GLG News by Jim Belfiore

Implications: Bad news for some, though, will soon turn out to be good news for others.  The second half of this year will yield ample opportunities for residential land / lot buyers.  

Analysis: During the first half of the year, homebuyer demand hit new lows, and builders, straddled with finished lots and inventory homes, dropped offering prices faster than at any other time since the beginning of the downturn.  The outlook appears bleak, too, for homebuilders entering their twelfth quarter of the downturn.   

Bad news for some, though, will soon turn out to be good news for others.  The second half of this year will yield ample opportunities for residential land / lot buyers.  

Lenders have been hesitant to push homebuilders into foreclosure, choosing to “work through” technical defaults.  Few projects have gone back to banks, most of which are located in fringe areas.  The projects, largely, are marginal from a marketing perspective.  

Almost as if a bell sounded signaling in the second half of the year, though, banks appear ready for an onslaught of closer-in residential land / lot foreclosures.  The three Taro Properties Arizona projects referred to in the subject article are good examples- which are located in relatively in-fill Gilbert areas and Phoenix.  BREC has received numerous market research inquiries regarding other likely near-future foreclosures.  

To date, opportunists seeking lender “deals” have found negotiations limited on foreclosures.  Transactions, BREC believes, will increase soon- as early as late third quarter / early fourth quarter- as foreclosures increase and lenders seek to unload projects they have taken back.  Several financial institutions appear to be struggling with liquidity, a matter that should benefit deal-seekers.  The offer-bid price gap will shrink in coming months.  

The second half of 2008 should be much more interesting than the first.  For buyers, business should be brisk.

Implications: Investors and market observers can count on continued homebuilder losses, as home prices a pushed downward further.

Analysis: When released next week, Belfiore Real Estate Consulting’s KnowledgeBase Current and Future Market Insights July publication will clearly communicate one thing:  builders are still searching for the pricing bottom.  During the months of May and June, builders- particularly publicly-traded builders- continued to push prices downward at an astonishingly aggressive pace.  Consider the discounts (all calculations net of incentives) at the following communities (select product lines, communities located within one square mile of one another- in Laveen, Arizona):  

Avalon Village
KB Home
Discounted Prices 13.6% from March to June

Laveen Ranch
Richmond American
Discounted Prices 8.9% from May to June

Redhawk at Rogers Ranch
K. Hovnanian
Discounted Prices 12.8% from May to June

Paseo Pointe
Pulte Homes
Discounted Prices 10.7% from May to June

Investors and market observers can count on continued homebuilder losses, as prices drop further.

Current heavy discount levels suggest the pricing bottom may be close.  In outlying market areas, new home offering prices are now below the cost of constructing homes.  In these market areas, BREC personnel believe the pricing bottom is imminent; few builders will start constructing new homes in these market areas if they believe selling the home will cover the cost of construction.  

BREC’s current pricing forecast calls for shrinking new home prices through the first quarter next year, followed by pricing stability.  

BREC is currently cautioning builders considering initiation of heavy discounts.  Although price discounts have typically lead to immediate home sales, home sales success is short-lived.  Prices in competing communities are adjusted downward, and these communities take market share from the builder that initiated the price adjustments. 

Implications: Our next lesson may be that homebuyers should carry some of the financial risk associated with owning a home.

Analysis: Mr. Wessel is right on, as he usually is, in the subject article.  “It is the hallmark of a credit bubble when lenders think that because collateral is going up in price they can ignore the borrower’s ability to pay,” Mr. Wessel quotes Peter Fisher of Blackrock Inc. as saying.  In other words, confirming someone’s ability to pay for a loan prior to giving them that loan is a good idea- an idea that sounds so simple but was largely ignored by some banks in 2004 and 2005.  

We have indeed, as Mr. Wessel points out, learned a lesson.  Today, lenders are documenting buyers’ income- verifying borrowers’ ability to make payments on their home loans.  Here in the Phoenix metro area, the financing tool of choice for entry-level and first move-up buyers is now the FHA loan.  Potential homebuyers like the low downpayment- just 3%- that accompanies FHA financing.  The FHA loan is built on the premise that people that can afford their homes will pay their mortgage, so verification of income is chief among lender underwriting priorities.  

Buyers unable to find the FHA-required 3% downpayment need not worry about getting into a home.  Homebuyer assistance programs exist and are heavily utilized by buyers.  In entry-level submarket areas like Avondale, Buckeye, and Maricopa, BREC estimates that more than 90% of all new home buyers are utilizing these programs.  Homebuilders simply “donate” the 3% downpayment to the assistance program, and the assistance program donates the 3% downpayment to the homebuyer.  

Closing costs aren’t even an issue for cash-poor buyers; the most common incentive currently provided to potential buyers is closing cost credits.  Buyers need only $500 to $1,000 to purchase a home today.  

One lesson we may not have fully learned from the downturn may haunt housing and finance markets in the future.  Today, some buyers that can afford their mortgage payments are forgoing payments and allowing homes to go into foreclosure.  These buyers owe more to the bank than their homes are worth.  As values continue to drop, these buyers are deciding to accept poor credit rather than pay for a depreciating asset.  

Conventional mortgages now account for the risk that values are dropping, and that buyers with little or no financial stake in a home may decide to stop paying monthly mortgage payments.  Many areas have been labeled “declining market areas”, and lenders require 10% to 20% downpayments on homes.  If values go down after the new homeowner takes possession of the home, the homeowner maintains a first loss position.  As long as the value declines do not substantially exceed the downpayment homeowners have put down on the home, the homeowners are unlikely to opt not to continue making payments.  

BREC’s forecast currently calls for slowing new home depreciation, as the number of purchasing opportunities continues to shrink.  Homebuilder price wars have driven metro Phoenix pricing down an average of 37% since the beginning of 2006.  On the outskirts, builders have written down their lot values and are now building homes at a loss.  Builders are discounting to sell-out, and leaving areas where money cannot be made.  This will allow for stabilization next year.  

The risk, though, of further significant depreciation exists.  Those contemplating this risk should also contemplate future foreclosure levels. Homebuyers purchasing homes today, with little or nothing down, could decide the value of their home has dropped more than they would like.  Despite being able to afford the mortgage payment they might decide- like those buyers walking from homes today- they will accept poor credit quality over a depreciating asset.  Our next lesson may be that homebuyers should carry some of the financial risk associated with owning a home.

