Orange County Housing Report
December 28, 2009

What does the New Year mean for Orange County real estate? Generally, forecasting draws from historical data and circumstances to predict the future. However, recent data and circumstances defy normal trends making forecasting the housing market more of an art than an exact science. There have already been many wildly varying forecasts released. With this in mind, let's first take a look back at what happened in 2009 in terms of inventory, demand, expected market time and distressed properties. The Active Inventory: We started the year with 11,326 homes on the market, and the active inventory reached its peak of 11,606 homes by the end of March, with an additional 280 homes compared to the beginning of the year, a 2.5% increase. From there, the inventory steadily declined throughout the remainder of the year. Currently, the active inventory has decreased an additional 131 homes, to 7,381 homes, a 36% drop from the 2009 peak. The inventory has dropped to levels not seen since December of 2005. In comparison, the 2008 active inventory grew from 14,944 homes in January to peak in March at 15,617 homes, a 4.5% increase. Throughout the remainder of 2008 the inventory decreased 26% to close the year at 11,842 homes. In 2006 and 2007, the active inventory grew through much of the year with each year peaking in August. In 2008 and 2009, the inventory cycle began to return to normal, in part because the discretionary homeowner (homeowners with equity that decide to sell) took a hiatus during much of 2008 and the first half of 2009. Had discretionary homeowners continued to place their homes on the market during this time, we could have been looking at inventory levels hovering around the 20,000 mark. As a side note, the reclassification of short sales ( where a home is sold for the less than the homeowner owes on it) from a status of "active", to a status of "backup" or pending during the short sale approval process, has helped the numbers to more accurately reflect the true inventory of homes available in the MLS.

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Demand (the number of new pending sales within the prior month) grew again in 2009 from 2,008 homes in the beginning of January to a peak of 3,652 homes in June, an increase of 82%. Since June demand has followed a normal cyclical, seasonal pattern. Demand was boosted by a major drop in home values over the prior couple of years, increasing affordability, as well as, historically low interest rates, the first time home buyer tax credit and the number of distressed properties on the market. In 2008 demand also peaked in June reaching a total of 3,060 homes, and then, as in 2009, slowed for the autumn and Holiday markets. Our current Holiday market demand has dropped, as is typical, by 523 homes to 2,515 homes. This is much stronger than last year at this time when demand dropped to 1,997 homes, 21% less than today. In 2007, demand was at 1,031 homes, 59% less.

The Orange County housing market started the year with an expected market time (the time it would take to sell the entire current inventory based on the current demand) of 5.62 months. As demand increased and the inventory decreased, the expected market time was reduced to its lowest level of the year in September of 2.33 months. Currently the expected market time is at 2.93 months. In 2008 the year began with an expected market time of 14.97 months, and declined to 5.93 months by the end of the year. In 2007 the year began with an expected market time of 7.78 months, and increased to 15.05 by the end of the year. At the current expected market time, it is technically a seller's market; however, distressed properties are keeping a lid on any real appreciation. Never-the-less all of the other attributes that are typical of a seller's market are very much a part of today's housing landscape: multiple offers, sale prices above list prices, tremendous competition, and buyer frustration.

The big story of 2008 was how much the distressed inventory grew and became such a large part of the housing market. This year, the big story was how the number of distressed properties has dropped. With moratoriums on foreclosures at the beginning of the year and the government insisting upon loan modifications, the number of foreclosed homes for sale dropped throughout the year. In the beginning of 2009 there were 5,118 distressed homes on the market, both short sales and foreclosed properties, representing 45% of the active inventory. The distressed inventory dropped 46% to a low of 2,346 in October, representing 31% of the active inventory.

With a decrease in demand due to the holidays, the current active distressed inventory increased by 41 homes over the past month and is now at 2,537 homes, representing 34% of the total inventory. In 2008, the distressed inventory started the year at 3,858 homes, peaked in August at 5,950 homes and then dropped to 5,379 homes at the end of the year. Short sales make up 85% of the distressed inventory versus 15% being foreclosed homes. At the beginning of the year, distressed properties made up 69% of demand versus 55% today. There is tremendous demand for distressed properties. Even though it is the Holiday market, the expected market time for all foreclosed properties is at 1.07 months, a DEEP SELLER's market. The sales to list price ratio for foreclosed properties purchased in the month of November were at 104%. That means that the average foreclosed property sold for 4% ABOVE the list price. There are only 378 foreclosed properties available in all of Orange County today in all price ranges. One year ago there were 1,294. There is similar demand for short sales with an expected market time of 2.12 months. The sales to list price ratio for short sales in November were at 99%. Short sales have become a major part of the housing market and will remain so throughout 2010. There are 2,159 short sales on the active market, 4,037 short sales are pending and 856 have been placed on hold. All of these statuses combined total 7,093. Short sales represent 48% of all listings, pendings and properties on hold.

