Feature Article
The Big "What If?"
Published in Inland Empire Magazine — March 2006
("Real Estate: What If?")
Mention real estate nowadays, and another word usually comes up: "bubble." Soaring prices have made homeowners dizzy — and given would-be buyers a sinking feeling.
Both responses are appropriate. In 2004, the median home price in California hit half a million — and kept going. As a result, affordability reached an all-time low. Yet the buying frenzy continued, with consumers traveling farther and accepting riskier terms to get into their dream homes.
Now the wind is shifting. Housing inventories have increased. Homes are staying on the market for weeks, sometimes months. Homeowners, fearful that prices have peaked, rush to put their homes up for sale — which exacerbates the trend.
"When you have larger inventories, buyers have more choices," says Bill Velto, Managing Broker at Tarbell Realtors in Upland. Now those buyers are less willing to accept any house at any price. But Velto doesn’t foresee an immediate price drop. "It’s not like the stock market, where we see it drop overnight," he says. Contrary to the image of a bubble bursting, any real change will take awhile to reveal itself, according to Velto. "It’s going to be six months, a year, a year and a half, where we’re going to be able to determine that prices have come down."
One bubble is definitely bursting: the expectation of quick profits. Today’s much-advertised "price reductions" reflect sellers’ acceptance of that reality — not a shift in hard numbers. Sellers often start high, then retreat to real market levels when they have no takers.
"I don’t see them selling lower than the last sale yet," says Kim Senecal, President of Prudential California Realty in Rancho Cucamonga. That would signal the sea change people fear.
Even so, acquainting clients with the new market conditions can be hard work. Senecal had to tell one million-dollar homeowner his asking price was too high — more than once. "I sounded like a broken record," she laughs. Finally the client relented and dropped the price to under a million. "Now," she says, "I have a chance of selling. But it should have been that price from the beginning."
Senecal remains bullish on the Inland Empire — but keeps one eye on a potential trouble source. Call it the NOD factor: notice of default. An increase in defaults can be an early sign of market distress. "There are," she says, "in San Bernardino County, probably an average of 25 a day." The rate in Riverside County is similar. According to DataQuick, the Inland Empire is one of California’s most vulnerable regions for a future rise in defaults.
The creative financing that’s made homeownership possible for scores of southlanders can also be their undoing, according to Leslie Magodoro, loan officer with Home Loan Consultants in Upland. Especially risky, he says, are "interest-only, pay-option ARM’s." Adjustable rate loans are inherently dicey now, when interest rates have nowhere to go but up. The "interest-only" feature, designed to keep payments low, also deprives borrowers of the equity cushion they’ll need should things go badly. Such loans usually call for a big jump in payment amounts down the line. And the "payment option" can involve negative amortization, with borrowers owing more as time goes on.
"They (borrowers) don’t understand," Magodoro says, "that if you go negative, and drop ten, fifteen percent in (property) value, you could be in quite a bit of trouble." In 2002, interest-only loans comprised 20 percent of the market. By 2004, that figure had jumped to 70 percent. Buyers, responding to skyrocketing prices, were using these instruments to get into homes they couldn’t afford otherwise. For many such borrowers, the day of reckoning will come in 2007. Experts look for a rise in foreclosure rates at the end of that year
Distressed buyers can affect the market because they have an overwhelming need to sell — now. Kim Senecal sketches a scenario she’s seen too often: people buy at peak prices, using skin-of-the-teeth financing. They count on instant equity to make it work. If that doesn’t materialize, the house of cards collapses. "(They) cannot refinance, because the loan-to-value is too high," she says. "So they’re stuck. And when the payment goes up, they cannot make the payments. Those people now have to move the house, at whatever price. They have no choice." When such sales accumulate, prices in general can start to drop.
It’s a serious concern, especially in light of a recent survey. The PMI Group insures mortgages, and thus has an acute interest in home values. Their recent risk assessment of the Inland Empire concluded its homes are overvalued by 30 percent. The reason: housing prices have outstripped income.
That verdict is echoed in another study by Doug Fabian and Josh Lewis, both veteran observers of the real estate market. They warn of a possible 30 percent drop in southern California home prices over five to seven years. But even under the direst predictions, home values would simply return to 2003 levels, which were regarded as stratospheric at the time. Those who rode out the " crash" of the early 1990s saw their homes regain value — and proceed into unimagined realms. That experience confirmed a truism: in the long run, real estate goes up, not down.
Given current conditions, many buyers will be tempted to wait. But that carries its own risks, including the prospect that prices will continue to rise in the near term — if more slowly. For those shoveling money into rent payments, buying usually makes sense. And there’s still room for significant appreciation in many neighborhoods, especially outlying communities like Hesperia, Banning and Yucca Valley.
Sellers can console themselves, knowing their homes still command awesome prices. Just don’t expect to sell in a day, and don’t be blinded by greed.
And for all homeowners, it’s a good idea to get out of "time-bomb" loans. Living within one’s means is an old-fashioned concept. Like many things old-fashioned, it’s apt to make a comeback. Wise homeowners will be at the forefront of that trend. Everyone has to live somewhere, and most pay something for the privilege. Making money in the process can be thought of as an added benefit. Considering the tax advantages and the promise of long-term value, real estate is still a good bet — if one is patient.
Bill Velto, who’s seen good and bad years, puts it in perspective: "There’s never a bad time to buy and sell real estate."
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