Implications: The question many looking from the outside-in may soon start asking is, “How many buyers are there for $300 / square foot to $800 / square foot housing in Phoenix?”  As the single-family market bottoms out, the answer will come.  Hopefully the timing is sooner rather than later.

Analysis: Suburban, garden-style condo and townhome developers felt the sting of the downturn in early 2006; as single-family detached prices fell rapidly, attached prices were pushed in the same direction.  Selling “lifestyle” in a suburb is difficult when buyers seek out the lowest priced options.  Higher priced, infill options, held up better in ’06.  Now, though, the stress of the slowdown is showing in these higher density housing developments, even as more opportunities come to market.  

The second largest lien filed this year in Maricopa County, the subject article starts out, was filed against the developer of The Summit at Copper Square.  Summit is a downtown Phoenix luxury condominium development.  While developer David Wallach suggests the lien is a “’procedural matter’” that is “’not unusual’”, buyers that have closed on units may think otherwise.  In a condominium development, a lien on the building is a lien clouding the title of every unit in the building.  

Summit is not the only development experiencing financial troubles.  The high-rise, luxury condominium development Centerpoint, located in Tempe, is in need of a $50 million cash infusion.  Avenue Communities successfully convinced its lender Mortgages Ltd. Securities to step down from its first lien position to attract another financier to step in with a loan (“Centerpoint needs $50M to complete Tempe high-rises”, Phoenix Business Journal, May 23, 2008).  

In and near Scottsdale a number of mid- and high density developments have popped up during the last 18 to 24 months.  Data collected by Belfiore Real Estate Consulting shows slow sales in most.  The only significant demand appears to be for the few plans priced under $300,000.  

Tomorrow, Trammell Crow will attempt to auction off 35 townhouses in its Westgate City Center community The Quarter.  Market-watchers were stunned to see, in the midst of a downturn, the apparent strength of the immediate market when the developer reportedly sold all 171 townhomes priced from $450,000 to $700,000 (at sell-out) in just 7 months.  Over the course of 2007, unclosed units came back to the developer; the 35 units are what remain to re-sell.  

Clearly, not all attached developers believe the market for high-end attached product is all that dire.  Two weeks ago, Statesman opened The Metropolitan in Chandler.  While pricing has yet to be released for the high-tech mid-rise units planned, Statesman representatives shared plans for units ranging in price from the high $200,000s (1,150 square feet) to the high $600,000s (2,000 square feet).  

The question many looking from the outside-in may soon start asking is, “How many buyers are there for $300 / square foot to $800 / square foot housing in Phoenix?”  As the single-family market bottoms out, the answer will come.  Hopefully the timing is sooner rather than later.

Implications: An improvement in consumer sentiment will lead to an improvement in new home traffic and home sales, as well as an improvement in other areas of the economy.  Buyers that “feel” good make confident purchases.  Watch consumer sentiment and confidence indices, as well as BREC traffic count figures, for improvements, which we expect late in 2008.

Analysis: Business students are taught not to let their feelings get in the way of business because emotions often lead to irrational decisions.  If consumers were taught the same thing, housing market conditions would be a little better today.  

In May, consumer sentiment, as measured by Reuters / University of Michigan, hit its lowest mark since June 1980, according to the subject article.  Every month over the last 2 years, Belfiore Real Estate Consulting has tracked new home sales office traffic counts throughout the Phoenix metro area.  During this time, traffic counts, like consumer sentiment and confidence indices have fallen dramatically.  In some Phoenix metro submarkets, year-over-year traffic has fallen as much as 70%.  Sentiment is the reason.  

Potential buyers are nervous about the economy; they are nervous about their jobs, worried the value of their largest single asset (their home) will fall further, worried about food prices rising further, concerned about retirement income and who will become the next President.  Their nervousness is reflected in the sentiment index and in BREC’s traffic count figures, and consequently, in the pace of home sales.  

Mortgage underwriting has taken some of the blame for slowdown in home sales during the last 24 months.  Undeniably, conventional 100%, no documentation loans- so-called “liar’s loans”- are nearly impossible to attain; these loans are largely the reason the home sales became so inflated in 2004 and 2005.  

Downpayments have made conventional financing difficult, particularly in more affordable market areas like the Phoenix metro area.  Buyers have become accustomed to no or minimal downpayments.  With many areas now being deemed “declining” market areas by lenders, downpayments of 10% to 15% are necessary to attain conventional financing.  

Interestingly, for buyers purchasing in most metro area submarkets, attaining financing with absolutely no downpayment is easy… as long as the buyer can provide proof they can afford a home.  Nearly all homebuilders are offering FHA loans.  Builders coupling these loan offerings with 3% in closing costs, and a third party 3% downpayment gift are finding that most buyers take advantage of the no-down financing option.  Clearly, financing for those seeking homes priced within FHA loan limits, is not a challenge for buyers that can afford to make payments on the homes.  

An improvement in consumer sentiment will lead to an improvement in new home traffic and home sales, as well as an improvement in other areas of the economy.  Buyers that “feel” good make confident purchases.  Watch consumer sentiment and confidence indices, as well as BREC traffic count figures, for improvements, which we expect late in 2008.

Implications: Rising costs and high delinquencies are pushing HOAs into bankruptcy.  Add HOA solvency to your underwriting checklist.

Analysis: For those with community interests in Arizona, beware!  Homeowners’ associations are struggling to pay their bills today.  As association costs have gone up in recent years, the number of people not paying is increasing.  Established associations weather the storm by increasing dues, an unwelcome reality for members.  For less established associations, increasing dues might be the best possible outcome; some will file bankruptcy in coming months, and existing homeowners may not have full use of amenities that drew them to the communities where they now own homes.  If you are buying an interest in a community with a HOA- whether it is a single home, multiple homes, lots, or land, you can now add the HOA to your list of financial underwriting checklists.  

