A hard landing in California: last year the air rushed out of California's housing bubble. Housing sales and new-home construction have nosedived. Home prices have fallen. The real estate and housing finance industries are scouting the horizon for a recovery in sales. Meanwhile, a turnaround in home prices and construction could take years.

Author:England, Robert Stowe
Position:Market Trends

After enduring hard times, there's a certain relief when you can finally say, "I'm so far down, the only way to go is up." For California, even that sort of relief seems a bit far off--but some already see signs of hope. [??] California is facing one of America's sharper housing market corrections, enduring a slump that has been under way since the latter half of 2005. A greater reliance on nontraditional lending practices, along with a higher level of investor speculation, are widely blamed for creating a bigger housing bubble here than elsewhere. [??] Market observers contend that a rising volume of subprime and alternative-A lending helped drive up housing demand and speculation. Further, sharply rising defaults and foreclosures on risky loans in some places are bringing home prices down even faster than they rose. [??] Economists and real estate market observers and investors are divided on when home sales and prices will hit bottom, and how long it will be before prices begin to rise again.



The housing downturn, which most observers believe started after the middle of 2005, accelerated in the middle of 2007, sending sales and new-home construction totals falling. By December 2007, sales volume for existing single-family detached homes in California had fallen 56 percent to 287,600 on a seasonally adjusted annualized basis, from the peak of 650,775 in October 2005, according to the California Association of Realtors[R] (CAR), Los Angeles.


In December 2007, while actual sales were lower, the seasonally adjusted, annualized sales volume rose to 301,040--the first time seasonally adjusted numbers had risen above 300,000 since August 2007.

By comparison, existing-home sales for the entire United States fell 32 percent (compared with California's 56 percent) from a seasonally adjusted, annualized 7.21 million in August 2005 to 4.89 million in December 2007, according to the National Association of Realtors (NAR), Chicago.

The median sales price for an existing home in California has fallen 20.4 percent, from a peak of $597,640 in April 2007 to $475,460 for December, according to CAR. The California home-price decline is almost double the 10.6 percent rate of decline in median prices for the nation, where prices fell from a peak of $230,900 in July 2006 to $206,500 in December 2007, according the National Association of Realtors.

"The residential real estate market in California is in a dangerous and difficult situation at the moment," says Stuart Gabriel, professor of finance and director of the Richard S. Ziman Center for Real Estate at the University of California, Los Angeles (UCLA) Anderson School of Management. While sharply falling prices from Sacramento, California, through the Central Valley to the Inland Empire (Riverside-San Bernardino metropolitan statistical area [MSA]) have captured the headlines, both coastal and interior areas face a difficult future, he says.

"Today we really don't have a functioning secondary market in nonconforming loans," Gabriel says. "This means sharply reduced financing opportunities for California's expensive coastal communities, which have relied heavily on non-agency or private-label financing. While portfolio lending can potentially take up the slack, such lending remains limited by the capital requirements of depository institutions," he adds.

In addition, lenders have tightened underwriting. "California's coastal markets cannot prosper without liquid [private-label secondary] markets," Gabriel says. "So, we're very concerned about the lack of jumbo mortgages," he adds. Gabriel believes the temporary increase in the Fannie Mae and Freddie Mac loan limits included in the economic-stimulus legislation will be critical to stabilizing those markets. The economic-stimulus package passed both houses of Congress on Feb. 7, and was signed into law by the president on Feb. 13.

California's interior markets--from north of Sacramento through the Central Valley to the Antelope Valley (which includes such cities as Lancaster and Palmdale across the San Gabriel mountains north of Los Angeles) and the Inland Empire in the south--have been hit by significant, elevated levels of nonperforming loans, defaults and foreclosures, Gabriel notes. Indeed, these markets are prominent among the highest default and foreclosure markets in the country, with Merced and Stockton tied at the top in the rankings of the state's leading foreclosures markets, Modesto next and Riverside-San Bernardino not far behind (see Figures 1 and 2).

California last suffered a significant housing decline in the early 1990s, in the wake of the end of the Cold War and the downsizing of the nation's aerospace industry, which was heavily concentrated in the state. The recovery was long and slow. However, in 1997, prices began to rise. From a median price for existing homes at $177,270 in 1996, the last year of the prior slump, the median soared to $556,640 in 2006, according to CAR. By comparison, median prices for existing homes in the United States rose from $115,800 in 1996 to $221,000 in 2006 (see Figure 3).

The year 2008 "will be the worst year in California history for residential real estate--it's a mathematical certainty," claims Bruce Norris, president of The Norris Group, Riverside, California, a real estate investor, forecaster and adviser. Norris predicted in 1997 that housing prices would double between 1997 and 2005, based on his analysis of data on demographics, affordability, the level of housing inventory and the pace of new-home construction, among other indicators. (In fact, the boom was even stronger than predicted--median prices rose 2.8 times from $186,490 in 1997 to $522,670 in 2005.)

Yet, there may be a silver lining to the speed with which housing sales volume and prices have moved lower in California.

"I think we're probably near or at the bottom in terms of the volume of building and in terms of the volume of resale transactions. Both are ... well below the levels sustainable by the state's population and job growth," says Steve Levy, director and senior economist at the Center for the Continuing Study of the California Economy, Palo Alto, California.

"I think prices are maybe now halfway to where they will eventually correct. They've dropped at lot in the last six months, and I think we may be in the middle or a little past the middle," he adds.

"At the speed at which this correction [in prices] is going, it might be over in a year," Levy says. If this turns out to be the case, then "prices will have fallen further in two or three years than they did in six or seven years in the 1990s," he says.

The scene on the ground

The signs of a housing slump are everywhere in the Golden State:

* Cesar Dias, an enterprising real estate agent and loan officer at Approved Financial & Real Estate Center, Stockton, California--the nation's foreclosure capital--set up a weekly Repo Home Tour of foreclosures in September for potential homebuyers, dubbed "a magical misery tour" by The Los Angeles Times.

* A single real estate auction house--Real Estate Disposition Corporation, Irvine, California--held a five-day auction of more than 1,000 houses in Southern California over three weekends in January and February 2008, most of them bank-foreclosed homes with a few new homes thrown in. This may be the single largest mass auction in the state's history, according to Norris.

* Like virtually all other home builders operating in California, KB Home, Los Angeles, sharply reduced the price of new homes in late 2007 at its Orchard Pointe single-family development in Madera, California, near Fresno, in the face of sharply falling sales. The base price on one popular model with 2,177 square feet was listed at $219,000, with upgrades also to be sharply reduced in price. By comparison, in the second quarter of 2006, the median new-home price in Fresno County was $367,320, according to the Real Estate Research Council of Northern California, Pomona, California. "The bank took back two of our models, along with the furniture," a sales representative on site at Orchard Pointe informed prospective buyers curious about why not all the models shown on the sales sheet were available for viewing.

* In Sacramento, Governor Arnold Schwarzenegger and the California Legislature face a projected $14.5 billion budget shortfall due to a slower economy weakened by the declines in housing activity, home construction, finance and retail businesses such as home-improvement stores, whose fortunes are tied to housing activity.


An economic slowdown

Opinions divide on the likely economic fallout from the housing slump in California. Most believe a slowdown is under way, but it is unclear whether or not it will mean an outright recession in the state.

Some think the recession is already under way. "The California recession may have started as early as May 2007," says Mark Zandi, chief economist and co-founder of Moody's Economy.com, West Chester...

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