Troubled Phoenix real estate market stirring: Prices beginning to rise

In the last 12 months major changes have emerged in the troubled Phoenix real estate market — changes that have gone largely unrecognized by the shell-shocked public. This month we introduce Michael Orr, real estate expert and newly appointed director of the Center for Real Estate Theory and Practice at the W. P. Carey School of Business. Orr explains what he’s seeing in the Phoenix market, and offers his outlook for the months ahead. After listening, be sure to look at Orr’s full report for complete analysis and data.

In the last 12 months major changes have emerged in the troubled Phoenix real estate market – changes that have gone largely unrecognized by the shell-shocked public. This month we introduce Michael Orr, real estate expert and newly appointed director of the Center for Real Estate Theory and Practice at the W. P. Carey School of Business. Orr explains what he’s seeing in the Phoenix market, and offers his outlook for the months ahead. After listening, be sure to look at Orr’s full report for complete analysis and data. [podcast]

Transcript:

knowWPCarey:  We’re meeting today with Michael Orr, who is the new director of the Center for Real Estate Theory and Practice. Before we get started on this new report, I was wondering if you could just the give audience a brief bio.

Michael Orr: I’m a mathematician by training. I went to the University of Oxford, took a maths degree, and then I joined IBM and was working in the computer industry for 30 years; ended up in California. Decided I wanted a change in career and found myself moving into real estate, getting very interested in the idea of real estate investment -- could you kind of predict what was going to happen in the market by reading the right numbers. Then I ended up completely obsessed with what the numbers meant rather than actually having the time to go out and buy and sell real estate itself. Nowadays, I’m spending all of my time researching real estate sales, demand/supply patterns, and reporting on them.

knowWPCarey: I understand that you are the author of a report, a somewhat long-standing report?

Michael Orr: Well it’s called the Cromford Report. It’s a little bit of a misnomer in that it’s more of the website where people come to get snippets of information rather than a written report. So I’ve been running the website for about five years, and it’s now become quite widely recognized as a source for information about the Greater Phoenix housing market.

knowWPCarey: I have before me the January 2012 report, and there’s a lot of information in this report, and I would encourage anyone who’s listening to click on the link that I’ll provide and go look at it; but let’s talk about the three big items that you would hope people would remember from this very first report.

Michael Orr: Yep, first of all, and this is probably something that they’d find hard to believe, but we’re actually seeing pricing higher than it was 12 months ago. I know people got used to prices just coming down steadily over the years, but, overall, we’ve got an increase of about three percent for single-family homes. It’s not looking as good for condos and townhomes; they’re still down a little bit, but the overall market, because single family is so dominant, is moving in the right direction. Behind that, the reason for the increase in pricing is we had a huge reduction in supply. Not so long ago, we had this famous glut of foreclosed homes. A very large part of that is already being taken care of and is in the hands of new owners, and we’re seeing a big drop in foreclosure rates. The supply has not just reduced; it’s actually got to the point now where it is below normal.

knowWPCarey: Right.

Michael Orr: Although a lot of people are not in the market right now, anybody who’s coming in is often very surprised at how little is available.

knowWPCarey: That, of course, will drive price up.

Michael Orr: You know if demand holds steady, and supply goes down, then the laws of economics say prices will rise.

knowWPCarey: That’s right.

Michael Orr: That’s what we’re currently seeing. Not in a big way, you know we’re only seeing the start of a recovery. If it carries on like this month by month, we could see the start of a significant upward price trend.

knowWPCarey: All right, that’s very interesting. It sounds like we are finally going to be heading into some territory where there will be something different and better to say about real estate here in the Valley. What’s different about what you’re doing with this data compared to what Dr. Jay Butler had done for so many years?

Michael Orr: Well, I decided it would be very useful if I could categorize the sales into more than just normal sales and foreclosure sales because the market has gotten pretty complicated. There’s actually a lot of different types of sales, and each one is behaving differently. I look separately at, for example, new homes versus resales. I look at bank-owned homes versus government-owned foreclosures.

knowWPCarey: Right.

Michael Orr: Also any sales which were purchased by third parties at the foreclosure auction and, of course, short sales which are an extremely important part of the market right now.

knowWPCarey: Exactly.

