More proof that all real estate is local.
The idea that all real estate is local, down to the city, Multiple Listing Service area and even neighborhood level, has gotten controversial lately. Critics of the idea claim it's just another one of the real estate industry's smokescreens, in this case intended to obscure the fact that if Central Valley prices are down 40-plus percent, Peninsula and South Bay prices should also be, and soon will be.
And, in fact, many Peninsula and South Bay neighborhoods have lost 40 percent—or more—since 2007. But even more haven't, which suggests that neighborhood marketplaces can differ dramatically. The best way to verify this is to look at the most important indicators for each marketplace.
Let's look at a typical cross-section of the local market, in this case single-family homes in the cities or MLS areas of Central San Jose (including Rose Garden), Willow Glen, Santa Clara, Sunnyvale, Cupertino, and also Campbell with adjacent areas of San Jose. Why these cities and MLS areas? For four good reasons. First, all my clients are looking in the South Bay these days (fortunately, not for the same home) and there's no better way to show them what's going on than to hand them a few charts. Second, the MLS areas and cities I've mentioned are, for the most part, meat-and-potatoes markets. They aren't the frou-frou markets of the mid-Peninsula, whose prices make buyers shudder. In fact, the lower end of this group is so just-plain-folks that it performs much like the East Bay, the Central Valley and, I suspect, much of California. But, reason number three, this group still has a broad range of prices, from $200k to $2M, which helps us track the performance characteristics of a full range of neighborhood marketplaces.
So, reason number four, you can use this information, with seat-of-the-pants adjustments, to see how your own neighborhood market is doing—divide these prices by maybe .6 if you live on the mid-Peninsula, and by .8 if you live from San Carlos to Burlingame. But if market conditions are portable across different parts of the Bay Area, doesn't this negate the idea that all real estate is neighborhood local? No, because I don't claim that the market for homes in, say, the Burbank neighborhood of San Jose is unique to the entire real estate universe. I do claim, however, that each price range in your area consists of neighborhoods with certain common characteristics—amenities, ambience, location, school quality, demographics, typical financing and housing stock and lot size—that differentiate them in important respects from neighborhoods in other price ranges in that same area.
So rather than track by city or MLS area which, if all real estate is neighborhood-local would be too broad a brush, let's take this South Bay market and slice it into five quintiles by average list price. And for our time period, let's use the most recent month likely to have the majority of its sales closed and therefore give us the most complete up-to-date information, May 2009.
Here's how the quintiles, each of which represents roughly 85 pending and (mostly) closed sales, stack up in terms of average list price. Remember, each quintile is really a cross-section of similar neighborhoods grouped by price to represent the micro-markets of this South Bay market.
As you can see, there's a broad range of average list price for such a relatively small and contiguous area—it might take you an hour to drive its circumference by freeway—which tells us that this market has a broad range of amenities, ambiences, locations, school quality, demographics, typical financing and housing stock and lot size, which in turn tells us that even this relatively small market has micro-markets. Which suggests that, at the least, all real estate looks, costs and lives local.
Next let's look at days on market (DOM) for each quintile/micro-market to see how long it's taken the average house to sell.
Again, there's a fairly broad range, with a 39 percent difference between highest and lowest DOM, which means that each quintile marches to its own drummer. The chart also seems to tell us that, with some minor variation, the higher the price, the quicker the sale.
"Bid", the average amount homes sell for, over or under list price, also tells us a great deal about market activity in each quintile.
In this chart, list price is represented by zero, with overbids above the zero line, underbids below. And there's a surprise: now the situation is the reverse of the previous chart. Instead of generally looking stronger as list price increases, now the market generally looks weaker as you go up the price range. This indicates that market conditions are stabilizing at the low end, while continuing to erode toward the top end.
Why? The next chart gives us a big clue.
Inventory increases as you move up the price range, which means that competition for buyers increases as well. That's assuming, of course, that a) demand is equal in all price ranges, and it may not be, and b) sellers are equally motivated in all price ranges, and they may not be.
Let's wrap up this section by looking at my favorite market indicator and yours, absorption, because it'll settle the question every buyer and seller asks: is it a seller's or buyer's market? Or maybe I should say, "every buyer should ask", because these days buyers naturally assume that it's a buyer's market. But is it, in all price ranges?
As faithful readers—both of them—know, absorption is simply the ratio of sold to unsold homes for any given period, in this case May 2009. The chart above shows that absorption goes down as list price goes up, at least in the South Bay market we're looking at and, in fact, in many local markets. This confirms that the low end is stabilizing, and that the top end has a ways to go. But these numbers don't tell us everything they can without being put in context: how good is the 5th quintile's .36 absorption ratio, and how bad is the 1st quintile's .16 ratio?
.36 absorption may not look good—it means that only one in three 5th quintile homes on the market in May 2009 went into contract—but it is, in fact, a very respectable ratio, and not just by the standards of the 2009 real estate market but by the standards of any market. A ratio in the .40s means boom times. A .16 ratio, on the other hand, is as bad as it looks and worse. It's a marketplace that doesn't quite have a "going out of business" sign, but it's one that's open by appointment only.
So there it is, one South Bay market going in at least five directions, which means that no one "South Bay market" exists, except for the convenience of non-combatants like economists and reporters who can afford to throw all these disparate micro-markets in one pot and call it a market. But those of us in the trenches—buyers, sellers, agents, even appraisers and the lenders they work for—may be very surprised, and not pleasantly, if we adopt this one-size-fits-all approach.
