Research

It's complicated: Seasonal factors hold real estate prices steady, but what's next?

The June housing market report indicates that some stability may be returning to prices in Phoenix, however the market is complex and continues to be out of balance. Mike Orr, director of the W. P. Carey School’s Center for Real Estate Theory and Practice, reports that there was indeed little change in prices between May and June of this year, but compared to last year prices are up. Supply continues to be tight, however, making another period of price increases possible.

2012-08-15

The June housing market report indicates that some stability may be returning to prices in Phoenix, however the market is complex and continues to be out of balance. Mike Orr, director of the W. P. Carey School’s Center for Real Estate Theory and Practice, reports that there was indeed little change in prices between May and June of this year. Comparing to June 2012, however, the evidence shows significant price recovery. Median sales price is up 29 percent to $150,000 and price per square foot is up 21 percent, to $98.11.

Supply, however, continues to be down. There are 33 percent fewer homes for sale this August compared to August 2011. And the distressed supply is down 68 percent for the same period. Lower supply means fewer sales: single family home sales in June fell almost 16 percent compared to June last year. The lower end of the market, especially, is squeezed because of the drop in the supply of foreclosed properties.

Today we’re talking with Mike Orr about how this scenario is playing out for buyers, sellers and investors.

[podcast]

Read the interview:

The Sellers: A rare breed

KnowWPCarey: What does the world look like if you're selling your house right now?

Orr:Well, the first thing to say is we don't have enough sellers. There are a lot of people who are not selling and there are probably a lot of reasons why we have fewer sellers than normal. Obviously, there are lots of different types of sellers. For quite a while we've had a lot of sellers who were banks selling foreclosed homes.

We've had a lot of people who were in distress trying to avoid foreclosure by doing a short sale, so they're kind of reluctant sellers and not very interested in the price, either, because they're not going to get any of it if it goes to short sale. The sort of traditional sellers is still quite scarce compared with any of the last 12 years, but they are starting to inch up a little bit.

KnowWPCarey:Do they comprise a greater share of the seller population now than a year ago, though?

Mike Orr: Yes -- much greater, because although they're down, they're only down by about 30-odd percent whereas the others are down by 60-odd percent. In just the last month or two we've seen a slight increase in the number of homes listed for sale. Now ordinary people, a lot of them may not be selling because (a) they still think their home is not going to sell for enough, either to cover what they owe or what they think it's worth. ‘Maybe I'll wait a few years and see what happens. If the market is recovering and the prices are going up, why sell now unless you have to?’

Then there's going to be those people who want to sell for a very urgent reason. They've got a job in a different state and they've got to sell, so they may not have an equity problem, and they're the people who are probably going to be most pleased with the current situation because they're free to sell and they're going to be able to sell very quickly, because unless we're talking about a very expensive home, there's going to be plenty of people interested in buying.

KnowWPCarey: Now one of the facts uncovered in this report is that prices are stabilizing, so do those ordinary homeowners who may want to sell but are holding out for a higher price, are they unaware that perhaps things are plateauing out a little bit?

Orr: Well, the stabilization is just month to month and you've got to take a longer term view of this. I did predict last month that it would get more stable because the summer is always a quieter month for transaction volume and generally on pricing too. Prices tend to be at the highest in the May period and then sort of cool off a little bit during June, July, August. That's partly because the luxury segment is not getting as much traffic. People don't like going around [when it’s hot]. If they don't have to, they don't want to go around in 113 degrees or whatever we are today.

That leaves the market almost by default to the people who are buying for investment at the low end, so that kind of drags the medians and the averages and everything down, [although it’s] just a seasonal affect. The same thing goes for the people who are buying for retirement or for a vacation home only. They could buy any time of year. They tend to avoid the summer. So you've got normal patterns during the period from the end of September onward. Then we have this extra group of people who are buying to try and get in before the school year starts who add to the volumes in March, April, and May. So we've got this seasonal affect, and that is why I think we're plateau-ing now -- not for any other reason. The underlying imbalance between supply and demand still exists, so that implies we've still got upward pressure on pricing.

It's just being balanced by this seasonal pressure downwards, so we're stuck in neutral. The big question will be, if in October when we're getting back to normal, will prices start to move upwards again? It's a bit early to … I don't like to do long term predictions. In my heart I think they will, but in my head I say I don't know yet.

The Buyers: It’s a cash game

KnowWPCarey: Okay. If I'm a buyer, how do things look to me these days?