According to Robb Lipsey, President of full service HOA management company Premier Community Management, association finances are a growing concern, particularly for newer HOA communities.  “Delinquencies are increasing and existing members, which include developers and homebuilders in communities not fully sold out, are being forced to pick up the shortfall for those not paying.”  In cases where builders go bankrupt, existing homeowners are faced with tough decisions, according to Robb.  In one meeting, a builder recently informed homeowners in the half-built community that they were being forced into bankruptcy and HOA dues would need to be doubled.  

One association member in a newer Queen Creek area community recently shared that its association had $400,000 in delinquencies, and legal fees associated with collecting on the delinquencies.  While researching the likelihood of homeowners catching up on dues, the Board uncovered some unpleasant information: more than 500 of its members were 90 days or more past due on mortgage payments.  

According to City Property Management Company, when East Valley HOA Santana Ridge Homeowners Association developer Weinstein Communities recently filed for bankruptcy existing HOA members were faced with increasing dues to maintain amenities installed throughout the partially built community.  Their decision: increase dues from $200 per month to $310.  

As an increasing number of HOAs struggle to stay in business this year and next, legislation will likely evolve to protect HOA community members.  HOA funding protections, including and possibly beyond reserve funding requirements, will likely become a hot topic.  Land and lot buyers prepare!

Implications: Mr. Moulle-Berteaux seems to lack is an in-the-streets perspective.The housing market will shrink and prices will decline further before the Phoenix metro housing market hits bottom.

Analysis: Let it be known that Mr. Moulle-Berteaux was the first to write it: the housing crisis is over!  Allow me to dispel the rumor… the housing crisis is not over- at least here in the Phoenix metro area.    

Mr. Moulle-Berteaux suggests we not “forget that the housing bust is nearly three years old”, that the drop in home sales (“63% from peak levels”), the drop in residential construction (“close to 15-year lows”) and affordability (“house prices have fallen 10%-15%, while incomes have kept growing”) are reasons why we have hit the bottom.  His analysis seemingly boils down to two sentences: “The next question is: Even if home sales pick up, how can home prices stop falling with so many houses vacant and unsold?  The flip but true answer: because they always do.”  Ironically, later in his editorial, Mr. Moulle-Berteaux spews the following about thoughts of those that believe housing prices will fall further: “this simplistic analysis is appealing on the surface, but is flawed for a variety of reasons.”  

Housing prices have come down significantly.  New home offering prices in the Phoenix have come down a whopping 37% (Belfiore Real Estate Consulting) since the beginning of 2006.  During the last 6 months, new home offering price declines have been among the most significant recorded since the market hit peak.  Even in North Scottsdale, the top performing Phoenix metro new home market in 2007, inventory home prices have declined more since the end of last year than they had since the beginning of the downturn (7.8% decline from late December 2007 to April 2008, Belfiore Real Estate Consulting data).   

Resale prices have come down about 17.5% (Arizona Regional Multiple Listing Service).  Houses, as Mr. Moulle-Berteaux points out, have become more affordable.  Permit issuances are down 71% (DataQuick Information Systems).  Mr. Moulle-Berteaux seems to have all of the easily attainable data at his fingertips.  

What Mr. Moulle-Berteaux seems to lack is an in-the-streets perspective.  If he was here in Phoenix, we could take him out to sales offices to hear how much traffic is down (in many communities traffic is down 50% to 75%, Belfiore Real Estate Consulting data).  We could bring him along to a few builder meetings, where the builders might share that they are on the brink of extinction, paying money when they close homes rather than receiving money.  Mr. Moulle-Berteaux could field a phone call or two here in the office; he could hear how one of the most aggressively priced builders in the Valley sold an average of 2.0 homes per community in March but only 0.1 per community in April (historically one of the top traffic and sales months).  If Mr. Moulle-Berteaux spent a few days with us he would have a better understanding of how buyers were feeling and what obstacles remain to purchasing a home.  

The housing market will shrink and prices will decline further before the Phoenix metro housing market hits bottom.  Foreclosures are increasing; builders are struggling to stay in business; buyers are nervous about their jobs, savings (or lack thereof), and their home values; and banks are tightening underwriting standards.  Fewer people- not more- are shopping for homes this month.  

Recent price declines, we believe, signal a last ditch attempt by several small and mid-size builders to stimulate sales.  Some of these builders will sink during the next 3 to 6 months, clearing the way for remaining builders to stabilize prices.  The “bottom”, we believe, is 9 to 12 months away.  

Although we clearly disagree with Mr. Moulle-Berteaux’s analysis, we encourage you to pull up the article and forward a copy to as many friends as possible.  Some good “news” may encourage a few people to go out and buy a new house, something many of us hope would happen on a large scale sooner rather than later.

Implications: The limited demand within Northeast Phoenix should come as no surprise to the State.  The deceleration in home sales has created a surplus of finished and planned lots.  Despite current market conditions, BREC anticipates the market area continuing to hold value better than most Valley submarkets this year.  Land and lot demand, though, should trail a pickup in sales- which isn’t expected until sometime next year.

Analysis: State land auctions have become tougher sales during the last 30 months, even in Valley areas considered to be among the most desirable.  State land commissioner Mark Winkleman laments in the subject article about how difficult sales have become in the Desert Ridge area (Belfiore Real Estate Consulting submarket: Northeast Phoenix) since early last year.  Last year, Toll Brothers purchased an 81-acre state land parcel for $19.7 Million.  

Northeast Phoenix has held up better than most Phoenix metro area submarkets.  While new home offering prices in Northeast Phoenix dropped 8.1% last year, the submarket ranked among the better performers in value loss.  Move-up buyers seeking close proximity to Scottsdale (at a discount to North Scottsdale prices), quality amenities, shopping, and good schools held submarket prices up relative to other submarket areas.  The average metro area submarket lost 14.0% last year.                                                 

Demand for new homes has slumped in Northeast Phoenix, particularly during the last 9 to 12 months.  Last year, Pulte’s new Fireside at Desert Ridge opened, driving an average of 53 buyer parties to visit each subdivision per week in April of 2007.  Since, average traffic has plummeted.  In December, weekly buyer traffic stood at 12 per week (a drop of 77%).  BREC will collect Northeast Phoenix traffic figures again next week for its May edition of KnowledgeBase Current and Future Market Conditions Insights.  

