The Housing Bubble

The Washington Post has this update on the DC area condo market. “It’s no secret: After a dizzying five years during which buyers threw ever-larger sums of money at condominium projects, units are languishing on the market and prices have stalled. So why, then, are so many developers still building condos by the thousands?”

“The resounding answer from developers large and small is that..basically, their condo projects are so special, so uniquely designed, strategically located or attractively priced that buyers will continue to choose them over the competition.”

“In the Washington area, more than 25,000 new condos are on the market, up from 18,000 a year ago. Developers are planning to introduce an additional 26,000 units over the next 36 months. Furthermore, about 9,000 more condos are competing for buyers’ attention in the resale market.”"Jim Abdo is embarking on a $1 billion, 3,000-unit project in Northeast Washington, said he is confident that the Arlington condos would sell once buyers saw their 22-foot ceilings, large windows and other features he described as unique. ‘Quality sells through any change in the market place. Period,’ he said.”

“But many developers say they are closely watching the market and adjusting plans. LaZerrick Howard, who owns about 25 apartment units in several District buildings, converted four of his units on the eastern edge of Capitol Hill and began selling them as the Courtney Condominiums in March. After two months, he dropped the asking price from $290,000 to $275,000. In June, he lowered it to $260,000 and sold two of the four units.”

“‘The market slowed down on me,’ said Howard, who also offered to pay for a year’s worth of condo fees and increased incentives offered to real estate agents. In the beginning, ‘I thought they would sell themselves. I was thinking, ‘Do I even need an agent?’ But the market changed so quickly. I had no choice but to regroup and figure out what you need to do to sell.’”

“Christopher Clemente, chief executive of Comstock Homebuilding Cos. in Reston, is tweaking his own plans. Two months ago, Comstock launched a rent-to-buy program in two apartment buildings it bought to convert to condos. The program represents Comstock’s first foray into the rental business. Clemente said the program is proving to be a good way to generate revenue while the buildings are being converted.”

“Comstock said it is also offering breaks on financing, condo fees and closing costs and even lowering prices on some units. ‘Buyers are out there,’ he said. ‘It seems that they’re waiting to make sure their buying decision is a wise one.’”

“Dean Baker, a longtime bear about the housing market, said the market could drop by up to 25 percent and disputed the notion that some well-planned condos would escape unscathed. ‘Whatever makes the place desirable, it’s presumably already reflected in the price,’ Baker said. ‘There’s always going to be a few that escape relatively unharmed. But virtually everyone is going to be affected to some extent.’”

“‘I don’t see a whole lot of good reason for buying a place right now,’ John Delmore, a telecommunications lawyer from Arlington, said last week after a year of on-and-off condo shopping in the District. ‘I think it’s worthwhile to see if prices do come down or if there are more incentives.’”

Several readers suggested a topic on where the legal chips may fall in a housing downturn. “Who holds the Real Estate legal hot potato(es)? So many fingers in the real estate industrial complex pie.”

“As the bubble breaks, lawsuits from upset buyers, money lenders and the like would seem to become inevitable. Who is most culpable? Are all players sufficiently shielded from a legal perspective such that R/E lawsuits will be fruitless? Will an uptick in legal actions slow or speed up the bust?”

“For example, how about collusion between loan orginators and appraisers? Provable? Actionable? Yet another example, buyers overstating income on stated income loans. Will lenders go after such individuals?”

“Another example, from yesterday, posted on this blog: ‘resale experts are saying that builders are messing up their market by dumping so many built-but-not-sold homes on the market with outsize buying incentives.’ Could recent homebuyers recover damages from a builder who is currently underselling the very same product?”

One reader replied, “I think our legal system needs to be VERY selective about what truly warrants a lawsuit in regards to housing. All out criminal activity; I’ll grant that. But ’steering’ or ‘false promises’ (i.e. a realtor says, ‘Oh this home will double in value in 3 years!’, etc. are IMO unethical, but not illegal. If the false promises are not put in writing, it’s ‘he said, she said’ and would NOT warrant a lawsuit.”

“People need to be responsible for their own actions rather then be allowed to continually play the victim role.”

Another said, “Unfortunately, in a major housing bust there would be very little ‘wealth’ to be redistributed through legal action. Builders learned long ago to use small sub-corporations for every development they ever create. The small sub-corporations go bust, file for bankruptcy or just dissolve, so even if you win a judgment it usually turns up empty.”

