Brief History of Real Estate Downturns

The housing analysts tell us we are in the 25^th month of the current housing downturn. Historically, housing downturns average 27 months so we may be near the end. Although there has been a significant decline in sales volume, home prices have continued to show small amounts of appreciation. With the Fed cutting interest rates, Congress passing bills to aid housing, and more money available for home lending, the financial markets will begin calming down. This down cycle will come to an end, just as they have done since 1970, and an excellent buying opportunity may lie ahead.

1970s:

With a protracted war in Southeast Asia and OPEC doubling the price of a barrel of oil, real estate sales and prices came under great pressure. However, by the late 70s inflation caused prices to rise and, as the decade came to an end, home prices in Orange County had risen 15.04% on an annual basis.

“The median price of a home today is approaching $50,000 . . . housing experts predict price rises in the future won’t be that great.” – National Business - 1977

1980s:

 With inflation hitting 21.5% and home loans reaching 18%, the Federal Reserve began to tighten credit to reduce inflation. This caused home sales to decline, but home prices continued to appreciate.  That decade, the worst year was 1984. Orange County recorded price appreciation of only 0.90%.

 “The golden-age of risk free run-ups in home prices is gone.” – Money Magazine – 1985

By the late ‘80s, defense contracts began to pour into southern California and once again, the housing boom was on. Home prices in Orange County rose that decade at an annual rate of 9.43%.            

1990s:

On Nov.11, 1989 the Berlin Wall came down and, by January of 1990, Congress cut the defense budget. In a short period of time, a lot of highly-paid workers in defense and manufacturing had lost their jobs. Orange County home prices declined from 1991 to 1996 by 3.22% annually, for a total of 19.33%.

  “A home is where the bad investment is.” San Francisco Examiner – 1996

In the last 3 years of the decade, Orange County home prices rose 27.42%, wiping out all the losses of the early ‘90s and ending the decade with a net gain of 0.90% annually. In OC, the 36 year annual average for home appreciation has been 9.76%!

2000s:

The appreciation chart above shows just how much Orange County real estate has risen this decade. The media (all forms) will have you thinking that Orange County real estate prices are collapsing. That is not the truth! If you believe the housing downturn did begin in 2005, here are some numbers you should ponder:

These numbers show that if you bought in the beginning of the housing downturn, you still have made a gain on your real estate. If you acquired property anytime after that, your price declines (if any) are minimal. Truthfully, this is not much of a housing collapse. I do not doubt that some areas have had larger losses, but in general, the Orange County housing picture is not as bleak as is portrayed.

Source: U.S.  Dept. of Commerce, CAR, Dataquick Information Systems

The Media

Today’s various media outlets play up bad economic news more than ever, which leads to misconceptions about economic realty. Our economy is extremely strong, with a 2^nd Qtr. growth rate of 3.8%; corporate profits are superb; and personal income is growing more rapidly than spending - thus pushing up the personal savings rate!  All the while, the world economy is exploding.  One area of constant attention from the media is the sub-prime market.

The Sub-Prime Market

The media will still report massive delinquencies and huge foreclosures in the sub-prime market, but those reports will not be accurate when you compare them to the total mortgage volume in the U.S. Even if lenders were to lose as much as $100 billion dollars on sub-prime loans, that only represents 1% of the entire mortgage market.

It may surprise you to know that sub-prime loans make up 5% of the U.S. total loan market, while Alt –A loans (those with credit better than sub-prime but less than prime) total only 8% of all loans. If you are wondering why the big banks made these sub-prime loans in the trillions of dollars, here is the answer:

?   Bear Sterns 3^nrdquarter revenue was only $166.1 million due to $900 million in losses

?   Lehman Bros. earned $887 million after writing down $700 million.

?   Goldman Saks earned $2.85 billion after writing down $1.5 billion in loan losses

?   Bank of America (#2 U.S. bank), after putting aside $1.81 billion for potential credit losses, saw net income rise to $5.76 billion - up from $5.48 billion last year.  (only 1/10 of 1% of BofA loans have gone to foreclosure)

 ?   Deutsche Bank charged-off $3.1 billion in the 3^rd quarter but still made a profit of $2 billion! 