The lack of demand for new homes has pushed homebuilders to reconsider state land purchases.  Meritage Homes and Toll Brothers, both publicly-traded builders that have purchased state land in recent years, are trying to renegotiate their auction purchases (as pointed out in the subject article).  Meritage has been trying to sell some of its parcels to builders, but has reportedly not been willing to drop lot prices significantly enough to attract buyers.  Gray Development Company recently missed an infrastructure payment on a piece of land it purchased in 2004 and subsequently received an extension to pay.  

The limited demand within Northeast Phoenix should come as no surprise to the State.  The deceleration in home sales has created a surplus of finished and planned lots.  Despite current market conditions, BREC anticipates the market area continuing to hold value better than most Valley submarkets this year.  Land and lot demand, though, should trail a pickup in sales- which isn’t expected until sometime next year.

Implications: Some homeowners with the means to pay their mortgage payments are halting those payments, walking away from their homes instead, accepting that they are upside down, and choosing 7 years of bad credit over an unknown period of negative equity.  If Mr. Bernanke is successful in his call to bankers- that is, lower the mortgage debt for those homeowners whose homes are worth less than their outstanding mortgage balance and “struggling” to make payments- fewer owners will likely walk from their homes in 2008.   Our question to Mr. Bernanke is: what about next year?  Prices are still dropping rapidly.

Analysis: Federal Chairman Ben Bernanke’s latest solution to rising foreclosures: persuade banks to write-off a portion of borrowers’ mortgage debt.  Mr. Bernanke appears to have the problem right.  Some homeowners with the means to pay their mortgage payments are halting those payments, walking away from their homes instead, accepting that they are upside down, and choosing 7 years of bad credit over an unknown period of negative equity.   

The most recent foreclosure data and discussions with those being losing their homes support Mr. Bernanke’s thoughts on the problem.  Subprime difficulties and resetting rates are still the biggest challenges, but the percentage of foreclosures involving prime loans is increasing rapidly.  In January, the number of prime borrowers- those borrowers with “good” credit- foreclosed upon was up to 41% from 37% in the fourth quarter (Simon, Wall Street Journal, “Some Borrowers Rescued”, 3/4/08).  Credit counselors are echoing the problem- negative equity.  The reality, it appears, is as Mr. Bernanke suggested earlier in the week (presented in subject article), “’a stressed borrower has less ability…and less financial incentive to try to remain in the home… because of the pervasiveness of negative equity positions’”.  

If Mr. Bernanke is successful in his call to bankers- that is, lower the mortgage debt for those homeowners whose homes are worth less than their outstanding mortgage balance and “struggling” to make payments- fewer owners will likely walk from their homes in 2008.   Our question to Mr. Bernanke is: what about next year?  Prices are still dropping rapidly. 

Belfiore Real Estate Consulting data reflects Phoenix metro area same store new home offering prices fell 16% in 2006, and an additional 14% in 2007.  New home price drops have been most significant during the last 5 months.  Resale prices have only recently begun falling; they stand to fall significantly in 2008, as resellers (including banks) compete with homebuilders to sell off supply.  In many submarket areas, resale home sellers do not stand a chance in competing with homebuilders until the resellers drop prices further.   Dropping mortgage debt to today’s “supposed” market value for homeowners threatening to walk doesn’t make sense today.  In 18 months, aren’t the same homeowners going to threaten to walk after prices have dropped further?  

Mr. Bernanke’s focus is misdirected.  Limited demand and an oversupply of homes (resale and new) is pushing prices downward.  Falling home prices are acting as a disincentive, as he points out in his own words, for owners to work to stay in homes, forcing foreclosure rates upward.  These falling home prices have been predicated upon homebuilders’ belief that lower prices stimulate sales.  Prior to convincing banks to lower mortgage debt, Mr. Bernanke should work on convincing homebuilders that home price decreases fuel skepticism and fear, which feed upon one another, and while the decreases may facilitate a few sales in the short-term, they make home selling more difficult after the initial 45 to 60 days following the price decrease.

Implications: Apparently, front page “news” is one way to boost new home sales.  Cachet’s inventory home auction, in which the builder reportedly sold 37 of 41 homes it hoped to sell, appears to have been a huge success.  New home auctions will likely gain traction in metro Phoenix in the coming months.  Hopefully, it doesn’t take disparaging front page articles, like the one that drove buyers to Cachet's auction, to build upon Cachet’s success.

Analysis: Apparently, front page “news” is one way to boost new home sales.  Cachet’s inventory home auction, in which the builder reportedly sold 37 of 41 homes it hoped to sell (Arizona Republic, 2/25/08), appears to have been a huge success.  The Verrado homes that sold on Saturday represent more sales than the builder had sold all of last year in Verrado.  Home prices were bid up from the low minimums advertised by Cachet.  Some potential buyers were quoted in the Republic’s follow-up article as being disappointed that the home prices increased much more rapidly than expected, suggesting Cachet was able to cash-out.  

The auction is good news for Cachet and for an industry faced with tougher conditions in the near future.  Cachet has been the subject of sell-out and bankruptcy rumors for months, as speculative inventory has grown and the builder has attempted to sell its lots in what were previously considered highly desirable master planned communities.  

The auction also reflects some hunger on behalf of homebuyers.  The “crowded ballroom” and rapid bidding by those in attendance, as reported by the Republic, suggests a crowd of buyers are sitting on the sidelines waiting for better deals to come along.  This weekend’s message is clear: bargain home shoppers will show if they believe a good deal is available.  

The auction story does have a downside.  Friday’s front page article painted a picture of desperation.  It mentioned the industry’s “glut of unsold homes and canceled contracts” and Cachet’s previous attempts to attract buyers with luxury cars.  Some potential buyers likely read the article as confirming what they already knew: “Things are bad; things may get worse; and, unless a really, really good deal comes along, it’s best for me not to shop for a home at this time”.  

New home auctions will likely gain traction in metro Phoenix in the coming months.  As one builder’s success is publicized, others will attempt to match that success.  Hopefully, it doesn’t take disparaging front page articles to build upon Cachet’s success.

