Nov062012

Orange County housing market rose due to restricted inventory in 2012

In late 2011, the valuation metrics in the OC Housing News Report became very bullish. Due to low interest rates and slowly deflating prices, the cost of home ownership relative to rent fell far below historic norms. In other words, it was much cheaper to own than is usually is. Despite the falling prices, the valuations were attractive, and this report began issuing strong buy signals. Those that trusted that advice bought at what appears to be the bottom of the market. Only time will tell if the spring 2012 bottom is durable.

In spring 2012, lenders dramatically slowed their foreclosure processing and disposition in order to create a shortage of properties on the MLS and stop the decline in house prices. They were successful. Inventory is very tight, and many buyers are competing for the few available properties. Many are going into escrow over asking prices but not closing due to borrower qualification and appraisal problems. Backup offers are a good idea.

Rents are firming and beginning to rise slowly in most markets. This is a sign of a tepid economic recovery in Orange County. Historically low interest rates, falling prices, and rising rents have greatly improved payment affordability in Orange County.

Prices are at or below rental parity for buyers using conventional financing putting 20% down. This is a buying opportunity, and demand has picked up slightly for owner-occupants using conforming loan financing. The increased affordability and decreased supply is forming a bottom at the middle tier of the market.

Prices are reaching rental parity in many markets for buyers using FHA financing bringing more first-time homebuyers to the market. Also, private equity hedge funds are actively buying low-end properties and holding them for rental cashflow. This increased activity suggests price stabilization at the low end.

The jumbo market is still moribund, and few transactions are taking place at price points over $900,000. The high end will be subject to volatility as liquidations continue.

The spring rally is ending bit low inventory and flat prices are expected over the fall and winter. Unless we see more inventory, prices will not likely go down this fall and winter as is its customary seasonal pattern.

Despite the many reasons for caution, the current valuations when financed with today’s record low rates make this an excellent buying opportunity. The lack of inventory makes buying difficult, but the valuations make it worth the effort.

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Bullish based on restricted supply?

Ordinarily, prices rise when a product or service is in high demand. An increase in demand causes the supply to drop, and the resulting imbalance forces prices to move higher. The problem right now is that we don’t really have much of an increase in demand. In fact, the owner-occupant demand is still at 1990s levels and showing no signs of improvement at all.

The price increases we currently see in the Orange County housing market — and prices certainly are going up — are a result of a dramatic decrease in supply, largely engineered by the major banks. As you can see below, demand is up somewhat (about 9%), but supply has totally evaporated with a 60% decline.

The same is true in Irvine. Demand is up about 10%, but supply is down 58%!

The problem with a supply-side recovery is what happens when the supply returns. The current levels of supply aren’t caused by any real shortage of available homes. Tens of thousands of delinquent mortgage squatters inhabit properties that could be turned over to a paying mortgage holder. In Orange County, there are currently 3,500 properties in pre-foreclosure, and another 5,005 awaiting auction. These numbers are down dramatically since the beginning of the year, but that’s only because the banks stopped foreclosing. Despite the low number of filings, banks are not out of delinquent mortgage holders to foreclose on.

There is good reason to be cautious about buying. However, the federal reserve has pledged to keep interest rates low for as long as it takes to mop up this mess, and it isn’t likely that the government will suddenly start forcing the banks to foreclose on these people and liquidate the properties. The banks have been playing this game for six years now. They have become good at it.