Thursday, April 20, 2006 | As previously threatened, we continue our series on commonly-held housing market misconceptions. This week we will look at another rationale that is often used to justify San Diego’s immunity to declining home prices.

The claim goes something like this: “If homeowners can’t get the prices they want, they will just take their homes off the market until such time as they can get the prices they want.” Thus, we are led to believe, will the citizens of San Diego sit out any ephemeral bout of housing market weakness, and thus will prices remain steady.

Should home pricing power start to go south, I agree entirely that potential homesellers will want to wait it out. The question is how many of them will have that luxury.

Of primary concern is the de-facto speculation discussed in last week’s column. To briefly review, about 80 percent of San Diego homeowners who bought in the past two years used adjustable-rate mortgages (ARMs). The rise in ARM rates that began in mid-2005 all but guarantees that homeowners who have adjustable mortgages resetting any time soon will face significantly higher monthly payments.

But rising interest rates aren’t the only issue. Almost 50 percent of buyers during the past couple of years used interest-only mortgages, holders of which are exposed to the above interest rate risks but can additionally expect to have their payments increase when the time comes to start paying down loan principals.

And while I don’t have a specific headcount, I am assured by mortgage brokers that negative amortization loans were quite the rage in 2005. Borrowers using these loans pay no principal and only some of the interest, guaranteeing a significant eventual payment increase on top of whatever could be expected from rising rates. Federal banking regulation bigwig John Dugan, head of the Office of the Comptroller of the Currency, has said that it is not unreasonable to expect that some neg-am borrowers will see their monthly payments double in the not-so-distant future.

Meanwhile, as of last year, fewer than one-third of homebuyers made any down payment at all. And many earlier buyers who had built up some home equity due to general market appreciation have since withdrawn that equity through home equity lines of credit and cash-out refinancings – usually at an adjustable rate, of course.

In short, we have a substantial number of housing-market participants who may soon find themselves facing what is referred to in the business as “payment shock” – and they might not have much in the way of home equity nest-eggs to help them take the hit.

The problems aren’t only found on the expense side of the ledger. In a prior column, I discussed San Diego’s economic dependence on housing, noting that a hefty portion of employment growth over the past few years has related in one way or another to the real estate industry.

A continuing erosion of housing demand will translate directly into less income for real estate agents, mortgage brokers, and other housing intermediaries. Low demand will also lead to a slowdown in construction and the employment it provides. A lack of price appreciation will curtail the home-equity cashouts that have proven such a boon to San Diego retail businesses.

Whether or not homesellers try to wait out a period of housing weakness has no effect on these realities.

In the months and years ahead, people whose income depends on a robust housing market, whether directly or indirectly, may find themselves making less money than they expected.

Whether due to rising mortgage bills, falling incomes, or a combination of both, a large number of San Diegans simply may not be able to continue making those monthly house payments. It is unfortunate, but it is nonetheless a very real possibility.

People in this situation will not be able to sit tight and wait for the good times to start rolling again. They will have to sell. And it is when people have to sell that prices start dropping.

Rich Toscano is an independent real estate analyst residing in Hillcrest and working in La Jolla. He writes extensively about San Diego housing at Piggington’s Econo-Almanac.

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