The 2011 San Diego Local Real Estate Market Update – 2011 Predictions and Expectations and Beyond!

2011 will be a year of change, that’s for sure, but the market overall is looking much more stable and consistent than that of the last couple years. The nation as a whole has been knocked around by the great recession and we are seeing the after effects from the most severe economic downturn in decades. That being said, this year will be one of more stability whereas last year was a tumultuous rollercoaster, not only for real estate, but for the greater economy as a whole.

I would love to say that this year will be the break out recovery year that everyone is hoping for, but the fundamentals point to the contrary. Depending on how you measure, there are anywhere from 15-25 Million people that are unemployed. There are 7+ Million households in some form of financial trouble and facing the possibility of foreclosure. Depending on how you measure, we are running a 14-55 TRILLION dollar deficit and we are creating money like crazy and buying back our own debt to gloss things over until things get better – it’s crazy. Notwithstanding the societal, environmental, and geopolitical issues that are impossible to ignore, you could basically say that we are living in the most fluctuating, fast-paced and most exciting time to be alive in human history. I would argue that never before in the history of our species has a single generation had the ability to enact such immense change both presently and well into the future. It’s safe to say that there is a lot going on in our world, and so much so that you need to rely on your trusted advisors more than ever, so I am pleased to be able to provide you with the best information and best service possible for all of your real estate needs.

Of the several negative issues mentioned above, there are an equal amount of positive developments that are occurring as well when it comes to local real estate. The last couple years have been difficult, but we are all doing our best to make our way through these challenging times. The three biggest barriers preventing a full-blown economic recovery are high unemployment, excess inventory, and people’s negative perception of the real estate market, in general. Ill addresses each of these separately.

Unemployment: Everyone talks about unemployment and it is a big deal because when a work-worthy person cannot find employment, the loss of that utility value is small, but when multiplied several million times for all those who are unemployed throughout the nation, it takes its toll on everyone to a considerable degree. Its eats away from GDP because that would-be worker is not making the money that leads to consumption, it takes the USA down a notch on the world scale in overall productivity, it takes away from tax revenue that is so badly needed by our government, and it has a damaging effect on the family unit when the breadwinner of a family cannot find work. Until jobs are placed by this excess workforce, we will continue to have problems. Ben Bernanke, the Chairman of the FED, has recently stated it will take 5 or more years to get to 5% unemployment, which most economists consider the “natural” rate (of unemployment). It’s good to see that USA today on a recent front page is touting that jobs are being created and we are making progress, unfortunately it is slower than everyone wants or expects. From a real estate perspective, the more people that are unemployed or on limited work schedules (furloughs), the fewer people there are that can actually qualify for a home loan. Last year alone 93% of all home purchases were done so using some sort of mortgage financing, so although it may seem that there are a lot of all-cash buyers out there, it’s quite the contrary, and this lack of buyer capacity will cause a reduction in overall demand, which will have a dampening effect on home values. We have seen this effect take shape over the past 18-24 months specifically, but the good news is that the worst is behind us.

Excess Inventory: We are in the midst of a massive turnover of real estate. This turnover was one that was thought to be an onslaught of foreclosed homes, but it hasn’t turned out to be that way. Banks are smart and if there is a shadow inventory of homes that are being withheld from the public, it is being released in a very controlled manner. After all, why would the banks release the entire foreclosed inventory at once? All that housing supply would just eat away at their bottom line. The opportunity cost of holding these foreclosed properties is greater than just fire-selling them away to get them off the books. There are a lot of myths out there regarding all those foreclosed homes and their relationship with the banks that own them. Just know that this is an issue that is far from over; in other words, the banks do own a considerable amount of REO (Real Estate Owned) property, and that these homes will become available at a controlled level over time until all the excess property is absorbed. Essentially, this is the best way to go about getting rid of all the excess property anyway. It’s good for the banks because they make more money, but at the same time it is good for current homeowners because values will remain stable, as well as being good for the economy in general.

