(3/15/2007) California foreclosures are up 300% ... Is the SFO Bay Area housing-market primed / sub-primed for a meltdown?
Article by Sam Mishra, MBA (MIT Sloan)
California foreclosures are up 300% year over year for January 2007. Recently, RealtyTrack data showed that with 142, 429 foreclosures in 2006, California suffered a year over year increase of 131% compared to the number of foreclosures in 2005: this amounted to one foreclosure for every eighty-six households in 2006. For these gloomy numbers, the creative financing of sub-prime mortgages with zero down and 2-28 (2 year fixed teaser rates followed by 28 year much higher fixed-interest rates) terms are to blame. As the two year honeymoon with teaser rates are expiring / have expired nationwide, most home-owners are experiencing mortgage shocks of much higher rates, are defaulting, and their homes are being foreclosed. In many cases, this is leading to personal bankruptcies, not to mention the businesses in the sub-prime mortgage industry facing bankruptcies themselves.
Clearly, sub-prime lending is a problem, with thirty of the biggest lenders going bankrupt / closing shop. However much the big financial institutions claim that the sub-prime contagion will be contained and not spread to broader credit markets, numbers speak for themselves: the reputable Wells Fargo has more than 10% of all its mortgages issued as sub-prime, …. No wonder, the 2% decline in the stock markets two days ago (on 3/13/2007, Dow Jones Industrial Average slid by more than 242 points) was attributed to the sub-prime meltdown acting as a catalyst for the downturn. Obviously, the stock markets are correcting, as the economy slows down.
Against this backdrop of gloom and doom, it makes sense to analyze how much longer home prices can hold up in the red-hot nine-county SFO bay area housing market. In many ways, SFO Bay Area is the most expensive MSA for real-estate. The housing boom is seemingly intact in the bay area, where median home prices keep going up. In January 2007, median home prices went up year over year compared to January 2006 in Alameda, San Francisco, San Mateo, Marin, and Santa Clara counties. In real-estate economics, everything is dumb-ed down to three words: location, location, location. Those in the Bay Area who bought houses recently are cautiously optimistic. Realtors keep marketing the fact that as long as there is pent-up demand, prices will keep going up --- after all, professionals with six-figure incomes in Silicon Valley and San Francisco keep renting apartments because house prices are beyond their reach --- so it makes sense to get in now (i.e., buy that first dream home) while factors are still favorable (i.e., interest rates are low, the Bay Area economy is thriving with close to 4% unemployment, and those who bought homes recently are going to ride out a pull-back if one happens, etc. etc.).
While listening to these late bulls, an investor / first-time buyer should keep in mind the fact that the real-estate agents are only after commissions, commissions, commissions. So, one must do one's own homework. This means analyzing the mortgage structure of home owners in the Bay Area. Yesterday, the print edition of San Jose Mercury News carried out an article which touted that Bay Area is less exposed to sub-prime loans than the national average of 14.7%. In Vallejo-Fairfield-Napa area only 14.4% loans are sub-prime; with lower numbers elsewhere: 10.6% for Oakland / Alameda County / Contra Costa County, 6.8% for San Jose / Santa Clara County / San Benito County, and only 5% for San Francisco / San Mateo County / Marin County.
However, the problem is visible in these numbers. Napa / Fairfield is almost the same as the national average in terms of sub-prime loans --- so as time goes by, more and more of these mortgage holders will default. Similarly, Oakland and East Bay with its diversified economy with close to 11% of all mortgage in sub-prime category is also bound to crack. San Jose and Silicon Valley with close to 7% is still half of national average and seemingly looks good. However, bay area real estate is indeed expensive --- so all the sub-prime mortgage holders must have bought homes which are sub-million-dollar homes. After all, those who buy million dollar plus property are the more affluent ones with good credit, and thus less financially gullible to buy real-estate with zero down and teaser rates. In other words, if one excludes million dollar plus homes, the number of sub-prime mortgage holders in San Jose and Silicon Valley comes close to the national average. So, San Jose and Silicon Valley are bound to get the same foreclosure pains as is happening elsewhere in the nation in the next few months. Once foreclosures increase further, the real-estate markets in Bay Area, especially the sub-million-dollar homes and condos will suffer the same fate as Los Angeles, San Diego, Miami, Las Vegas, and other big metros which are currently churning on a downward spiral.
Let's take the other factors which seemingly are conducive for real-estate growth: interest rates are low. Well, they are not lower than 2001/2002, when Fed started hiking the rates. And all these sub-prime mortgages started originating in 2001 / 2002, when the rates were lower. And the interest rates are higher today. And they are considerably higher for those who took the 2-28 mortgage, are out of the two, and into the 28, and can't refinance because of poor credit!
