Cold as a banker's heart.
A long-neglected term, "short sale", gets a new life these days within the real estate community.
We'll look at what a short sale is, what causes it, how lenders are responding, how short sales perform in the marketplace, what effect they may have on the market, and for how long.
Despite its recent resurrection, ask most local real estate agents what a "short sale" is and, if they know—and the blissfully ignorant don't—they'll tell you it's a sale in which a lender lets a borrower sell her home for less than the outstanding loan balance. The proceeds from the sale of her house are "short" the loan balance.
It's a definition that doesn't begin to scratch the surface.
Let's look at a typical short-sale scenario and how it begins. It's 2005 and Homeowner X pays $699,000 for a home, financing her purchase with a first loan of $559,200 and a second loan of $139,800. That's 100 percent financing: the first and second loans equal the purchase price of $669k. I bring this to your attention not because there's anything inherently wrong with 100 percent financing, just as there's nothing inherently wrong with any loan product as long as the borrower understands both the pros and cons of that product. What's been overlooked in all the hoopla about "risky loans" is that in every case—whether it's an option ARM with a 1.5% teaser rate, a "safe-and-sane" thirty-year fixed at 7.5% or a "hard money" loan at 11%—the borrower always gives up something to gain something. Always. Even with the so-called gold standard, the thirty-year fixed-rate fully-amortized loan.
Risky loans didn't cause the "mortgage mess". It was risky loans in the wrong hands.
How did those loans wind up in the wrong hands? In a variety of ways. By qualifying borrowers at the teaser rate, for example, not at the much higher adjusted rate. By making low-documentation and no-documentation loans far too accessible. And by layering risk on risk, as when no-doc financing was combined with 100 percent financing.
In Homeowner X's case, let's say that she a) had no money for a down payment, which indicates a borrower with no safety net, and b) maybe fudged her income numbers, with or without the able assistance of her loan agent, under pressure to make his quota, and c) was aided and abetted in this caper by a lender more interested in making a quick buck on the secondary market than in making a secure loan. Let's add that d) maybe she didn't have the best credit, or maybe she had no credit. Let's also add that everyone involved in arranging and approving the loan knew that Homeowner X can't afford the mortgage payments when the interest rate adjusts in a month or three months or a year.
But Homeowner X is told (if she's told anything except "sign here") not to worry, because California real estate always appreciates 12 percent a year, so in no time she'll have enough equity to refinance and break even or maybe make a few bucks on the deal. That's the sales pitch, at least from some loan agents, working for some lenders.
Then three things happen, all of them inevitable. First, her interest rate adjusts, just like the fine print said. Second, real estate stops appreciating in her neighborhood, as even the California Association of Realtors® predicted back in 2005. Third, the lenders who got her into this mess either disappear or pretend that this one-night stand never happened. All of which not only makes it difficult or impossible for her to keep up with her payments. It also makes it difficult or impossible for her to refinance without bringing money to the table, money she doesn't have or she probably wouldn't be in this mess in the first place, while at the same time removing potential buyers of her home from the market.
Buyers much like her. Buyers who in the past wouldn't have been buyers. Buyers who now aren't buyers once again. Buyers who should never have been buyers. Woops!
Homeowner X struggles to stay current with her rising loan payments. Or, if she has an option ARM, she makes payments large enough to keep her lenders from filing Notices of Default but too small to pay down the principal, so the balances on her two loans go up instead of down. Time to sell and get out, right? Perhaps, but her $699,000 home may have lost value, and $699,000 is, as you'll recall, also the beginning total balance of her loans. Maybe her $699,000 home has lost only 4 percent in value, but that's $27,000 she'll need to pay off both loans, plus her selling or refinancing costs, and that's $28,000 she doesn't have. And she might need to bring even more than that to closing, because her current loan balance could be higher than the beginning balance. And if she's fallen behind, they're be penalties and late fees.
And we'll see later that a short sale house may be a stigmatized house, as much if it were on a busy street or next to a roaring freeway, which means it'll sell at a discount to comparable non-short sale homes, which means her home won't sell until it's marked down lower—perhaps much lower—than the market value of comparable homes.
If this litany of homeowner woes sounds like I've accepted the bubblehead credo, I should point out that bubbleheads have, at least in my area, been predicting the imminent demise of real estate since the late 1990s, long before risky loans became a factor. Bail-out? The mortgage mess bailed out the murky thinking of the bubble blogs. They'll give you fifty reasons not to buy a home but, until they got the free gift of loose underwriting, all the bloggers had going for them was the inevitability of market cycles. Predicting a downturn in real estate is like predicting the sun will set.