Michael Orr: It’s a lot of work to actually categorize every sale into each one, but I work with my colleagues at the Information Market who are also data providers and data analysts, and they’re good friends of mine. Between us, we were able to break every one of the 8,000 sales that went through in January and categorize them so we could do some thorough analysis.

knowWPCarey: You will be doing this kind of breakdown month to month, do you think? Michael Orr:Well yes, the first month was the hardest …

knowWPCarey: Sure!

Michael Orr:… you discover all the problems, but next month should be a lot easier, and I hope to keep this going so we can spot trends in each submarket. I was surprised, actually, even though I study this data all the time, that lots of things jumped out at me that I didn’t know before we started this exercise. knowWPCarey: Well that’s great. That’s great. Let’s get at it then. How about new-home sales? What do you see in there?

Michael Orr: Well they were surprisingly strong from a very, very weak January last year, but we did see a significant improvement in new-home sales. The developers, the builders are feeling much more optimistic about this year than they were 12 months ago.

knowWPCarey: Good, that’s good.

Michael Orr: Obviously, we don’t want them to go and build like crazy and create too much supply, but at the moment there’s no danger of that. It was also obvious that the bulk of the transactions were happening in the southeast valley. Gilbert, in particular, is a very dominant part of the Valley for new homes; Phoenix and Chandler coming up behind there.

knowWPCarey: What about the west valley?

Michael Orr: Not so much going on there. Goodyear with 43 sales was the most significant city for new homes, but there are a lot of areas where there’s virtually no new building going on.

knowWPCarey: Wow, 43 sales. That’s amazing. Tiny numbers for this state.

Michael Orr: Oh yes! If you go back to 2005, the whole Phoenix area was doing about 4,200 a month.

knowWPCarey: Amazing. Amazing.

Michael Orr: We were only doing 333 last year, and we’re up to 496 this year. Still very low numbers, but the change is in the right direction.

knowWPCarey: What about that category of transaction that you might call a normal resale?

Michael Orr: Sales between a normal owner-occupier and another owner-occupier used to be the predominant part of the market. For several years, it’s been very small because it was dominated by distressed homes, but that is also coming back. We saw a 57 percent increase year on year in the number of ordinary, normal sales. However, the pricing is not so good there. Now I said overall prices were up, but the pricing for these normal transactions are actually down, year on year, partly due to the fact that we’ve got fewer luxury homes in the mix this year than we had this time last year.

knowWPCarey: Okay. Okay.

Michael Orr: When you’ve got more luxury homes, that pulls the medians, the average and the price per square foot up.

knowWPCarey: All right, so one of the phenomena that we’ve witnessed here in Phoenix is the flip. What’s going on with the investors?

Michael Orr: Well we’ve had investor flips going on for a long time, and they’re not going away. In fact, they were also increased quite a bit over the last 12 months. However, there were really two strategies for investors, and we’re also seeing a lot of investor purchases turn into rentals. When it turns into a rental, it’s not in my sales numbers. The actual acquisition is in there when the investor buys it from the bank or from the trustee or wherever they acquire it, but when they turn it into rental, there’s no resale so there’s no recorded document.

knowWPCarey: I see.

Michael Orr: That’s like a house disappearing from the database, going into the rental pool for an unknown number of years. I speak to many of those investors, and they generally have a five to seven year horizon where they think they’re going to keep this property and run it as a landlord for that period. Then hopefully five or seven years from now, they’ll be able to sell it either to another investor or even to the person who’s living in there renting it.

knowWPCarey: Sure. Sure.

Michael Orr: And make a profit that way. We basically looked to all homes which have changed hands within six months of their previous transaction and that generally is a sign of somebody who is flipping the house.

knowWPCarey: Right.

Michael Orr: It’s quite an important part of the market, because a lot of these homes when they go through foreclosure, they end up very distressed. You know the appliances are often missing. The walls need repainting. The carpets probably will get changed, the landscaping is terrible. Obviously, the investor is not going to get a good price if they just buy it and sell it in that state. So they generally spend quite a lot of money tidying the place up, and then their strategy is not to sell it at full market. They generally offer a significant discount to normal owner-occupiers because they want it to sell quickly.

knowWPCarey: Exactly, yeah. Get in, get out.