Furthermore, 2011 will be the year of the short sale. On average, the bank will make 10-15% more by doing a short sale as opposed to foreclosing on a home. A short sale makes sense for a bank because the seller in a short sale works with their agent to find a buyer and all the bank needs to do is “push the button” and approve the deal. With a foreclosure, there are mounting holding costs, property taxes, eviction costs, repair costs and lawyer’s fees that the bank is responsible for, and when compared side by side, the short sale is the win-win for the bank and borrower alike. 2010 was a record year for foreclosures where over 1 million homes were taken over by the banks. Many experts predict that 2011 will be the absolute peak for foreclosures, and estimates are as high as 1.3 Million homes being taken over the banks. That being said, these experts are not taking into account all of these would-be foreclosures that will inevitably be sold as a short sale because in most cases, doing a short sale is considerably better than a foreclosure in terms of the overall effect on the financial and credit health of the seller/borrower. The more people doing a short sale, the quicker we can absorb the excess distressed inventory in the market, and because the federal government has rolled out attractive programs that entice cooperation for the bank and sellers in a successful short sale, this will add momentum making the short sale the most popular and viable go-to option to absorb inventory and make substantial inroads on the way to economic recovery. As a result, expect to see a consistent and substantial supply of short sale inventory for at least the next 18-24 months.

This time horizon is the same for foreclosure properties as well, and the reason being is that the peak of the market in terms of prices was in late 2006 and early 2007. Up to this point there were still 0%-down and sub-prime loans being made, and many of these loans were underwritten on a 5 year fixed interest rate. By the time 5 years would come around, the terms of the loan would increase the payment substantially, but your typical borrower at this time in 2006 or 2007 was given the notion that they would easily be able to refinance out of their loan, no problem… well, things have changed. These loans are the loans that will be your next foreclosure or short sale this and next year. These are the loans owned by debt-laden and over-extended borrowers who cannot keep up with their monthly obligations any further. Since these toxic loans continued to go on unabated until about 2008, we will continue to see the negative implications and aftermath up until 2013.

Owners that own homes that are worth 40%-50% less than what they bought them for a few years ago can see that their value isn’t coming back anytime soon. They are smart enough to know to remove themselves now when everyone else is doing a short sale so that they can put themselves in a decent position to buy a home again in the future, where the prices will still be reasonably good. This sentiment is running rampant, and I know because I am getting more calls and referrals about short sales than ever before. For the market as a whole, this is great because it takes a home that is upside down and a borrower that is in a crappy position financially, and it resets value to a qualified buyer that can afford the home and is committed to a length of homeownership for more than just a couple of years. This is the type of stabilizing mechanism that will get us where we need to be, and the short sale is one major avenue of getting us there.

People’s Perception: Call it perception, or call it consumer confidence, if it is negative, then we are in for a rough ride. Along with this New Year came an overwhelming rebirth of spirit and hope; (at least that’s what I see and feel). The end of 2010 brought the closure of a year that for many was one they would like to forget. I am seeing great developments popping up all over the place, and in general I am seeing the overall sense of people’s sentiment improving. Although we are improving at a slow and arduous rate, we are nonetheless moving in the right direction. Unless the majority of us believe we are headed in the right direction, we will be less well off and more susceptible to the potential hurdles and pitfalls while on our way to recovery. To look at this another way, consider the uninhibited optimism of real estate as a whole throughout the years 2004-2006. This was essentially an apex of consumer confidence and people were paying crazy amounts for homes that were selling for hundreds of thousands less just a year or so before. There is a severe herd mentality with real estate, as with the stock market and many other daily societal interactions for that matter, and herd mentality was never more apparent than with the housing boom of 2004-2006. People’s perceptions were that prices were going to continuously go higher. Unfortunately, the opposite was true, and during the ensuing correction and recession, the perception changed and most people felt that prices were perceived to go continuously lower, but I argue that this was back in 2008-2009. We are now in a position of trying to gain a modicum of stability and confidence and that is what I am seeing develop which will continue to do so throughout the year, barring any unforeseen anomaly. In fact, a national poll stated that 7 of 10 people report that home values have stabilized in their area. In other words, the crap hit the fan, but the worst is behind us and we are slowly getting the pieces back together again. While it may not feel great, it’s considerably better than where we were just a year or two ago, and the populace is getting more and more positive as time goes on.

Looking Ahead

Overall, San Diego has had a healthy correction over the past couple years, and its poised to remain stable and remain one of the best places in the country for a buyer to invest their money on real estate.

At one point at the peak of the market in 2006, only 12% of households could afford the median priced home – seriously! How could people expect that prices were going to go higher when only 12% of all the families in San Diego could afford the middle of the road home…crazy. Today that number has more than tripled, and for a median-sized condo, the number is more than 50%. Affordability is at a 40 year high and a recent poll reported that 8 of 10 people believe that buying a home right now is a good financial decision and 68% of people feel that now is a good time to buy a home.

