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Thursday, December 15, 2005 | When real estate market analysts want to know what is likely to happen to home prices over the coming months, one of the first things they look at is the cancellation rate for preconstruction property deals.
In San Diego, that rate has almost doubled from last year. It has also risen drastically throughout 2005. Experts agree that this means the San Diego real estate market is finally cooling down. What is not yet clear is whether prices are simply flattening, or whether the market is about to begin a downturn. That could be disastrous for many real estate owners.
“I watch that cancellation rate like a hawk,” said Sharon Hanley, a realtor who has compiled cancellation rate data for 25 years. “It is the first harbinger of a problem.”
In preconstruction deals an investor pays a deposit to secure buying rights at a set price for a property that is yet to be built. The idea is that in the time it takes for the property to be constructed, the asking price for that property is likely to have risen. Once the property is built, the investor pays the original asking price, then immediately “flips” the property to another buyer for the higher price, netting a tidy profit for very little money down.
Of course, that equation breaks down when home prices aren’t rising, or are decreasing. That’s when investors start to drop out of these arrangements and cancellation rates begin to rise.
The cancellation rates for detached properties rose to 40 percent in the fourth quarter of 2005, an increase from 22 percent in the second quarter and 33 percent in the third, Hanley said.
Two years ago, things looked different. Third quarter rates were 19 percent and rose to 30 percent in the fourth quarter.
Hanley said cancellation rates are usually lower for detached properties than for attached properties like condos.
Hanley stressed that seasonal variations in the cancellation rates are to be expected, with rates traditionally rising around the holiday season. However, she said this year’s rates are certainly higher than she would like to see them.
What stops real estate analysts from ringing alarm bells, however, is that the real estate market in San Diego has been exceptionally hot in the last two years.
“We need to begin to return to normal, this just can’t continue forever,” said Gerald Trimble, managing principle of Keyser Marston Associates real estate developers in San Diego.
Raphael Bostic, director of the Master in Real Estate Development Program at USC’s School of Policy, Planning and Development, said the increase in cancellation rates simply means speculative buyers are moving out of the market.
“It doesn’t necessarily mean, however, that the market is on the verge of collapse or that there’s going to be some dramatic weakening in terms of market performance,” he said.
Hanley said the cancellation rates have been extremely low for the past three years, sometimes reaching single figures – something she said she’s never seen before. She said the latest increases merely signal that the market is returning to normal and are no cause for concern.
“It is definitely a symptom, but it’s not the only thing, and I’m not seeing the other three things I look at,” she said.
Those other three symptoms are: an increase in real estate inventory on the market; decreases in the number of properties being bought and sold; and decreases in sales per parcel of land. Hanley said all of these have remained largely steady, which came as a surprise to her.
Investors and real estate brokers in San Diego acknowledge that the days when they could “flip” a property for a great profit at next-to-no risk are quickly sinking away. Indeed, some investors have already found themselves trapped by what once seemed like stellar deals, but that have recently turned sour.
Jim Abbott, managing partner at Jim Abbott and Associates, Prudential California Realty, said a number of his clients made preconstruction deals with developers in downtown San Diego, which they are now trying to escape. He cited Bosa Development Corporation’s property The Grande at Santa Fe Place as one property where roughly 50 investors are trying to sell, with very few buyers coming forward.
One of those investors is Darren Wassell, who grew up in San Diego but now lives in the Bay Area. He said he won’t be re-investing in San Diego real estate any time soon.
“I’m competing against 25-30 other people trying to sell my place,” Wassell said. “Whereas, a year ago, people were like, it doesn’t matter, they just wanted to flood in and buy.”
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