Perhaps the biggest surprise of the year has been the large drop in distressed sales. Throughout the year, everybody heard about the various foreclosure moratoriums and the pending wave of foreclosed properties to come, also known as the "shadow inventory." The shadow inventory includes all homes that have been foreclosed on but the lender has (purportedly) purposefully held off of the market, all homes scheduled for a trustees deed upon sale (the final foreclosure action) and, most important, all homes that are 90 days or more delinquent. There is a significant shadow inventory, but many economists and analysts have made an error in presuming that lenders are purposely holding already foreclosed homes off of the market. Instead, most of the shadow inventory is already on the market as short sales. There are over 7,000 in Orange County alone that are on the active market, pending or on hold. In Los Angeles, there are over 13,000, in Riverside there are over 8,000, in San Bernardino there are over 5,700, and in San Diego there are over 8,500. Minus Ventura County, there are over 42,000 short sales in Southern California alone. The short sales have piled up across the United States. There has been tremendous pressure from the federal government for lenders to modify loans. Thus far the program has not been very successful. Now the government is concentrating short sales. The government wants lenders to modify first, short sale second, and, as a last resort, foreclose. On November 30th of this year, the Obama administration, through the U.S. Treasury, released the Home Affordable Foreclosure Alternative Program (HAFA), providing financial incentives to servicers and borrowers who utilize a short sale or a deed-in-lieu to avoid a foreclosure on an eligible loan. In response, lenders are gearing up to handle the large volume of short sales.

The first time home buyer tax credit also had a positive impact on the housing market along with the increased conventional loan limit to $729,750. The tax credit was supposed to end November 30th, but has since been extended through June of next year. So, we can expect a bump in activity due to the credit for the first half of 2010. The government was late to provide an extension to the increased conventional loan limit from 2008 to 2009, so the first few months of 2009, the conventional loan limit dropped to $625,500 and then it was increased again to $729,750. The increase was set to expire at the end of 2009, but this time the government actually planned ahead and extended the increase through the end of 2010. This is very important to the Orange County housing market since loans above the conventional loan limit, jumbo loans, are much more difficult to obtain.

The federal government has been working overtime to help instigate an increase in demand and an eventual recovery within the real estate sector. The first time home buyer tax credit has been expanded to include move-up buyers who need to sell their homes first and extended through June of next year (homes need to be pending by April 30th and close by June 30th). As discussed prior, the conventional loan limit has been extended through all of 2010. But, the biggest wild card for 2010 is what will eventually happen to interest rates as the Federal Reserve halts the purchase of mortgage-backed securities. Here is my forecast:

• The lower price ranges, below $1 million, and especially below $750,000, will continue to experience strong demand and values will remain flat or appreciate slightly. Homes priced below $1 million accounts for 76% of the active listing inventory and 94% of demand. Buyers and sellers can continue to expect multiple offers and sales prices at or above the list price. Bottom feeders need not waste their time.
• The upper price ranges, above $1 million, and especially above $2 million, will continue to experience muted demand along with a drop in value. The upper price ranges are beginning to experience the large decrease in value that has already been experienced within the lower price ranges. The upper price range drop in value will be led by an increase in distressed sales within those ranges. Jumbo loans may be tougher to obtain in the upper ranges, but as values drop, demand will increase. The appetite for upper end distressed sales has grown and, with proper pricing, will attract higher demand and multiple offers.
• The number of units sold will increase year over year slightly. The difference will be much stronger in the first quarter of 2010 and the gap will tighten for the remainder of the year. For the most part, the demand curve will closely mirror 2009.
• The discretionary seller will return to the marketplace, keeping inventory levels at a healthy level. We can expect the active inventory to grow to no more than 9,000 homes.
• Short sales will be king in 2010. With the federal government turning their attention to short sales, the process is going to improve. The government had been strong arming lenders to modify loans, but success has been very limited. There will be a lot more short sale approvals, which translates to successful closed short sales. The infamous "shadow inventory" will actually translate to more short sales. Short sales are already a major component of today's real estate market. The only thing missing right now is a higher success rate and that is about to change. Expect the number of closed short sales to continue to exceed the number of closed foreclosed property sales on a monthly basis.
• The number of foreclosed properties on the market will increase slightly year over year, but will NOT be a wave fueled by the "shadow inventory."
• We can expect the distressed inventory to rise slowly with more short sales and foreclosed properties on the market; but, this will be offset by the incredible demand for distressed properties. With demand so high, the sale price of distressed properties will be placed at the last comparable sale, not below.
• As the Federal Reserve's purchase of mortgage-backed securities comes to an end after the first quarter of 2010, interest rates will rise to about 6%. That may seem like a giant jump, but 6% is still historically low.
• It is going to be a long wait for homeowners waiting for home prices to rebound. With unemployment high and more distressed homes on the market, the most likely scenario is going to be flat home prices for the next couple of years, with no real appreciation or depreciation.

There have been a lot of lessons learned over these last 4 years. The most important housing market lesson has to be that people need to look for a place to call "home" for the long term, making sure that their family can afford the monthly payment. While historically, over the long term, a home is a great investment, it is not meant to be an asset to be flipped every two years because the government has made it convenient to write off the gains. A home is meant to be a secure place in this world to call your own.

Source: Steven Thomas, President, Altera Real Estate