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Catch 22 Artificially Suppressing San Diego County Rebound

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Commentary by George W. Mantor

RISMEDIA, July 21, 2009-Despite a worsening local job picture with unemployment now over 10%, the real estate market in San Diego County is exhibiting signs of steadily increasing activity and price increases. But, recent government action is preventing motivated buyers with good credit from even getting their offers considered.

The county is a little over 4,200 square miles and home to 3.2 million residents. It is a geographic island with an International border to the South, Pacific Ocean to the West, the 200 square mile Camp Pendleton to the North, and to the East, the 460,000 acre, 130-mile long Cleveland National Forest. Beyond that are a series of rugged mountain ranges and the Anza Borrego and Sonoran Deserts.

The small amount of developable land within the county remains undeveloped for a reason; either it isn’t feasible due to remote location or steep terrain. There are also 18 Indian reservations, many of which now operate as casinos and do not intend to develop much of their land.

Newspaper stories citing an endless parade of U-Hauls heading north and eastward rarely note that the population continues to increase by 35,000 to 40,000 people every year. Few people leave San Diego because they want to. This exodus is being driven by job losses, particularly in the building industry. If you are a framer or a mason, there isn’t much work. But, build we must, sooner or later.

While it may sound preposterous in terms of the current housing glut to say this, the fundamental problem in San Diego County is a severe and perpetual long-term inability to build as many homes as we need to meet the demands of a growing population. We should be building about 15,000 homes per year. In 2008 we built 3,725. This year we will build fewer than 2,000. In fact, most of the building these past two years has been primarily multi-family and fire replacements.

So much for the long term. More recently, we have seen some very interesting trend lines that could foretell the beginning of the next boom. For those looking to find bottom in San Diego County…Oops, there it went.

Consider this:

According to SANDICOR, the County Multiple listing service, over the past decade, from 1999, through 2008, combined sales of single-family detached and attached homes averaged 34,465 per year or 2,872 per month.

2008 was right in line with the 10-year average with 34,182 sales.

But, now we are seeing numbers equivalent to the boom years. May 2009 produced 3,222 sales. June produced 3,678. When compared to historical baselines, the market would appear to be well into recovery.

Granted, the summer months are the most active and an argument could also be made that because the population is increasing, a normal market would exceed historical baselines by a percentage equivalent to the increase in population. Nevertheless, we are seeing positive trends that, if they continue, could very well take us into record numbers again.

Rising Sales Prices

From January through June, the prices have been rising. Considering that nearly half of San Diego sales are foreclosures and that they tend to be smaller, older, and generally have fewer amenities than their newer counterparts, the very fact that prices are rising at a time when half the sales are distressed properties is itself amazing and another positive indicator.

Case Shiller Index

A number of people have asserted that the Case Shiller Index is the only reliable method of determining the strength of the market, and that it shows prices declining. The index is two months behind so the most recent data we have is for April. Not very reflective of the market at the moment

Case Shiller studies only look at a small and misleading segment of the market, detached homes that have sold twice during a short period of time. Those would overwhelmingly be distressed sales, foreclosure or REO properties that circumvent the give and take between a true seller and buyer, and represent a form of asset dumping.

Increasing and now decreasing affordability

As sales prices bottomed in January and started back up, their gains were followed 90 days later by inversely proportional declines to the affordability index.

Days on the market

The average market time is now 45 days, which is good. But, many properties have languished on the market since last year, while newer listings can sell within hours. And, while some zip codes have a substantial number of homes available, others have nothing left but the dregs.

Declining inventory

So far, the long anticipated flood of foreclosures hasn’t come to market. We’ve got our fingers crossed, but defaults continue to cause concern because we do not understand the nature of the defaults. I have speculated before that there may be homeowners who are simply withholding their payments to obtain relief from their lender. But, for the moment, we are very close to a balanced market.

A balanced market occurs when the ratio between listings and sales is about 2.5 to one. Fewer listings shifts the power from the buyer to the seller.

From 2004 through 2007, there was an enormous spike in listings, from an average of approximately 60,000 to approximately 77,000, well beyond historical norms.

Although 1999 holds the record for most sales in a year with 40,251, 2004 was the peak year for this particular boom with 40,126 sales against 64,529 listings. But, as sales declined in 2005 to 37,908, listings ballooned to a whopping 81,500, followed by 76, 721 in 2006 against 28,977 sales.