Implications: “Speculators” / investors seem to bear the brunt of criticism when discussing the downturn in residential real estate.  Undeniably, this group contributed to both the rise and fall of residential real estate.  However, the MBA statistics, coupled with BREC’s previous estimates of investor buyers, reflect an equal proportion of 2004 and 2005 resident buyers are being foreclosed upon.  Others appear to be deserving of some of the blame for the current downturn….

Analysis: Although we have no way of knowing with a simple read of the subject article, the authors must intend to evoke some level sarcasm with their title.  Speculators “may have” accelerated the housing downturn?  Sales levels and home prices in 2004 and 2005 jumped with investor activity, and inventory levels drastically increased in late 2005 (followed by ’06 price declines) as investors pushed resale inventories upward practically overnight.  These so-called investors were not solely responsible for the phenomenal growth in the boom years and certainly and not wholly responsible for the downturn, but they have clearly contributed to both.  

The value of the subject article lies in the figures provided by the Mortgage Bankers Association (MBA).  Arizona is among states with the highest percentage of non-owner-occupied foreclosures as a percentage of all loans.  According the article, 22% of foreclosures are likely speculators because the mortgage notes are held by people other than the residents of the homes.  

The subject matter highlighted by the article’s authors is mortgage fraud.  Many of the investors being foreclosed on did not disclose they were investors; in fact, many signed contract addendums, specifically stating they were not investors.  In a quote, Mr. Toll of Toll Brothers, even hints at some surprise.  

Belfiore Real Estate Consulting (BREC) has previously estimated up to 25% of 2004 and 2005 metro area buyers were investors.  Assuming the estimation is accurate, a nearly-equal percentage of resident and non-resident buyers are missing their mortgage payments.  

“Speculators” / investors seem to bear the brunt of criticism when discussing the downturn in residential real estate.  Undeniably, this group contributed to both the rise and fall of residential real estate.  However, the MBA statistics, coupled with BREC’s previous estimates of investor buyers, reflect an equal proportion of 2004 and 2005 resident buyers are being foreclosed upon.  Others appear to be deserving of some of the blame for the current downturn….

Implications: Few will debate whether or not prices are actually falling; most every measurement has recently shown a decline, and with economic projections what they are, prices are expected to continue to fall.  How long and how far are the questions at hand.  Belfiore Real Estate Consulting (BREC) has some thoughts on the Phoenix metro area….  

Analysis: The weight of the world seems to be on Federal Reserve Chairman Ben Bernanke these days.  Despite all of the Fed’s best intentions to stimulate the economy, uncertainty seems to be the greatest certainty heading into the middle of the first quarter of 2008.  

According to the subject article, the most taxing question on Mr. Bernanke’s mind today is: “How much longer and farther will American house prices fall?”  The question is clearly a loaded one, evoking other questions related to the economy, jobs, supply, demand, the credit crunch, etc.   

Few will debate whether or not prices are actually falling; most every measurement has recently shown a decline, and with economic projections what they are, prices are expected to continue to fall.  How long and how far are the questions at hand.  Belfiore Real Estate Consulting (BREC) has some thoughts on the Phoenix metro area….  

BREC’s measurement of the fall in new home prices involves the study of “same store” net, new home offering prices.  Since the beginning of 2006, BREC data suggest metro Phoenix new home values have dropped an average of 27%.  And, January data, currently being input, suggests the drops have continued- despite some early-year optimism that pushed traffic levels upward.  

Resale home prices are another subject.  Resellers have not dropped prices significantly.  Data provided by Arizona Regional Multiple Listing Service, Inc. reflects resale offering prices in the Phoenix Metro Area dropped only 0.5% from the beginning of 2006 through the third quarter 2007 (NAR Market Watch, latest report published, weighted average offering prices for Maricopa and Pinal Counties).  Other indicators reflect resale price drops of less than 10% since the beginning of the current downturn.  

The gap between new home and resale home prices suggests resale prices have significant, near-term downward pressure.  A demand shift to new homes (from resales), particularly on the outskirts of the metro area, is clear today.   Resale prices stand to drop significantly in 2008.  BREC’s latest estimates call for a fall in resale prices of at least 12.5% this year.  

As mentioned above, the latest new home data collected by BREC reflects continued new home price cuts, as well.  BREC’s current forecast suggests net new home offering prices will drop 7.5% in 2008.   

Current finished lot inventories remain high in the most competitive areas of the metro area, pushing lot prices down.  A couple of positives today: (1) a limited number of transactions, which are being sold to buy-and-hold investors (these investors are taking lot inventory out of circulation, effectively decreasing competition), and (2) few lots are under development, and even fewer will be under development 12 months from now (limiting additional competition, allowing current supply to start to burn-off).  

Those worried with the direction of home prices, including Mr. Bernanke, should concern themselves with two items currently: (1) consumer sentiment, and (2) the availability of mortgages.  Nervous consumers- whether nervous about the direction of the economy, their own jobs, or home prices- historically have reduced household spending.  During the 4th quarter, the direction of consumer sentiment became clear as subdivision traffic levels fell rapidly.  Consumers are now hearing how much more difficult it is to attain mortgages.  Tightening underwriting standards have and will continue to result in fewer homebuyers.

Implications: When Mr. Corkery wrote this article more than 2 weeks ago, the reality is few land sales were occurring in Phoenix.  His timing was off: several thousand lots and option agreements are now being signed, as builder's rush to remove lots from their balance sheets prior to year-end.

Analysis:

Arizona real estate professionals were scratching their heads when the subject article was published more than two weeks ago.  Citing only two recent land / lot sales in metro Phoenix, Mr. Corkery declared “the market also is beginning to see a phenomenon that at first glance would seem to contradict these other trends [falling pricings and accumulating glut]: land sales.”  In other words, despite challenging and still deteriorating market conditions, buyers are purchasing land.

