Sunday, December 12, 2004

On the Record: Bay Area real estate

San Francisco Chronicle

Real estate is a major topic for the Bay Area. This is one of the most expensive housing markets in the nation, yet the past two years, stimulated by low mortgage interest rates, have seen record numbers of sales and prices increases. What is going on in the local real estate market?

To answer that, The Chronicle invited three experts to discuss the topic: Avram Goldman, president of Coldwell Banker Northern California Residential Real Estate, who heads the largest staff of real estate agents in the top half of the state; John Karevoll, senior analyst with DataQuick Information Systems, who has been gathering and parsing data on real estate for the La Jolla (San Diego County) company; and Ken Rosen, a UC Berkeley professor who specializes in the real estate market..

Q: Is there a real estate bubble?

Goldman: I don't believe in the bubble theory. I think there are cycles when real estate is very good, and then cycles when it corrects. It doesn't have to do with real estate. It has to do with more global issues, economic issues and other issues.

If you're looking currently, I don't see in the near future much of a bubble. We're looking at slowing of appreciation. That can happen because you cannot continue to go up double digits forever. It just doesn't work.

It's not a healthy situation for the market. Is there a bubble? Is there an impending bubble? No. I don't see an impending bubble. Will appreciation potentially slow? Yes. That could happen, but that's a good thing.

The market sometimes needs to pause and catch up and catch its breath. So if you look at the things that really drive the real estate market, you have interest rates which are still at 35-year lows. I think the biggest thing that's driving price today is lack of inventory. There are more buyers than there are houses to buy.

Q: What do the numbers tell us?

Karevoll: We just probably had the second-strongest October ever in the Bay Area, and prices continue to go up at about 18 percent. I'm missing the last three days of the calendar month for that. Except for the new peak there, it (the median price of a home) went up from $544,000 in September to what looks like will be $553,000. This is for resale houses.

A bubble means that a market has taken leave of its senses.

The buying activity there is fueled by the expectation of gain, and right now, as Avram said, what we're seeing is basically buying activity where people are putting roofs over their heads. You can't use the bubble criteria there.

As far as a correction goes, yes, especially when interest rates start to go up. The bubble thing just doesn't seem to be happening despite an enormous number of forecasts from near and far that said that it would happen.

The market does what it does. What did Ed Leamer of UCLA (director of its Anderson Forecast) say a couple of years ago? He said, "What are they smoking up there in the Bay Area?" He just couldn't make sense of the numbers here.

Rosen: I'm going to disagree with all of that. We call it a bubble, and that's the wrong word for Northern California. What we have happening here is extremely low interest rates, and easy credit has put a lot of new buyers in the market, and we don't have a lot of people cashing out and leaving the area.

I'm going to give you some economic numbers that indicate that there is a disconnect going on here. What's happening in the Bay Area is this: We have a deficit of home ownership, so people took advantage of the low interest rates and easy credit to become homeowners.

We have the lowest home ownership rate in the state. I believe it's 58 percent. Nationwide, it was 69 percent. So we have a deficit.

Let me give you the demographics and the job situation, which I think eventually will cause us a problem. We've lost 135,000 jobs the last three years in San Francisco. We've lost 175,000 in San Jose. In Oakland, we lost only 30,000, and we've actually gained 6,000 in the East Bay.

So the job situation would have said that this would be a very bad housing environment. Every time we've had a recession like this, with a run-up in prices, which we did have in the late 1990s, you would get a housing recession. But what offset that was the extraordinarily low interest rates.

Q: Where do you see things going in the next five years?

Goldman: I'll just go out three years. I don't know about five years. But given that interest rates don't rise beyond the 7 percent level, given that the deficit doesn't go up another 50 percent, I see pretty good things for the housing market.

Karevoll: There's some softening here and there, but it's still very strong. I do agree that other factors have offset the terrible economy. There have been extraordinarily low interest rates, easy credit and trade-up buyers having built up more money.

I'm worried about the Bay Area and California as a whole. The California Association of Realtors affordability numbers are 14 percent for San Francisco. Oakland is about the same. San Jose looks like it might be a hair better.

The problem with that is that's with very low interest rates. I'm thinking that if interest rates go up, it's out of control.

Q: If Bush raises the level of what the government can spend and borrow, will that affect interest rates?

Rosen: No. What really matters is the stock of debt and how much growth in the debt there is relative to the size of the economy and who holds the debt. So the deficit is going to go to 4 to 5 percent of GDP from 3.5 percent.

What's really the negative about it is who's holding it. It's being held by India, China, Hong Kong, Taiwan and Japan. We have a $550 billion trade deficit. They have to recycle the money. So what they're doing, so far, is buying Treasuries.

