Wednesday, Dec. 27, 2006 | The year’s beach season was in full swing before many in the county noticed a chill in a San Diego housing market that had been sizzling for years.

“The beginning of the year was still kind of jubilant from last year,” said Michael Colby, economist at MarketPointe Realty Advisors. “No one really realized where we were until the middle of July.”

That was when county homeowners started hearing negative news about the market – substantiated news, at that.

“Before that, it was just experts saying, ‘This is not sustainable,’” he said. “Now, the data actually showed a change.”

Indeed, 2006 proved the end of an unprecedented housing boom. Gone were the years of booming home prices, sizable sales stats and frantic “flippers” overbidding on otherwise undesirable properties. Speculators vanished, potential buyers invested more time in their decisions and some whose jobs were created by the boom – novice real estate agents or mortgage brokers – found other work.

San Diego proved an extreme version of what was happening in markets across the country, as inflated markets started to cool after a similar years-long run of price appreciation. The national housing market, and its downturn, became a factor in discussions about the otherwise healthy national economy.

For the first time in a decade, the median price of a home dipped negative compared to the previous year. Year-over-year price declines continued monthly from June, eventually reaching a low point of $482,000 in November. That was a $36,000 drop from the previous November, according to DataQuick Information Systems.

Median prices weren’t the only indicator of the slowing market. Many analysts considered a decline in sales activity the most concrete marker of a slowdown. The number of homes sitting unsold on the market soared to more than 23,000 units this summer before declining to about 19,000 in December – 10 times as many homes as the market’s lowest supply in 2004.

And 25 percent fewer homes sold in the first eleven months this year than in the same period in 2005. Home builders drastically scaled back their plans, slashed their profit outlooks and laid-off employees. To attract consumers to the homes that were sitting vacant, they offered incentives ranging from appliances to Hummers to cruises, allowing them to mask price concessions in earnings reports. Existing home sales struggled, too – sellers hoped to garner the prices paid for their neighbors’ homes during the boom, but many buyers waited to see if prices would fall further.

And so, homes took about 30 percent longer to sell than they did in 2005. Sellers of detached homes were looking at an additional two weeks or so, on average, before they could slap a “SOLD” sticker on their yard sign, according to the San Diego Association of Realtors. The association experienced a sales volume drop of 25 percent from January to November, a $5.7 billion difference from the same period in 2005.

The drop in demand – and profit share – among the county’s estimated 10,000 real estate agents will force many out of the profession, experts say. Job losses in the real-estate related sector, including agents, mortgage brokers and construction workers, will have lasting, significant effects on the local economy, they project.

The Bearers of Bad News

Many in the real estate industry blamed the media for the negative mindset of their formerly enthusiastic clients. Newspaper, television and radio outlets reported data as soon as it was released by analysts, revealing the drops in sales rates and prices. Agents, builders and brokers lambasted those reporters, blaming the media for perpetuating a perception of doom for the housing market. The local Realtors’ association and the builders’ association teamed up on an advertising campaign, admonishing San Diegans that homeownership was an opportunity not to be missed, despite some negative trends.

“2004 and 2005 were incredibly overheated,” said Charles Jolly, 2006 president of the Realtors’ association. “We knew anything compared to that would be a huge downturn.”

But the numbers didn’t lie. The median price drops told a softer story than what was actually happening in the market, many said. The real estate boom had risen to blockbuster status in conversations around the water cooler and at cocktail parties, and media outlets were among those reporting the data that emerged – and the hangovers associated with such a raging house party. The excitement about investing in real estate that had so easily spread through society for a few years shifted to a widespread feeling of uncertainty.

In these circumstances, convincing buyers to get into the market just for the sake of doing so will be a tough sell, said Peter Dennehy, vice president of the Sullivan Group Real Estate Advisors.

“The market as a whole has gotten the memo,” Dennehy said. “It is very hard to convince someone that it’s a good time to buy right now. That ‘let’s just get something,’ ‘gotta get in on the market’ – I think that perception is gone.”

But Dennehy does, like Jolly, consider San Diego a “buyer’s market.”

“Buyers have a lot of choice; they know that they have the upper hand,” he said. “It’s always a good time to buy a house if you find a house you need at a price you can afford, if the home meets your needs.”

Reaching for Affordability

In 2000, the overall median price for a home in San Diego County was $234,000. That price leaped up annually by 15 to 20 percent for years, landing at $494,000 in 2005. The median price soared a total of 210 percent during those five years.

And so, despite this year’s market “softness”, prices haven’t come down all that much. The all-home median price for 2006 – once December’s prices are tabulated – will likely still be within a few thousand dollars of the 2005 price, even if it is a bit lower.

As prices come down from epic levels, some say it will boost affordability in the region. But for many who were convinced the home appreciation train was never going to stop again, the price drops could be disastrous.

