Pent-Up Supply

Despite the news headlines of a real estate bubble and economic termoil, many sellers believe their properties have appreciated since they paid peak prices. They are asking, “What Bubble?”unsold

Denial comes in many flavors. One of the more interesting forms of denial is exhibited by those sellers who are completely oblivious to the price crash. Either these people are completely ignorant to what is happening, or they are willfully ignorant and believe the problems all around them do not apply to their property. If I had to guess, I would lean toward willful ignorance as the most likely explanation.

The market for mid- to high-end homes is like playing the lottery. There are very few sales occurring at these price points because people are no longer being given huge loans, and they will not be any time soon. With mortgage financing going back to qualifying people for amounts they can afford to pay back with their real income, the only sales at the high end are buyers with enough cash to close the deal. There are very few of these people relative to the number of sellers out there. The few lucky sellers are cashing in a lottery ticket funded by a knife catcher.

The 92603 Zip code shows the extreme dissonance between asking prices and selling prices in today’s market. According to DataQuick, the median sales price in 92603 at the end of March was $638,000. According to Redfin, the median asking price is $2,190,000. Someone explain to me how that is supposed to work.

Let’s employ a bit of logic here. Median sales prices reflect what people are paying in the market. Even with super-low interest rates and plenty of kool aid, buyers in this zip code are only bidding prices up to the low $600s. Buyers are not going to raise bids any time soon because that would require toxic financing which isn’t going to be available, probably ever again. If buyers are unable to raise their bids, sellers must either lower their prices, or there will be no transactions. The extremely light transaction volume reflects this reality.

If there were no distressed sellers in the market, transaction volume could fall to near zero, and prices could stay artificially inflated indefinitely. The current asking prices in the market act like an informal cartel. With the huge incentive to cheat by lowering price to capture a knife catcher, prices would come down eventually, but it would be an agonizingly slow process. However, the reality in our market is that there are large numbers of distressed sellers whose properties will be on the market 6-12 months from now (See The Foreclosure Onslaught Continues for nice graphs). Prices will fall.

ARM Reset to Final Sale



Now that all the foreclosure moratoria have been lifted, lenders have been sending out notices of default to all the people who defaulted over the last 6 months who were not entered into the process. Months ago, I wrote a satirical piece titled, Moritorium on Defaults Announced. The point of the writing was to demonstrate the absurdity of foreclosure moratoria. The problem isn’t foreclosures, the problems is borrowers who default. Stopping foreclosures does not stop defaults; what is does do is create a backlog of foreclosures as people default and live in their houses rent free.

If you look at the flowchart above, many properties are at the notice of default stage. In 90 days, most of those borrowers will be given a notice of trustee sale. As soon as 21 days after that, the property may be scheduled for foreclosure auction. Then depending on the backlog of REO and the lenders staffing, these properties will be prepared for sale in the open market. From the time of the notice of default until the property is offered for sale in the open market takes 180 days or more. Since this process was restarted in earnest in April, look for the first of these REOs to hit the market in October.

When you think about it, the lenders really hurt themselves by delaying 6 months. The flood of REO to hit the market this fall and winter could have been arriving on the market today when there are more active buyers. Instead, the REO that should be hitting the market now is going to be added to the numbers due to hit this fall naturally. The result is going to be an enormous influx of supply just as demand is starting to wane due to the end of the prime selling season. Supply will overwhelm demand, and the mid- to high-end market will see a big leg down in pricing just as the low end did during the fall and winter of 2007-2008.

Adjustable Rate Mortgage Reset Chart


The ARM reset schedule has always shown a 2-year gap between the subprime wave of foreclosures and the second wave from the mid- to high-end foreclosures. The defaults from the second wave began early, and they have been exacerbated by the weak economy. This would have had the effect of shifting this wave forward in time and smoothing it out, but instead, the government and lenders embarked on a program of foreclosure moratoria that pent up this supply into another large wave.

Perhaps on a national level, the moratoria may have helped do some workouts and save a few marginal borrowers with conforming loans, but locally, our jumbo-dominated market with extremely leveraged borrowers is not eligible for these workouts. The ARM reset wave may have been lessened on a national level, but here in California, we will see the full brunt of the second wave of the foreclosure crisis.