Belfiore Real Estate Consulting (“BREC”) phone lines lit up with calls from investors, builders, and lenders wondering what and where these “hot land sales” were occurring.  The reality is, few sales were actually occurring at the time.  Mr. Corkery, it seems, was either misinformed or had different opinions on what constitutes “hot land sales”.   Today, though, just two weeks after the article, deals are being made.  Builders looking to remove stale lots from their books by year-end are selling out at highly discounted prices.  “Distressed” sales in emerging market areas are now occurring.  BREC research suggests most of the distressed lots in outlying areas range from $300 to $450 per front foot.  Several transactions will have builder personnel working hard through year-end.   Buyers tend to be investor groups with a “buy and hold” strategy; they plan to purchase the lots and hold onto them until the residential market recovers and builders again need lots in which to build upon.  Since lots are being purchased at such highly discounted prices, competition among lot sellers, investors believe, will likely be limited to those holding finished lots (rather than developers selling developing raw land and selling new lots).  Site improvement costs will make raw land development unprofitable because builders should be able to purchase investor lots at lower prices.    A significant number of investor “buy and hold” transactions occurring during the next few months would have a positive effect on market conditions.  Fewer lots would translate into fewer community choices for buyers.  Fewer community choices, provided home demand remains similar to current levels, would mean more home sales for active projects.  Absorption rates per community would increase.   Notably, not all lot buyers are investors.  Entrepreneur Greg Hancock closed on highly discounted lots in Maricopa late last month.  Mr. Hancock is expected to soon enter the market as a home builder with a distinct advantage over his competition: finished lot costs well below actively selling competition.   The land market is now heating up.  The Wall Street Journal may want to consider republishing Mr. Corkery’s article.

Implications: Phoenix metro area employment and population growth will slow in 2008.  Consequently, so will demand for new housing, but how much will it slow?  How do you forecast employment growth?

Analysis:  

The “Today’s Buzz” article in the Arizona Republic last Wednesday cites Friedman, Billings, and Ramsey in reporting the mortgage industry has more employees than it needs. FBR estimates the industry has overcapacity of 22.2% to 33.3% based on current and projected originations. Next year, FBR estimates, the mortgage industry will need 100,000 to 150,000 fewer employees nationally.

Similarly, the University of Arizona’s Eller College suggests the loss of 30,000 Arizona construction jobs by early 2009 in its July issue of Arizona’s Economy. Until January, the Construction industry continued growing. By May, only 2.4% of Arizona jobs (6,000) had been lost.

For economists, quantifying job losses and forecasting future losses is likely much like looking at any other data points- considering variables, plugging historical figures into a model, and pushing out some figures. For those people in the industry being affected, particularly those individuals in shrinking organizations, considering job losses is a more personal task. Who will be here next year? Will I be one of those sent home during the next Reduction in Workforce (RIF)? These are unpleasant questions.

Despite how unpleasant the task is, though, Belfiore Real Estate Consulting (“BREC”) encourages you to spend some time understanding and forecasting job growth (and losses). Forecasting housing and mortgage demand cannot be determined without understanding demand. Job growth typically drives population growth, which drives demand for housing.

The Bureau of Labor Statistics (“BLS”, www.bls.gov) is the “base” source, typically, for job growth data. Usually, the job growth data quoted by the media and analysts is from the “Current Employment Statistics” program (“CES”). Businesses and government agencies are regularly surveyed to determine job growth. The following link will take you directly to the CES page of the BLS site: http://www.bls.gov/sae/home.htm.

BREC reports CES, non-farm, non-seasonal data when discussing job growth. In 2006, 107,000 net new jobs were created in the Phoenix metro area, according to the BLS. During the 12 month period ending in September 2007, 55,200 new jobs were created in Phoenix.

A number of sources are available for forecasting job growth; BREC depends upon Moody’s Economy.com (www.economy.com), a national economic forecasting firm, for forecasts on job growth.

At its recent Market Update and Roundtable Discussion, BREC announced Economy.com’s latest job growth forecast. Economy.com’s forecast suggests only 18,000 jobs will be created in 2008. Economy.com’s figures include assumptions of construction and finance job shrinking spreading into other economic sectors. Consequently, the metro area’s population is expected to grow by only 77,800 people next year. Although population fluctuates based on a number of factors, job growth is the primary factor typically affecting population growth.

Nearly 80,000 people may seem like a lot of people when viewed independently, but when compared with recent historical growth the figure has less impact. According to the U.S. Census Bureau, the Phoenix metro area has grown by an average of 121,338 people annually from 2000 to 2007 (2007 figure is a projection). And, nearly half of the population growth is babies- due to births (versus people moving into the market- net in-migration).

Economy.com’s job and population growth forecasts suggest significantly lower demand for new housing in 2008 than in 2007. BREC currently projects demand for 26,525 single-family permits next year. The forecast, lower than early- and mid- year projections, considers:

• Job and population growth forecasts
• Current speculative supply and changes in future supply
• Historical population to single-family permit ratios

Implications: When making your determination on the future of the economy, how many units will be sold next year, or how many people will move to Phoenix, consider how banks have reacted to bad news this year; the statistics above; and how lenders may react to bad news next year.

Analysis:

If you are one of those people still on the fence, one of those questioning if we could find ourselves in a recession next year, one of those wondering how in the world Belfiore Real Estate Consulting (“BREC”) could conclude that Phoenix population growth could shrink to 78,000 people and only 26,525 single-family home permits might be issued in 2008 (our latest forecasts, population based on Moody’s Economy.com projections), pick up a copy of today’s Wall Street Journal. The subject article provides an explanation.

As Karen Weaver, international research leader at Deutsche Bank AG puts it in the article, “Mortgages are still deteriorating at an accelerating pace, and that’s scary. We haven’t come near a stabilization, and we expect things to get worse as the bulk of resets have yet to come”. And, J.P. Morgan Chase & Co. analysts recently said, as quoted in the article, “As bank losses continue, we expect bank lending capacity to be reduced”. BREC’s translation: Lending standards will tighten in the future. I have long shared my belief of, “he who controls the money, controls everything”. In this case, the “he” is the banks, and the “everything” is the economy. The housing market and overall economy will deteriorate further if credit continues to tighten.

According to the article, citing First American LoanPerformance, 20% of subprime mortgage loan holders were more than 60 days behind in August. Mark Zandi, economist at Moody’s Econoy.com, estimates in the article that mortgage losses could hit $225 billion. Zandi believes $2 trillion in wealth, in the form of home values, will be wiped out by the bottom of the fourth quarter of 2008.

