Current Market: June 2008 Archives

For at least the last thirty years, I've been hearing "affordable housing" advocates yammer about the high cost of housing, and how working families can no longer afford "decent" housing, which they apparently consider to be the three or four bedroom, two bathroom detached home. They go on and on about what is necessary to create more of this type of housing and our "moral obligation" to create more of it. Against this, we have their actual actions, politically allying with forces that make housing more expensive by constricting the supply.

Newsflash: Making business difficult for suppliers of a good does not lower the price nor improve the availability of that good.

Who does artificial constriction of the housing supply hurt?

Certainly not developers. The price of the actual permits, last I checked was in the $20,000 per unit range. But the decreases and constrictions and delays in supply add something like $160,000 to the price tag of that same unit. The people who want housing are here. If the demand is there and the supply isn't, what does that do to price? Oh, those poor developers! They're being hurt to the tune of $140,000 additional profit for each unit they build. Please, Brer Fox, don't throw me into that briar patch! To stay within the genre, trying to harm developers in this sort of fashion is a tar baby for those trying to do it.

It sure as heck doesn't hurt the wealthy, either. They can afford housing. Matter of fact, the constriction of supply makes their real estate investments appreciate more rapidly. Increasing demand and regulatory brakes on the ability to furnish supply is pretty much the recipe for rising prices. Furthermore, this encourages speculation, driving bubbles like the ones that we just went through. It wasn't the wealthy that got hurt by that bubble. It was the folks who could just barely qualify and the people who stretched more than they should have or told fibs in order to qualify. Who was that? It certainly wasn't the wealthy. High end housing was the first to start sitting longer, because the wealthy weren't worried about getting priced out.

It certainly doesn't hurt current owners, who ride the price wave in the same manner as the wealthy investors, if not quite to the same level of profit. Anytime the ratio of demand to supply rises, so does price, and anyone who already owns benefits. These are folks well-established in life for the most part, along with high income individuals and those who inherited wealth. Sound like anyone who needs to be getting what is effectively a public subsidy?

So who does keeping the supply of housing low hurt the worst?

The young. People just getting started out. People who won't get started for another fifteen years, by which time current housing prices will seem like the Golden Age. Every time there's a new household but no new housing, the price goes up. We're going to keep gaining new households, and I don't see enough new housing on the horizon. You do the math.

Transplants coming from where housing is cheaper. Even if they own a $100,000 house free and clear, that's only a 20% down payment on $500,000. Lots of San Diegans seem to have an attitude about transplants - but most of them are themselves transplants. The question of "who is a transplant?" is very much a question of where you draw the line. Speaking as a second generation native, my take is let's just trash the whole transplant prejudice thing. People want to live here. Providing they're in the country legally, they have the same rights to do so that my family and I do. We can create the housing for them, or we can create shortages, which lead to higher prices and unaffordable housing for everyone.

The working poor. Yes, the very people the affordable housing folks claim they want to help. But keeping the supply low, delaying the arrival of more units onto the market while keeping others from happening at all, is a recipe for rising prices. A couple making $15 per hour each makes just over $5000 per month, which translates to about $2300 they can afford for housing and all their debts. Assuming they have no other payments, that's a purchase price of a little over $300,000. That might buy a severe fixer detached home or a condo in decent shape. What happens the next time they need to buy a car? Unless they're one of the rare folks who still manage to put money aside every month, they have to consolidate the car loan with their mortgage in order to afford it. Ditto any other sudden expenses. This is the opening movement to a symphony of financial disaster.

I know that the political alliances in this country have gotten completely nonsensical, but it's past time for affordable housing advocates to break away from the same party that houses the anti-development and anti-business activists. Yes, ACORN, I'm looking at you (among many others), with your "retain voter registrations of your favorite party, trash registrations of their opposition" drives (blatantly illegal, by the way, and this isn't the only such story by any means). Never mind what's the matter with Kansas, I want to know what's the matter with affordable housing activists. By any reasonable measure, they're making the problem worse with their political alliances, by supporting the agenda of their natural antithesis. If their game is to actually make housing more affordable, most of them are miserable failures at what they say they're working towards.

Of course, if the game is to make the problem worse, so that people have no choice but to deal with these organizations as supposedly the only hope of the working poor, thereby increasing their own power, these organizations are doing just fine. Trojan horses for empire building are one of the classic recipes for political success.

Caveat Emptor

My advice to sellers is very simple: Hold off if you can. Things have already improved, but better times are coming once more inventory clears. The prognosis for this is very good. I'm seeing fewer short sales, at least in my area, which means that there are fewer people who need to sell.

