Real Estate Market Update

A great deal of media attention has been given to the sub prime loan market and rising foreclosures as a result of lenders making loans to marginal borrowers. Interestingly, only 9% of existing loans would be characterized as sub prime and many of those borrowers are not headed to foreclosure.

The areas currently hardest hit as a result of the sub prime loan fall out and resulting foreclosures are those that have experienced significant new construction and in many cases over building. These tend to be areas where prices are more affordable, land is available/inexpensive, and the political climate is pro-growth.

To illustrate why, picture a developer who built a tract of 300 homes in a community and sold them a few years back. You can imagine a billboard in front of the development that read “Why rent when you can own? With no money down and a teaser rate on your loan you can have payments similar to what you are paying now in rent!” These billboards certainly worked because first time buyers flooded to these developments to realize the dream of home ownership while taking part in the double digit appreciation we have been enjoying for many years.

Fast forward to today where properties are no longer appreciating, and in fact in many areas are depreciating. These newer homeowners that bought with no money down are in trouble for two reasons. First, they generally didn’t understand their adjustable rate loan or they assumed they would refinance after they benefited from appreciation. However, many of these homeowners have seen their monthly payments more than triple and can longer afford the home they are in. The second problem, homeowners that put no money down, even if the had market stayed flat, don’t have any equity. As you can imagine, a homeowner who can no longer afford their payments and actually owes more against the house than it is worth is a prime candidate for foreclosure. This phenomenon is what is leading to rampant foreclosures in some areas of our state and country.

Until recently, the sub prime market was having almost no impact on the Southern Santa Barbara real estate market because we have virtually no new construction and no sub prime loans (it is so expensive in Santa Barbara people can’t afford homes without a substantial down payment).

The sub prime fallout did not start making an impact on our market until the end of this summer where it indirectly affected us by causing an upheaval throughout the mortgage industry. In August we experienced what many referred to as the “Mortgage Market Meltdown” whereby the fear of sub prime fall out caused investors of mortgage backed securities to leave the market. As a result, lenders suddenly had no money to lend, unless they were lending to borrowers needing conventional loans under $417,000. This odd number called the “conforming loan limit” is determined by the government and qualifies these loans for federally backed mortgage insurance. Loans over $417,000 are considered “jumbo” loans and do not have the same government backing that conforming loans do. This meltdown put the brakes on our local real estate market which by its expensive nature relies heavily on jumbo financing. Virtually over night, we saw interest rates on jumbo loans go from the 6%’s to the 8%’s and much more stringent guidelines made it very difficult for borrowers to qualify. As a result, more expensive and desirable communities like Santa Barbara finally felt ramifications from the fall out in the sub prime market.

Because of rising foreclosures in the hardest hit markets and lack of available financing in the more expensive areas, the sales data for the month of September is quite bleak. Nationally, the number of sales dropped 8% and the median home price fell 4.2%. In California, we saw a 39% drop in the number of sales in September compared to September of 2006 and the median price was off by 4.7%. In Santa Barbara we saw a year over year drop of 23%, but the median price actually rose significantly. However, the median price of a single month is not a very good indicator of a trend and Santa Barbara has seen a decline in real estate values. Interestingly, in the last market correction that took place in the early 1990’s, the upper end of the market was hardest hit and the lower end was less impacted. This time around it is the lower end of our market that is seeing the biggest price declines and upper end home values appear to be holding. As previously mentioned because Santa Barbara, in general, is an upper end market, we are fairing much better than less desirable areas. However, within the Santa Barbara market, our higher end homes are doing better than our lower end homes. For example, significant price decreases are apparent in many of the Goleta tract neighborhoods, whereas some Montecito homes are actually still experiencing modest appreciation.

So when will sales activity pick back up again? I believe that we will see more sales in the first quarter of 2008 than we do in the last quarter of 2007 mainly because the jumbo mortgage market is already coming back. The two recent cuts in the Federal funds rate has brought confidence back to mortgage backed security investors. In fact, interest rates on jumbo loans are back in the 6%’s and lenders are coming back into the market making it easier for borrowers to obtain financing. Most analysts predict that the mortgage market will have recovered by the end of the first quarter of 2008. This will be good news for communities like ours that rely on jumbo financing and that were outperforming other areas that were experiencing declining real estate markets for some time now. The wild card will be the psychology of the market and whether or not buyers will come back into the market now that financing is again available and prices have softened.

Many experts say that there is pent up demand to buy houses from buyers who have been sitting on the sidelines waiting for the market to firm up. If buyers start coming back into the market because of attractive financing options, we could see our market firm up quickly with sales activity increasing. While I don’t expect a dramatic turn around to a “seller’s market”, I do expect the number of sales to increase and prices to remain level in 2008.