Sub-prime loans in California represent only 25.7% of the total residential loans in the state.  From the summer of 2005 through all of 2006, 43% of all California loans funded were in both categories of these sub-prime loans. Today, most of the problems arise in just one type of these loans - the Adjustable Rate Mortgages (ARMs). How big is the problem? Not big at all! In the first quarter of 2007 in the U.S., 88.5% of borrowers with ARMs were not delinquent on their payments!

The media, knowing that they are losing viewers and subscribers, are well aware that fear helps to keep people tuned in or continuing to read. So they throw the big number of mortgage delinquencies in the headlines, but fail to tell their viewers how few actually go through the entire foreclosure process!

Source: Mortgage Bankers Association, National Homebuilders Association, Inside Mortgage Finance

     ?     The media never asks, “In the U.S., what was the all-time low delinquency rate?”  The answer is 4.0%!

Notices of Default

Notices of Default are filed when lenders’ loans have been delinquent for a specific period of time. These loans begin the foreclosure process. The four states of California, Florida, Nevada and Arizona currently have the largest amount of loans in the foreclosure process. Yet, in the 1^st Quarter, 24 states saw a decline in foreclosure starts and 36 states saw a decline in the 2^nd quarter!   

Foreclosures;  Occur when the buyer has been unsuccessful in curing the debt, and either a lender or an investor has acquired the property.

     ?   In California, 54.6% of homeowners in default emerge from the foreclosure process by bringing their payments current, refinancing, or selling the home and  paying off what they owe.            

     ?   In Orange County, 75% of homeowners in default emerge successfully. Those that do go to foreclosure, 57% are under $500,000  and 92% are under $750,000.

Now you can see why the problem is greatly over-blown and why state-wide home prices have not crumbled. On a final note about foreclosures:

   ?   The #1 reason they occurred was due to fraud and speculation!

           As of Aug 30^th, California investors (those not living in the home) represented 21% of the loans in default. In Nevada, the number is 33%,  Arizona is showing 26%, and Florida has 25%. The U.S. average is 13%.

   ?   The # 2 reason – unethical lending.

   ?   The #3 reason – loss of job.

   ?   The #4 reason was due to medical problems.

Source: Mortgage Bankers Association, Federal Reserve, Federal Bureau of Investigation, MLS

In the 1990s, real estate values dropped over 19% in Orange County; in this housing downturn it has been minimal. So what makes this cycle different. The truth lies in the fact that today’s homeowners have more income, more equity and more wealth than in previous cycles.

Why The World Changed in 1979!

Baby Boomers’ Impact

Never before in the history of the world has a generation accumulated so much wealth as the baby boomers. The Internal Revenue Service will tell you that, from 1945 to 1979, incomes increased at the same rate for all tax brackets. By 1979, the early baby boomers had been in the workplace for over 10 years. They were the most educated generation to ever enter the work force, and they had the skills for our changing world. Their income from 1980 to 2004 exploded!

        ?   The top 20% of incomes grew by 59%, while the bottom 20% of incomes grew by a measly 7%!

        ?   The top 1% of incomes grew by 200% - earning more than the entire bottom 50% of wage earners!

Last year’s rise in income was a 5-year high, and income rankings in the U.S. put California wage earners at #8!

 ?   The number of taxpayers making more than $100,000 last year grew by 3.4 million and accounted for more than two-thirds of the growth since 2000! 

 ?   Those making more than $1 million grew by 26% and numbered 303,817 in 2006! These individuals, who constitute less than a quarter of 1 percent of all taxpayers, reaped almost 47 percent of the total             income gains in 2005. 

 ?   The top 85% of the nation’s wealth resides with the richest 15% of Americans; the bottom 50% of Americans holds only 2.5% of the Nation’s wealth.