Michael Orr: So they’re still very attractive to the new-home buyer, because they’re saying, “Well I get something below market price, and it’s just had new carpets, and it smells of new paint. You know these things sell pretty quickly. And it’s quite lucrative for the investors who are able to buy right and sell right. knowWPCarey: It’s not a terrible thing for the neighborhoods either.

Michael Orr: No if there weren’t these investors, these things would just deteriorate further, so I don’t think it’s a negative thing.

knowWPCarey: Well how about the short sales?

Michael Orr: These are definitely growing. A few years ago, getting a short sale done was quite tricky. The banks weren’t really very well organized to look at the complex arrangements that are necessary.

knowWPCarey: And not interested maybe, not interested enough.

Michael Orr: Well they just didn’t have the staff. I think now they’re motivated to do it because every short sale that completes, counts on the sort of positive side of their good guy/bad guy table.

knowWPCarey: Okay.[Laugh]

Michael Orr: Foreclosures are definitely regarded as bad things where short sales—a negotiated short sale is generally better for everybody all around.

knowWPCarey: Right.

Michael Orr: We’ve seen a significant increase – it actually went to about 26 percent in Maricopa and 45 percent in Pinal over the last 12 months. That’s an encouraging trend.

knowWPCarey: What’s going on the REOs?

Michael Orr: Well the REOs, the real-estate owned, I divided those into those that are owned by the commercial banks and those that are owned by the government agencies, like Freddie Mac and Fanny Mae and VA. The most surprising is how much those have gone down in volume.

knowWPCarey: And why would that be?

Michael Orr: Well partly because there are fewer—there’s fewer homes going into the banks for them to turn into REOs. To become an REO, it has to go through a foreclosure. It doesn’t become a REO if somebody else buys it at the trustee sale.

knowWPCarey: At the auction …

Michael Orr: Now in 2008, only about three percent of homes got purchased by a third party, and the rest all went back to the bank. Now we’re seeing about 50 percent of the homes going to a third party at the trustee sale, so the banks are only getting half of the foreclosures back.

knowWPCarey: What happened there?

Michael Orr: Well basically the demand from investors to turn homes into rentals, or into the flips we’re talked about, was such that those investors are no longer waiting for the bank to own it so they can buy it from the bank. They’re kind of moving upstream and buying it directly from the trustee.

knowWPCarey: Is this a situation where there’s more cash available to them? Or is it a competitive stance or …

Michael Orr: It’s really trying to get the best price. I think those people at the trustee sale are being very careful about what they bid for. Making sure they can make a profit when they sell it or they rent it, but they’re in a very competitive situation. They’re not the only investor, so there’s—if they were waiting until the bank took possession, they’ve probably missed some of the best opportunities.

knowWPCarey: I see, yeah.

Michael Orr: So they’re kind of moving up the supply stream.

knowWPCarey: It’s actually becoming a more sophisticated investment environment.

Michael Orr: Yes and the tools that those people use have become quite sophisticated now. People have developed all sorts of websites to allow you to bid remotely at these things; almost like an eBay situation. It’s still tough for an average person to buy at a trustee sale though because you have to have a cashier’s check for ten thousand for every house you’re going to bid on before you bid.

knowWPCarey: Oh boy. Before you bid.

Michael Orr: And you’ve got to pay the outstanding balance within 24 hours.

knowWPCarey: Virtually on the spot.

Michael Orr: So you haven’t got the time to go get a loan or anything like that.

knowWPCarey: Right. Right.  

Michael Orr: Now there are hard money lenders who will lend you the cash to buy a home—secured on the home, but we’re talking about very high interest rates, so you don’t want to borrow that money for any lengthy period. But you don’t necessarily have to have all cash. I mean you can use these hard-money lenders particularly if you’re going to flip the property and, therefore, get enough cash to pay that loan back within a couple of months.

knowWPCarey: Right. Right. It would be a really difficult scenario for an average person who wanted to buy a house to negotiate it. It’s just kind of not our playing field.

