Saturday, March 20, 2010

Has California Real Estate Bottomed?

We've contended, in prior blogs, that real estate would perform better in 2010 than the consensus view and that, in particular, California real estate would be more sturdy (

In large part, the basis for this speculation was the suggestion that several factors would add support, such as a falling dollar, the oncoming hyper-inflation train and the complete wash-out that occurred in 2007-2009.

The "attractiveness" of real estate, in most people's views, is uni-dimensional and is fixated on price alone.  Has the price gone up or down?  That perspective is understandable, but incorrect. 

Real estate should be viewed as BI-dimensional - incorporating two factors: price and carrying cost.  A low price is not helpful if interest rates are sky-high.  High prices are far less onerous if interest rates are low, in particular "real rates", the difference between the nomimal rate and the underlying rate of inflation.

In the best of worlds, buyers should pray for low prices combined with low, or even NEGATIVE real rates of interest.  Why?  The low price is obvious, but the real rate may not be.

If you think about it, a mortgage, especially a FIXED rate mortgage, is nothing more than a bond.  A lender is "long" the bond, while a borrower has actually "short sold" a bond.  If rates go up, bond prices go down, and a "short seller"  will make money as the value of the bond depreciates.

If real rates are extremely low, or even NEGATIVE, as they are now, the market is in a state of extreme dis-equilibrium.  Negative real rates mean that borrowers are paying you to borrow!  Here's an easy way to look at it:  Let's say that inflation is running at 4% per year but you can borrow at 2%.  Every year, you pay in dollars worth 4% less than they were the year before, while tacking on 2% in additional costs.  Therefore, you are being paid to borrow!

Negative real rates are NOT NORMAL.  Historically, the real rate of interest has tended to oscillate between positive 1% and 3%, as investors typically will not accept negative returns.  So, what's different today?  An entity known as the Federal Reserve, combined with an administration desperate to keep the budget from spiralling out of control, have intervened in the credit markets to keep rates artificially low(  Ergo, negative real interest rates.

The evidence that this bullish fundamental combination of factors is bolstering real estate is dribbling in.  California's median home price rose 11.2% in February from February 2009, although home sales in the state slipped for the second consecutive month compared with a year earlier, according to a report released Thursday by MDA DataQuick, a La Jolla, Calif., housing-data provider.

The median home price increased to $249,000 in February from $224,000 a year earlier, DataQuick said, and represented a 0.8% rise from January 2010.  Home sales in the state fell 3.8% in February from a year earlier to 28,111 sales, but were up 0.9% from January 2010.

The San Francisco Bay Area's median home price rose 20% from February 2009 to $354,000, while home sales fell from year-earlier levels for the second straight month.  In Southern California, the median home price rose 10% to $275,000, led by a 13% rise in San Diego, while the number of home sales rose from year-earlier levels for the 20th consecutive month.

The increase in the statewide median price, the biggest year-over-year jump since March 2006, partially reflected a shift in the types of homes being sold in the state, as fewer foreclosures and stiff competition for bargains ate up inventory at the market's lower end, said DataQuick analyst Andrew LePage. "There has been a shift in what's selling and what's not selling," Mr. LePage said. "The high end has woken up, whereas it was comatose a year ago."

While the news is improving, there remain widespread problems.  For example, default notices jumped 19.7% in February from January, though they were down 37.7% from February 2009, according to a report released earlier this month by research firm

The supply of foreclosed homes that banks need to sell is rising again, signaling further downward pressure on home prices in some parts of the U.S.

Even though the number of people behind on mortgage payments kept rising last year, the flow of homes into bank ownership slowed markedly because of efforts to determine which distressed borrowers could qualify for programs that attempt to avert foreclosures by reducing monthly payments.  Meanwhile, brisk demand from investors and first-time buyers helped banks unload many of the homes they held.

The outlook for sales of  homes depends heavily on the extent to which the economy improves, jobs get created and, of course, real interest rates.  It will also be affected by how many distressed borrowers can be rescued from foreclosure through loan modifications.  Nearly 8 million households, or 15% of those with mortgages, are behind on mortgage payments or in the foreclosure process.  Foreclosures are heavily concentrated in a few states, notably Florida, Arizona, Nevada, California and Michigan.

So, the real estate market is absorbing two countervailing forces:  the crummy economy and people's ability to stay in their homes versus the upward pressure from inflation and low negative rates.  Marko's Take?
The one-two combo of accelerating inflation and negative rates will win.

Think I need to "get real" on the real estate outlook?  TAKE ME ON!

Marko's Take

For any readers in the Southern California Area, the California Wildlife Center is having an open house tomorrow, Sunday, March 21 between 12pm and 4pm.  The CWC is in Malibu.  Please come out and support this worthy cause.  If you do and want to say hi, I plan to be there around noon.  For more information, including their address and mission, click here (


  1. That is a pretty darn good summation of things. Personally, I am staying on the sidelines. I can't help but think a good deal today will be a better deal tomorrow.

  2. Well Kevin:

    No one can really pick a bottom and the real estate market has limited upside in the near term anyway...There will be good deals for a while but I DO think the bloodbath, is , for all intents and purposes...over.



Take me on!