And since the mortgage mess has muddied the waters, I should also mention that the current market is exposing just which neighborhoods were pumped up by risky loans in 2005 and 2006 and, so far at any rate, they've been the ultra-affordable neighborhoods. Which makes sense if you understand what created the market for risky loans: lenders looking for profits in all the wrong places, all the places no one else had gone yet, and consumers who under traditional underwriting standards would never have had the income, assets or credit to get home loans.
What's ironic about this is that the demographics of these borrowers aren't the demographics of Internet users. It's my experience that high-risk borrowers are often people who look for community from their neighbors, not from their computer. So those earnest exhortations on the blogs to avoid risky loans were read, not by people likely to use risky loans, but by the people least likely to go near a loan office.
Back then the bubbleheads weren't just preaching to the choir. The choir was preaching to the choir.
Those blissfully ignorant agents I referred to, the ones who aren't too clear on the concept of short sales? They work in Silicon Valley's midrange or top-end markets, where short sales and foreclosures have always been few and far between, and where homeowners haven't regularly found themselves "upside down" (had a loan balance on their home higher than its market value) since the tech bust of 2001. But Valley agents who work in neighborhoods where single-family homes sell for $900k or less are seeing more and more short sale listings. In one local city, Santa Clara, short sales account for a mind-bending 25 percent of active inventory as this is written in late January 2008.
Often these blissfully ignorant agents have been in business less than ten years, or since Silicon Valley real estate recovered from the recession-driven doldrums of the early 1990s. It's telling that of the three short sale Q & A articles I found on the California Association of Realtors® Web site, one dates from January 1994, another from September 2007. That thirteen-year gap means it's been a long time since "short sale" was part of a California agent's vocabulary.
It certainly wasn't part of mine until just a few months ago.
My education started innocuously enough with a September 7, 2007 article by M. Anthony Carr, posted on the Realty Times Web site, called "Lenders' Worst Enemy in the Short Sale Arena". Carr recounted two instances of corporate not-my-job indifference that, when combined with a fatal reliance on an "expert" thousands of miles from the market, short-circuited two short sales, cost a lender big bucks and unnecessarily put homeowners in foreclosure.
In the first case, a Washington DC-area condo received an offer of $219k, slightly below its estimated market value of $230k. In a slow market, most motivated sellers—or at least those sellers not hamstrung by a desk jockey in their lender's short-sale department—would either take this offer and run or respond with a token counter-offer. We are, after all, talking about a difference of only $11k, a difference that could and probably will evaporate in a matter of months as a soft market gets even softer.
But according to Carr, "the short sale representative in California [three thousand miles away]...said he had to have $262k or the offer was no go. The appraiser in Texas [fifteen hundred miles away] agreed with him...". (That Texas appraiser must own a very high-powered telescope to be able to appraise a home in DC.) The sale fell through, of course, since unlike the short sale rep and the appraiser, the buyer and buyer's agent were a) in the DC area, and b) active in the DC real estate market, and c) under no illusions as to the market value of the condo. Wouldn't this attitude needlessly send properties to foreclosure, the listing agent asked the short-sale rep? "Not my department", he said. And therefore not his problem.
Brr. Did it just get chilly in here?
In the second case Carr reported, a short sale listed at $559k got an offer at $550k shortly before the scheduled foreclosure sale, and not long enough for the buyers to arrange their financing. But instead of delaying the foreclosure to accommodate these obviously motivated buyers, the lender auctioned the home to an investor for $494k, $56k less than the first buyers had offered. The investor then offered the home to the first buyers at $552k, and they would have bought except that "a title search revealed that there was a federal government lien on the house". (Question: why didn't the listing agent run a preliminary title report before he put the house on the market? Homeowners usually stop paying their other bills before they stop paying the mortgage.)
"In both cases," says Carr, "the lender employees didn't talk to each other...[in the later case] a simple phone call from the short sale department to the foreclosure department would have saved this lender $56,000". Not to mention a foreclosure on some homeowner's credit history, and a below-market "comp" to cripple a neighborhood's real estate market.
