Is San Francisco, the most overvalued US housing market, going to crash?

San Francisco is the most overvalued housing market in the United States; however, the conditions necessary to cause a catastrophic house price decline are absent, and it seems unlikely house prices will crash.

I have a challenge for housing bears: outline a realistic scenario where prices crash from here. I’m an old housing bear; I would be happy to carefully and loudly pontificate on an upcoming market crash, but I simply can’t come up with a realistic scenario whereby it occurs. Sure, there are implausible scenarios, mass investor exodus, suicidal lender policy changes, sudden interest rate spike to 7%+, but nothing that seems very likely — or possible at all.

The premise of the original housing market collapse went something like this: People took on mortgage debt which couldn’t be sustained by current income; those borrowers were going to default, lenders would foreclose, lenders would liquidate their inventory, and the resulting flood of must-sell inventory would push prices lower quickly. For the most part, the bust played out in that fashion until the rules were changed — mark-to-fantasy accounting, loan modifications, shadow inventory, long-term squatting. Once the rules were changed, lenders were able to gain control of the flow of inventory, and house prices bottomed and the bubble reflated strongly. With all these measures in place, and with no pressure to remove them, a housing bust with rapidly declining house prices is very unlikely in the foreseeable future.

The unlikely scenarios

A number of unlikely scenarios could cause either a change in the supply, flooding the market with must-sell inventory, or a change in demand, preventing borrowers from financing today’s prices.

Investors could decide to get out of their illiquid trades and simply dump copious amounts of inventory on the market and accept whatever they get for their properties. Stock market investors do this all the time, so it could happen in housing, but it doesn’t seem likely. First, all the investors with significant inventory are seasoned real estate investors who recognize the perils of liquidating illiquid real estate assets. Most, if not all, of these firms have long-term locks on the investment capital, and they are under no pressure to force an unprofitable liquidation to recover capital. There are many other, less damaging methods of extracting cash if they needed it; they could obtain debt or refinance, sell in bulk to another investor, create their own REIT and sell shares to smaller investors, and any of a dozen other methods widely known to these players. A fire sale scenario simply isn’t plausible.

Lenders could decide to change their policies of can-kicking through loan modifications and instead begin aggressively processing foreclosures. But why would they do something suicidal like that? It would put them out of business. Bank regulators aren’t forcing that to happen, and with the degree of control bankers have over their handlers, it isn’t likely bank regulators will suddenly get tough and force a near collapse on the banking industry; therefore, I believe a sudden change in lender or regulator policies isn’t plausible either.

The federal reserve could lose control of the long end of the yield curve, and mortgage interest rates could spike to 7% or higher. This would cause demand to vanish as only today’s 4.5% mortgage rates enable current borrowers to finance today’s inflated prices. I wrote about this potential problem at length in How will the Federal Reserve’s continued printing money impact housing? While it’s possible mortgage rates could rise suddenly, it doesn’t seem a likely scenario unless the economy picks up and inflation gets out of control. It would take a large amount of wage inflation, which seems extremely unlikely, to cause inflation to get out of control. The federal reserve has already proven it can print and print and print and print and not cause inflation.

We could have a terrorist attack, a global recession, or some other outlier event, but if something shocked the system, I would expect the federal reserve to print even more money to stimulate the economy, so those events probably wouldn’t crash housing. Basically, unless something forces supply onto the market from sellers who must take what they can get, house prices simply don’t go down; I just don’t see how it could happen otherwise, and I can’t see a plausible scenario where must-sell inventory hits the market. Do you?

Is San Francisco housing headed for a crash?

Home prices edge down, but still hover well above $500K

In San Francisco, there should be a saying: Buy a home at the right time, sell at the right time.

Do so, and you’re set for life.

Do wrong, and you’re headed for foreclosure and bankruptcy.

Yes, it’s a crowded, highly desired metro with myriad issues keeping home buying on the high-end. Yet, the hottest neighborhood in the nation is in San Fran.

But fluctuations in prices from the peak of the 2000s housing bubble to today show the area always charting a volatile course when it comes to price appreciation and depreciation.

DataQuickreleased a report Wednesday showing the median price paid for a “Bay Area” home in December hit $548,500. That is a slight decline from November, but still up 23.9% from $442,750 a year earlier, the research firm said.

The median price rose year-over-year for the past 21 consecutive months. Yet, local sales figures for December reached their slowest benchmark in six years.