Orr: If you're buyer who needs a loan, things are pretty tough because to get a loan you're going to have to not only jump through all the usual hoops, you're going to have to get an appraisal for that home. It's likely that you're competing with many other people for that same home. Even if you put in the best and highest offer, there's a good chance that your appraisal may come in a bit lower than that and therefore you'll not be able to step up to that offer, unless you put in more money as a deposit. That's not a very attractive option to most people. It may not even be feasible.

It's very challenging. It's much more fun being a buyer if you've got cash, so even some of the people who are not investors are trying to find ways in which they become cash purchasers by finding a source of funds which they can pay back later so that they can make a cash offer.

KnowWPCarey: Right … Have instruments like that been developed for those people?

Orr: I've talked to a few lenders who are trying to find ways to do that. Basically [you may find] a kind of short term bridging loan so you can buy the home for cash and then refinance later, but it's not the sort of thing the big lenders are very interested in doing.

KnowWPCarey: You might secure a loan like that before you go shopping?

Orr: Yes, but that's pretty exotic. I'm not saying a lot of people can actually do that. For myself, being a relatively old person, I've got money in my retirement account. Probably lots of people say, well, you shouldn't do this, but one option would be to go, "Well, I can go borrow from my 401(k). Buy a house with it and then put it back later when I finance the house."

KnowWPCarey: Refinance the house. Interesting.

Orr: Obviously, that's got its repercussions too, but at least it means I could compete on the same sort of basis as these very deep pocketed investors who are still extremely active. Some of the ones who came last year are actually sort of stepping back because they're finding the price has gone up so much they're not as excited about Phoenix as they were. But new groups are coming into town, relatively late, and taking over the buying.

KnowWPCarey: Comparatively speaking, we still look attractive.

Orr: Well, yes. You've got to look back and say, "Well, let's look at the absolute prices." For most of the houses, when you look at the cost of the land and the cost of the construction, even at the prices which are quite a lot higher than last year, you're paying less than it would cost to rebuild that home if it burnt down.

I would think in the medium to long term, we're going to be looking at much higher prices just because the cost of construction -- the labor cost in particular -- is going to be going up over the next few years.

Investors: The cast has changed

KnowWPCarey: We touched on investors a little bit. There's been a cast change.

Orr: Yes. I'm seeing investors take an even larger share of the market. That's kind of what you would expect in the third quarter based on what I said about seasonality, but it's also, I think, [that] some of the ordinary owner occupiers who've put in ten offers and had them all refused, they're kind of losing heart. Saying maybe I'll come back later when it's quieter. Some of those who've previously focused on fix and flips, they're actually sort of fading a little bit because they can't get enough supply to really keep that business going with as much volume as they used to.

KnowWPCarey: Because it's a serial kind of a business where you work on several at a time?

Orr: Yes. I mean, a big player in “fix-and-flips” has probably got lots of crews, and they buy as many as 40 homes a month and sell that many a month. Maybe they're down to only 20, 25 right now because there are just not enough foreclosed homes coming back onto the market compared to this time last year.

KnowWPCarey: So that's the other factor. Those foreclosures are way down.

Orr: They are down very much. They were down month-to-month, but they're very much down year-on-year and that's because the prime source for some of these fix-and-flips is to go to the foreclosure auction, buy something that's in a pretty bad state that nobody else is interested in, and over the next couple of months, turn it into a very attractive home. Those people have always been around, but they're limited by the supply of distressed homes. You're not going to be able to fix and flip a home that doesn't need fixing.

But it's not like we're back to normal. [The foreclosure rate is] still higher than it should be, but it's definitely coming down.

KnowWPCarey: By what order of magnitude? A couple times? Three times?

Orr: The number of notices is probably about three times, two and a half to three times what I would consider normal, but it does vary from month to month quite a bit. We were up: at one point we had 11,000 notices in a single month for just Maricopa. We're now down in the 3,000 to 4,000 range. It's quite a big drop. I would think somewhere between 1,500 and 2,000 would be a typical month once we get back to normal.

The other type of investor is the person who buys to rent out, and they are very much in the driving seat now. We're talking about not just single investors, but groups of people, hedge funds and people who are really seeing this as a once in a lifetime opportunity to acquire an asset which is appreciating fast and also generates cash.