A few weeks after reading this Laurel-and-Hardy approach to loss mitigation, an agent in my office mentioned a "scathing" New York Times article accusing Countrywide, the largest mortgage lender, of not honoring public promises to modify loans of distressed borrowers. I found the article on the Internet, and read that "borrower advocates who work with a broad array of lenders say that none make it harder to modify loans than Countrywide...[which] deploys a 2700-member unit, called the HOPE Team, that it says helps borrowers modify their loans and hold onto their homes...[but] according to a dozen borrowers interviewed for this article, and thousands more who are working with borrowers' advocates, it is often difficult to reach Hope staff members. When they do, these people said, they encounter hostility and are charged large and unexplained fees throughout the foreclosure process—whether or not they wind up keeping their homes".
The Times quotes Countrywide as claiming that "it has saved 39,582 mortgages from foreclosure so far this year...but according to Countrywide's own data...roughly 450,000 [of the mortgages it services] are delinquent. So providing home preservation assistance on the 39,852 loans amounts to just 8.8 percent of Countrywide borrowers who have fallen behind". Even at that, Countrywide's "workout" numbers may be wildly optimistic since "almost 14 percent of its homeownership preservation efforts involved borrowers who agreed to sell their homes for less than their loan amounts, called short sales, or involved homeowners turning over their deeds to Countrywide to prevent a foreclosure". The numbers say that about 5580 Countrywide borrowers so far have lost their home despite (or because of) a loan workout.
So maybe there aren't too many borrowers mourning the demise of Countrywide, but as I always say, the media doesn't often get the complicated stories right. But then a week later I talked to a guy in the front lines of short sales, and what I heard from him was even more chilling.
I'll call this front-line soldier Salvador. Salvador is a bright guy and a good businessperson. I call Salvador when I need his crew to clean my listings. Like many, Salvador got into real estate part-time a few years ago when real estate was roaring and, like many, he struggled even then. And real estate is moaning now, not roaring, at least in the neighborhoods where Salvador sells or tries to sell. So to buck him up, I mentioned that I'd seen his ad for a San Jose listing. He looked mournful and, knowing a little about how tough the San Jose market is these days, I expected a heart-tugging story of too much work, too many competing listings and too few buyers.
It was worse than that.
In a way, what Salvador told me was the old old story. Yes, his listing was on that down-bound train to foreclosure, but for once the reason had nothing to do with predatory lending, subprime or 100 percent financing, or the "liar loans" and "exploding ARMs" that have lately made headlines and brought down many a homeowner. His seller was simply a man, recently divorced, who couldn't make the loan payments by himself, a situation that can send homeowners into foreclosure even when homes sell like hotcakes and loan underwriters are allowed to be the real nitpickers they itch to be.
Miraculously, Salvador's listing had gotten an offer, which he'd dutifully submitted for approval to the lender, Bank of America. Buyers normally expect sellers to respond to offers within a day or two, or even in hours, but B of A hadn't responded to this offer—yea, nay or maybe—in almost two weeks. Salvador was thinking of calling his contract at the bank, even though it was "premature": he'd been told not to expect a response for four to six weeks! Why this eternity? Because he'd also been told that B of A has one processor for every one hundred short sales. So while his offer inched its way to the top of that overwhelmed processor's heap, competing inventory poured onto the market, list prices of old listings were slashed, neighborhood home values plummeted, and the buyer who'd made that offer was almost certainly casting a covetous eye on other, possibly nicer, quite possibly cheaper and most certainly fresher homes.
Here's a modest suggestion: what if B of A and Countrywide hire back the thousands of loan processors they laid off when business tanked and plug these former processors into their loss mitigation departments? No can do, I guess. Loan applications mean potential profits, while short sales mean potential loses. Gotta tighten the old corporate belt, even if it means that more than a few people suffer.
Brr. Did someone leave a window open in here?
A few weeks after I heard Salvador's story I read a reader's response to the Inman News article "Loan servicers sign on to Bush's HOPE NOW plan". As you may have heard, HOPE NOW is a "private-sector plan to help struggling homeowners" keep their homes, and a laudable "example of government bringing together members of the private sector to voluntarily address a national challenge", according to the White House Web site. A fine idea, and great PR at a time when the mortgage banking industry could use it, but completely bogus according to this reader, an agent in California's notorious Central Valley. Writing from "the heart of Foreclosureville", this agent reported "I've got clients calling me regularly, fearful about losing their homes. Of course, I tell them to first contact their lender to look into some kind of a loan modification. And you know what? The banks won't do it!"
