 2 paragraph piece.

The real estate market always works in cycles, just like the seasons. That is true everywhere. Real estate is still one of the best financial investments a person can make and one of the only ones that you can have a $250,000 gain as a single person or $500,000 as a married couple (provided it’s your place of residence and you have lived there at least 2 years) tax free.  As you can see from this graph compiled by the California Association of Realtors’(CAR),

 

rate of return on real estate investments vary from year to year but overall over a period of 34 years from 1968 to 2002 there was an 11.7% average increase. Not only do you get a better return than most other investments, you get to enjoy living there while the value increases. One should always be thinking of real estate as at least a 5 year investment.  

We have just come out of a very long upswing market in the bay area which began in the late 90’s and continued up through 2006 and the first part of 2007 where we reached a peak. We were overdue for a market correction. Within that time there were some periods when things went down a little bit for a while, like when the dotcom crash occurred. But the market recovered very rapidly. So what is different now?

I recently attended an all day class where Deputy Chief Economist of California Association of Realtors, Dr Klinehenz, spoke. His information on the cycles of past markets was very helpful.  The real estate market is measured in two ways, number of units sold and the median price. Looking back at the last 40 years it appears that the cycles in housing went for 10 year stretches between big dips.

The dips were more pronounced in terms of number of units sold while the medium price was less volatile. From 1970 to 1980 there was a mostly gradual increasing market as to price and number of sales in California. Then in 1980 there was a big dip in the number of sales that bottomed out in 1982 and went in a “V” shaped curve back upward. At the same time the average prices were not that affected, they mostly just leveled out. In 1989 the market again took a turn and by 1991 came to a less drastic lowering in the number of home sales than in the 80’s but the prices steadily declined until 1996.

So what was going on in these 2 different periods? The crisis in the 1980’s was inflation, and like today’s problems, stemmed around financing issues. The inflation rates of the 1980’s were from 10-14% when what we normally want to see is around 2.5%. This resulted in extremely high interest rates (we are talking about 18-19%).  People nowadays get upset by interest rates when they are around 8% and believe them to be high but on the scale of things, our interest rates today have remained very low. 

 

In the 1990’s the situation was a little different. The economy began to change in 1989 and then in the Bay area we had the 1989 Earthquake which compounded the effect. The real estate market was slower to rebound mostly driven by job losses and high rates of unemployment.  In other words, there were other factors going on that affected the overall picture having to do with the broader economy. Keep in mind that although there was a decline in housing prices statewide, they were not that drastic.

So what factors are we taking into account today. The current crisis in the market is much like the one of the 1980’s and the economists are predicting that our curve will look more like the one of the 80’s than the slow decline over time of the 1990’s. 

Sales in the 1982 valley were at 189,345 units. As you can see from this chart we have reached a similar low level in units sold. 

As you can see from this graph we reached a low last fall that continued into the beginning of this year and then started to rise.  In terms of median price, we are seeing a decline in Alameda County as of February 2008 of 12.6% and in Contra Costa of 14.5%.

Another marker for market conditions is the unsold inventory which looks at number of months of inventory we have given the current rate of sales.

In the markets of the past years we have had 2 to 3 months of inventory. Now we have around 13.5 months in Alameda County. Keep in mind that these numbers differ between cities and neighborhoods as most of the markets I work in show a far lower number of months than this. Inventory verses demand is really what dictates prices going up or down.

We have some other factors affecting real estate in California as well. 

Do to higher gas and food prices real disposable income is very low. Unemployment is a little higher than last year but not as high as it was in 2003 when the dot com crash occurred. The big difference between California and many other parts of the country is that we are expected to have a population increase while many other parts of the country are experiencing a large population decrease.

But overall, the current crisis in California is about the unavailability of purchase funds, especially for those who need to buy with less than 20% down. The sub-prime problems hit the fan at the end of last summer. That continued to some degree into the early months of this year combined with the normal winter slump. As a result prices have come down in the bay area.

Now, of course this chart is an average for the whole counties and we all know here in the east bay, in Alameda and Contra Costa Counties, there are neighborhoods that have not come down as much as these percentages indicate.

