Is the real estate market passing through the bottom of the cycle? Have we reached the point where prices — which rose like crazy from 2001 through late 2005 and then declined gently in most parts of the Sacramento region — will finally flatten and eventually begin rising once again? That’s a question on the minds of many forecasters, buyers and sellers.
But it’s hard to determine what’s happening because the current real estate slowdown is different from past downturns. The way people shop for a home, and the way they finance their purchase, has changed, which makes reading the tea leaves all the more challenging.
“After reaching what appears to be the bottom in the fourth quarter of 2006, we expect existing home sales to gradually rise all this year and well into 2008,” says David Lereah, chief economist with the National Association of Realtors. “New-home sales should continue to slide, but we look for that sector to turn around later in the year.”
In the meantime, sales are down and so are prices. Colleen Badagliacco, president of the California Association of Realtors, says that between “2003 through 2005, inventories were lean, multiple offers were common, and buyers and sellers alike knew they needed to move quickly to consummate a transaction.
“But as the market began to slow in late 2005, buyers sensed that they would get a better deal if they waited, while sellers still hoped to sell their home at a premium,” Badagliacco continues. “This drove a wedge between buyer psychology and seller psychology, creating more market friction and leading to a slowdown in activity.”
Mark Milner, chief risk officer of safety-minded industry giant PMI Mortgage Insurance in Walnut Creek, sees the same trend.
“The only way you’ll find out you’re at the lowest point is after it happened.”
— Michael Lyon, CEO, Lyon Real Estate
“Years of rapid appreciation have made homes less affordable in many areas, and that’s not sustainable over the long term, so what we are seeing is not unexpected,” Milner says. “Over time, moderating appreciation will bring prices back in line with economic fundamentals, particularly incomes, bringing the market back to a healthy balance.”
In a survey of the 50 largest metropolitan areas around the country, PMI concluded that Sacramento is the region most at risk of declining real estate values in the year ahead.
PMI gave the Sacramento-Arden-Arcade-Roseville region a score of 604 (or a 60.4 percent chance of prices going down), just one point ahead of the scores for the San Diego region and the Oakland-Fremont-Hayward section of the Bay Area.
Actually, eight of the 11 regions most at risk in PMI’s national survey were in California. And six of those California regions actually saw prices go down.
“Sacramento led the trend with a 17.1 percentage point drop in year-over-year appreciation” from 2006 to 2007, the PMI survey found, a percentage that almost counterbalances the 18.5 percent increase in Sacramento home values between third quarter 2004 and third quarter 2005.
Michael Lyon, CEO of Lyon Real Estate, the Sacramento area’s largest privately held real estate firm, went on record last fall with a prediction that home prices would decline, on average, about 10 percent over 2007. That will come on top of the 10 percent the market has already lost since the peak.
“By the end of this year, a lot of homeowners will see a 20 percent loss in equity. But their equity also went up 100 percent or more since 2001, so everybody that’s been in the market over that time got 80 percent,” Lyon says.
“After reaching what appears to be the bottom,
we expect existing home sales to rise well into 2008.”
— David Lereah, chief economist, National Association of Realtors
Lyon has some words of advice for prospective buyers trying to time their entry into the market at the bottom of the cycle.
“The only way you’ll find out you’re at the lowest point is after it happened,” Lyon says. “They’re playing roulette. It’s a big mistake if buyers wait when they should be looking, educating themselves, getting tied in with a good agent, using a search engine …”
The use of search engines is one of the ways the current real estate market differs from the early ’90s slowdown.
“Eighty-five percent of buyers now use the Internet,” Lyon says. He also says just 15 percent of buyers use the classified section in the newspaper as their primary source. That’s a stark contrast with the early ’90s, when most people didn’t go online.
Because many buyers use the Internet to create lists of homes in their price range, woe unto the seller of an existing home who sets his asking price unrealistically high. Sellers of existing homes also must compete with national builders, who offer incentives and discounts.
“This is the thing that’s so different from any other downturn, like from 1990 to 1995,” Lyon says. “Here we are in 2007, and resale is not just competing against resale, but also against national builders that have great deals. They’re using stock market money; they have to keep building. They are going to keep putting up a product even though the margin is next to none because they have to keep their crews going.
