Research

Podcast: Foreclosures and short sales complicate a volatile real estate market

The troubled Phoenix real estate market has experienced high levels of activity this summer. With the federal tax credit ending soon, first-time home buyers have been scrambling to get into a deal. Meantime, investors anticipating a rise in prices are coming back to the market. Much of the activity involves foreclosures and short sales — transactions that can be complicated and sometimes include a surprise at the end for sellers. Jay Q. Butler, a professor of real estate at the W. P. Carey School of Business, has been tracking this market since the early 1980's. He says the future of the market depends on what happens in the Arizona economy.

2009-09-21

The troubled Phoenix real estate market has experienced high levels of activity this summer. With the federal tax credit ending soon, first-time home buyers have been scrambling to get into a deal. Meantime, investors anticipating a rise in prices are coming back to the market.

Much of the activity involves foreclosures and short sales — transactions that can be complicated and sometimes include a surprise at the end for sellers. Jay Q. Butler, a professor of real estate at the W. P. Carey School of Business, has been tracking this market since the early 1980's. He says the future of the market depends on what happens in the Arizona economy.

Transcript:

Knowledge:The Phoenix Real Estate Market seems to be coming to the end of its long slide. The conditions here are still volatile. With the Federal Tax Credit ending soon, first time home buyers are scrambling to get into a deal. In the meantime, investors are coming back to the market in an anticipation of rising prices. Jay Q. Butler is a Professor of Real Estate at the W. P. Carey School of Business. He’s been tracking this market since the early 1980s. He says foreclosures are a driving force.

Butler: In the resale market, about 30 percent of all recorded resale activity is banks taking homes back. About half, of what we call traditional transactions, are banks or lenders selling homes and foreclosures. Now we’re said to be about 67 percent of the resale market is driven by foreclosures. Price variation of foreclosures varies tremendously throughout the valley. The markdown from a foreclosed home to the final sales price, say in Maryville, is 50 percent. On the other hand, in Gilbert it’s about eight percent.

Knowledge: What does that mean, the markdown?

Butler: Well, basically the lender took in the home say, for $100,000.00. In the Maryville area, they’d be selling it for under $50,000.00. In the Gilbert area, they’d probably sell it for around 95 to 100, and that’s just an example because most of the homes in Gilbert are going for that um, mid 200,000 range.

It’s, it’s one of the problem areas. The banks are able to sell them and obviously investors are buying them to rent out or hold for flips, and owner-occupants, although they’re having a hard time competing with the investors who typically pay cash, there are opportunities for them to find very nice homes at fairly attractive prices.

Knowledge: You know one of the things that I’ve wondered is how much more foreclosure activity is there out there, number one; and number two, do the banks pour these properties back into the market right away, or do we have to be afraid of like a build up that’s going to just trickle out?

Butler: The big concern about foreclosures is there’s two big concerns. One is that there will be an increase in foreclosure activity later this year because of job losses. One of the big unknowns in the job market is the furloughs and the lost pay. We can track lost jobs. It’s hard to track the other, and these may begin to take a toll on people. People have been moved from 40 hours a week to 30 hours a week or 20 hours a week may not have the income to sustain their home.

The other one is a little bit talked about, but it – a lot of people aren’t certain it’s going to actually happen. Sometime in the mid 2010, a lot of the adjustables and the Alt-A loans will come in for a reset on their interest rates. A lot of people feel that will be another tidal of foreclosures.

Others believe that because of the foreclosure activity that’s already occurred, low interest rates right at the moment, and potentially greater foreclosures from job loss, that title wave is not going to be as big as people think it’s going to be. So we may be weeding our way through. Conspiracy theories that lenders hold foreclosed homes off the market in order to sustain prices, and there may be some of that going on, but most of the time they hold them – they don’t really hold them off the market.