Further, interest rates are trending at an all time low. They have never been this good, and that is saying a lot. If you take the average mortgage rate over the past 30 years, it is approximately 7%. Today rates are below 5% and that is just astounding. Never has there been a period in the past 70 years where there was a real estate environment of low interest rates and reduced prices. It is truly a historic time to be involved in the market, because I firmly believe that we all will look back several years from now and see what a buying opportunity this was. I will argue that the years 2009-2014 will be a 5 year window of awesomeness in terms of purchasing real estate over the long term. That does not mean that you buy a home and 5 years later its worth double – what happened in the last boom market was an anomaly and it would not have happened had lenders and large banking institutions condone the risky behavior of lending to sub-prime borrowers and the excessive use of exotic loan programs. All this did was make this recent correction more severe. Hopefully we will learn from these mistakes. That being said, buyers today should be poised and prepared to expect modest appreciation for their real estate investment. Over the long haul, this turns into a substantial gain, especially if you aggressively pay down your mortgage. I just feel that what we witnessed over the past decade was a once in a lifetime episode, so we should not expect that kind of market disequilibrium to that extent ever again.

As we work our way through the excess inventory, we will find ourselves in a more stable real estate environment. I started working and building my career in this industry back in 2006, and I will be the first to say that I have never seen a “normal” real estate market; I have no idea what normal feels like. That being said, once the distressed element of the for-sale property is absorbed, we will find ourselves in a relatively stable and normal market, but not for long.

I argue that within 2 years, San Diego (along with the rest of the nation) will experience a housing shortage. I have written about this earlier in 2010, but simply put, the last couple years have seen a trickle of new inventory and new construction. Typically, we Americans need about 1.3 Million new housing units each year to account for population growth and need to replace old and decrepit structures. If you have tried to get a construction loan over the past 3 years you would know that it was nearly impossible to do so. From my numbers, roughly a third of the actual housing requirement has been reached, which means that over the past several years, a pent up demand for housing has been brewing. This doesn’t seem to make sense because of all the foreclosures and short sales, but as this excess inventory gets swapped up, the housing shortage will present itself in full effect

Essentially, we are moving from a glut to a strain with the supply of housing. Prices will begin to increase as this occurs and there will be further momentum in prices going upwards due from the corrected and expanding economy as well as inflation. This comes as good news for a homeowner when taking into account the medium and long term prospects of home ownership, and presents a window of opportunity for those considering a new home purchase. It is wise to act now while prices and the cost of money is low, and build a solid and secure future for yourself financially.

Overall, San Diego is going to come out of this great recession first because it was one of the first real estate markets to go into correction-phase. It’s also a highly desirable area, unlike the overinflated and overbuilt sprawl of places like Phoenix, Las Vegas, and the Inland Empire. We are a city formed and enclosed by the ocean, canyonlands and mountains. Our supply of land is truly finite and only on the periphery of our county will you find available tracts of land for new construction. Our local economy is no longer dependent on the ebb and flow of the military industrial complex as it has been for most its history. We have a burgeoning biotech, telecom, and computer industry base that offer the jobs that justify our current real estate home values. Throughout the recession, there have been plenty of investors and first time homebuyers that gladly pickup property because they have faith in San Diego’s prospects for the long term. San Diego is unlike a Stockton or Fresno or Bakersfield or Victorville, where you can get a newer home for $125,000 but there are foreclosures everywhere and there aren’t enough buyers to absorb all of the distressed inventory. We are lucky and privileged to live in an area as beautiful and desirable such as this, and the price to live here reflects that sentiment accordingly.

Conclusively, San Diego has weathered the storm quite well. The average reduction in overall price from the peak of the market in San Diego County in general is about 20-25%. The future can look very different depending on whom you are getting your information from, but based on the market and the fundamentals, we are bound to expect further stability and equilibrium as the economy recovers, jobs are regained, excess inventory is absorbed and people overall believing that the future will leave us better off than where we are today. Although we won’t be seeing a recovery at the pace that we would like, we are heading in the right direction. There are bright times ahead of us, and we need to keep that in mind when we are exposed to the contrary. I for one am bullish on buying real estate in San Diego and my goal for this year with my wife Jessica is to save up a down payment for our new home together and take advantage of the phenomenal interest rates. Let’s get successful and prosper together, and I wish you the best for 2011.