Sales Down, Prices Up?

It's pretty clear that the air is quickly coming out of the housing bubble, and that this lull began several months ago, but one thing I don't understand is how prices in the summer continued to rise while sales have been going down. For example, October sales for San Diego County (single-family resale, condo resale, and new homes, combined), were down 12.67% from October 2004. However, the median house price over that same time span increased 4.91%.

What gives?

I am not an economist by any stretch of the imagination, but I always thought that supply and demand were interconnected. I believe that the number of homes for sale hasn't decreased, in fact I recall reading that it's actually been increasing. So if there are more homes for sale, and fewer selling, shouldn't prices come down? If so, then why is the median price still showing appreciation?

My guess is that the year-over-year appreciation numbers are a lagging indicator, and that prices are already trending downward. And potential buyers might be balking at the prices today, figuring that they'll go down tomorrow. This would help explain a static price point - sellers unwilling to concede on asking price, buyers unwilling to pay asking price - which would also result in fewer total sales. But what do I know?

Are we at the top of the market? I imagine, I can't see prices continuing to escalate from here, not with interest rates continuing on their methodical increases. I hope that those buying at the top are buying using fixed-rate products and have a house payment that is not too tight and is forgiving if there's an unexpected blip in their personal financial picture. From The Housing Bubble:

No one knows for sure if we've reached the top of the real estate market, but a growing numbers of experts, like Bankrate's Senior Financial Analyst Greg McBride, are warning home buyers not to overextend themselves when looking for a new home.

"If you're buying a home now, you need to look at it from the standpoint of building that equity cushion. So if prices don't cooperate when it comes time to sell, you're not stuck owing money at the closing table."

Wise words, Mr. McBride. I wonder how many people will be upside-down on their homes over the next five years.... more than we are expecting, I'd wager.

California Mortgage Defaults On The Rise

For the first time in three years, mortgage defaults have increased in California, with the majority of default notices addressed to residents of Southern California. (A default notice is, to my understanding, a notice sent to the borrower after they have missed a certain number of payments. It is not a full blown foreclosure, where the house is seized, but it is the first step on the road to foreclosure.) During Q3 2005, over 12,500 default notices were sent to Californian home owners.

From California mortgage defaults rise for first time in 3 years, "Financially distressed homeowners have largely been able to avoid foreclosures because rising real estate prices allow them to sell their properties instead." While home prices have been rising over the past several years, I saw the start of the slowdown we currently are mired in when house hunting last year. Even a year ago, the days-on-market numbers were increasing, seller and buyers were agreeing on prices below the original asking price... and now local realtors are going months without a sale.

Historically, the mortgage defaults are still at low levels due in large part to the boom in housing prices over the past half-decade. But what happens when the boom slows (as it is now) and then retreats? What happens as interest rates continue to rise and home owners shackled with adjustable rate mortgages or (gasp) interest-only loans, start having to dole out more per month than they had budgeted and they're upside down in their home? (Don't forget, in 2004 48% of all mortgages taken out for San Diego properties were interest-only!)

It will be interesting to see how this metric fares over time. I can't see it heading any other way than up...

The Glut of Condo Conversions

There was an interesting article in the San Diego Union Tribune on the glut of condo converstions here in San Diego. Most telling is the increasing number of condo conversions coming online here in SoCal, which, coupled with the cooling in the housing sector, has led to an increase in inventory. The following figure illustrates this trend, with over 3,500 condo conversions in Q3 2005.


A condo conversion basically takes an existing apartment building, redoes the exterior, lays new carpets, updates the kitchens, and so on. Some look pretty nice at the end, the ones whose exterior styles aren't too typical of a particular time period. Those whose outter looks clearly date the place, turn out less well, and you wonder why someone would drop $500K for a 900 square foot condo that looks like nothing more than a nicely decorated apartment from the 70s.

Living in a neighborhood of San Diego that has more than its fair share of condos and apartments, along with the typical astronomical costs for coastal communities, the condo conversions are in full swing here. In about a half-mile radius of our home, there has been at least seven condo conversions in the past couple of years. The most recent two today that just started selling in the past couple of months have taken more vigorous efforts to attract buyers - sign flippers. Every weekend we now have two people on our street corner: one flipping a big, rectangular cardboard sign for a condo conversion down the block, and another flipping a sign for a condo conversion down the street the other way.