Some of these homes are so beaten up they can’t be sold, or there’s going to be a lot of money put into them, and there are better opportunities for people to buy homes than what some of these are available. Also in some areas they’re getting over saturated with resold foreclosures, and people are concerned about that. So lenders really have some market issues that probably are holding some of the homes off the market.

Knowledge: And in a sense you can’t blame them because they need to recover the money they loaned in the first place, so why wouldn’t they hold off until they can get a better price.

Butler: Well, I think it goes back to sort of the attitude of a lot of lenders. There’s all sorts of issues, for example, recently on short sales. We found out and have talked to people that lenders are now requiring promissory notes on the deficiency which they’ve never done in the past. There was the anti-deficiency law that was passed and then repealed where the home owner potentially could have been held for any deficiency.

That will probably be back in the next session. A lot of people going through for loan modifications find the lenders won’t talk to them, or unless they are three months behind in payments they won’t talk to them. So a lot of people are getting very frustrated with what’s going on. It’s going to be difficult to work that through over the next several months.

Knowledge: I wonder if you could just back up a little bit and talk a little bit more about short sales and the deficiencies. An educational point here.

Butler: Well the basic idea of a short sale is, is that let’s say that people have $200,000.00 worth of mortgage on the property, but they can’t sell it for that amount and sell it for 180, so they got a short sale that’s 20,000. What was happening prior to the big foreclosure event is groups would – investors would be willing to buy the home for a price under the mortgage if the lender would forgive the amount – remaining amount due.

We even saw Congress change the Internal Revenue Code that this was no longer a gift and wasn’t a taxable entity, and they sort of did it, but it’s sort of a custom-crafted thing. Every deal is a little bit different, and a lot of people got involved in it beyond the companies that were specializing in short sales.

All of the sudden in the last few weeks, we’re getting telephone calls – reporters are getting telephone calls that some lenders are now requiring - let’s say that the home has a $200,000.00 mortgage. They sell it for 160. They will expect the seller to sign a promissory note for the $40,000.00, or something in that area. It’s basically a 10 year, around seven to eight percent interest rate which has been unheard of. It’s not really – we know why lenders may be doing it; we’re just not certain.

For a lot of people they’re finding this note occurs on the day of close. They think they’re through with the thing and all of the sudden this happens, so if you want the deal to go through, you have to sign it. If, if you don’t, you don’t sign it; but you’re in still the same situation. So you’re – you’re getting these stories, and they’re being reported really doesn’t help the image of the lender too much.

Knowledge: And it would seem to me that that might be an incentive for a homeowner just to go through with a foreclosure rather than be stuck with a loan after the fact.

Butler: Well, a lot of people may, and in certain neighborhoods lenders may find that they can sell the home very close to what they’re foreclosing on and not on the short sale arrangement. You know again, in some neighborhoods like in Gilbert and in Chandler and some places in Tempe and parts of East Mesa, prices are holding fairly stable.

Basically lenders are interested in short sales because it would cost them X thousands of dollars to do a foreclosure, so if they could save money by doing a short sale, they would probably be interested in doing it. Now they’re finding that the market is fairly active for foreclosed properties, so they may not be as willing to do short sales or other modification programs.

Knowledge: What else should be – we be watching for in terms of signs or indicators that things are getting better in real estate?

Butler: Well it’s very hard to say, because although the discussion is of course that the – if we look back in the next few months, the recession probably ended some time in September, but there are two really big weak spots in the economy right now. One is jobs.

Bernanke and others have made it very clear the job market is still extremely weak, and we may not see much job growth for the next year or so because; one, is a lot of companies may not want to rehire; but because they’re furloughs and temporary layoffs and other programs. They simply will move a person they had moved to 20 hours back to 40, so it’s not a new job being created. It’s great for them, but we’re not creating new jobs.

Also for creating new jobs, the general accelerator prayer has always been construction and to some degree retail, but nobody expects those two sectors to be strong. The sectors they’re expecting some strength in is education, healthcare and certain basic business programs. Again, these are not going to be big growth areas. Also economies in other states like Texas and others, which are in relatively good shape, are being very aggressive in trying to attract companies.