Sales fell off a cliff because prices are too high relative to current incomes at interest rates above 4%. Buyers simply can’t afford current asking prices, and toxic financing options are not likely to proliferate any time soon — but they are available (See: Troubling evidence of new Coastal California housing bubble)

DataQuick says 6,714 new and resale homes sold in the nine-county Bay Area last month. That’s the “lowest for any December since 2007, when 5,065 homes sold,” the company added. Still, December sales edged up a slight 0.8% from 6,659 in November.

But it’s the course charted over the past decade that paints a picture of a market with wide, inconsistent price swings. Those selling at the right time make out big time, while the rest suffer. During the peak of the housing bubble, the median Bay Area price reached $665,000 in June and July 2007. By March 2009, the recession had plunged local values, kicking the median San Fran price down to $290,000, according to DataQuick. That same figure is back to more than a half a million dollars today.

“If current trends hold, including year-over-year price appreciation of 20-plus percent, the typical home would be selling for $50,000 to $60,000 more by spring,” said John Walsh, president of DataQuick. “Perhaps twice that at the upper end of the market. That could loosen up quite a bit of inventory. The question then is, how much of the pent-up demand that accumulated during the down years is still there? An additional issue is the fussy mortgage market, although things are moving in the right direction there, slowly.”

20%+ by spring? Pent-up demand? I want some of what he’s been smoking.

One thing that could slow down escalating prices is the future mortgage market, which remains subjected to regulatory headwinds.

In December, jumbo loans well above the conforming loan limit of $417,000 made up 49.2% of the purchase lending market – down from a revised 49.8% in November. Government-insured FHA home purchase loans accounted for 11.3% of all Bay Area home purchase mortgages in December – up from 10.4% in November and down from 13.8% a year ago.

But the ability to access government loans is diminishing somewhat.

“In recent months the FHA share has been the lowest since early 2008, mainly because of tighter FHA qualifying standards and the difficulties first-time buyers have competing with investors and cash buyers,” DataQuick said.

Mark Calabria, director of financial regulation studies at the Cato Institute, addressed California home affordability issues more than a year ago, blaming some of it on real estate regulations.

“It’s really a supply constraint,” Calabria said. “They should look at trying to deregulate their land markets. In a relatively competitive market, you could build affordable housing without massive subsidies,” he explained at the time.

He is right about the supply constraints creating a false shortage thus driving up prices, but it’s unlikely that will change any time soon. Landowners and lenders benefit from sky-high prices; municipalities benefit from higher tax revenues; only future homebuyers get screwed by higher prices, and they don’t represent a coherent political force to cause change. No, the supply constraints are going away.

I don’t see a crash coming any time soon. As long as supply continues to be restricted and the percentage of all-cash purchases is high, prices simply won’t go down. Sales volumes may continue to decline, but prices will remain suspended where more buyers can’t afford them unless something changes at the banks and they begin approving more short sales or foreclosing on their delinquent borrowers rather than modifying their loans. At some point, we may see a medium-term slow-burn decline like the mid 90s, but a 00s type crash isn’t forthcoming.

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[idx-listing mlsnumber=”TR14008459″]

6162 LEYTE St Cypress, CA 90630

$550,000 …….. Asking Price
$670,000 ………. Purchase Price
10/17/2005 ………. Purchase Date

($120,000) ………. Gross Gain (Loss)
($44,000) ………… Commissions and Costs at 8%
($164,000) ………. Net Gain (Loss)
-17.9% ………. Gross Percent Change
-24.5% ………. Net Percent Change
-2.3% ………… Annual Appreciation

Cost of Home Ownership
$550,000 …….. Asking Price
$110,000 ………… 20% Down Conventional
4.42% …………. Mortgage Interest Rate
30 ……………… Number of Years
$440,000 …….. Mortgage
$108,379 ………. Income Requirement

$2,209 ………… Monthly Mortgage Payment
$477 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$115 ………… Homeowners Insurance at 0.25%
$0 ………… Private Mortgage Insurance
$0 ………… Homeowners Association Fees
$2,800 ………. Monthly Cash Outlays

($406) ………. Tax Savings
($588) ………. Principal Amortization
$178 ………….. Opportunity Cost of Down Payment
$158 ………….. Maintenance and Replacement Reserves
$2,142 ………. Monthly Cost of Ownership

Cash Acquisition Demands
$7,000 ………… Furnishing and Move-In Costs at 1% + $1,500
$7,000 ………… Closing Costs at 1% + $1,500
$4,400 ………… Interest Points at 1%
$110,000 ………… Down Payment
$128,400 ………. Total Cash Costs
$32,800 ………. Emergency Cash Reserves
$161,200 ………. Total Savings Needed
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