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It’s already April, and our monthly market update is now overdue! C.A.R. released their data for the month of February on March 25th which is always the basis for our own analysis, combined with data on foreclosures, REOs, mortgage rates, CPI, and income distribution data. As expected, it was another month of bearish data, but when we look closely at the charts we can see some interesting trends about to emerge.

As expected, the median sales price fell once again, but the monthly drop in February was far less dramatic than in the months before. The median sales price fell from a revised $253,330 in January to $247,590. That’s only a 2.3% drop, quite small compared to the 5% to 10% drops we’ve been seeing for the past 12 months. In the chart below, notice how close we are to the long term support trend line. As mentioned before, we expect prices to move below this trend line for a short period during which the CA real estate market will be oversold and offer one of the best buying opportunities in history.

But we are convinced that the best buying opportunity is actually starting now. Even though the exact bottom may not have been reached yet, the competition for good deals is far less today than it will be once everybody realizes we have bottomed. At that point a lot more buyers will flood back into the market and getting the deeply discounted deals we are getting now will be much harder. Today, the market is still gripped in fear and only contrarians like us are happy to jump in and buy from the fearful, including banks. We know that we are close to the bottom, and we’ll start holding more and more properties we buy over that period.

Sales in February stayed high at 620,410 and were little changed from the previous month (624,940). We expect a leveling-out in sales volume over the next 3 months, and a slowdown towards summer and fall.

The unsold inventory index in California remains relatively unchanged. It came in at 6.5 months in February, and has been around the 6-month level since July 2008. This is a good indication that excess supply (which peaked a year ago) has been mostly absorbed, and new supply is being bought up at a steady rate. A 6-month UI index doesn’t really make this a “hot” market, but it’s a healthy number and another indication that we are nearing the bottom.

Housing affordability remains at an all-time high. It stayed at 53%, unchanged from the previous month. This high level is unsustainable in the long term, and we expect it to turn down soon and head to the 40 level and stabilize there.

Finally, let’s look at foreclosures and NODs. The following charts are a good reflection of how loan modifications and short sales have reduced the number of properties that go to the bank (REOs), but note that Notices of Default (NODs) stay high, keeping up the pressure on the banks to continue working out loan mods and approving short sales:

It will be interesting to see how this discrepancy between NODs and REOs will unfold over time, whether loan modifications will have a lasting impact, and how long the banks will refrain from foreclosing on properties. Today, about one third of all scheduled trustee sale auctions are being canceled, which is quite high. We also notice this in our short sale negotiations. The banks are easier to work with and are getting more and more reluctant to foreclose, and are more willing to work out a short sale or loan mod. We believe this is the right approach. It is not only better for the home owner, but also for the bank’s bottom line since a bank takes the biggest loss when they go the REO route. A short sale almost always saves the bank money compared to an REO sale, and a loan mod is even better. It is good to see that the banks are starting to make better decisions.

C.A.R.’s sales and price report for January was released this afternoon, completing our data set for the monthly report. By the way, you didn’t miss last month’s report, we got so busy with our real estate investment business that we had to put our blog on the back burner. So today you’re getting an update for the last two months.

January was an exceptionally brutal month for the California real estate market. The median sales price tumbled by almost 10% to an unbelievably low $254,350. That is 57% off the peak of April 2007 ($597,640).

The last 18 months were just one straight line down, and momentum is still not slowing. We are now close to trend line support on our chart but given the unrelenting downward momentum an overshooting is likely and we may see the median sales price get close to $200,000 before turning. With respect to timing we still believe that a turn around will take 3-5 years, and we may have just entered a period of a slow grind through the $200,000…$250,000 zone.

Here’s an update of our inflation-adjusted sales price chart. Again, the trendline in the above sales price chart corresponds to a horizontal line in its inflation-adjusted counterpart which also corresponds to a Housing Affordability Index of 43%. At this point we believe that the inflation adjusted median sales price will drop below this support line:

The Housing Affordability Index is in support of this prediction as well. It broke the 43% level in December and has reached an all-time high of 53% in January:

The HAI chart speaks for itself. A combination of low median sales price and low mortgage rates have pushed this index above 50%. More than half of the population can now afford to buy a home. If these high levels persist for a few years, it should put a bottom under the CA real estate market. But only time will tell.