New Mexico with its incentive programs and others are being very aggressive going after solar energy and other alt energy type programs. Same thing with Texas. They have the incentive money, very stable government, a very stable economy and they’re being aggressive to go after the new jobs. So there’s a lot of concerns about how the recovery is going to play out in the state of Arizona over the next year or so.

Knowledge: Is Arizona not being aggressive in the same fashion?

Butler: Well in a sense, we did away with our incentive funds in – in one of the first set of budget cuts, and basically even California and Texas greatly enhanced their incentive funds, and so we need these sorts of things. There are not a lot of companies looking to build or relocate, and obviously they’ll be looking for the greatest possible deal that will benefit their company and their share holders, and you’re looking at things.

Not only incentives in the sense of plan operations and forbearance on property tax and other things, but training grants and other things that will provide them with a solid labor force that they can move ahead on, and – and there’s not a lot of companies doing this. So where the deal is, is going to be the state that gets them.

The key issue, this recovery could be quite lengthy, and it will not be even. A lot of people are thinking a W type recovery or a U, or at the bottom for long periods of time. We have a lot of unknowns. The commercial real estate market is now showing – is weakening, and there we can see the vacancies.

But we also know that in many projects, if not most, the landlord has renegotiated the lease to lower their rent for a period of time, and we don’t have a real measure on this. If it goes too long, the landlord may – or the owner may not generate enough money to pay their debt, and they may fail. So there’s a lot of unknowns in this recovery and, while things should show some positive signs, there’s a lot of concerns about how we move ahead.

Knowledge: Any advice for folks out there who are thinking of selling or buying or whatever?

Butler: Selling is going to be difficult. To sell your home, you’re competing against foreclosed homes that are a lower price. The buyer market is not that big. Financing is very strict. You got to have a fairly strong FICO score, but a lot of the rates that are quoted in the newspapers you need a FICO score of at least 700 or better, and this usually means both borrowers. If it’s a husband and wife borrower, it used to be they only looked at one FICO score.

They’re now looking at both, so unless you have to sell, probably not a good idea to do it. For buyers it’s an opportunity, but it would be a frustrating opportunity because you think there are all these great deals. Well, in a lot of areas where you might want to live, like in Gilbert and Chandler, it’s not that big of a market. The tax credit is running out at the end of November.

There is some talk of renewing it, but we – nobody sees it actually happen, and with healthcare and other things tying up Congress and the administration, there may not be a lot of push to do it. So there are opportunities out there, but you’ve got to be patient. You may want to wait for a while, and just be very careful about what you’re doing because there are a lot of scams, and a lot of property that are in physically bad shape.

Knowledge: What about townhouses and condominiums and what the dynamic might be with the apartment rental situation?

Butler: In townhouse condos, if you’re buying to occupy, this has never been a big market in Arizona – in Phoenix, about 8 percent of our housing stock, condominiums are – are inexpensive, but you really have to look at the homeowners fees. Also, it’s a very competitive with a lot of the new stuff that came online and – and many of the new projects failed. So there’s pretty good deals there especially in seasonal housing and other things, but condominiums have never really done well in Phoenix.

They’re not a good secondary market I don’t think, so you’ve got to be careful about them. Also a high percentage of condominium units are in the rental market, so you may buy one, but you’re going to live in the midst of renters. In the rental market, rents are down. Concessions are being given. Vacancies are up, but again, it’s not across the board.

It’s in some of the high-end apartment units, you’re getting better concessions, but you really have to shop around and look at it. Look at the condition of the apartment unit and other things because what some people are finding is they’ll move into an apartment complex, because the rent was cheap, but they’re not getting maintenance. The swimming pool is not being taken care of, and maybe the owners will go bankrupt .

Real Estate