“Appraisers are generally covered by insurance, but if they used legitimate comps, they are fairly well insulated.”

“Any real litigation will probably take place between the MBS investors and the loan originators on the grounds of breach of contract, fraud, lack of due diligence, etc. There may also be shareholder or investor suits against the MBS entities for their failures to exercise due diligence and there may be a large number of actions seeking recourse (to return the loans) to the original lenders.”

“There will be an enormous number of prosecutions sought for mortgage fraud. What number of these will be accepted by the states and prosecutors is unknown.”

Another added, “Get ready for BK filings to stave off all the potential lawsuits. This is standard business practice.”

One agreed, “Yep. This is what happened here in the South Bay (LA) back in the mid 90s. This area is made up of mostly smaller mom & pop type builders. In 1997, we were looking for a builder to partner up with. We wanted to build on our Hermosa Beach property. We interviewed at least 5 ‘reputable’ builders. But we also did background checks on these guys too. 4 of the 5 had filed BK at some point in the 90’s.”

“But of course it did not stop them from starting up again. Most of these guys have made a ton of $$ in this latest boom but most are highly highly leveraged today.”

And another, “Here’s another major misrepresentation on the part of the mortgage industry and borrowers; many people bought investment properties and said they were going to live there. They misrepresented that it was an owner-occupied transaction. Underwriting for investment properties is much stricter.”

And finally this, “I know folks at several large consumer plaintiff law firms. (west coast) I have had conversations with all of them months ago about getting up to speed on the potential real estate problems that may arise.”

“Topics tossed around were title companies and mortgage brokers that have in any way participated in offering hints as to how to show financial information in a better light. The worst may revolve around filling out blank tax return forms with information that is different from information on the returns filed with the IRS.”

“Appraisers may have issues to deal with regarding valuing a house to the loan amount requested.”

“There is also a possibility of a case of collusion amongst banks and agents/brokers with regards to steering buyers to preferred lenders and whether or not there were kickbacks for those referrals. I worked in the legal field for 10 years. Have no doubt that there will be some very large scale litigation if prices drop much more.”

The Arizona Republic reports that the big homebuilders are ‘regrouping.’ “A parade of builders has announced sales declines of as much as 40 percent in what one analyst called ‘confession season.’ It has been hard for some builders to face the new reality. Some analysts say builders got so accustomed to the good times that they forgot that real estate runs in cycles, and they still haven’t adjusted.”

“They’re sitting with bloated inventories of unsold spec homes, created when buyers canceled deals. There were 8,700 finished but unoccupied homes in the Valley at the end of March. That compares with 4,300 at the same time last year. ‘You see it in spades in Phoenix,’ said Stephen East, an analyst with Susquehanna Financial Group. ‘There’s a huge amount of inventory that has come on the market in the last six or nine months.’”

“Despite their homey marketing, housing is a commodity for many builders. The big national builders roll houses off their production lines like carmakers cranking out Chevys. They’re in trouble when the mass market can’t afford their product. Analysts say that is exactly the situation now.”

“‘These builders, where volume is the name of the game, they have to be really careful about where they price,’ East said. ‘And I think large public builders have to take some blame for the dramatic run-up in house prices.’”

“Builders are realizing that their customers can no longer afford the houses that were within financial reach before last year’s boom. ‘The builders open the doors, and there aren’t any qualified customers,’ RL Brown said. ‘They say, ‘My God, what happened?’ What happened is he moved his price beyond the customer.’”

“‘It’s the right decision,’ said Greg Williams, president of KB’s Phoenix division. ‘It’s the moral thing to do. If we think we’re overpriced, we have to adjust the price.’”

The Fresno Bee. “Sales of new homes in Fresno and Madera counties have fallen by more than 25%, and the number of canceled sales has skyrocketed this year as builders struggle to adjust to a slowing marketplace.”

“A record-setting 5,233 existing houses are for sale in Fresno and Clovis, up from 1,823 two years ago, according to the Fresno Association of Realtors. Meanwhile, sales of new single-family homes in Fresno County through May fell to 1,291 from 1,735 during the same period last year.”