“So this is a new pressure, one that we’ve been describing for the last year to sellers,” Lyon says. “And what’s happened in the past year is that a lot of sellers are becoming realistic — unless they bought in the last two years, in which case they may have to sell their home at a loss if they’re in a hurry to move.”
“Years of rapid appreciation have made homes less affordable in many areas,
and that’s not sustainable over the long term.”
— Mark Milner, chief risk officer, PMI Mortgage Insurance
Another unusual factor is mortgage interest rates. “We had cheap rates when the market hit the skids,” Lyon says. “Interest rates contributed to the ramp up in prices [from 2001 to 2005], but ultimately didn’t save the market from the fallout. Even if we had 4 percent rates, we still would have hit the wall.”
Leslie Appleton-Young, chief economist for the California Association of Realtors, agrees that “the interest rate environment played a significant role in the housing market of the past few years. From 2002 through the first half of 2005, interest rates were either expected to fall or remain at attractive levels.
“When the fixed rate temporarily exceeded 6 percent in 2003 and 2004, sales slowed,” Appleton-Young continues. “But in each case, market activity accelerated when the rate fell below that threshold.
“By contrast, when the fixed rate moved past 6 percent in late 2005, it remained there. Expectations adjusted and anticipated further rate increases, contributing to the slowdown in sales in late 2005 and into 2006.”
Some observers are also watching to see if the unconventional mortgage options that flourished during the boom will boomerang on buyers and lenders.
An analysis by PMI Mortgage Insurance suggests that in a worst-case scenario, with interest rates rising by 1 percent per year for the next four years, there could be some ugly fallout. Buyers who received interest-only mortgages could experience payment shock in the fourth year, when interest rates increase.
In the meantime, buyers are still lining up for mortgage plans that get them into a home with very little money up front. According to the California Association of Realtors, 21.1 percent of homes purchased last year were financed with a zero-down payment mortgage. And among first-time California homebuyers, 40.9 percent made a zero-down payment.
Lyon doesn’t see storm clouds in this area. “The foreclosure rate on mortgages is currently running around 4 percent,” he says. “It’s not even close to some of the big highs in the 1980s, when we had 19 percent interest rates.”
The Sacramento real estate market is also being buffeted by two factors that are hard to read in terms of where they’ll send buyers: commute difficulties and the cost of flood insurance.
Traffic on area freeways is widely considered to be bad and getting worse, and the cost of gasoline is over $3 a gallon, with some predicting prices will stay high into the summer and beyond. With higher rates for electricity and natural gas as well, some homeowners have grown weary of keeping up a big house on the fringes of the metropolitan area.
“People feel they’re spending too much time on the roads, and we’re seeing them migrate, getting closer to work,” Lyon says. That’s focused buyer attention on what Lyon calls a “sweet spot” stretching from Davis on the west, through downtown Sacramento, south into Land Park, east into midtown, and on out into Fair Oaks, areas that offer a fairly low-stress commute for many workers.
“By the end of this year, a lot of homeowners will see a 20 percent loss in equity.”
— Michael Lyon, CEO, Lyon Real Estate
“For homes in that area between 2,000 and 4,000 square feet, the market has fared well,” Lyon says. “If you drive around East Sacramento or Land Park, you won’t see a lot of ‘For Sale’ signs. The product is turning. Very little product is sitting.”
Lyon says there’s also growing interest in what he calls “the back door to downtown; neighborhoods like Arden Oaks and Arden Park, where it’s a 15-minute drive downtown on Highway 160.”
Lyon predicts that as the market gradually turns around, this sweet spot will “edge out into Carmichael. And in 2008, the North Natomas and Elk Grove areas will start to come back ... there’s been a lot of price correction.”
The wild card in all of this is the flood issue, which became much more important in the aftermath of the New Orleans disaster. Sacramento is often mentioned, along with New Orleans, as one of North America’s most at-risk cities.
In February, the Sacramento Area Flood Control Agency went to property owners with an election-by-mail that would increase assessments on homeowners and could attract matching state and federal funds, funding a total of $2.6 billion in local flood-safety work, including upgrades to Folsom Dam and the Natomas Basin levees. The measure has been enthusiastically supported by local business leaders. But upgrading the flood-control system will take 10 years or more.
Many observers also expect the Federal Emergency Management Agency to reclassify some neighborhoods as more flood-prone and require homeowners with federally backed mortgages in those neighborhoods to buy flood insurance. How that move might impact buyers is a topic on the mind of many in the real estate industry, including Lyon.