2007 produced 70,645 listings and only 20,695 sales. Obviously, the market did not absorb anywhere near the number of listings produced which raises the question, what happened to them?

The answer to that may not be as ominous as it appears. Up until about 2006, builders rarely cooperated with brokers and their inventory wasn’t represented in the MLS. Also, the spike in listings was largely in attached homes.

At exactly the same time that builders could finally respond to the surge in demand, the economy began to unravel and the market began to decline. But, with the exception of a few large master planned communities, most of the building was in the attached sector, and many of the properties that flooded the market in ’05, ‘06 and ‘07 were conversions of apartments. Many of these and a substantial number of new attached homes have converted to rental housing and left the market.

Currently, there are only 2,936 attached homes listed in the MLS and only 5,915 detached homes available. The two to one margin between detached and attached product is also being perfectly reflected in sales numbers.

Price per square foot

The median price per square foot is now $208. But, the cost to construct a comparable new home is closer to $300 per square foot and up.

Shrinking gap between listing and closed price

MLS statistics are showing a trend toward a shrinking gap between list price and sales price.

Pent-up demand is coming back to the market in San Diego County with such intensity that moderately priced Short Sales and REOs are generating as many as fifty to a hundred offers.

Bidding Wars

Typically, this sort of demand/supply imbalance would lead to bidding wars and increased selling prices. But, not now. The bidding wars are there but not the appraisals to support the higher prices. Buyers who are willing to pay more are being rejected by institutional sellers in favor of lower priced buyers out of apprehension that the property won’t appraise. So much for the free market setting prices.

San Diego is getting its first taste of government intervention in the real estate industry, and for buyers who are losing out and to other property owners whose home values are being artificially depressed by new appraisal laws, it’s just another reminder of how completely ineffective government has become.

The Home Valuation Code of Conduct (HVCC) which went into effect on May 1, 2009, prohibits mortgage brokers from ordering appraisals directly from, or having any contact with, a licensed real estate appraiser. This includes providing relevant information. Instead, lenders are required to use third-party “appraisal management” companies, or “middle-persons,” that oversee the process and filter communication.

If loan programs change and the borrower needs to submit to another lender, or even another, the cash-strapped buyer will be required to pay for each new appraisal.

Also, the third party or “middle-person” has slowed the process to a crawl, delaying closings and causing loan locks to expire. The “middle-person” frequently sends an appraiser from out of area who does not understand the local market. With no one allowed to talk to him, his conclusions may add further costs for the consumer. And, don’t forget, the “middle-person” has to get paid…for each appraisal.

The unintended consequences are many, negatively impact both buyer and seller, and are resulting in closing costs increasing hundreds or even thousands of dollars.

The old doctrine of the borrower paid for the appraisal so it’s his, no longer applies.

Rather than weighing more information, the consumer will now get the “benefit” of less. This effectively cuts off the supply of valuable and current information about market conditions. At a time when more, not less, information sharing is the way of the world, this is an odd one to fathom. I have always made it a point to meet my appraiser at the property and provide him with the information and the analysis that I used in determining the listing price.

But, by suggesting that there has been wide spread malfeasance by appraisers is preposterous. Some, yes, just like politicians and government employees.

This is just another example of a red herring drawn into the argument to pull attention away from the real problems behind the housing crisis: wages haven’t kept pace with inflation and our prosperity has been squandered by massive fraud for money by government employees, politicians, CEOs, accounting firms, foreign nationals, securities dealers and sophisticated business people.

But now, thanks to government, the San Diego market has yet another obstacle to recovery to deal with.

Don’t miss George Mantor as he discusses what’s next for San Diego real estate on Saturday, July 25th from 10 a.m. to 12 p.m. at Prudential CA Realty in Carlsbad, California. Mantor will discuss what really happened to our prosperity, point out the signs to look for in a recovering market as well as provide information about programs that are available to assist and encourage buyers.

George W. Mantor is known as “The Real Estate Professor” for his wealth building formula, Lx2+(U²)xTFP=$? and consumer education efforts. During a career that has spanned more than three decades, he has amassed experience in new home and resale residential real estate, resort marketing, and commercial and investment property. He is currently the founder and president of The Associates Financial Group, a real estate consulting firm.

Mantor can be reached at GWMantor@aol.com.

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