Michael Orr: Yeah and it’s gotten very sophisticated, and it’s very difficult to understand what’s going on. I wouldn’t recommend anyone going to the trustee sale and trying to do it on their own without learning an awful lot about it. Maybe the best thing would be to work with one of the bidding companies that will actually understand it all and actually do the hard part for you.

knowWPCarey: Right. Right.

Michael Orr: The opportunities are still there though, of course. You know that’s probably one of the cheapest ways to acquire a home because you’re only competing as people who can afford $10,000.00 down. There are definitely not so many buyers as there would be.

knowWPCarey: Exactly. Exactly. Well, what about those government-held homes?

Michael Orr: What’s interesting is that the Fannie Mae and Freddie Mac sales have also gone down very strongly like the banks’, but the pricing has actually improved. At one point, you were seeing the government-owned homes that were selling for considerably less per square foot than the bank-owned homes. It was like the government was prepared to accept lower bids, but we’ve seen a much more significant increase in pricing there. They’re pretty well priced at the same as the commercial REOs.

knowWPCarey: Why did that happen? Do you have any notion?

Michael Orr: You know I don’t know the reason. I can just tell you that we can see it happen, and it was a fact. Maybe there was such a flood that the Fannie Mae and Freddie were just prepared to accept low-ball offers to get the properties off their hands.

knowWPCarey: Just to keep them moving.

Michael Orr: But we’ve now got enough buyers that they don’t—actually the prices have been moving up consistently for many months now on all of these REOs, and they’re not the bargains they used to be.

knowWPCarey: Interesting. Right.

Michael Orr: They’re still cheap compared with history, but two years ago people were paying extremely low prices for these. That’s really how the first bottom in the market occurred, really, in early 2009 when prices for REOs got so low that nobody could resist them anymore—

knowWPCarey: Right. Right.

Michael Orr:  and the market started taking off again at that point.

knowWPCarey: Right. Well, what about the HUD sales?

Michael Orr: That’s really a special case. When a bank gets a property through foreclosure that was guaranteed by the government, they can say, “Okay I don’t want this home back. I don’t even want to sell it myself,” and they give it back to the government, and the government turns it into a HUD home. Normally HUD homes are very few and far between, but in the last year, we’ve actually seen them spike up and then drop down again. The main thing to remember about HUD homes is they’re probably the cheapest in the whole market.

knowWPCarey: Probably were the cheapest, to begin with.

Michael Orr: Yes.

knowWPCarey: So it’s not high-quality stock.

Michael Orr: You don’t see luxury homes, HUD homes, but you can sometimes find a home very cheap. They’re almost always offered to normal home owners before investors get a chance to bid on them.

knowWPCarey: Oh really.

Michael Orr: If you’re looking for a cheap home to live in, a HUD home can be attractive. Because you’ve got two weeks to bid without competition from the investors, but you may have to do quite a bit of repair work to make it habitable. You could often get a loan that includes the repair work as well as the original purchase price.

knowWPCarey: Really?

Michael Orr: So there are schemes to help you buy those homes.

knowWPCarey: Are there income qualifications for people who get involved?

Michael Orr: Well yeah, like any loan, you do have to qualify.

knowWPCarey: But are they targeted at lower-income people?

Michael Orr: HUD tries to make it easy for a normal homeowner to acquire it, and they will work with you.

knowWPCarey: Cool.

Michael Orr: There are realtors who specialize in those types of homes too.

knowWPCarey: Interesting.  

Michael Orr: We’re not talking about huge numbers, though. We’re seeing maybe a couple hundred a month. Now at the peak of last year, we were seeing as many as 600 a month, but the supply, again, is starting to die off. They are very popular, so once they get listed, they usually sell within a couple of weeks, and they’re gone.

knowWPCarey: Sure. Sure. All right, how about third-party purchases from trustee sales?

Michael Orr: This is what we were talking about earlier where people actually have that $10,000.00 deposit—

knowWPCarey: Okay, yeah.

Michael Orr:- and they buy the home. They are also well up year on year, and the pricing is up; not dramatically, but it’s definitely getting more competitive there so the pricing is moving upwards, and the bargains aren’t quite as extreme as they were at one point. What’s important, though, is that of all the foreclosures that take place, a lot of them are turning into those third-party purchases. They’re not going back to the bank like they used to, so there’s been a concept for a while that the shadow inventory of homes that the banks own, and they’re hiding from us. That’s really is fiction, but the banks do not want to own homes, and they certainly don’t want to hold them for any length of time.