Yes, he knows the reasons why. "Loss-mitigation departments are dramatically understaffed; investors have limits on restructuring (only so much profit can be lost); they need some kind of assurance the borrower will get current again; and in many cases the person on the phone is a minimum-wage employee with no decision-making ability beyond reading his or her script".
Another letter to Inman, from someone whose company "negotiates short sales", reports that homeowners "only a payment or two behind are forced to talk to Collections". You can well imagine the warm fuzzies that follow: "they get abused verbally, and the only option they are given is 'pay now or move because we'll foreclose'". Or they speak to someone in the workout department who tells them they need to fill out an application, plus provide financial information and a letter of hardship. "Many times the paperwork never shows up, or when it does, it gets lost by the servicer". The bottom line: "trying to track down paperwork; waiting on hold indefinitely; getting different 'stories' from each person they talk to; never finding one person willing to take responsibility for their file—it's very easy to get frustrated and give up with little or no progress made".
The news from the front lines was getting worse. And I was about to go there myself.
Three articles made it clear what the battle would look like.
The first was veteran real estate journalist Kenneth Harney's "Investor Report: Short Sales Transactions Hot" posted on the January 11, 2008 Realty Times. Harney interviewed a short sales specialist, Raffi Tal of Los Angeles, who told him that one of the most common "potential complications" of a short sale is "houses that have not just one mortgage lien against them, but two or even three: a first mortgage or deed of trust [as home loans are called in California], a 'piggyback' second and a home equity line". And "all the lenders...need to agree on terms before a short sale can proceed. In a foreclosure, the junior lien holders [the second loan and perhaps an equity line] typically would get wiped out. But in a negotiated short sale deal, they're likely to hold out for a least a little piece of the proceeds—maybe 10 cents or 20 cents on the dollar—rather than settle for nothing". So it's not just a matter of getting "the lender" to accept less than the loan balance. It's a matter of getting two or even three lenders to accept less, and the ones with the most to lose by playing hardball seem the ones most likely to play hardball.
Brr. Did somebody turn on the air conditioning?
And sometimes short sales aren't even that simple.
The January/February issue of California Real Estate, the official publication of the California Association of Realtors®, has two stories reporting the new realities of the real estate marketplace. In one, an agent from Concord is quoted as saying that "some banks are promising answers (to offers) in 60 days. That puts sellers in a horrible position, and a lot of offers fall through because the seller [he may mean "buyer"; short sellers don't have much choice] doesn't want to wait that long for an answer". This agent tells of "a $500,000 property reduced to $475,000 after 30 days and to $445,000 after 30 more days", ample time for buyers to vote with their checkbooks on the market-correctness of each succeeding list price. "Finally, the seller received two offers—one at $445,000 and another slightly below—and presented the higher one to the bank. The offer looked like a go until a bank appraisal set the value back at $470,000—even though the property hadn't sold the week before at that price. The bank eventually (italics mine) countered at $453,000." Meanwhile prices in this market continue to slide and "what was a good offer before, probably is no longer a good offer". In other words, last month's market-correct offer is this month's above-market offer—and how many buyers are willing to pay too much, especially when the media and their friends are telling them DON'T BUY in blazing neon letters ten feet high? And if that's not enough to kill demand for short sales, the agent says "I know one (buyer) who went through three or four short sale offers before one finally funded".
And notice that once again an appraiser throws a monkey wrench in the works. You have to wonder if these appraisers, obligingly propping up prices as they fall, were the same appraisers obligingly pumping up prices as they rose. And the same appraisers blaming everyone but themselves. And assuring us that they're the last honest men in real estate.
In another article in the same issue of California Real Estate, economist Richard Green, professor of real estate finance at The George Washington University, reminds us that many loans in default "are not owned by a lender. They were put into trust and they're tranched [divided] and they're owned by different classes of investors. It's not entirely clear actually who owns these things". If that's not enough—what faceless, heartless institution or institutions must the short seller track down to negotiate with?—Green says that "certain classes of investors, those who have senior positions" get all their money back if the property goes into foreclosure. If I understand this correctly, what incentive do those investors have, if and when they're found, to negotiate a short sale?
Or, as Frank Nothaft, chief economist of Freddie Mac, puts it, "Right now, we're outside the economic models".