To demonstrate these nuances even further, let's drill deeper and compare these quintiles which, as you'll remember, are really neighborhoods grouped by list price to represent micro-markets, by the well-known signature of this bust, the bank-owned home (REO), and its near cousin, the short sale.
Now the differences are dramatically apparent. In the 5th quintile, REOs make up over half of pending or closed sales, while short sales, which are often tomorrow's REOs, account for more than one in five. But note that the proportion of REOs and short sales decreases rapidly as we move up the price range. By the 2nd quintile, REOs have disappeared and short sales are a negligible percentage. Here's the key to why each of these quintiles—neighborhoods grouped by price range—performs so differently these days: banks are motivated sellers although, at least in this area, not necessarily desperate sellers. The chart also shows you which price ranges were fueled by risky lending practices during the boom, and which have and most likely will continue to suffer the consequences.
So, okay, it looks like we have at least five different marketplaces—and we could easily have had ten or fifteen—within a relatively small area, which vouches for the existence of micro-markets, which endorses the idea that all real estate is local. But even now you haven't gotten the whole story. Because some of these micro-markets even have their own micro-markets.
To identify them, let's look more closely at the bottom, 5th, quintile first, homes listed at $399,000 or less, using the absorption indicator.
Heard that bank-owned homes are selling briskly? Here's the proof: REOs in the 5th quintile had an outstanding, 2005 boom-like absorption rate of .53. And even "other", non-REO/non-short sale, homes sold at a very healthy .41 clip. That great REO absorption rate is the reason banks aren't necessarily desperate sellers these days, at least in this area: the low end of the market is largely a seller's market. First-time buyers and investors are hurling themselves at the most affordable homes, taking advantage of low interest rates (although a significant number of these sales are all cash due to appraisal and other financing problems) and prices we haven't seen in these neighborhoods since 1999.
Only short sales, the neglected step-children of this market, have dragged their feet. The fact that short sales have a microscopic chance of closing, once they're in contract, has everything to do with the poor .23 absorption rate shown in the chart. And even that low rate is wildly overstated. Remember, the absorption rate counts not just closed sales, but also pending sales that went into contract in May, seven to eleven weeks ago and haven't closed. Remember also that the typical escrow is only four to six weeks. So it's not a good sign that just 2 of the 27 short sales in the 5th quintile have closed, while 30 of the 43 REOs and 11 of the 14 "other" sales have. And it's a fact that very few pending short sales will close before their lenders foreclose.
Days on market tells us much the same thing about these 5th quintile micro-market micro-markets.
Again it's clear where the action is. 5th quintile REOs are selling just as quickly as homes in the 1st quintile, but at a much higher absorption rate. So while 1st quintile—top end—homes sell quickly, they only sell quickly when they sell, which is not often. But at the opposite end of the spectrum, 5th quintile REOs not only sell quickly, they sell often, and often with multiple offers, and often with that gold standard of real estate transactions, the all-cash deal. And REOs would sell even faster if banks didn't insist on a) having them on the market a while before they accept offers, and b) taking their time responding to offers.
Average bid among the three components of the 5th quintile confirms what we've already seen.
Yes, REOs have been selling for an average that's above list, which suggests competition for REOs, which suggests that demand for REOs exceeds supply. "Other" homes, on the other hand, have been taking a shellacking.
So here's the big question: are REOs selling like hotcakes because banks give them away? In other words, does the "bank-owned discount" so cherished by economists and reporters really exist?
Apparently yes, according to the numbers, but this is one time the data do lie, or at least mumble. Because that 5 percent "bank-owned discount" you see above doesn't begin to do justice to the difference in condition between the typical REO and the typical conventional sale, even in a price range where relatively few homes have gotten tender loving care. But if your job is only to look at numbers, not houses, then yes, there's a "bank-owned discount".
Next let's see if the three components of the 4th quintile, with its list price range of $399,000 to $550,000, show the same differences.
Not as much, but note that the absorption rate (or "success rate") for both REOs and "other" is more than respectable, and higher than this sub-market's total average of .29 would indicate. They aren't blazing seller's markets, but they are doing far better than many other local markets. Again, short sales bring up the rear of the column, and since just 3 of 30 pending sales in this quintile have closed, their real absorption rate will be even lower than the chart indicates.
The 4th quintile's days on market has a surprise.
Yes, amazingly, "other" homes are selling quicker than REOs, which suggests that Ma and Pa Seller are learning how to cope with the new "less is more" marketplace. Of course, as anyone looking in this area and price range knows, not every REO and low-end conventionally-sold home is flying off the shelf these days. I've seen a few homes that have been on the market a year or more with only modest price reductions, as well as homes on the market months with no reductions. But all this means is that this market isn't shy about identifying unmotivated and unrealistic sellers.
Is there a "bank-owned discount" in the 4th quintile?
Apparently, and now the "discount" is much greater but, again, I'm skeptical. For a discount to exist, REOs and "other" homes must be in identical condition. If they aren't, any price difference would be a deduction for the inferior condition and presentation of REOs and not a discount. But if both REOs and "other" are in identical condition, why would buyers pay more for "other" homes than REOs? Because buyers are fools? Yes, there's a school of thought that says this, either in so many words, as on the blogs, or in the more polite language of the academic ("buyers don't have enough information") but when every listing is on the Internet this doesn't hold water. So, again, what we're really measuring here is the premium buyers will pay for the invariably better condition and presentation of the typical "other", conventionally-sold home.
So there you have it: seven cities or MLS areas and at least nine different sub-markets. Plenty of proof that all real estate is local. And, in this case, plenty of proof that, if you're looking at affordable homes, you'd better bring your best game.