San Diego Market Prognosis December 2007

Moderately good news for sellers, not so great for buyers.

I wrote a few days ago about the federal government and lenders agreeing to freeze rates.

This isn't a panacea, by any means. It may not help people who had interest only loans, which will still begin to amortize. It won't help those already in default. It certainly won't help those who bought with negative amortization, who never were paying the real payments.

That said, it will give those who could afford the initial cost of money, but have been frustrated by the fact that prices have declined and they're upside-down and therefore cannot refinance into a "normal" loan type because of that fact.

Practical effect on the market: Nothing immediately, as in right this instant. But based upon statistical summaries of who has what loans, at least half of the people who would have been forced into foreclosure in coming months are going to be able to hold on. The vast majority of these, given the five year breathing space given by the government deal, will be able to keep making their payments until such time as they are able to sell or refinance normally. This means the "huge tidal wave of foreclosures" that market doomsday advocates have been going on about becomes a shallow wash.

The statistician and the financial planner in me are actually both in admiration of this move. It not only doesn't cost taxpayers any money directly, I suspect that the longer term effect will be to save us some money, as fewer lenders go down and we have to stand up for fewer government guarantees. It won't help those who couldn't afford their loans in the first place, but it will give aid and comfort to those who suffered solely from price declines. I've said over and over again that the only time the value of a property is important is when it's bought, sold, or refinanced. Unfortunately for those who bought with 2/28s or 3/27s that have now reset higher (or are about to), refinancing is one of those times. They bought with a loan that they really could afford now, just not indefinitely. They knew they were going to need to refinance, and were counting upon their value not to have decreased critically when that time came. However, prices in much of the country have critically decreased. This means that when they needed to refinance because their rate reset, now they were prevented from doing so by the terms on which lenders will extend replacement financing.

Yes, these folks should have limited themselves to properties they could afford on a thirty year fixed rate basis, and I lost a lot of business through preaching about making the situation sustainable. However, I don't have it in me to throw people out of their homes for the (sarcasm on) horrible crime (end sarcasm) of not following my advice. The agents and loan officers who gave such people horrible advice are heaving a huge collective sigh of relief, but my desire for schadenfreude isn't great enough to endure the consequences for all those others, either. Furthermore, the more the market declines, the worse everyone gets hurt. This includes people who were thoroughly blameless as well as people like me, who did our best to avert the disaster. I also suspect that most of the malefactors are still going to get burned, having advised clients to do things which are not covered by the government agreement.

In fact, the government plan helps affected homeowners in direct proportion to how well they really could afford their property in the first place. Also being voluntary on the part of the lenders, it wouldn't have happened if they didn't see it as being in their best interests. The plan gives them cover for doing en masse what they would have had to do for those borrowers individually. All in all, the government has accomplished a noteworthy feat of financial judo.

Furthermore, it carves the heart out of any predictions of coming disaster in the housing market. There is not going to be a huge amount of involuntary supply hitting the market in the coming months. In point of fact, a large percentage of the people who would have lost their homes to foreclosure have already "voluntarily" placed their properties on the market, as the least damaging avenue available to them as individuals. Many of these did not even know they could ask their lender for a modification. Some still don't know that it's true in general, but due to the publicity about this deal, have done so about their loan in particular.

Indeed, I would expect a certain number of people to withdraw their properties from the market, as they contact their lenders and find out they can now afford to stay. They bought these properties because they wanted to live in them, after all. It's only been four days since the announcement as I write this, so I wouldn't expect to see such results of that yet, as it's going to take a while before the homeowners are sure they can take it off the market.

Here's one fact: we've seen a slight uptick in new escrows locally this last week over last, from 450 to 470. The ratio of supply to demand, at 40 to 1, is the lowest I've seen it since the early days of summer. Smack in the middle of Christmas season. You might have seen me write that nobody wants to move the Christmas Tree before, despite it being the best time of year to buy, not only vis a vis sellers but also for tax reasons. Given the market environment, this is indicative of an uptick in demand more than anything having to do with supply. In the middle of Christmas season.

So here we are seeing a small increase in demand as well as the seeds of a decrease in supply. At the time of year when activity is usually at its lowest. What does this tell you?

I've been saying for six months that mass psychology is the only thing keeping this market down. The old Fear and Greed, reversed in their effects from two years ago. People afraid prices are going lower, or greedily betting that they will. But trying to time the market - any market - is a bad idea.

San Diego Area Median Income is now $69,700 per year. For the mathematically challenged, that's a monthly income of $5800 per month. Using standard Fannie and Freddie standards (and A paper lenders have been sitting pretty these last few months), that means that the median family can afford $2613 per month. As I type this, I've got a 6% thirty year fixed rate loan for less than one total point. If someone doesn't have a down payment, add PMI of just under 1%. With $100 per month for insurance, they can afford $320,000. With $200 per month for HOA dues, that's still almost $310,000. There are seventy-five properties on the market in the same zip code as my office where the asking price is that low. If you consider the properties where it could be bargained down that far, it's at least 120 and probably over 150. In one zip code. Median income families without a down payment, and below average (but not putrid) credit. There are over 100 zip codes in the San Diego MLS.

There were 774 sales consummated in the last 30 days, throughout the county. And keep in mind that $69,700 median includes statistics of minimum wage people as well as CEOs. A couple where each earns $15 to $20 per hour can easily afford a starter property, even without a down payment. No, they can't afford the brand new 5 bedroom 4 bath 3000 square foot mini-mansion that advertisers are telling us everyone "needs", but they never could, either. Our parents raised families of five in three bedroom 1200 square foot homes, our grandparents raised families of eight in one and two bedroom 600 and 800 square foot apartments. There's no reason why a family of four can't fit in either one - no reason except envy, that is. For the last decade or so, marketers have been telling people that they didn't have to settle. Well, that was never true, and the loans that enabled people to pretend it was are no longer to be found. I've written before about the long term benefits of home ownership. You can have what you can afford, or you can miss out on the benefits altogether. Matter of fact, as I've said before, the best way to leverage yourself into what you want is to start by buying what you can afford now.

Given these facts, I'm thinking that we're seeing the low point of the market right about now. The horrible part about relying upon mass psychology and using it to try to time the market is that mathematically, at least fifty percent of the people who do so will be left in the dust when the market takes off. All it takes is one good month, and a market turn fueled by the mass psychological phenomenon (or the collapse of such) becomes a positive feedback loop. In fact, if the market does get worse, that only exacerbates the strength of the recovery when it happens. Affordability-wise, we're back where we were four to six years ago. Given the scarcity of new land for development and other constrictions of supply, and the fact that we're not suffering from any shortages of people who want to buy property here, this may be the best opportunity to buy in San Diego we'll see in our lifetime.

Caveat Emptor