Speed of price correction is ‘almost unprecedented’

USC economists present some bad news, some better news
By Glenn Roberts Jr., Friday, June 27, 2008.

Inman News

SAN FRANCISCO — The bad news: It’s “almost unprecedented” that home prices are falling “this swiftly and this steeply in this short period of time” in some California market areas.

That’s according to Delores A. Conway, director of the Casden Real Estate Economics Forecast at the University of Southern California Lusk Center for Real Estate, who spoke Thursday during an economic and housing forecast presentation at PCBC, an annual builders’ conference.

Prices have fallen about 30 percent in the past two years in some market areas in the state, she said.

“Things look pretty bleak now,” she said, with foreclosures “really mounting” in some areas and prices falling sharply in inland California market areas like Stockton, Sacramento, San Bernardino and Riverside.

Historically, there have been price declines of similar magnitudes, Conway said. For example, there was a 20 percent decline in home prices in the Los Angeles area in a past market cycle. But that took place over a 6-year period, she noted.

More bad news: “Banks really don’t have as much money to lend. The lending criteria have really tightened up. The other piece is buyer psychology. When buyers see prices falling they don’t want to jump in … they may risk losing their down payment or any money they put into the house.”

The falling prices and rising foreclosures “tend to really create almost a downward spiral.”

Liquidity remains a major issue, particular for homes above $1 million that exceed the conforming loan limit. “It is very difficult to get jumbo loans. The inventories are mounting (for these homes),” she said.

Unemployment is a concern in markets like Orange County, which had a high concentration of mortgage-related jobs, and in the Inland Empire, which has lost many construction jobs, she said.

The better news: Homes are becoming more affordable, with monthly payments falling because of relatively low interest rates and falling home prices. In Riverside County the typical monthly payment for homes has dropped by about 33-38 percent from its peak, she said, “so we don’t have a whole lot more to go.”

Some foreclosure properties in Riverside County are drawing multiple offers, and that is a sign that the market may be on the rebound. “There is buying interest that’s returning to Riverside,” she said.

“We’re already two years into this correction,” she said, adding that it could take another 12-24 months, depending on the area.

The good news: “We are moving through this price correction pretty quickly,” Conway said.

Raphael Bostic, director of the Master of Real Estate Development Program at the USC Lusk Center, said that lending activity in some market segments in California “shut down here much more dramatically” than in some other U.S. markets because of the comparatively high cost of homes in the state.

And while there are several legislative and regulatory efforts to expedite the market’s recovery, “Until banks and (others) decide to participate in a significant way — there is very little that anyone can do about it. It’s got to be lender to lender.”

Consumer psychology is key to the recovery, Bostic said. “We need to watch how consumers are acting. To what extent does the $5-a-gallon (gas prices) change people’s preferences and how they live?”

A view that “everything is a disaster — everything has collapsed and is never going to return again” is erroneous, he said, and provided examples of market areas where the up and down cycle was muted or even non-existent.

“The local context is really important,” he said. Mountain states markets, such as Billings, Mont., and Ogden, Utah, experienced slow rises in home prices and have not seen the sharp descent exhibited by some California market areas, he noted.

Those markets that were “late to the party” in appreciation are generally weathering the downturn better than others, he also said.

The markets experiencing a high volume of foreclosures now tend to be those markets that had heavy building activity during the housing run-up and may be slower to recover as a result.

Richard Green, director for the USC Lusk Center, said some lenders have severely pulled back on jumbo lending. “What they’re saying is we’re closed for business” for high-value loan amounts, he said.

The mortgage market is factoring in default rates for prime mortgages that are four to five times higher than what it had considered in previous years, he said, which could be out of line with the actual risk.

Green said he is watching the TED Spread, a measure of credit risk that compares the interest rate in U.S. Treasuries contracts with that of contracts in U.S. dollars at banks outside the United States. The spread has been rising lately, he noted, and tends to be greatest in times of financial crisis.