So how come so many people got into trouble buying houses and now are taking huge losses? Our current financing problems with real estate are in large part related to financial institutions (in order to continue showing profits) approving loans for people in 2004 – 2006 that could not actually afford to buy them. In order to help them qualify they were often put into loans that adjusted after 2 years to much higher interest rates. They were assuming they could refinance and get into better types of loans. Many people were qualified on the basis of a negative amortization loan which means that they are not fully paying the interest on the loan, so every month the principle gets bigger. The initial payment was low but this can’t last forever. With the market already moving into a natural declining price adjustment cycle combined with their payment becoming higher due to the nature of their loan, these individuals were unable to afford their home. They could not refinance because the house would not appraise for the value of the increased loan and therefore had to sell their home in a short sale or their loan was foreclosed.

The increase in short sales and bank owned property due to foreclosure (a topic for a future discussion) brought housing prices down dramatically in certain areas.  As you can see from this chart; the numbers of notices of default going out increased dramatically from the 4th quarter of 2006 to the 3rd and 4th quarters of 2007.  Some areas were not as drastically affected by the sub-prime crisis. 

Although the charts above are about Stockton, you can see a very similar situation in many parts of our markets as well, especially in Oakland where 580 is often the dividing line.  In the east bay those areas are Piedmont, Berkeley, Albany, and in Oakland neighborhoods such as Rockridge, Crocker Highlands, and Montclair. Wherever people traditionally put more down for their home purchase, the sub-prime crisis had less effect on home owners being forced to sell their property. Other areas, where some first time buyers (who could not really afford the first time buyer prices) were getting in the market, have been affected to a large degree and prices are at record lows. This presents a great opportunity for people wanting to get in the market at affordable prices and take advantage of appreciation when the market begins to stabilize.

According to our economist with CAR it seems that the market is likely to remain low for the rest of this year and the beginning of next year. At that time foreclosure rates will return to a more normal level and bank owned property will get sold and done with. This will be the window of time that buyers can get in and get a great deal. They expect this period to last for around 12 to 18 months and we are 4 months into it already.

Could prices come down even more? Maybe a little but is it really worth risking loosing the chance to get a house you are happy with at a really good price.  As you can see from the chart below, we had our biggest

drop in the numbers of sales between 2006 and 2007 which resulted in the largest decrease in prices in 2008. But the downward trend is beginning to level off while interest rates have come down. This is the time to buy folks’; there is no question about it.  I see it week after week in open houses. More and more first time buyers are coming out to see houses. Open houses in the east bay markets this year have seen increasing large numbers of people turning out. There is pent up energy around buying a home. People want to buy a home and move on with their lives, they just want to be sure we have reached the bottom. I hope seeing all this information can be of assistance in the process for you as it has for me in seeing that the time to buy and get the best prices is from now until sometime mid next year. The time to wait is over if you have the financing to move forward. We are already seeing some change in the financial market with some 90% financing returning which should make it easier for more buyers to move forward. 

Here in the bay area we have a unique environment in that it is a very desirable place to live. The bad thing about that is that housing costs remain high making it difficult for the first time buyer to get into the market. 

 We are now in a time period where buyer affordability is higher than it’s been in a long time.

The good thing about the bay area for real estate investment is that once you get into the market and begin to own property, it is one that traditionally appreciates at a faster rate than other parts of the country. The areas closest to San Francisco always begin to increase in value faster than the areas further away. This trend will probably be more emphasized in future markets as the price of gas continues to go up. Being a short drive from a BART station or other forms of public transportation will also be a factor for where values go up the fastest. 

One final note I’ll leave you with is that the east bay, of all the bay area property, is the most affordable. We have wonderful cities, neighborhoods, parks, culture and good places to eat. We have public schools with very high ratings and many more private schools with excellent programs. We are a short commute to San Francisco. I think the likelihood of our markets being a very good financial investment in the years to come is very high. That’s why I believe in our communities and their strengths for our financial future ahead.

Edited by Dan Joy