I think they're going to try to buy real estate pretty soon. So I would open a Coldwell Banker office in Hong Kong and Shanghai, and I think you'll recycle a lot of money over here because the Asian economies love the Bay Area.

Q: Will Bay Area prices decline?

Rosen: I think the Bay Area, because of this huge backlog we had, may take a longer time to unwind. I can't imagine with these affordability ratios that we won't see (more) slowing in the market over the next three years than we've had the last period of time.

It hasn't stopped yet. It's still red-hot. I think price declines are very possible, but that's where we disagree. It wouldn't shock me to see a price decline of 15 percent on average over a three- or five-year period.

Q: Have we ever seen house prices decline?

Karevoll: Yes. From 1990 to 1994, the Bay Area probably lost about 10 to 11 percent of its value.

Q: Are more homes bought as a short-term investment?

Karevoll: I think if there's speculation anywhere, it would be in the condominium area. There might be a little bit of it there, but the standard single-family house isn't speculation.

Q: Isn't there a sense of expectations of huge profits in the short-term?

Karevoll: I don't see that. I'll tell you where we saw it. We saw it in the late 1970s. We saw it in the late 1980s. We saw a little bit of it in the late 1990s, but I'm not seeing that now. These are homeowners. It's a whole different phenomenon.

Q: What did home-value appreciation average in the last three years in the Bay Area?

Karevoll: It's lower than you think. It's about 10 percent. Everyone's thinking it's doubling. It just isn't. It's much lower. We had the boom in the late 1990s in certain locations, including San Francisco. I think it was up 26 percent in one year, but 2001, 2002 and 2003 have been very modest.

Q: What is the flipping rate? What is the statistic that you look at to see what it is?

Karevoll: There's a whole bunch of definitions. The way we look at it is a percentage of sellers selling right now who have owned their homes for less than half a year. We've also done it for three months and 12 months. Right now, it's 3.8 percent at a half year or less.

We hit almost 5 percent back in the late 1980s.

Another element of flipping to me is absent ownership. In other words, are people buying homes to live there? That's a big part of it.

Q: What's that right now?

Karevoll: In the Bay Area, it's low. About 7 percent are buying homes they don't live in.

Q: Are there other short-term ownership patterns?

Karevoll: Parents are buying homes for kids. For example, at UC Berkeley, many parents come in and buy a condo for four years while their kids are there. So I don't know how much that plays into it. It may be 1 percent. I don't know.

Q: How do you see the supply constraint being solved?

Rosen: Remember 10 percent (price) increases a year. That's the real number -- not much bigger. It's very important to say that because we all think it's a much bigger number. We've seen givebacks in the rental market.

Rents have dropped 35, 40 percent. Vacancy rates are at just about their highest levels, (but) they're turning a little bit now, getting a little bit better. I think the main effect is there's been a reallocation of people from rental to home ownership. That's what's taken place. I don't think the building problem in the Bay Area is ever going to solve itself. We have a limited supply of land.

Q: Do fewer people in the Bay Area sell than in other areas?

Karevoll: We've got this churn rate, how fast (houses) turn over. Basically, the Bay Area is about the same as the rest of the state. California has always had a higher turnover rate than the rest of the country.

We just do more of everything here. We get divorced more often; we move more often; we get fired and get new jobs more often. Everything happens faster in California, and that's reflected in the length-of-ownership statistics.

One other thing about the market -- and this is one of those obscure little factors that's going to play a big part -- we have to remember that for every mortgage dollar being loaned out there right now, there are two waiting in the wings to be loaned.

All of these huge institutional investors look at investment just the same way everybody else does. They have pension fund money to invest; they have insurance fund money to invest. They're chasing securitized mortgages, and they have been now for the last four or five years.

Once the stock market kicks into gear, as it is doing right now, we're going to find that an awful lot of that money dries up, and that will also influence interest rates. There's not going to be as much money waiting in the wings out there as there is right now. That's going to be a huge factor

Q: Are credit standards get tighter?

Karevoll: Right now, (lenders) are making loans to people that they didn't used to make loans to, and it would be easy to conclude that that is because of looser underwriting criteria.

They have much better risk management information than they used to. They're able to make loans they didn't used to make because they are able to quantify how much more risky those loans are.

If you filed for bankruptcy, you wouldn't have been able to get a loan, a mortgage, five years ago, but you can today. They're making loans to multiple heads of households.

You've got to remember that you go back 30 years, they wouldn't use spousal income as a qualifying criteria. The thing is, the people who are out there on the edge, that have declared bankruptcy, they don't have a 5.5 percent, 30-year fixed rate mortgage. They get a 7.5 or 10 percent 30-year fixed rate mortgage because those loans are more risky.

Q: Where will interest rates be in the next year?