Sales in January surprised at 624,940 (annualized), a 100% increase year-over-year:

But for now, most buyers are scared. Even though sales volume came in at a very high level, the only buyers brave enough are investors picking up REOs or short sale properties, or smart first-time home buyers that see the good deal that this market offers them. But most of those sales are concentrated in a few local areas that have fallen the most, and houses in these areas are now highly undervalued. In Santa Clara County, those areas are Alum Rock and Central San Jose, and in Santa Cruz County it is Watsonville. All other areas have highly depressed sales volumes, sky rocketing unsold inventory indices, and accelerating drops in median sales price. We’re also seeing the high-end areas starting to drop now (Willow Glen, Cambrian, and Los Gatos in Santa Clara County and Aptos and Capitola in Santa Cruz County), the falling sales volume in these areas is finally having an impact on prices.

The number of NODs (Notices of Defaults) and REOs (Trustee Sales that go back to the lender) have increased as expected, now that the impact of Bill 1137 has subsided. The charts below demonstrate beautifully that this bill only managed to delay foreclosures and NODs:

As depressing as all of these charts look, we are quite optimistic looking forward. Spring is just around the corner, seasonally a time when buyers emerge. The high number of sales that have been restricted to the low-income areas so far should now spread to areas with median-priced homes, like Blossom Valley and Santa Teresa in Santa Clara County. And we also think that low mortgage rates, first-time home buyer tax credits, and other government incentives will increase the number of buyers in the months to come.

Today, C.A.R. released the November sales and price report. The median sales prices continued south across the board. The statewide number for single-family residential homes came in at $285,680! Wow. That’s quite a drop from October’s $311,060, which was revised down to $301,740. Santa Cruz County posted the second largest month-to-month drop in median sales price of all counties, 12.6% down from October, now at $437,000. The extremely low sales volume in Santa Cruz County (with the exception of Watsonville) is finally showing its impact on sales price. Santa Clara County didn’t fare much better: the median sales price came in at $515,000, a 6.4% drop compared to October.

Overall, sales volume stayed high (514,710 statewide), reflecting the large number of distressed sales that continue to dominate the market.

It is interesting to take a closer look at the price development in local areas. Alum Rock and Central San Jose are still adjusting hard and fast downward, and are likely to overcorrect in the coming months. Watsonville is starting to look like it’s finding some support near $350,000, and we’re expecting a similar development for Alum Rock and Central and South San Jose. On the other end of the spectrum, the more expensive areas in San Jose (Willow Glen and Cambrian) are still holding up remarkably well, and so is Rio Del Mar in Santa Cruz County.

Notices of default and foreclosures are starting to increase again, and we expect this trend to continue into the new year.

With a $285k median sales price, the Housing Affordability Index jumped to 43 this month, and is now in a territory where it should stabilize. But given the severity of this housing crisis we wouldn’t be too surprised to see it go towards 50 before adjusting stabilizing at above 40.

Finally, unsold inventory index remains relatively low (6.9 in November).

On behalf of the entire NorCal team, we wish you happy holidays.

If horror movies are not your thing, how about some scary charts from the land of out-of-control economics? Ever since the bailout plan went into effect, the monetary base of the U.S. has taken off like a rocket. “Monetary base” is comprised of currency and commercial bank reserves. The spike you see in the chart below is mainly caused by a large increase in bank reserves, aimed to address the credit problems. The idea is for the banks to lend this new money into the frozen credit markets to increase liquidity. So far this hasn’t worked. The banks are just sitting on the new reserves, leaving a desperate Federal Reserve and U.S. government “pushing on a string”. Given this monetary base increase, we are reluctant to call our current financial conditions deflationary, but the dollar rally and crashing housing market certainly suggest that we may be in a brief period of deflation. The main of source of these additional reserves are newly issued Treasury bills, which were THE main safe have asset over the last few weeks. These extra T-Bills, in combination with acquiring bad private sector debt (e.g. AIG, Bear Stearns) allowed the Fed to provide these extra reserves to the banks (see Econbrowser for more details.)

The Fed plans to re-absorb the additional reserves by selling the newly acquired assets at some point. That sounds all fine in theory, but given our fragile economy we wonder when that might happen. In the short term, we’re looking at a mountain of additional reserves ready to slosh through our financial system, and a large increase in Treasury bills, undermining the quality of the U.S. currency. The medium to long term result may very well be inflationary.

The fact is that the Fed’s balance sheet increased from about $880 Billion a year ago to $2 Trillion as of this week. The Fed is getting exceedingly creative in balancing the additional assets by creating a host of new vehicles, but we are concerned that sooner or later the world will lose faith and the dollar will become a very unwanted currency. Dollars and Treasury bills will be exchanged into other assets and currencies that are considered more sound, and provide a better return and protection against inflation.