Mortgage lenders nationwide responded to runaway home prices – and consumer fear of being priced out forever – by offering creative loans. The appeal of these mortgages is that they allow borrowers to enter a housing market they might not have otherwise accessed through low monthly payments. Some choose to pay only the interest. Others pay only a portion of the interest accrued each month, meaning that their debt incurred actually grows – rather than shrinks – for a period as the loan ages.

These so-called “exotic” loans are founded on the assumption that real estate always goes up – that by the time the loans are due to reset, the borrowers’ home values will have increased enough that they can, if they need to, use that equity to refinance the loan and avoid the substantially larger payments ahead.

When those loans reset, the monthly payments can be kicked up by a few thousand dollars a month. Sometimes, the payment can more than double.

And despite the impending surge in mortgage bills amid an uncertain, slow market, the loans’ popularity persists. One kind of exotic loan, negative amortization on an option ARM, constituted 35 percent of the mortgages originating in the first nine months of 2006, according to First American LoanPerformance. That compares to just 1 percent in 2003.

The low introductory period of some of these loans ended in 2006, and even more are set to end in 2007. A number of homeowners faced a sizable jump in their monthly payments, reducing the amount of money they could spend on other things.

The popularity of creative financing options worries analysts. Some buyers got into homes even though they could only afford the introductory payment on the loan. When the introductory periods end, those watching the market fear an avalanche of foreclosures from those who can’t afford their loans anymore. And for those who shift their budgets to account for the higher payments, the impact to the consumer spending in the region could be significant.

Technology Rising

“On the whole, we’re looking at more ‘fingers-crossed’ thinking. Six months ago, it seemed a lot more desperate than it does today.”
– Peter Dennehy,
Sullivan Group Real Estate Advisors

Traditional media outlets weren’t the only purveyors of information about the market. Online innovations allowed Average Joes to snoop at their neighbors’ home values, post listings and blog about their findings. Some were created this year, while several created in previous years, like Zillow, bounded in popularity.

Dennehy said the phenomenon commoditized the housing market.

“That worked to fuel the boom,” he said. “And now it exacerbates the perception of the housing market – whether that’s reduced listings, foreclosures, or whatever.”

Many real estate agents consider the websites a threat to the services they provide. But David Cabot, the incoming president of the Realtors’ association, said he embraces Zillow and the other sites as good tools that give his clients one more piece of information to compare.

Some Realtors think the new sites will force them and their colleagues to prove to potential clients that they’re more than chauffeurs. About 4,000 agents joined the local association in the last five years, and about 200 have been joining every month since January, Jolly said. He and Cabot expect a 20 percent decline in agent count in 2007 as the public starts to expect more services in exchange for commission, and the inexperienced agents are weeded out.

Crystal Ball Gazing

University of San Diego economist Alan Gin said the housing market’s impact on the economy, and vice versa, is significant for the county. Gin said he’s surprised at how rapid the drop in prices and sales has been already this year. And the end to rampant home appreciation also signals a slowdown for the “wealth effect” – many homeowners in this recent boom used their homes like ATMs, refinancing their original mortgages to withdraw some of their increased value and spend it on cars or cruises even a second home. This year’s decline brought a sobering effect to that phenomenon, and the retail world may feel that drop in consumer spending significantly next year, Gin said.

With the potential for foreclosures or decreased consumer spending from high mortgage payments, job losses in construction and other real estate related fields and a market that may force middle class households to leave the county in order to afford a house, Gin said it’s too early to tell what the impact will be for the economy. But it doesn’t look good, he said at a recent USD real estate conference.

It was the first time in seven years of delivering an economic forecast at the conference that Gin didn’t expect San Diego to outperform the nation or the state in the next year, he said. He identified slowdowns in the job and housing markets as areas of concern.

Those watching the local real estate market often wince when asked to deliver a forecast. Data can be tracked; motivations cannot, they say. Buyer and seller psychological factors will almost certainly continue to play a role in the market in 2007, and that x-factor blurs whatever crystal ball image they might conjure.

But they gave it a shot.

Robert Brown, a professor at California State University in San Marcos, compiles statistics on the housing market each month. He thinks a drop in prices could spur buyers back into action.

“If, indeed, people are just sort of waiting to see what’s going to happen in prices, then, if we do see a decrease in price, that will encourage people to get into the market,” he said. “And that [activity] will counter any significant price decreases.”

Cabot, the incoming San Diego Association of Realtors president, said he expects prices and sales to pick up by the end of March. Inventory levels may rise in the beginning of the year, he said, but increased sales will absorb those levels quickly.

Colby, of MarketPointe, said in order to absorb the number of homes unsold, the county will see more price drops. He said while some expect sales to turn around next year, he thinks it will take a while longer.

“Sellers are pretty sticky,” he said, referring to the reluctance sellers have to lower their prices.

Dennehy, of Sullivan Group, said he expects an up-tick in sales in February or March, with the trend remaining essentially flat for another year or so. Prices will continue to come down until sales and inventory catch up, he said.

“On the whole, we’re looking at more ‘fingers-crossed’ thinking,” he said. “Six months ago, it seemed a lot more desperate than it does today.”

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