Obviously, when foreclosure is taking place, there are a bunch of homes that have just been foreclosed, the banks haven’t started to sell yet. So you could probably find, right now, about 4,000 of those, but that’s just because they’ve been foreclosed in the last couple of months. You can’t necessarily expect the bank to sell them immediately because they might have to do an eviction first. They might have to get valuations done by specialists so they can know what to price it at. It generally takes them eight to ten weeks or so to put it out on the market, but we’re not talking about a month’s worth. That 4,000 is not a lot of homes in the Phoenix market especially as they’re going to be priced fairly aggressively. The banks price them to sell and they don’t hang around.

knowWPCarey: Well we could talk a little bit here about who the purchasers are. Maybe this is also a fiction that a lot of the investors are actually from out of state or even out of the country. Is that necessarily true?

Michael Orr: Well there are always a number of purchases in Arizona from out of state. It’s a good thing because people want to move here. In a typical month, about three-quarters of the homes are bought by people with Arizona addresses; moving from one part of Arizona to another. About a quarter come from out of state. The trend is not dramatic at the moment. We’re seeing roughly the same thing. We do get a lot of interest at the moment, specifically from Canadians. That’s been true for several years now partly due to the strength of the Canadian dollar, which means they get—they perceive a lot more value than we do because they’re paying in Canadian dollars. It’s also partly because the Province of Alberta is also doing very well with their oil sands industry, so people are making money up there.

knowWPCarey: Okay. [Laugh]

Michael Orr: Calgary in particular, and the weather’s not that wonderful up there a lot of the year.

knowWPCarey: True, true. Michael Orr: So they do like the idea of coming down to Arizona and soaking up some sun.

knowWPCarey: It would be interesting to look at that number in years past when we had huge population growth.

Michael Orr: Yeah the Canadians used to be much less significant back in say eight years ago. It was the Californians who were buying Arizona property then. Because they’ve been through their own housing crisis, they’ve dropped dramatically in their percentage share, and the Canadians moved up into first place.

knowWPCarey: There you go.

Michael Orr: We could talk about how people buy homes.

knowWPCarey: Okay.

Michael Orr: At the moment, cash is king especially if you’re in a multiple office situation. The seller will often take the cash deal even if it’s not the highest bid because they’re confident that it’s going to go through.

knowWPCarey: Exactly.

Michael Orr: Whereas, if the buyer has got to get the loan approved, there’s some concern about, well, what if the loan gets disapproved.

knowWPCarey: And where lending standards have been so strict, that’s a possibility.

Michael Orr: It’s definitely a possibility. Lending standards are probably as strict as they’ve ever been over the last year. There are very, very slight signs that they’re easing up just a little bit. The amount of down payment as a percentage of the total value is reducing just slightly and the credit scores—the average credit score to be able to get a loan is coming down a little bit, but it’s still very high.

knowWPCarey: Right.

Michael Orr: The cash buyers are definitely in a strong position. Of course, the investors we’re talking about, especially if they’re coming from out of state, often bring a pile of cash with them, and that’s how they get to be the dominant buyer in a particular area.

knowWPCarey: Right.

Michael Orr: We’re seeing about 41 percent. Last year, it was down to about 40 percent cash buyers by unit. That’s very much higher than normal. It would normally be about ten percent; so four times the normal amount of transactions being done by cash.

knowWPCarey: Okay. You’ve created a category here, landlord purchases. Can you explain a little bit what you mean by that?

Michael Orr: Yeah actually Arizona is unique in that we have a document called the affidavit of value which we’re required to fill out when we buy a house and file with the county. It’s to help the county assessors work out the tax status of a house. You have to state whether you’re planning to rent the house or occupy it yourself.

knowWPCarey: So those investors who are buying properties and then renting them, would fall into this category.