For people from the stock market, to them, it's a bit like buying a share that pays a good dividend and goes up in price. Now, I think their glasses may be a little bit too rose tinted. Of course, if you haven't done this before, you may find that real estate has actually got a lot more stumbling blocks than you thought. To get that revenue from the house, you've got to find a tenant. You've got to try to make that tenant actually pay on time. You've got to worry about maintenance: fixing all the things that might go wrong because it's your responsibility, not the tenant's. Looking after these assets is a lot more difficult than looking after a share or a bond.

KnowWPCarey: Exactly. Yeah.

Orr: I think we've got a lot of people learning quite quickly. Some of them who've been around a bit longer have been extremely financially successful over the last few years because they've been getting very high rents compared with the purchase price. Now they can look at pretty good appreciation of their asset over the last 12 months at least.

Increasing numbers of rentals

KnowWPCarey: What jumps out at you this month -- versus last month, for example?

Orr: Well, the one thing that jumped out at me with a little bit of surprise was the out-of-state purchase percentage is going down. More of our sales are actually in state, but that could be because many of the people who are buying as investors are buying with a local LLC: it looks like local, but actually it's really remote. I guess I was also surprised at quite how much the investor percentage has gone up.

KnowWPCarey: How much has it gone up?

Orr: Well, we're looking at—the range is now 30 to 35 percent of all transactions are marked as being bought to create a rental. That's for Maricopa and Pinal combined. Last year it was more like 25 percent. Back five years ago, something like eight percent would have been typical. A lot more rentals being created. At the moment they still seem to be getting the leases signed up pretty quickly. In fact, I was talking to someone this week who said he went to an open house for a rental. Because he was 30 minutes late, there were already 20 other people signed up as prospective tenants. Some places clearly it's still very competitive, even for a rental.

KnowWPCarey: Right.

Orr: Now at some point, we don't have an infinite number of people who want to lease homes. If we end up with too many [rental] homes, the vacancy rate's going to start to creep up and the market will have to adjust to that, but we don't seem to be there yet despite the large number of homes that have been turned into rentals over the last three years.

The sky is falling … or not!

Orr: Some of the interesting things that have been coming out in the last couple of weeks, there've been a couple of high profile, very negative projections made by, for example, Fiserv. S&P/Case-Shiller came out with a model predicting that Phoenix prices would go down 9.5 percent between January this year and January next year. Lots of people have said, "How can they come up with that number?' Without knowing what their mathematical model says, I can't really tell you. That's how mathematics works if you don't have the right or timely input data. It's pretty evident to me based on what I'm seeing from up-to-date information that it'd be almost impossible for prices to fall that much given that they've already gone up a very significant—

KnowWPCarey: It would have to be some catastrophic event.

Orr: Yes. Given that we still got an excess of demand over supply, I think that's just so farfetched it's got more than a zero percent chance of happening. Then we've still got a number of people talking about shadow inventory -- it will never die! There are all sorts of different definitions of it. The one that frustrates me most is the people who think the banks have foreclosed on the homes and they're hiding them somewhere.

KnowWPCarey: Just hoarding them.

Orr: Waiting to dump them on us when we least expect, which is just kind of silly and I can disprove it easily because I've got a list of all the homes that the banks own. The ones that are more difficult to grasp are the ones where people are late with their loan payments but have not gone into foreclosure yet. That's the sort of thing that's not of public record. The lender knows and the homeowner knows, but you and I don't know about that.

The only thing we can do is go by research that's done by the lender processing companies who know that the transactions are late. They won't tell us who it is, but they will tell us what the percentage is and they'll count it and say whether it's different month-to-month. We can see that compared with normal times, we've still got more delinquent loans in Arizona than we should have, but the number has gone down a lot in the last two years. In fact, it's gone down quite a lot just in the last 12 months, about 23 percent down. The number of 30 day late or more has gone down by that much if we include the people who are already in foreclosure too. That's actually the highest percentage of any of the 50 states. That encourages me. Even if there was a shadow inventory of people who are late with their payments, it's getting smaller.

KnowWPCarey: It's getting smaller.

Orr: It's less threatening. I can have a lot of sympathy with that theory of shadow inventory in those states where it's getting bigger. Those are the ones that would worry me. We do have this divergence. Arizona, California, and many of the other Western states have actually got delinquencies declining, but some states like New Jersey, in fact most of the New England states and a few of the Southern states, have actually got a worst delinquency problem now than they had 12 months ago. If there is a shadow inventory, it's going to be concentrated in the East and the South rather than the North and the West.

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