The physical gold market is the most sensitive indicator and is already reacting to the perceived threat of inflation. Physical gold on ebay is trading at about $900 per ounce and demand for physical gold is extremely high globally, with delivery times at 6-8 weeks. (COMEX gold is still trading at $730 per ounce, due to a large amount of short selling and doesn’t reflect this demand yet.)

The effect of this sharp inflationary spike would be an increase in the price of materials, energy, food, and other “real stuff”, and that will include real estate as well. It will get more expensive to buy the materials to build a house, and the transport of those materials will cost more as well. Replacement costs will go up. Repair costs will go up. It is quite possible that Helicopter Ben’s bailout actions may end up putting a bottom under our crashing real estate market and turn it around. But it is also possible it will destroy the financial system as we know it. If we had a choice we’d prefer stable economics with a stable money supply and a healthy natural correction of the market imbalances. The billions of dollars that are pumped into our financial system today will ultimately prevent that from happening.

Nobody knows exactly if or how this inflation scenario is going to unfold. We hope the Fed is going to be successful, but an expansion of the monetary base by 35% within 40 days certainly does not qualify as “sustainable” or “in control”.

If you aren’t scared enough yet, please check out this chart, the borrowed reserves of U.S. depository institutions:

Borrowed reserves are equal to credit extended through the Federal Reserve’s regular discount window programs as well as credit extended through the newly established Term Auction Facility. In short, money the banks borrow from the Fed. From 1973 until the end of last year, borrowed reserves generally stayed below 1 billion dollars. Starting in December 2007, borrowed reserves went up from 0.2 billion dollars to 691 Billion dollars as of today!

Going from 0.2 to 691 Billion dollars amounts to a 3400 fold increase. This number gives you an idea on how highly leveraged our financial system is (was?) Imagine you’ve been carrying a $1000 credit card balance on average for the last 10 years. In 2007, some of your investments start to tank, and you need to borrow money to cover your losses. But your investments were so highly leveraged, that you end up needing 3.4 Million dollars to stay afloat! Wow. We are officially scared.

Happy Halloween.

In any falling market, a bottom is reached when demand once again outstrips supply, when buyers start to overwhelm sellers. In real estate, the demand is always present (we all want to buy a home rather than rent one), but it is curtailed by the household income (not all of us can afford that.) The relationship of median housing price to median household income determines the percentage of households that can afford to buy a home. Based on that relationship, the California Association of Realtors (C.A.R.) started to publish a Housing Affordability Index (HAI) in 1984. The HAI simply expresses what percentage of households can afford to buy a home, and it takes mortgage rates, housing prices, and income distribution into account. It assumes that a household should spend less than 30% of its income on mortgage payments.

The HAI is a great indicator. Kurtis Squyres from FarBelowMarket published an interesting blog post on how the last two bear markets in California real estate bottomed when this indicator climbed to about 40%. This led us to do some research on it as well, and we came up with some interesting results that can help us estimate at what median home price the bottom of the current bear market may occur.

First, let’s take a look at a monthly graph of this index starting at 1988, when C.A.R. started publishing it every month. For whatever reason, C.A.R. stopped calculating this index as of January 2006, but fortunately they published their methodology, which allowed  us to continue the data set until today. For comparison purposes, the median sales price chart for homes in CA is shown right below with the same time frame.

Notice how the bottom of the last bear market in the early 90’s was reached about 2 years after the HAI hit 40%. It stayed at that level for about 5 years, peaking several times at 43%. Between ‘93 and ‘98, enough people could afford to buy a home that this put a bottom under the market and finally caused prices to move up again. At that point, the housing affordability index started falling and reached extremely low levels in ‘05 to ‘07. During those years, only 12% of CA households could actually afford to buy a home based on C.A.R.’s guidelines! But a lot more did, due to easy credit and lending practices.

We published the median sales price graph in an earlier post, and used the trendline drawn below the last two bottoms to predict where and when the next bottom might occur. This trendline is actually more than just a technical analysis tool. It turns out to be the increase of home prices due to inflation. The line goes flat if we adjust the median sales price for inflation:

Since our data set starts at 1979, we inflation-adjusted it to 1979 Dolllars, in other words we’re now looking at a chart of median home prices for the case that inflation started to magically diasppear as of 1979. Our trendline has now turned into a horizontal support line at a price level of $75,000. In the past, every time the median sales price in CA hit a level of $75,000 in 1979 Dollars, a bottom was made. The fact that this line is flat makes a lot of sense when you look at the inflation-adjusted median household income also plotted in this chart. It’s flat as well! If you take away inflation, our incomes over the last 30 years did exactly… nothing. Expressed in 1979 Dollars, CA households made $17,200 on average over the past 30 years. So while housing prices went up and down, household income stayed constant, so you’d expect the real estate market to bottom at roughly the same level, $75,000 in 1979 Dollars in our chart. And it’s probably no surprise that these bottoms correspond to a housing affordability index of about 40%. In fact, if we calculate the HAI for an income of $17,200, a home price of $75,000, and a 30-year average mortgage rate of 7.4%, and use a 1979 income distribution, we arrive at 43%.

