Steve Johnson

April 20th 2010

Over the past few weeks the local Santa Cruz newspaper has written several articles about the health of our local real estate market. The most recent article reported the recent rise in the median prices of homes. Unfortunately the recent rise in median home prices has little to do with the health of our market. It is more reflective of the seasonal pattern of our local market, in which the median price of homes historically rises during our spring and summer months due to the increase volume of homes being sold.

Of greater interest and more reflective of the health of our real estate market was the recent article that reported over 10,000 Santa Cruz homes are financially under water. If you remember, the first major cause for the downturn the real estate market was attributed to sub-prime loans. We have cleared out a large portion these loans over the last two years. But now we are facing the next wave of troubled loans. Which are the variable loans that were made over the last five years. Many of these loans are now coming off their low initial teaser interest rate and are now scheduled to readjust to a higher interest rate.

Therefore our local real estate market is not out of the woods yet. We currently see a lot of home owners still having trouble making their mortgage payment and thus resulting in getting a Notice of Default (NOD) from the banks.. As shown by the graph below, we have not seen an appreciable decrease in the number NODs in the last two years. There are a few new plans by the government and banks to stem this tide of foreclosures. But as of now there has not been much success with the loan modification programs. So until we see NODs fall significantly, the real estate market will be slowed by the influence of bank owned properties and short sales. Thus a good market for Buyers and poor one for Sellers.

2010 Santa Cruz Market Forecast

Over the last year, I have written numerous reports about the state of our local real estate market. As you know from these reports and the general media, we are in one of the most compelling real estate markets in our lifetime. This is demonstrated by interest rates being near all time lows, home prices plummeting at record rates, and we have not seen this many bank foreclosed properties since the Great Depression.

2009 was a great year for buyers at the low end of the market (Homes under $500k) and was the major driving force of our local market. We even saw at times a feeding frenzy with multiple bids on properties. There are several factors for this growing number of buyers, which include the availability of low interest FHA loans, the federal government first time home owner buyer incentive and very low homes prices. With all the buying competition, we have seen a slight rise in home prices at the low end of the market.

But 2010 could bring a shift in the winds. Mortgage interest rates have been kept low by the government buying mortgage backed securities and they plan to stop making purchases at the end of February. If that happens, interest rates are projected to rise. On top of that, the government first time home owner incentive program is supposed to end April 30^th. Loss of both of these government programs will have an effect on the low end of the market. Thus we could see a drop in available buyers at the lower end of the market in the second half of 2010 and a slower market.

The middle market (Homes between $500k - $1.1m) has been relatively balanced. Home values have gone down across the board since 2007 and it appears that home prices are bottomed out. Beach homes are still in good demand and are doing better in holding their value. This can be seen in areas like Capitola. In comparison, the rural areas have seen the biggest drop in home values. But home prices are starting to stabilize and it is hoped we will start to see more move-up buyers this year.

The high end of the market (Homes over $1,1m) has been very slow and home prices have come down some. But they have not bottomed out yet. Currently we have an abundance of high end homes and a dearth of buyers. Beach home property values have gone down some, but there seems to be enough demand to keep prices from dropping dramatically. But in comparison, the larger estate country homes have taken a big hit. The demand for these homes is much smaller and thus property values have tumbled. We can expect to see more of the same in 2010.

In summary, we are expecting to see a constant flow of Notice of Defaults resulting in growing the bank inventory of foreclosed properties. Thus 2010 will be much like 2009 with the following twist. High end homes will continue to drop in price. Interest rates will start to move up over the year. Without continued government support, the lower end of the housing market will start to slow down. And banks that are sitting on a large number of foreclosed homes will start releasing a greater number of their inventory, thus keeping a downward pressure on home prices. So it looks like 2010 will be another great market for buyers.

One of the leading indicators on how well our local real estate market is doing can be determined by the number of Notice of Defaults. As seen by the graph below, we have continued to hover between 150 and 200 NODs from almost the beginning of the year. Thus the ongoing trend of bank foreclosures, short sales, and REOs has been steady through out the year and we have seen little improvement in the real estate market.