All of these statistics scare lenders into becoming more conservative, and ultimately into requiring higher FICO scores for loans and higher down payments for home purchasers. While most industry players believe some tightening was necessary (from mid-2005 lending standards), inevitably lenders become overly-cautious, and make it impossible for less risky buyers to purchase homes, and unnecessarily push the economy downward.

When making your determination on the future of the economy, how many units will be sold next year, or how many people will move to Phoenix, consider how banks have reacted to bad news this year; the statistics above; and how lenders may react to bad news next year. Consider what will happen if loan standards become more stringent than they are today.

Implications: Homebuilders are employing differing speculative inventory strategies in the market today. Lennar's is driving home prices down further. This artcile explores Lennar's strategy and other strategies being employed.

Analysis: Speculative building continues to drive home prices down for some builders, and in most cases, entire market areas where builders with significant inventories are currently operating. Why then, would some builders continue to produce homes buyers seem to have enough of? The answer is not a simple one. Some inventories are the result of buyer cancellations. Others are intentional, out of what builders believe is necessity. And, still others, it seems, are the result of builders simply wanting to keep the machine moving rather than slowing.

Inventory homes are arguably necessary for any builder wanting to sell a new home today. In the Phoenix metro area, constructing a home usually takes 4 to 6 months. A volatile lending environment, oversaturated resale market, falling home values, and buyers’ perceptions of the market, increase the likelihood of cancellations as closing on a new home approaches. Builders selling “new build” homes have experienced exceptionally high cancellation rates; the 4 to 6 month construction time seems to be enough time for something to cause the seller to cancel the home purchase. Those builders selling spec homes, on the other hand, are experiencing far lower cancellation rates, as they sell and close within a relatively short period of time passing.

Some speculative building is necessary to produce cash flow today - as many builders believe. A reasonable number of spec units, perhaps up to 4 homes at various stages of construction, seem to fit today’s environment. The variation in completion times allows for builders to serve a particular buyer’s needs versus the builder feeling the need to “fire sale” homes.

Baffling those following the market closely, one publicly-traded home builder, Lennar, has continued to pump out spec homes, despite its stated strategy of keeping inventories down. Two weeks ago, Stuart Miller, Chief Executive of Lennar, announced, “Our response to, and primary focus in, this environment continues to be to adjust pricing to meet current market conditions in order to keep inventories low and to keep our balance sheet positioned for the future. The net effect has been a continued deterioration of our net margin and accordingly, higher impairments to our inventory.” Lennar’s strategy, according to internal personnel BREC has spoken with, is to sell only spec homes, particularly those that are 30 to 60 days from completion. Many of Lennar’s Phoenix communities have 5 to 10 spec homes within 60 days of completion and several more under construction. As long as such a strategy is employed, Lennar, and likely home sellers (builders and resellers) selling homes nearby Lennar communities, can expect to continue experiencing declines in home values.

Regardless of your strategy as a builder, or the strategy of the builders you are selling lots to or following, incorporating an appropriate speculative building strategy can be the difference between selling homes or not selling homes today. Equally important, is understanding the strategy of those selling nearby. For those building near home builders like Lennar, prices may be forced lower as a result of excessive new home inventory.

Implications: The FHA plan discussed in this article puts the burden of poor individual and lender decisions on the government and taxpayers, perhaps not a burden many of us believe we should be required to bear. However, considering the magnitude and the possible effect on the markets if the 2.2 million resets are remotely similar to my neighbor’s resetting rate, we might be thankful if the program is adopted in coming weeks.

Analysis:

An estimated $575 Billion in adjustable rate mortgages will “reset” in the next 16 months, according to Deutsche Bank Securities (“One Family’s Journey Into a Subprime Trap, The Wall Street Journal, 8/16/07). According to The Center for Responsible Lending, an estimated 2.2 million loans will reset in the next 24 months. The reset is reached when the fixed period of an ARM, commonly 2 to 5 years, ends and the adjustable period begins. With the housing market reeling, a number of lenders going belly-up, and lending standards rapidly tightening for lenders still in the game, the level of resets could hardly come at a worse time.

Apparently, many of those people that financed / refinanced their homes with ARMs either thought they would refinance prior to the reset or were clueless as to how they would be affected by the reset in rate. It is more difficult to refinance today than it was 6 or 12 months ago, and for those with credit scores under 620, it is virtually impossible without a personal cash injection. The realty is that many of those individuals with resetting rates are upside down on their loans; a new bank is not going to refinance them. And, for those that were clueless, they may learn a hard finance lesson in the very near future: the effect of increasing interest rates on hundreds of thousands of dollars.

An area of great interest to us here at BREC is the average reset rate of those loans expected to reset in the next 12 to 18 months. Such information would allow us to “guesstimate” the number of troubled loans. The higher the reset rate, the higher the number of borrowers that will default on the loans. We have not been able to attain this information yet, but are trying to attain it and will share the information when collected.

If you are like I was a couple of weeks ago, you may not think reset information is as important as it is…. I thought the reset rate on one’s primary mortgage might equate to Prime or Prime + 100 basis points, certainly a high interest rate for a home loan, but perhaps a manageable rate for many borrowers.

Two weeks ago, a neighbor of mine (and family) moved out of his home hurriedly one Friday afternoon, a move unexpected by his neighbors (including me). As I pulled into my driveway, I went over and asked the neighbor what was going on, surprised he was moving. He informed me he had gotten a “great deal” on a house down the street and that he would be selling his house.

One week later the for sale sign popped up in the neighbor’s yard with a rider: “Pre-Foreclosure”. Upon further investigation, I found this neighbor was short selling his home. The lender, whom had just refinanced the house 1 year ago (the fourth lender to do so since 2002), is apparently willing to accept less money for the home than the loan amount due in order to avoid foreclosure. If I had known what I would uncover with further digging, I could have guessed this homeowner may have ended up in this situation. The initial loan rate on his first and only mortgage was 8.5%; the reset rate on the loan, which would have become the interest rate in August of 2008, was 8.0% + 6 month LIBOR. In today’s rates, the interest rate would have been around 13.5%.