The last cautionary tale is by the late Robert Bruss, known for his "Real Estate Mailbag" advice columns and special reports. Browsing through the "20 Essential Questions Smart Home Buyers Must Ask to Avoid Overpaying In A 'Buyer's Market'", I found this advice on short sales: "Lenders want to be certain that the seller walks away with nothing! (italics his) As a smart buyer, unless you and your buyer's agent somehow smell a bargain [and we've seen how hard lenders work to prevent anyone from getting even a whiff of bargain], or you absolutely must have that home, keep looking and don't waste time on a short sale which often fails". This from a guy known for his positive outlook.
My latest source on front-line conditions in the short-sale wars is an agent I talked to a few days ago who I'll call Bob. Bob, I should tell you, has forgotten more about real estate than most agents will ever know. In the past year he's had three short sale listings, and just turned down a fourth. Bob confirms Raffi Tal's contention that the holders of second loans are notorious for torpedoing short sales. According to Bob, some will agree to a purchase price over the phone, then stall or withhold vital information (in his case, the loan pay-off) so that escrow can't close. And Bob claims you're lucky if you can even get them on the phone so they can lie to you. Lender accessibility and response time vary greatly. Some lien holders get back to you quickly, some never. Since, as we've seen, the junior lien holders' only hope of getting even pennies on the dollar is to negotiate a short sale, this stonewalling seems not just reprehensible but self-defeating. Bob tells me it comes partly from the decision-by-committee culture of the institutions who bought securitized loans, and partly from a naive belief that being hardnosed will squeeze a better offer out of the buyer. But in a declining market it's the buyer, not the investor, who has the leverage. Buyer just picks up his marbles and moves on to other houses and more realistic sellers, and in most markets there's an ample supply of both. Bob says everyone involved in a short sale needs the patience of Job: the only short sale listing he's had that closed took "months and hundreds of phone calls". Bob does say that lenders and institutional investors are far better prepared to handle short sales now than they were a year ago...which makes you wonder how bad it was a year ago.
Brr. Man, it's a meat locker in here.
Well, I really hate to criticize a specialized and highly-nuanced industry I don't understand; I like to think that this discretion is what separates me from the academics, bubbleheads and other gadfly wannabes. On the other hand (famous last words) I'm reasonably certain that snafus, surliness and heroic foot-dragging don't happen by accident.
That's all I'm going to say about that.
But enough generalizing. Now let's turn our attention to one beleaguered outpost in the short sale wars, that local city I mentioned awhile ago, Santa Clara, where about a quarter of active listings are short sales. Let's look at that city's market from top to bottom during the period 9/1/07 to 12/31/07. Why Santa Clara? For several reasons. First, because it's squarely in the price range most affected by short sales. Second, because it's large enough to give us adequate data, but not so large that the data is unmanageable (a big consideration when much of it can't be exported to a spreadsheet). And, third, because I've been working with buyers there, the kind of on-the-ground experience that I like to think separates me from, yes, the academics and bubbleheads. Why look at the last four months of 2007? Because this period reflects the immediate aftermath of the credit panic that started in August 2007.
First, let's get a feel for how inventory in the city of Santa Clara shook out in the last third of 2007.
I should mention that I've counted only Santa Clara single-family homes for sale, and only those within the Santa Clara Unified School District, a K-12 that generally has low test scores. I don't include Santa Clara single-family in the Campbell or, most particularly, Cupertino elementary districts, because a highly sought-after school district raises home prices above what the average buyer is willing or able to afford. And because highly-regarded schools attract more affluent buyers, short sellers in the Cupertino district have been rare.
You'll notice that I've counted not just short sales but also sellers described by their agents, in one way or another, as highly motivated; we'll see if, and how, a connection exists between motivated sellers and short sellers. I also have a category for bank-owned properties; a category which I call "other (all)", which includes all other properties, excluding the afore-mentioned short sales, bank-owned properties and motivated sellers; and finally, a category for a sub-set of "other (all)", properties over thirty years of age. We'll see in a moment why a home's age is relevant.
It's plain that bank-owned homes were almost non-existent in the Santa Clara market during the last third of 2007, which suggests that this city's market is only beginning to process the consequences of loose underwriting. Short sale listings, which you'll recall are not bank-owned but often become so, accounted for 17 percent of inventory in late 2007; by late January 2008 they made up 24 percent, indicating that short sale inventory is on the rise.
Okay. Next let's look at how sales break down among these categories over the same period.