“What really hits buyers is the monthly cost of insurance,” Lyon says. “At this point, because prices are dropping in general, we haven’t really seen an effect. If we had prices going up, I could give you more of a defensible statement. But I don’t know how much effect it will have on prices.”
Lyon suggests that if buyers have to pay $50 more per month toward insurance based on a neighborhood being downgraded to a 100-year level of flood protection by FEMA, “then you have to ask what that $50 a month would have given you toward a mortgage. It will probably be something like $50,000 more of house. So if you qualified for a $600,000 home with flood insurance, then you’d qualify for $650,000 in an area where flood insurance is not required.
“But a lot of these flood areas are also job areas. If there’s enough pressure from people leaving Placer County and El Dorado County and moving closer to downtown, the demand will outstrip any monthly expense” for flood insurance, Lyon predicts, potentially leveling the field.
Overall, Lyon sees the regional real estate picture brightening over the next two years. “After 2007, state government is going to be hiring,” Lyon says, “and light manufacturing is actually doing pretty well in the Sacramento area; that’s another job creator. The underlying engine for the real estate market is jobs.”
That said, Lyon doesn’t expect to see things change overnight. “It will stay a buyer’s market this year,” he says, comparing the still-cooling real estate scene to “a big ship ... this momentum is hard to stop.
“But if you think you’re going to get a great deal at a great price by waiting until a year from now, you might find yourself competing with other buyers.”
County-by-county projections
Michael Lyon, CEO of Lyon Real Estate, offered these insights into the market on a county-by-county basis:
Sacramento
During the boom years, Sacramento County absorbed a lot of new residents. “For the guys that take a train to work, the bulk moved into Sacramento County,” Lyon says. That sent prices up from around $120,000 for the average Sacramento County home in 2001 to around $400,000 at the market’s peak in 2005. As prices rose, some longtime Sacramento County residents moved to Placer or even Nevada County.
But the shift also spurred a resurgence of residential building in downtown and midtown Sacramento, including several proposed luxury condos. Some of those projects have encountered financing problems early this year, but Lyon predicts “this is just a short-term, take-a-breath” delay.
Placer
“Placer has been able to plan strategically for growth,” Lyon says. “It’s kept the pressure tab off. We are seeing price drops in Placer; there’s enough new product being built to keep the pressure on resale and keep prices going down. But we’re getting better buyer activity in Placer than in El Dorado County.
“It all gets back to job creation, cheap land and being able to flux” with the changing market, Lyon continues. “Placer’s also become a job center. The Highway 65 corridor is a prime example.”
Yolo
Though there are significant new home developments being built in Woodland and West Sacramento, Lyon still describes Yolo as a “lack-of-inventory area, a bastion for professionals because of the schools.”
The rate of new construction is slower in Yolo County than it is in most other counties in the region, but Yolo has seen once-stratospheric home prices coming down. It’s now possible to find a few three-bedroom, one-bath homes in Davis for around $375,000.
El Dorado
“They’ve got more views than anybody else,” Lyon says. “But so many homes were sold in the heat of battle, a lot of sellers don’t have a lot of ‘play equity.’ People are hard-pressed if they’re asked to get rid of actual cash they put into their property. There were a lot of sales in the last few years, and there’s a lot of expensive product
“But as soon as an El Dorado property is priced right,” Lyon continues, “it will sell quickly. However, a lot of people are unable to get their prices down to make those sales.”
Nevada
This scenic foothill county has Gold Rush history and several smart software startups. “But they’ve got 18 months of standing inventory” in terms of unsold homes, Lyon says, almost double that of Yolo County and higher than any other county in the region. Some parts of Nevada County are running closer to two years of standing inventory.
“You know you’re in trouble when you find a 500-square-foot house with one bath and they’re asking $500,000 for it,” Lyon continues. “Nevada County had too rapid a ramp up in prices.”
Yuba-Sutter
During the boom, some buyers were happy to exchange a longer drive from these twin counties north of Sacramento — in exchange for the opportunity to own a home.
“Buyers will drive again,” Lyon predicts, “but right now, there’s too much product in this area.” Prices have also come down in the Natomas area, and the inventory of new and existing homes for sale in Natomas has risen.