I have pondered what my neighbor could have been thinking when he signed the loan papers during his last refinance; I have also pondered what the lender could have been thinking, how the underwriter could have approved the 4^th refinance since 2002, and how he or she believed the loan would be repaid at such a high cost. I am at a loss and now wonder the effect all resetting loans will have on the overall economy in the next 16 to 24 months.

One plan being floated to ease the effects of resetting loans is explored in the subject article. The FHA would be given the ability to refinance low and middle income ARM loans with no down payment by the home owner. Additionally, mortgage insurance premiums, typically based on a “one-size-fits-all” program, would be based instead on the risk associated with the loan.

The FHA plan puts the burden of poor individual and lender decisions on the government and taxpayers, perhaps not a burden many of us believe we should be required to bear. However, considering the magnitude and the possible effect on the markets if the 2.2 million resets are remotely similar to my neighbor’s resetting rate, we might be thankful if the program is adopted in coming weeks.

Stay tuned…

Implications: Tightening lending requirements of remaining players and higher home loan rates will push the housing demand lower, adding further downward pressure to home prices and increasing the likelihood of Fed intervention.

Analysis:

Financing options thinned further for potential home buyers. Yesterday, American Home Mortgage Investment Corporation (the 10^th largest U.S. home lender) sent 6,300 of its 7,000 employees home when it filed for bankruptcy, and two other lenders announced they would stop funding new loans. American Home Mortgage, as pointed out in the article, is one of more than 50 lenders in 2007 to file bankruptcy.

American Home Mortgage was unique, though, from most of the other 50 lenders that have filed in 2007. The lender financed few subprime loans, instead focusing on Alt-A loans, which have typically been considered more stable because borrowers’ credit scores are of higher quality than those utilizing subprime loans. Lenders rely on the credit score rather than documentation, charging a slight premium (up to a half point) over prime loans due to the lack of documentation provided by the borrower.

What can we expect with fewer lenders offering home loans? Fewer potential buyers can qualify for a home loan today versus 6 months ago. According the one source, Goldman Sachs, 10% to 15% fewer buyers can now qualify compared with one year ago. Further downward pressure will be put on home prices. Buyers have only so much money to pay monthly for a place to live; with more money going towards interest, less can be spent on the price of the house. The odds of the Federal Reserve stepping in to affect the direction of lending and the housing markets increase daily. Inflation talk and rising Fed Rates will take a back seat to discussions on how to stabilize the market. Declining rates seem to be a real possibility in the near future, and further intervention may be necessary.

Builders and builder-lenders considering new projects would be wise to underwrite new projects conservatively. Demand for new homes will be affected largely by what financing options are available and at what price those options come at through 2007 and into 2008.

Implications: Horton's drop in net new home orders is alarming, given that the builder is the low price leader.  How will they alter their strategy to counter current conditions?

Analysis: Any builder trying to sell homes in Goodyear, Maricopa, Surprise or any of the other Phoenix Metro area market where D.R. Horton is actively pushing product knows one thing for certain: Horton is the low price leader. On a price per square foot, Horton has numerous projects where it is offering homes in the mid- to high $60 / square foot price range. As other builders have adjusted downward to compete during the last 12 to 18 months, Horton has driven prices further by responding almost immediately with further cuts.

Horton’s aggressive pricing strategy has appeared to have a positive affect on sales pace. In many communities, Horton salespeople have reported sales ranging from 6 to 12 homes per month. The high number of homes under construction within its communities seems to substantiate the claims.

So… it comes as a surprise that the builder has stumbled so significantly recently. As sighted in the subject article, Horton reported early in July that its net home sales had dropped 40% from last year. Today, Horton will report its third quarter earnings; provided its calculations were right, the report will likely not be all that positive. A drop of 40% in 12 months by the most aggressively priced, large metro area builder is an indication of just how bad current market conditions are getting. Such a substantial drop may spur a change in the company.

Many of us are working hard to figure out just how much Horton (and others) can drop prices- just how low home prices will go. Will Horton’s prices become even more aggressive? Will all of the gains experienced in 2004 and 2005 be wiped away? The only certainty, from our perspective, is prices will continue to drop. Belfiore Real Estate Consulting believes new home prices will drop an additional 6% in 2007.

Implications: Lennar is taking a "build through it" approach in the Phoenix metro area.  Depending on your angle, you may or may not think the approach is a good one.

Analysis: Anyone developing lots, building homes, or just studying a market area in which Lennar is actively building and selling homes nearby knows the home builder is employing a unique approach to building and selling homes. The subject article highlights the builder’s testing of a web auction approach to selling homes. In the Phoenix metro area, the builder has clearly taken a “build through it” approach to the downturn in the market.

For its salespeople, the even flow building approach Lennar has continued employing through the downturn is recognized as a positive. Builder representatives have a constant flow of houses being built and completed, offering only speculative homes to buyers. Regardless of sales, the builder continues starting new homes, discounting nearly complete and completed homes as much as necessary until the homes sell. Lennar salespeople are busy writing contracts. Sales volumes have dropped with the market but are higher than most builders are able to achieve.

As one might expect, Lennar’s speculative inventory is well above that of most builders in the market. For the 3-month period ending in May, Lennar was carrying an average of 13.2 speculative homes per active subdivision (average for 17 communities surveyed by Belfiore Real Estate Consulting during this time), versus a market average of 8.0 units per subdivision. Of those 13.2 homes, 7.1 were complete or within 60 days of completion, versus an average of 5.5 metro area average per subdivision.

Speculative inventory drives prices down. Lower prices will sell homes, as Lennar has proven. And, for this reason, builders and developers competing with Lennar do not like Lennar’s current build through it strategy. Lennar has shown its muscle, driving home prices down to meet its sales goals (when necessary). Lennar’s pricing becomes the new market pricing, and competitors must adjust pricing within their own communities in order to compete.

The natural question that may occur to those observing Lennar’s strategy is: how can the builder make money selling homes with its current strategy? If Lennar is truly a leader in pushing prices downward to sell its speculative units, how far will the builder be able to drop prices before it can no longer employ its current strategy? Belfiore Real Estate Consulting has been told by Division personnel that the builder will not employ its current strategy in high-profile, upcoming communities.

We’ll continue to monitor the market and let you know of any changes.