You can see that short sale listings account for fewer sales in proportion to their presence in the market or, put another way, short sale listings haven't sold as well as other listings. We'll speculate on the reasons in a moment. It's also of interest that sellers described as "motivated" accounted for proportionately fewer sales as well. We'll talk about this as well.
Next we'll look at my favorite market indicator, absorption.
Here it's easy to see the differences in performance among the five categories of sellers. As regular readers (both of them) know, I'm high on the absorption rate because it's the pulse of the market. Absorption isn't rocket science. It's simply the number of sales for a given period, in this case the last four months of 2007, divided by total inventory for that period. I say "simply" and yet absorption is the most important measure of a market for any buyer, seller or agent: it's the "success rate" for that market.
The stratospheric success rate for bank-owned property simply means that a whopping two of the three bank-owned homes listed during this period sold. More noteworthy is the discrepancy in "success rate" between, on the one hand, short sellers and motivated sellers and, on the other, the two categories of "other", non-short/non-motivated, sellers. Here you'll see why I separated "other" sellers into the categories "other (all)" and "other (older)". The market we're studying—Santa Clara with Santa Clara schools—is on the whole remarkably homogeneous: if you've seen one Santa Clara neighborhood, you've seen most of them, which is one reason Santa Clara is inexpensive. But there's a relative top end to Santa Clara, Rivermark and the other new developments in Northside Santa Clara. Virtually every other neighborhood in Santa Clara is at least thirty years old and often older.
What makes the age of homes important? Because every Santa Clara short sale home I've seen is at least thirty years old or older. Not that the market for newer Santa Clara homes is doing all that well. One in four listings taken off the Santa Clara market unsold in late 2007 was a newer home. But none of the sellers of these homes were, or came back to the market as, short sellers, strong evidence that the mortgage mess has so far had a much greater impact on the very bottom end of the market, older homes, which suggests that this was the market most pumped up by risky loans.
That's why I've given the older houses of "other (all)" their own sub-set called "other (older)": to make it more likely that we're comparing apples to apples. This sub-set of older, obsolete housing stock minimizes two factors that otherwise might skew our comparisons: the broader appeal of new construction, and its higher price, both of which change buyer demographics. When we compare these other (older) listings with short sale listings, we're a lot closer to comparing the same housing stock, which means that we're a lot closer to comparing the same buyers and the same neighborhoods, and that's critical—although, as we'll see, we may still find significant differences in buyers and neighborhoods, and that's important too.
Next let's look at the average sales price of closed sales in the last four months of 2007 (a number of sales from that period are still pending and haven't closed). Isn't it interesting that the average sales prices achieved by both short sale sellers and motivated sellers are virtually identical, and that these averages are substantially lower than the average sales price of the most comparable category, other (old)? It's another suggestion that the categories of sellers under undue duress, short sellers and motivated sellers, are much the same sellers in much the same houses in much the same neighborhoods. I don't show bank-owned property here because neither late 2007 sale has closed as this is written.
Let's wrap up this section with a comparison of the average number of days that homes in each category spent on the market before selling.
Short sale listings had the awkward distinction of leading in this fatal statistic, at almost three months on the market. Three months might be a quick sale in Detroit or Modesto but it's a long long time in this area, and nearly three times as long as the closest comparables, other (older) homes. This lends credence to the contention that lenders are taking their time deciding how to (or even if they'll) respond to offers.
There's something else at work here. Remember, short sellers operate with damaging, artificial constraints. Not only are they unable to approve the terms of sale of their own home, but the original list price at which they come on the market often has more to do with their loan balance than on how much their home is worth in today's market. Even more than most sellers, the short seller bases his list price more on hope than on reality, more on wishful thinking than on what buyers will pay. Start at a list price too high and any seller, short or otherwise, will spend long unproductive days on the market.
Let's see if the numbers suggest that short sellers really do come on the market priced too high. Let's stay with the late 2007 crop of Santa Clara sellers of all kinds we've been following, and look just at those sellers who entered the market then and still hadn't sold as of 1/17/08. This nets us 29 short sellers, 13 motivated sellers and 55 other (older) sellers. Remember, these sellers are selling homes largely comparable in age. Next let's see how these three categories of sellers have responded to buyers' lack of interest in paying the original list price. Other (older) sellers cut their list price an average 2.1 percent over an average 96 days on market; motivated sellers slashed their list price a healthy 5.2 percent over 135 days; and short sellers took a chain saw to their list price, lopping off a whopping 9.1 percent over 81 days.