“Add to that a 56% increase in the number of active subdivisions, and the fact that nearly 14% of all new-home deals fall through before completion (compared with about 1% last year) and you have a situation where builders are forced to retrench.”

“‘Builders will do what they can to keep their operations going,’ said Patrick Duffy, managing director of Hanley Wood.”

“‘Buyers recognize values are going down, and that causes them to cancel a sale. The general mood of the marketplace has turned into ‘Let’s wait and see what happens,’ said Mitch Covington, president of the Building Industry Association of the San Joaquin Valley. ‘The market was ripe for a correction,’ he said. ‘We knew it was going to come, but we still sell homes.’”

“One thing builders don’t want to do is drop prices, unless they have to. Developers know if they cut the price in the third phase of a subdivision, buyers of houses in the first two phases will squawk. However, that does not stop big publicly held builders with quotas to reach from offering one-day sales and other programs in an effort to slash excess inventory, Duffy said.”

“Dick Ellsworth, land specialist at Grubb & Ellis, said some larger builders are reducing their land holdings but are having trouble finding buyers for so-called ‘paper lots.’ One of those is Centex Homes, which spokeswoman Lissa Walker said was overloaded with property. ‘We have land positions through 2011 or 2012,’ she said.”

The Voice of San Diego has this report on the condo market. “While the news that home prices finally went negative year-on-year last month grabbed plenty of attention this week, a new report shows that the price dip has been even more exaggerated for condos and townhomes.”

“When compared with June 2005, median prices dropped $20,000 in the county last month for single-family attached homes, a category that includes condos, condo-conversions and townhomes. That’s a 5.2 percent drop over the year. The prices also decreased by 2.4 percent from May to June and 5.7 percent from the beginning of the year, according to HomeDex.”

“Realtor Jim Klinge, who has been in the realty business for 22 years, said the current conditions are unlike anything he’s seen before. ‘It’s anything but normal, if you ask me,’ Klinge said.”

“Chris Thornberg, at the University of California, Los Angeles, said the housing market is in uncharted territory. Thornberg attributes the ‘everything’s fine’ response from the realty industry to the ‘bunker mode’ mentality that comes in circumstances like these.”

“‘People are loathe to realize losses in homes,’ Thornberg said. ‘They don’t want to talk about it, to think about it.’ Thornberg said that these numbers aren’t evidence of a soft landing. ‘The industry has been really blase,’ he said. ‘This cooling off of the market is very, very hard and very, very fast; more than we’ve seen before.’”

“The lower prices have also had an impact on the rate of production undertaken by San Diego builders and developers. In the market heyday in recent years, builders held back on production of detached homes, but overcompensated and ‘got a bit crazy’ in the condo market, said Alan Gin, professor of economics at the University of San Diego.”

“‘They were counting on condos being new starter homes,’ Gin said. But, he thinks the changing prices will lead first-time homebuyers to wait until prices drop low enough for them to afford a detached home. That reluctance to jump into the market will reduce the demand, and will thus reduce the prices, even further, Gin said.”

“While marked decreases in the median prices of single-family attached homes were noticed in all areas of San Diego in June, South County experienced the largest differential, with decreases of 11.3 percent from the same month last year, 12.6 percent from January and 7 percent from last month. That’s a year-on-year price drop of more than $40,000.”

“Those decreases are hitting home for several of Chula Vista Realtor Dawn Lewis’s clients, four of whom are what Lewis calls ’short sales.’ These are people whose initial home loans were for a higher price than their homes are currently worth. ‘They think it’s better to cut their losses now than to wait to see what happens later,’ she said.”

“Lewis said she’s even willing to take less on commission if it means finding these often desperate clients a way out.”

“Builder incentives and price reductions, often about $20,000, accompany nearly every condo sale in the current market and have taken the place of upgrades and gimmicks that used to help sellers close a deal, said Peter Dennehy, senior vice president for Sullivan Group Real Estate Advisors.”

“‘People are saying now, we need more help making our monthly payments than we need granite countertops, flatscreen TVs and that sort of thing,’ Dennehy said.”

“Chris Redfearn, an analyst with the University of Southern California’s Lusk Center for Real Estate, agrees that San Diego, especially downtown, will benefit from the aggressive underwriting and investing in condos, he said. ‘The original investors may get hammered. But ultimately, downtown is going to become a great place.’”