Karevoll: They will go up. It's just a matter of how far. A year from now, they could be 6.5, and they could be 8 and probably somewhere in between.

Goldman: I don't see interest rates in the next year going above low 7s, maximum.

Rosen: By the end of 2005, between 6.5 and 7 for a 30-year fixed rate mortgage.

Q: What percentage of people moving out of the Bay Area are homeowners versus renters?

Rosen: The vast majority are homeowners. It makes a lot of sense. Their house is now worth $1 million or $1.5 million. They can sell it, trade down, get the capital gains tax-free and pay no income tax in Nevada.

California has a crisis. The Bay Area's problem isn't housing as much as how do we create jobs? The housing factor could hurt because companies have to pay a lot more for their employees to live here.

Q: If trade-up buyers use the equity from their homes, where do first- time buyers get their money?

Rosen: They don't need a big down payment today -- very low down payments, creative financing. You can basically be qualified at a 2 percent rate on a deferred-interest mortgage.

Easy credit has most helped them. Wealthy buyers don't care about that. What percentage of buyers are first-time buyers? I want to say something like 30 percent, and it's eroding.

It's not that there aren't many of them. It's that the other side is so able to take advantage of this trade-up market.

Q: Is it just that rich people want to live here?

Rosen: Until two years ago, it got very affordable because prices hadn't moved up much, and interest rates had come down. So interest rates and easy credit were two main reasons along with the wealth effect -- people reallocating their money to housing rather than stocks.

For first-time buyers, it's always been tough. People are stretching. It used to be that you couldn't spend more than one-third of your income to buy a house. Now the criteria are stretched. It's 42 or 43 percent.

Goldman: And even higher, depending on the profession they're in. And the only deduction most Americans have is the interest rate deduction.

If you're a doctor, an attorney, or starting your career in the technology field, and you're making $250,000, you're hitting the alternative minimum tax, so you need some shelter. So your relative house cost is much less.

Q: One marketing tactic that seems prevalent in the Bay Area is underpricing -- setting the asking price very low to create a feeding frenzy. It might not be illegal, but it's unsavory. How do you justify that?

Goldman: It's what the market will pay. It's the consumers who decide what they want to do. We have sophisticated consumers. They read about strategies on people underpricing homes.

I have 2,400 agents. I can't be in every listing presentation, but I will tell you my people try to accurately determine a price range, and then it's up to the seller to say, "We'll go with that." (Underpricing) may be a strategy for some, but I don't see it overall as an industry trend.

Rosen: Also, it's a strategy that works only when the market is so red hot.

Q: Are there still multiple offers on most homes?

Goldman: In January, February and March, it was crazy. There just weren't enough properties on the market. It seemed every property had 8, 10, 12, 14, 44 offers. Right now, that's moderating. That's a positive thing. Houses with multiple offers are going for less over asking price.

There are exceptions, particularly on the Peninsula, where you have a scarcity of listings, like Burlingame, like Menlo Park. It's unbelievable that at entry level -- $700,000 in Burlingame -- you may have 20 offers because there are so many people want to get in there.

Rosen: Doesn't that sound sick when you think about it? But it's only because we have a lot of people with income and wealth.

Q: What percentage of homes are FSBOs, for sale by owner, transactions?

Karevoll: Right now it's just over 20 percent.

Q: Is that high compared with the rest of the state?

Karevoll: No, it's about the same. It goes higher during recession and low appreciation times, and it goes down when the market is hot. We've had a range from 17 to 25 percent of the market.

That part of the market has its own demographics. A lot of minority buying doesn't go through the (Multiple Listing Service). There are whole categories of people who sell homes themselves for various reasons: Either they don't trust real estate agents, or they view agents as taking cream off the top of the deal.

Q: For years, you forecasters have been talking about some kind of housing downturn. Why didn't they see the signals that the correction wasn't going to happen?

Rosen: It did happen in 2001 at the high end. But then (the Federal Reserve) lowered interest rates to the lowest levels in 50 years. So there are offsetting effects. No one could ever have thought we'd have a 1 percent short rate. After 9/11 and the Nasdaq crash (Federal Reserve Chairman Alan Greenspan) thought we would have had a recession. So he created a very shallow recession. Interest rates were a prime motivating factor offsetting that. I still think that if interest rates go back to normal and we get another recession for external causes, we will have a house price correction.

Q: What's the normal interest rate?

Rosen: A 7 percent (30-year fixed) mortgage rate.

Q: What's the likelihood of another recession in the next few years?

Rosen: A 30 percent chance. Last year it was less. I think it's rising. I think the election increases the chance of something going wrong in a three- year horizon -- probably in the next six months.

Energy prices are part of it, the Middle East is part of it. So interest rates can offset any phenomenon that we've had.