Michael Orr: They will check a different box. I can count them, and I can see where—which parts of the counties are actually being dominated by landlords. There actually hasn’t been a dramatic change over the last 12 months. We’re high, but we were higher 12 months ago. It’s typically about 25-30 percent of purchases are being made by landlords right now; which is really about double what it would be in a normal situation.

knowWPCarey: So, what are we looking at going ahead?

Michael Orr: Well we’ve been through a pretty tough period. Arizona has had the second-worst collapse in house prices; only Nevada had a worse situation.

knowWPCarey: Okay.

Michael Orr: On average, we’re down about 58 percent from the peak overall. Any relief from that is very welcome. We had a period during the first half of last year when prices were pretty flat. Then we had another dip down just as the debt crisis which kind of froze government for a while and caused the stock market to have some turmoil, and that really took a lot of wind out of the luxury market which has not really come back. There is still not a lot of action in there, amongst the expensive homes; but ever since September, the bottom end of the market has been really taking off -- a lot of demand and the supply, as I said, drying up. Prices for homes at that end, below about 300,000 square foot are improving at a significant rate now. It looks like that’s going to continue. We’re actually seeing a reduction in supply from the beginning of the year.

Normally at this time of year, we see an increase in supply because people try to list their homes during the spring. So they have fewer homes for sale now than at the beginning of January is quite unusual.

knowWPCarey: Right.

Michael Orr: It’s not true of the more expensive homes, but below 300,000 square feet we’ve actually got fewer homes available. That means I think, we’re going to see some upward pricing pressure during the spring which is when most buyers are out. Now whether that carries on through the summer, we’ll have to wait and see.

knowWPCarey: Right. Right.

Michael Orr: The summer is usually a much quieter time for the housing market for obvious reasons.

knowWPCarey: Sure. Sure. Well, any round-up closing words you’d like to share?

Michael Orr: Well I think my summary would be that the recovery is started. We’re still in the early

knowWPCarey: Wonderful.

Michael Orr: tentative stages. We’ve had two bottoms so far; one was in April 2009, and the next one was August-September last year. Hopefully, we’re only going to get a double-dip and not a triple dip. knowWPCarey: Sure.

Michael Orr: You can never be certain of anything because, you know, world-wide economic disasters loom all over the place.

knowWPCarey: Everywhere. [Laugh]

Michael Orr: If we just focus on what’s happening in Greater Phoenix, then we’re definitely on a recovering trend right now, and the big change will happen when confidence starts to spread; not just from the professionals. At the moment, if you talk to realtors, they can see this recovery, and the investors—the investors can see the recovery too, but they want to keep it to themselves. They don’t want the competition.

knowWPCarey: Sure. Sure.

Michael Orr: But when ordinary people realize that now is actually quite an opportune time to get a house at a low price and with low-interest rates, then the market could recover at a more significant rate because we get more buyers coming into the market.

knowWPCarey: Right.

Michael Orr: That could get quite exciting. It could be quite tense, in fact, because with the low supply, if we have more buyers coming in, the supply could get really tight. That’s how recoveries work, when the supply is so tight, the people start bidding prices higher.

knowWPCarey: Right.

Michael Orr: More sellers say, “Oh in that case, if I can get that price for it, I might sell it after all.”

knowWPCarey: Then the ball starts to roll.

Michael Orr: Yeah and the cycle starts over again.

knowWPCarey: Yes. Yes. Hopefully, the next cycle will be a little less feverish.

Michael Orr: Well yep, hopefully, but unfortunately human beings

knowWPCarey: That’s not the way it goes.

Michael Orr: always purchasing decisions are made by human beings, and the emotions get involved very quickly.

knowWPCarey: There you go.

Michael Orr: We’ve been dominated by fear for many years now, but at some point, greed comes back into it again, and people start saying, “Gotta get that house before it goes up anymore.”

knowWPCarey: Oh boy, well looking forward to that. I think. I think. [Laugh]

Michael Orr:[Laugh]

knowWPCarey: Well thanks very much for spending the time to walk through the report with us.

Michael Orr: You’re very welcome.

knowWPCarey: And we will see you again in about a month.

Michael Orr: That’s right.

knowWPCarey: Alrighty.

Michael Orr: Thank you.

knowWPCarey: Thank you. [End of Audio]