I know that during a down market condos typically decline in value before single family homes, and have a greater percentage of decline. Similarly, in an up market the lag behind the appreciation of single family homes. I wonder, though, if there is much of a difference in the ups and downs in valuation for condo conversions vs. regular, built-as-a-condo-the-first-time-around. With the large number of condo conversions in the past couple of years, timed nicely with the beginning of the bubble burst, I guess we'll discover the answer to that question sooner than later!

The Biggest Bubble Ever?

There's an interesting article titled The Biggest Bubble Ever that does a good job outlining and summarizing the causes of the current housing bubble. Author Fred Dattolo contends that the major causes of the bubble include:

• Overheated prices - "Until 1995, housing prices largely kept pace with inflation. In the last nine years though, home prices on average have spiked 35 percent after adjusting for inflation. ... In San Diego County, for example, the median price of a home is now $472,000. ... That represents an increase of 129 percent in just five years! Yet the county’s median income, at $52,000, has gone up only by about 11 percent during that time." I've blogged about the affordability of median priced homes and about SoCal's median house price reaching an all-time high in August 2005.
• Over-ownership - interestingly, the percentage of home ownership has gone up slightly over the past few years, from a rather static quarter century average of 65.2% to almost 69%. What's more, sub-prime lending, which is lending to those with less than stellar credit histories, has increased by more than 25% in the past ten years!
• Too much debt - growing up I was always told that one's monthly house payment should never exceed 33% of their takehome pay. (Fannie Mae suggests this percentage not exceed 28%.) Today, however, "about half of the lowest-income households pay out at least 50 percent of what they earn toward housing."
• Speculation - I've shared by views as to why, in my opinion, San Diego's housing costs are so high - pure speculation. Not only does speculation increase housing costs, but it also introduces more risk into the marketplace.
• Complacency - the author argues that it's just too gosh darn easy to buy a home these days. "Lenders are continually coming up with more unusual (and risky) mortgages to allow less-qualified buyers—even those with limited cash and shaky credit—to purchase a home. Many “predatory” lenders are making offers that are practically irresistible. The banks and mortgage companies are often complacent themselves because more than 75 percent of the single-family mortgages they originate are sold in the secondary market to either Fannie Mae or Freddie Mac—government-sponsored private corporations that assume all the risk." Risky mortgage options include things like interest-only loans and option ARMs.
• Denial - "Some economists deny there is a housing bubble, especially if they work for realtor associations. According to cbs MarketWatch, even Freddie Mac’s deputy chief economist insisted there is no housing bubble (September 8). One argument some forward is that housing prices are strictly regional in nature so a national housing bubble is impossible."

The article continues on to look at the impact of rising interest rates and possible economic scenarios that might unfold when this bubble does burst. The article ends with the following ominous message:

Let’s briefly take a broader view of the U.S. economy. The budget deficit this year is a new record, and the gap between what the U.S. produces compared to what it consumes (the trade deficit) is also smashing records. The personal savings rate is at near historic lows. Total homeowner indebtedness compared to disposable income is very close to the highest it’s ever been. Homeowner equity compared to market value is way below normal even though prices have been skyrocketing! Despite ultra-low interest rates, industrial production is dropping and employment growth is stunted to an unprecedented degree. Real wages for the American worker are 6 percent lower than a quarter century ago.

Never before have we witnessed the confluence of so many negative economic factors to this degree. We are truly in uncharted territory. Yet the U.S. economy has been perking along largely because it’s been propped up by the greatest housing bubble ever known. We’ve shown how that simply cannot continue. When it starts to unravel, it will likely lead to the biggest bubble bust in world history, hurtling the U.S. economy into chaos, reminiscent of the Great Depression—or worse! The shock waves could lead to a major global recession like we’ve never seen. Prepare now to reduce your standard of living.

Some Anecdotal Evidence...

Anyone with any kind of science background knows anecdotal evidence is weak and shouldn't be given the merit one gives to formal studies and surveys, but still... Talked to an accountant today and the topic of real estate here in San Diego came up. He mentioned, as an aside, that a number of his clients who are real estate brokers haven't closed a deal in months. His wife is a mortgage broker and he said that over 80% of his wife's customers are of the 'no stated income' flavor, which basically means these people are buying more than they can afford and likely are just scraping by to make ends meet.

And who can be surprised by this news, seeing as California's housing affordability index has fallen to a 16-year low. In June of this year the median California home with a down payment of 20% and a fixed 5.71% mortgage would require an annual income north of $125,000. Problem is, the average Californian family makes less than $60,000. Eep.