If we'd had normal interest rates in the last three years, which I thought we were, there's no question we would have had a house price correction.

It's important to say that in the last three years, we've had a sharp slowdown in appreciation in the Bay Area. That 10 percent number is important. It's not doubling, it's not 20 percent a year.

We've had a much lower rate of inflation in house prices in the Bay Area, giving incomes a chance to catch up, even though they haven't.

So am I wrong this time? I can say I'm personally betting on it. We have a hedge fund, and we're selling short all the home-builder stocks.

Q: But what about your prediction (of a housing correction) for the past three years?

Rosen: The rates are what's causing this to happen. We think it's creating a bubble in many markets but not the Bay Area. The Bay Area already had its bubble. But there is a bubble, and the bubble is bursting. In Las Vegas, in Orange County, in Miami and any place that's had a bubble price increase, there's going to be a substantial price correction when rates return to normal, and the Fed is now signaling they're returning them to normal. So we know it's going to happen.

Q: There's so much data online helping people buy and sell. How does this growing influence change the business?

Goldman: California Association of Realtors has done a study on the Internet and buyers and (found that) they're very interesting people versus traditional buyers who call on an ad from The Chronicle or another source.

Internet buyers are usually better educated. They have higher incomes. They actually spend less time looking for a house. They're better informed. I see the Internet as a real positive for the industry. In terms of other real estate models like ZipRealty, it's just another model. It remains to be seen whether that model survives.

Q: What have the Internet and online brokerages done to commissions?

Goldman: I'm speaking only from my view, but I think there are other things that have done things for commissions, and I think part of it is your paper. But letting people know there are alternative commission structures, that's fine.

People want certain things. Not everyone drives a Hyundai. It's got four wheels, it's got seats, it gets you where you want to go and it gets good gas mileage.

But some people prefer a BMW, a Mercedes, something else. In real estate, some people want more services. Other people want less services. I think that's a good thing, not a bad thing. I think you just have to know what segment of the market you're going to work with.

Q: Are you saying that commissions are negotiable, that they're not fixed at 6 percent?

Goldman: Commissions are negotiable. They could be 8 percent, and sometimes they are. Have commissions gone down over time? They have, but that's because some people have chosen to take advantage of a different kind of real estate service. I think it's really up to the consumer to decide what they want.

But in the state of California, this is a very complex transaction. If you don't do things in the proper manner, there are some pretty drastic consequences.

Q: What's the median home price in the Bay Area going to be in two years?

Karevoll: It'll be $620,000 to $650,000 at least.

Goldman: I would agree with that. It's very, very hard to project, just because of interest rates and all the things we've talked about before. But given all the things in place, values could rise 5 to 10 percent a year.

Rosen: I'd say $600,000 in the base case, and if we get another recession, something different than that.

Q: Something lower?

Rosen: Lower. The snapshot as you heard is that it's very strong right now. The fact that it's softening in the last two months in a lot of places around the country without interest rates going up tells me something is happening.


“I don’t believe in the bubble theory. I think there are cycles when real estate isvery good, and then cycles when it corrects.”


“What’s happening in the Bay Area is we have a deficit of home ownership, and sopeople took advantage of the low interest rates and easy credit to become homeowners.”


“What we’re seeing is basically buying activity where people are putting roofsover their heads. You can’t use the bubble criteria there.”

The relentless rise of Bay Area home prices

Strong demand, along with low interest rates, is helping keep Bay Area home prices aloft. The median home price for the nine Bay Area counties overall reached a record high of $552,000 in October - slightly above the previous record of $549,000 set in August.

Figures shown here are the median price of single-family detached houses in each of the nine Bay Area counties in October, along with the percentage change from October 2003.











































Annual median price of single-family detached houses in the nine-county Bay Area:

1995 $227,000

1996 $234,000

1997 $254,000

1998 $274,000

1999 $302,000

2000 $364,000

2001 $386,000

2002 $422,000

2003 $455,000

2004 $527,000

(through October).

Todd Trumbull / The Chronicle.

Source: DataQuick Information Systems


Avram Goldman

Age: 57

Job: President and chief operating officer, Coldwell Banker Northern California

College: UC Berkeley, graduated Phi Beta Kappa

Board affiliations: National director of the National Association of Realtors; Habitat for Humanity, Humanitarian of the Year; San Francisco and Contra Costa associations of Realtors

Family: He lives in the Rockridge area of Oakland with his wife and three daughters.

John Karevoll

Age: 53

Job: Analyst

College: Volda College in Norway

Family: He lives with his wife and two sons in Running Springs (San Bernardino County).

Ken Rosen

Age: 56

Job: Chairman and professor at the Fisher Center for Real Estate and Urban Economics, UC Berkeley

College: Doctorate in economics from MIT

Family: Not provided


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