These relationships do make sense, if we think about it. As long as inflation-adjusted household income stays constant, and as long as houses don’t become more expensive (they may in the future due to a shortage and real price increase of building materials), the percentage of the population that can afford a home should roughly stay the same. But thanks to manipulated interest rates and lending environments, household that really can’t afford to buy a home are enabled and enticed to do it anyway, with the result of large swings in the median home price.

Since it’s probably safe to assume that our inflation-adjusted household income will remain the same for the next 5 years (it has for the last 30), we can come up with a pretty good estimate at what point the California market will bottom again. It will most likely happen when housing affordability climbs above 40% once again and stays there for 2-3 years. Looking at the HAI chart, we can see that we’re rapidly approaching this level, and will probably reach it early next year. HAI should stay around 40% for the next 5 years or so, and we may see a bottom 2-3 years from now, in 2011. The median home price at that point would be about $250,000 based on our trendline and inflation analysis.

That’s why we believe the CA market still has some falling to do over the next 3 years. But it’s important to keep in mind that this is for all of California. We’re already seeing some local areas hit our projected bottom levels today! Areas with a high number of foreclosures have corrected fast and hard this year, and some are already hitting support and show signs of bottoming out. Watsonville, in Santa Cruz county, is a good example. Alum Rock in San Jose is another one. We’re seeing our best deals in Watsonville and Alum Rock these days. Other more affluent areas with fewer or no foreclosures take a lot longer to drop, and will only fall when the areas around them fall. We spend a lot of time researching local price movements to identify the best deals. We believe that right now is the best time to invest in foreclosures, since we’re seeing bottoming prices coupled with deep discounts at which the banks are willing to let these properties go. If you’re interested in our deals we suggest you sign up to our buyers list or email us at info@norcaldiscountproperties.com for more information.

Property values have fallen fast and hard all over California this year, and the areas we invest in - Santa Clara County and Santa Cruz County - are no exception. We’ve been closely tracking all local areas in these two counties, and San Jose in particular. To find the best investment opportunities, we are looking for areas that have dropped more than others and are close to overcorrecting. In San Jose, these are East San Jose and South San Jose. The Alum Rock area in East San Jose is a good example, and we’re starting to see some incredible deals at 50..60% of ARV (after repaired value), most of these REOs. As of last month, the median sales price for single family residential properties in Alum Rock is $357,500. That’s almost half(!) of what it was only 12 months ago ($675,000). We are now back to values last seen in 2000! That’s 8 years of appreciation wiped out in less than a year.

And that’s just the median. As of last month, we are now seeing a number of 2/1 and 3/2 houses sell in the $240,000…290,000 range. Those are great deals! If you are a landlord, investor, or rehabber, and have been waiting for properties in Silicon Valley to become cash flow positive again, don’t wait any longer - we are there.

Assume for a moment you are the lucky buyer of one of these deals, let’s say a small 3/2 of 1200sqft that you were able to pick up for 250k. You put 20% or 50k down, and get a loan for the remaining 200k. The PITI on that loan would run about $1500/month. You spend another 10k for paint, carpet, and a few cosmetic repairs, and rent it out.

Rents in Alum Rock for a small 2 or 3 bedroom house are running anywhere from $1800..$2100. That is roughly $500 per month positive cash flow! And the rental market in San Jose (and elsewhere in CA) is getting stronger every month since more and more people who lose their home are forced to rent. Rental rates in San Jose have been rising since 2005, and vacancy rates have dropped from 7% to 3% over the same time frame. The vacancy rate of a normal healthy rental market is about 5%. Rental demand is starting to outstrip supply.

$500 per month positive cash flow is $6000 annualized, that is a 10% annual return on your initial 60k investment. Try to get a solid 10% return on ANY investment today, backed by an asset that will not fall 7% in a day, like today’s stock markets. And in only 10 years you got your $60k investment back. Talk about ROI! Plus, in a few years when the market turns around again you will get appreciation in addition to the monthly cash flow. Couple that with rising rental rates that will result in an increase of your monthly cash flow, and you got an investment deal that doesn’t get much better.

We are about to pick up some really hot deals in the Alum Rock and South San Jose area. If you’d like to get notified about our deals as soon as we get them, please contact us.