Federal Reserve Chairman Ben Bernanke has declared that 2013 will be a better year than 2012, and some market players take this as gospel. Yet an air of unreality hangs over the markets, kind of like the exhausted funk that prevailed in the waning days of 2007 and before the four horsemen of the apocalypse visited Wall Street.
You see, while presidents and Fed chairmen can declare the housing crisis over, the markets operate every day — and very differently in various parts of the country. In Arizona and the Southwest, for example, an investor boom is ongoing, built upon the quicksand of private equity and leverage. The smallest discounts to market value seem to accompany the biggest leverage ratios, in these cases, making the rental equation even more difficult. But Arizona is relatively attractive for investors compared to other markets around the country.
One of the revolutions in thinking in the real estate world and one that is still relatively unknown is the concept of marketing residential homes as investments. We are not talking about the get-rich quick fool on late night TV, but people who buy properties to create income and equity over a period of years, if not decades. It might surprise some HousingWire readers that seasoned individual investors, call them “Mom and Pop,” often have more on the ball when it comes to buying a home “right” than does the recently arrived MBAs working for a private equity fund.
If you look at home prices in Tucson, Ariz., for example, Zillow indicates that the market is up about 6% year-over-year. Median sale prices around $130,000 for Tucson are just off the lows and about $100,000 below the $220,000 peak in 2005. The total number of homes sold, however, is actually down 16% compared to the same quarter in 2011 and about 2% year-over-year. Seasonality plays an important role here, with strong volumes in the first half of the year followed by slower sales going into the winter and the school year.
If you look at actual home prices for Tucson, the Zillow data shows a 5.8% increase over a year ago, which is a little faster than you’d like to see in terms of a sustainable rally. When home prices are moving up more quickly than the growth in population or GDP, then you should start to worry about a speculative bubble. The difference today is the Fed’s low interest rate posture and a short-term dearth of inventory due to local backlogs in foreclosure inventory.
Since the start of 2012, median home prices have jumped from $120,000 to $150,000 in the Tucson area, a significant increase and one that begs the question as to the quality and sustainability of the rally. Areas such as South Tucson, on the other hand, have seen a decline in prices of almost 10% in the past year, illustrating the wide divergence of experience even in a given local market.
Looking in Scarsdale, N.Y., the picture is very different. Zillow reports almost 30 homes sold in 2012, an 80% increase over a year ago when only 11 homes sold. This is one of the most affluent communities in the U.S. where median home sale prices are above $1 million. The sale-to-list ratio in Scarsdale fell to 0.8% in 2011, meaning that sellers were being forced to accept sale prices well below the list price, but it has now recovered to nearly 1:1. The median sale price, however, remains well below the $1.7 million median price seen in 2007 when more than 50 homes were sold in this community.
There are several constraints on home sales in Scarsdale. First and foremost is the lack of financing above the Federal Housing Administration cap for government guaranteed loans, currently $625,000 in the New York, Connecticut, New Jersey tri-state area. While there are a number of bank and nonbank lenders who are writing jumbo, nonconforming loans, the volumes are a fraction of what is needed to serve the market. What this means in practical terms is that borrowers are forced to either cut prices or consider more creative forms of mortgage finance. Seller financing for part of the cost of a home purchase has come back into vogue.
The other factor limiting sales in areas such as suburban New York is the still considerable backlog in foreclosures. Because a lender cannot sell a property until the New York courts act on the foreclosure application, a considerable supply of homes sits on the sidelines. When these properties are free to trade, the lenders will be seeking to liquidate these homes quickly. In many cases, valuations in communities such as Scarsdale are still too high to make these properties work for investors as rentals. This means that while you might make money on a property over five to 10 years, investors could be cash flow negative in the first several years of the purchase of an investment property.
If we look at Sarasota, Fla., yet another picture emerges for 2012. The median home price in Sarasota is up almost 40% over a year ago, a sharp change from the down 30% seen in the median price during 2010. The median price gathered by Zillow peaked at more than $220,000 earlier in the year, but has fallen back below $200,000 since then. Again, there is a big seasonality factor in home prices and the results in Sarasota show this very dramatically. Year-to-date, about 80 homes have been sold in Sarasota in 2012, a level below that of 2011 and about half of the 2005 peak near 160 homes.
The median sale price in Sarasota has shown enormous volatility during 2012, with a high of $240,000 in the early part of the year and a low near $100,000 at the end of the summer. This wide dispersion in price swings suggests that there are a significant number of involuntary sales of distressed properties in the mix. But the bias in this market is clearly bullish, with more than 80% of all sales showing increased prices in 2012, according to Zillow.
What these three different geographic markets suggest is what we have always known, namely that real estate is a local market with very specific characteristics. While prices and volumes are better in 2012 than in the previous several years, in none of these markets have we returned to pre-crisis volumes or prices.
If you look at the data closely, 2012 was certainly better — but from a very low base. Current prices reported by Zillow and other sources, in fact, remain so depressed compared to the peaks of 2004-2007 as to suggest that commercial banks continue to face serious asset quality problems.
Many loans that banks count as performing remain impaired based on current comparable market valuations. Since home prices have only just started to recover compared to the peak valuations of 2004 to 2007, it seems obvious that the largest banks will continue to see above-normal loan loss rates for years to come. The FDIC reported that gross loan charge-offs for all banks was 1.6% in the third quarter of 2012, a significant improvement from the 2.4% in 2009 but three times the 0.5% reported in 2007. This movie is still not half over.