Further, those real-estate agents who tout that if you don't get in now, it will be too late by citing low unemployment numbers will themselves become unemployed, once they can't sell homes any more. The house prices might be holding for a while, but sales are down 15% to 40% in terms of number of existing homes and condos, year over year. So, 15% to 40% of real-estate agents are unemployed / partially employed, compared to last year! But more important, employment in Silicon Valley is not as healthy as it is touted by county and other government officials. Those who claim that unemployment is really 4% should go and talk to Ph.D.s who routinely sit in Starbucks, Panera Bread, and elsewhere with their computers. These skilled professionals who were once big executives in top-notch Silicon Valley firms like Sun, HP, and Intel can't find jobs any more, thanks to off-shoring / outsourcing, which is not going to stop anytime soon. And if you thought that rank-and-file engineers are secure in their jobs in Silicon Valley today, think again. I talked to an engineer, who after eight years in Oracle, left for the North Carolina - Charlotte - Raleigh area, so that he could finally buy a home --- he couldn't afford one here after eight years of gainful employment in a company owned and managed by none other than Mr. Ellison, the richest man in Silicon Valley.
I come across news routinely of couples, both of whom were working, and both of whom lost jobs, and thus could not pay mortgage any more. Ask any gainfully employed man in Silicon Valley / Bay Area, have a dialog, and he will confide that his wife, highly employable, highly educated, typically with an MBA, is looking for work, but can't find anything good, except may be a minimum wage job in Fry's Electronics! So, the number of 4% unemployment is elusive, confusing, and the tip of the iceberg in terms of what it means to be employed, and unemployed, in Silicon Valley. Real unemployment here is more like 15 % to 20%, if you include all the housewives who would like to work, but can't find anything. So, one needs to be cautious while investing in real-estate in the super-inflated bay area.
Let me summarize again the key facts for SFO Bay Area renters who would like to own a home, but can't afford one; also included are some recommendations for long-term action:
1. Don't fall for zero-down teaser mortgages. As foreclosures mount nationwide and sub-prime lenders go bankrupt, the policy makers will soon unearth this first savings and loan scandal of the 21st century, penalize some wrong-doers, and revert the nation back to traditional mortgages, with 20% down.
2. Renting in SFO Bay Area is being business savvy, buying a home today is asking for financial trouble down the line. Rent, don't buy. Rent is still half of mortgage in SFO Bay Area for the same real-estate square feet.
3. Don't listen to that aggressive real-estate agent. He won't pay your mortgage bills once the lenders come knocking when you are in financial distress. Chances are your real-estate agent will be doing some other job down the line, buying/selling real estate is currently a shrinking business in bay area.
4. Monitor foreclosures closely in your own locality. Unless you know what you are doing, buying foreclosures can be a risky business. You want to monitor the number though, to see if the supply glut in the housing market is going to be to your advantage in terms of nominal house prices coming down in the next twelve to twenty four months.
5. Flipping will be out of question in the next five years, if you bought a home today in the bay area. After paying for commissions, closure costs, property taxes, financing / re-financing fees, you won't come out ahead in the next five years, if nominal house prices keep going up at the 1% to 2% rate as they have been doing lately. Inflation-adjusted real prices are actually coming down. Nominal prices might follow. Housing starts are down 15%. Existing home sales are down 15% to 40%. Foreclosures are at all time highs, and will go higher, as the sub-prime loan scandal pans out in the next few months. So if you want to buy because of social pressures (oh, I don't own a home, everyone else does), it has to be life-style choice for at least ten years, if not more. In other words, you should be able to find employment for the next ten years to be able to pay mortgage. If you lost your job for some unfortunate reason, and if your spouse does not work, and if you are forced to move out of Bay Area, you will be flipping for a loss in the next five years.
6. All great employers: Oracle, HP, Sun, Intel, Cisco will lay you off at the first sign of trouble in the economy. Economists are propounding an economic hard-landing, from a painful growth recession to an outright recession; please listen to them. If you live and work in the Bay Area, you are facing the double whammy of an upcoming recession plus the accelerating off-shoring / outsourcing trends. The record low unemployment numbers are a myth. Do you know someone who has been looking for work for the last one year, but can't find one? I know plenty of them. If there was no unemployment, why are these skilled people not finding jobs? Could it happen to you? I hope not, but caution pays, for no job is secure in America today, and it is even less secure in the dynamic but ever changing Bay Area / Silicon Valley job markets.
7. The sub-million dollar housing market in all Bay Area locations (except may be the great city of San Francisco) has the same sub-prime problems as exists elsewhere in the nation. Analyze all paper reports, like the recent ones from San Jose Mercury news, by applying your intelligence. Just because a Mercury News report says that the bay area housing market is intact, it may not be. Learn to look under the hood, and read articles like this one, and other such analyses. Nearby localities from Stockton to Sacramento are crashing; the real-estate investment dollars will actually chase markets where prices are falling rapidly. So, there will be less dollars available for investing into the Bay Area housing markets.
8. Don't be in a rush to buy that dream home this spring-selling season. Why are you so excited about spring-selling? You are buying, remember; and not selling! The one who should be scrambling this spring-selling season is the home-seller, not the home-buyer.
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