Over the next decade, there will be a 25% increase in the population over 50 years of age. They have more money than any preceding generation, due to having dual incomes, equity growth, and record inheritances (60% goes to the top 40%)! This age group is spending $2 trillion dollars annually! Last year, 2.1 million boomers turned 60, with 25% planning on not retiring. They found a way to mix leisure with work and are not ready to fully retire – they have money and income and they are still investing in real estate.

They are one of 3 major buying waves, as 75% plan on moving to either the west or the south for warmth. Eighty percent own their own home, with 25% of those owning additional property.

Those Who Own and Those Who Don’t

1.      We are the youngest of the home-building nations. History does repeat itself! Every country has gone through a cycle whereby it breaks into two parts: those who own a home and those who don’t.

2.      When this happens, rental rates begin to soar. We are in the beginning cycle of this event, as evidenced by the fact that the national rental rate increased 5.3% in the last 12 months. OC rents have risen 6.1% in the past year and 6.5% for LA. Since 2001, the rise in rental rates has easily outpaced inflation.

3.      Obviously, this becomes a great benefit to those who own homes and rental properties – especially when the U.S. occupancy rate is now at 96.2%, OC is posting a 95%, and LA is at a 95.6% occupancy rate.

4.      The United States is unique among developing countries – we are still growing! Last year our population surpassed the 300 million mark as we added another 2.9 million people. This makes us the 3^rd most populous nation in the world, behind China and India. Since 2000, we have added 20 million individuals and by 2030, there will be 80 million more people living in America!

             Source:   2004/2006 Census, U.S. Bureau of Labor Statistics, IRS

Just How Rich Are We . . .

There are 390 billionaires in the U.S., holding $1.54 trillion in assets.  California is home to 88 billionaires, and 8 of them call Orange County their home!     

The Federal Reserve reports:

·        Consumers have $5 trillion dollars in liquid cash sitting in banks and savings and loans!

·         In 2006, households’ net worth rose 7.4% and now exceeds $56.2 trillion dollars!

·         Homeowners’ real estate equity is $10.9 trillion dollars – representing a 59% equity position!

·         The value of individual stocks and mutual funds held by individuals grew to $10.4 trillion dollars!

·         Other assets held by individuals include:

?    $  3.2 trillion in bonds and credit instruments - $1.1 trillion in insurance reserves

        ?     $  6.7 trillion of equity in non-corporate businesses - $11.1 trillion in pension funds

?    $  2.5 trillion in 401K’s – plus $10 billion in loose change in homes and cars!

?    The rich and super-rich saw their assets surge 11.2% last year, to $37.2 trillion dollars!

        (Boeing’s “mobile mansions” are private wide-party jets being customized at $150 million each!)

What Are They Doing With This Wealth?

They, or their parents, are also in the process of transferring their wealth to their children and grandchildren. These newest home buyers make up the largest group of the 3 buying waves. They are presently 23 to 33 years of age, and will add 1.2 million new households per year for the next decade! They are purchasing at a median age of 26, yet those purchasing under 25 years of age now represent 14% of the first- time home buyers market.

And let us not forget the wave of buyers that represent the normal buying market. This group is projected to grow at a rate of 1.17 million per year for the next 7 years. They include 1^st time home buyers (median age 29) and those purchasing upscale homes (median age 45).

Impact of Immigration

Add to this the immigrants purchasing real estate and you can see that the U.S. home buying market will remain strong. From 1980 to 2000, over 6.2 million minority households joined the ranks of middle-income earners, and they are purchasing housing.

  ?  Immigrant children who arrived with their parents in the ‘80s and ‘90s, are now buying homes.

   ?  These 2^nd generation Americans, if history repeats itself, will out-earn their parents.

   ?  As 1^st time buyers, they represent 35% of the 1^st time resale market.

Immigration of new buyers is largely due to a U.S. policy of family reunification.  Today, there are 34 million immigrants, making up 12% of our total U.S. population and representing 28.4% of all households.

   ?   Presently, Latinos are the fastest growing segment of the U.S. housing market.       