Therefore Banks are continuing to build an inventory of bank owned property (REOs). This is good news for Buyers for several reasons. One, we can expect many more of these properties coming on the market next year. Two, these REOs will keep home prices low. Recently Banks have been pricing these properties very aggressively and in many cases we are getting multiple bids. This is a result of currently historic low interest rates and the first time owner tax credit, mixed in with some investors looking for rental properties. As you know already, this is one of the best times for Buyers of Real Estate.

Finally when we do see a downward trend in the NOD's, we will know that we are transitioning into a balanced health real estate market. I will be keeping an eye on this NOD trend and updating you monthly.

Over the last year we have seen both the Federal and State governments trying to stem the tide of property foreclosures via moratoriums and loan modification programs. This has resulted in slightly slowing down the escalating trend of home foreclosures. For the few that can qualify for a loan modification only 30% have been successful. Thus many of these failed loan modification homes end up being foreclosed upon.

Also as a result of these government and bank programs, we have seen a significant increase in Short Sales. Over the last six months we are averaging about 25 Short Sales a month. This is a result of some of the banks having more aggressive Short Sale programs. Banks that actually still hold the mortgages they made, are in a much better position to address the market. In comparison, banks that have sold off their mortgages to investors are having a much harder time making Short Sales work.

For example, Bank of America, Wells Fargo, Citi Bank, and Chase are the hardest banks to work with in a Short Sale. If you are lucky enough to be successful with them, it can take months and over a year to finalize a Short Sale. While some of the smaller banks can get a Short Sale done in a matter of weeks. Again in most cases these smaller bank are still holding the loan. So this is something to consider if you are buying a Short Sale property. The bottom line, there is a risk in waiting for Short Sale to happen while you pass up other properties on the market. But the risk is lower when working with the smaller banks. No doubt Short Sales will be a larger factor in our real estate market in 2010 as seen the graph below

One last thought, whether the banks sells a property via foreclosure or short sale action, they will be able to write off the loss from the property. A good number homeowners are walking away from their homes due to negative equity even though they can afford the payments. These homeowners are not willing to pay a mortgage on a home that is now worth half the value of what they paid for just several years ago. It does not make sense to them to pay on a mortgage on a house that might be worth what they paid for in 20 years.

Another solution to this problem is instead of the current loan program that changes the interest rate and/or term of the loan, it would make more sense for the banks in some cases to readjust the mortgage closer to the market value of the home. The bank will would still get to write off the loss on the original mortgage and not have to go through the additional expense of selling the home via the foreclosure route. The good news is that some smaller banks are making plans for such a program. This would also help add some stability to the real estate market by reducing the influence banks are having on the market via foreclosures and bank owned property sales. Most importantly it also slow down the downward spiral of home values.

It was just a few years ago, we rarely saw homes being foreclosed by banks and later sold by banks on the MLS as REOs (Bank Owned Properties). On top of that, Short Sales were unheard of in those markets of yester year. However in today's market, a good percentage of homes are REOs or Short Sales and they all have one thing in common. These properties are bought and sold by banks or the banks have final approval of the property sale.

As of last month, banks controlled over 50% of the real estate transactions in Santa Cruz County. For the most part, Bank control of transactions and inventory is not good for the market. These distress properties are some times neglected, abandoned and stripped, resulting in lower property values when they are sold. Recently some cities have required banks to maintain properties they own and this has helped. However the over all impact of bank owned properties has had a major negative effect on home values.

With the current national trend of ten percent of homeowners being delinquent on their mortgage payment, we are sure to see a continued trend of bank controlled transactions and inventory. Both State and Federal governments have tried to stem this tide with loan modification programs and foreclosure moratoriums, but these programs have had very little effect to date. So unless there is a new approach to this problem, it will take several years to reduce the number of bank controlled properties and return to a market that is controlled by home owners and buyers. The good news is that there are alternative solutions that are being considered. I'll go into more detail on these alternative solutions in my next blog.

Bank Foreclosure (Homeowner is unable to make mortgage payment, Banks sells home through a foreclosure auction process. In most cases the Bank buy back the home at the auction for the value of the mortgage.)

REO ( After bank purchase of the home via foreclosure process, Bank sells the home on the open market through MLS or at public auction)

Short Sale (Homeowner owns home with a bank mortgage that is greater than the properties market value. Homeowner with Bank approval can sell home short of the value of the mortgage. Results in, Homeowner loses equity and Bank takes a loss on the mortgage.