For buyers, it's not going to get any better than this. Stop worrying about whether the market has hit absolute bottom. Trying to time the market is worse than useless, and as I said in When You Should Not Buy Real Estate, the math works against buying for less than about three years duration. Look at the likely situation at least three years out in determining whether it's a good time to buy a place to live (if you can't last three years, stay a renter). That likely situation for property owners three years from now by comparison with now is so much better that I'm worried about diabetes every time I consider it. The local economy is doing well - enough people can afford higher prices than current to make this a strictly temporary depression in real estate prices. Growth policy is getting more restrictive all the time, and it's not like there's a whole lot of places left to build anyway. Increasing the density of existing housing doesn't seem likely in the short term, and the one municipal government that had a little bit of sanity on the manner has changed its tune for the worse. Against all these constraints on supply, demand keeps growing. The only thing working against price recovery longer term is the interest rate outlook, and I don't think those are going above the mid sevens, if that high - which would make a difference of about 10% to prices by equivalent payments - and the other factors more than compensate. Increased demand and economic ability to pay each account for more than that. Don't forget the effects of high gas prices, either, raising the value of the older suburbs that are closer in relative to that of the exurbs.

This buyer's market is not going to last three more years. I can't tell you exactly when it's going to become a seller's market again, but it isn't going to be three years. The ratio of sellers to buyers has dropped twenty percent in the last year, from 32.6 to 26.7, and absolute inventory is starting to drop - it's off over 2000 units in the last three months, when you'd expect more new inventory to be coming onto the market given the time of year.

Furthermore, those ratios are misleading because a large proportion of property for sale is still overpriced in terms of asking price when you judge by the prices things actually sell for. In my primary area, it appears that about sixty percent of what's on the market is overpriced given actual sales in the neighborhood. Some of these are Short sales where the lender just isn't going to deal due to mortgage insurance, and buyers would be wasting their time to make an offer. Others are represented by agents "buying" a listing, although that's pretty much a constant of any market. When you get down to sellers willing to allow their agent to market the property correctly and talk a reasonable price, the ratio is probably about ten sellers per buyer. Given that, Sellers don't have to compete nearly so strongly as they did even a few months ago.

Indeed, right now there is a severe constraint upon buyers that's likely to get loosened a bit in the near future: Available loans. The loan market always controls the real estate market. With San Diego designated a declining market by every lender I'm aware of, the buyers with small down payments have been locked out of the market. Currently, the only way to get high loan to value ratio loans is loans with a federal government guarantee attached: either FHA (decent) or VA (better). For conventional loans, the appraisal is automatically reduced 5% and the lenders are capping out at 90 to 95% of the lower of cost or market, which is to say, the lower of purchase price or appraisal. But Fannie Mae and Freddie Mac are still willing to buy 100% loans, at least up to the conforming limit (currently $417,000). It's just that the lenders they're buying the loans from who aren't. I'm not having issues with appraised value constraining the loan, but folks with less careful buyer's agents are, and they're needing a minimum 10 percent, and maybe 15% down payment just to get financing at all. But that "declining market" label came to us relatively recently, long after values had registered the lion's share of the drop we've had. It's going to warrant removal sometime in the not too distant future. Indeed, it seems to me that the numbers probably are there to support removal, but it's going to be a while longer before this fact is apparent, thanks to the boards of realtors who manipulated statistics to make the drop in property values appear as small as possible for as long as possible.

So what happens when the restrictions are loosened a little bit? Instead of ten to fifteen percent down payment, people need just 5% - and maybe none. Right now, people with 5% down payment just aren't a factor in the market for the most part. What happens to the seller to buyer ratio when they are? It drops. What happens when it does? Even more of the power swings from buyers to sellers. What happens to prices then? They shift upwards.

As a special note: The prices of Condos and Townhomes and even PUDs has been hit particularly hard - much harder than that of detached housing. I'm seeing nearly 200 current listings just in La Mesa, El Cajon, Santee, and Lemon Grove where the asking price is less than $150,000, and fifty have already sold. With an FHA loan, you can buy into those for 3% down, or roughly $5000. Payment on $150,000 at 6.5% (including FHA insurance) works out to $948. Add $200 HOA dues and $150 per month in taxes, and in many cases you're coming out about even on the rent - and that's without a significant down payment. Furthermore, less than $3000 per month of income can qualify you, when it might have taken twice that a few years ago and it still takes $5000 per month income for even the cheapest "fixer" detached home. With the Era of Make Believe Loans departed for now, Condos and Townhomes and maybe PUDs are going to be what first time buyers can afford in the future, and the price of gas is going to constrain people as to where they live. I expect those prices to recover more value, more quickly, than detached housing. These might not be what people want, but they are what people are going to be able to afford. Once prices start upwards again (and they will, soon), many people who won't consider them now will stop being in denial about economic reality. The choice for most folks is going to be "buy a condo or rent forever". Expect the demand and the prices to go up significantly.

Caveat Emptor