  ?  Asians will become the fastest growing segment of the U.S housing market over the next decade, largely concentrated on the West Coast. By 2015, China’s middle-class will be larger than the entire U.S. population. By 2025, India’s middle-class will reach those numbers!
  ?  The median price of homes purchased by foreigners is $70,000 higher than domestic buyers.
    ?   Foreigners buy U.S. real estate for investment purposes 22% of the time, and for fun and frolic 47%.

     ?   The falling dollar makes U.S. real estate a great buy for foreigners and immigrants.

   ? California, Texas, and Florida represent 52% of all purchases with California being #1.

     ?   Orange County is a major county for net-in migration of immigrants.

Source: 2004/2006 Census, Federal Reserve, Internal Revenue Service, National Association of Realtors, World Wealth Report

Why Our Economy Will Continue To Do Well!

The National & California Economy

In the 2^nd quarter of 2007, our economy grew at a 4% pace and is likely to produce a 2% to 3% growth rate for the year. Core inflation is down and the trade deficit is down. Since the mid-2005 housing cool-down, we have added over 4 million jobs and incomes have risen 7%, leading to a $1.35 trillion rise in the nation’s income. This is pent-up demand and will fuel the next housing turn-around.

1.    Since 2003, the U.S. has created over 4.5 million new businesses and over 8.3 million new salaried jobs.  Add 16 million self-employed and 25 million part-time workers and generated $167 billion of extra tax revenue last year.

2.    California is home to 1 out of every 11 workers in the U.S. and produces 15% of the GDP in America.

3.    Over the past 12 months, the U.S. has employed almost 2 million new workers; the unemployment rate of 4.6% is at a 6-year record low, and since 3% of the population won’t work even if you give them a job, we are near full employment. In the OC, our unemployment rate is only 4.2% vs. 5.5% for the state. Los Angeles County has an unemployment rate of 5.2%.

4.    Last year’s increased tax revenues have helped to reduce the projected deficit of $325 billion to $240 billion. Our tax revenues are up 14.1% over last year, and the federal debt was reduced by 20.8%. The first quarter of the government’s fiscal year saw a 32% reduction in the deficit compared to the last year’s 1^st quarter – a 5 year low! The Treasury has announced the elimination of the 3-Year Note due to lower deficits.

5.    Corporate profits have doubled in the past 5 years, and 2^nd quarter earnings showed that corporations are still going strong. Companies are buying back their stock (maybe as much as $2 trillion) due to having so much cash in the bank! Corporate cash is still at a historic high of $2 trillion.

6.    Since 1980, the Gross Domestic Product has risen 70% and is now at $13.3 trillion, helping to shrink our federal deficit.  Today, debt is only 1.8% of the GDP, compared with 6.0% in ’83 and 4.7% in ’92. 

7.    California is home to 36.5 million residents with a population growing over 800,000 last year. However, by 2050, our population will explode (nearly doubling) to 60 million people. With our large diversified economy, California will continue to prosper and the demand for housing will remain strong! 

The Fed has pumped tens of billions of dollars into the financial system, sliced interest rates on bank loans and, may cut the Fed Rate for the first time in 4 years. The Chairman has stated that the central bank will act as needed to limit the impacts on the economy. Housing is just too important to the overall economy. There are huge new pools of liquidity - in corporations, central banks, petrol-dollars, private equity, hedge funds, foreign savings, and especially in U.S. households which by far hold the largest pool.

During the past 20 years, global prosperity has created millions upon millions of wealthy individuals, as well as a billion or so new members of the middle class. This global development is lifting living standards around the world. Underpinning this expansion is the integration of half of the world’s population into the global market economy! These expanding economies and populations will profoundly affect our economy in a most positive way and once again, we will grow our way out of this downturn! The pent-up demand is constantly growing and soon, it will move into real estate home and condo purchases.

Source:   Federal Reserve, IRS, U.S. Bureau of Labor, California EDD, State of California,  2005/2006 Census, Forbes