(By the way, the academic looking at the ostensible effect of certain key words used by agents in their MLS descriptions would doubtless conclude that having "motivated" in the description is the kiss of death for a seller. I can see it now: "Don't let your agent say you're 'motivated' or you won't sell as quickly and you'll sell for less". Everyone gets a good laugh at the real estate community's expense and walks away feeling really smart. But what the academic wouldn't know, because he looks at numbers only in the aggregate instead of individually, is that "motivated" is most likely to show up in the oldest listings, listings that have already been on the market longer than average. So "motivated" is nothing more than agent code for "notice me!" or, more eloquently, "Hey, I know my seller started off on the wrong foot, but now he tells me he sees the light and wants to sell". The problem with this public change of heart is that it's often too late. The listing is now so stale that it belongs in the dumpster. Buyers, if they notice the house at all under a pile of other, newer listings, are wondering what's wrong with it. Even the most liberal application of "motivated" won't restore a home's essential market freshness. And in today's market there's another potential impediment to selling: the seller may indeed burn with new-found zeal to sell, but his short sale processor has her taken phone off the hook.)
Let's take a moment to summarize what we've seen, and to speculate on what it means.
Look at the inventory chart again.
Short sellers are a big part of inventory, right? And all that extra inventory has to drag down prices, right? Yes and no. I'm not going to say that short sales—as they're presently and often ineptly and callously handled—aren't having any effect on the market. I am going to say that a) you can cut that short sale inventory in half to get a true idea of its impact on inventory, and b) any effect that short sale inventory has on sales prices will be far less than its numbers suggest, at least while they're on the market as short sales.
Why? Let's revisit the absorption chart.
The success rate of short sellers is half that of sellers of comparable properties: .18 to .36. Now let's put those numbers in perspective: .36 ain't great and .18 is far worse.
So I'm saying that, as real competition for buyers, short sale inventory is proving to be real estate's version of Mussolini's divisions: mostly on paper. I'm going to postulate that this inventory does have an effect, but most significantly in the still-important area of market psychology. Short sale listings hang on forever and often don't sell. For Sale signs lining every street create the perception among sellers that "there sure are lots of homes on the market". This demoralizes them, and demoralized sellers are more likely to reduce prices. For Sale signs that line every street also create the perception among market spectators, including buyers, that "there sure are lots of homes on the market". This paralyzes the few real buyers left with uncertainty and indecision. Not only do they have an apparently endless supply of homes to choose from, but they also have the tantalizing prospect that next month's inventory will be even higher and next month's home prices even lower, and so on, and so on...
Short sales, to the extent that the public knows about them, are like bank-owned property in that they encourage the idea that real estate is in distress. And who wants to buy real estate when it's in distress? "Everybody who can get financing" should be the answer, but that's not how market psychology works. Ever notice that buyers don't buy in buyer's market, only in seller's markets?
I've mentioned that the success rate of Santa Clara short sellers in late 2007 was half that of sellers of comparable other (older) properties. But are those properties really comparable? Are these really the same homes? The sales price chart below says that short sale listings sold (when they sold) for about $35k less than other (older) listings.
This might suggest that short sales sell at a discount to the market. In other words, they're bargains, screaming deals! I know at least one highly successful, highly sophisticated agent who thinks so, and there must be plenty of other would-be wheeler-dealers out there who think so as well. But you know better. Yes, you know how hard lenders make it for anyone to get a screaming deal or, for that matter, any kind of deal, on a short sale. The sales prices of the few Santa Clara short sales that have closed will confirm this.
So you're inclined to believe that something else is going on. And it is. Short sales, as well as foreclosures, have hit certain price ranges far harder than others, even in a homogeneous city like Santa Clara. Which is to say that short sales and foreclosures have hit certain Santa Clara neighborhoods far harder than others. Which is to say that, as we'll see shortly, short sales and foreclosures have hit certain ethnic groups far harder than others.
Is there really no way to get a good deal on a short sale? Another agent I know suggests blanketing the market with offers, all of them contingent, so that if by some miracle you manage to buffalo a short sale department into giving you a good deal, you can back out of the other offers you've been papering the town with. This has a certain appeal, I guess, as long as you don't mind getting hand cramps from writing all those offers, but you may already have spotted the drawback: if every buyer, or even just a significant number, start throwing offers around willy-nilly, then lenders won't know which of the offers on their desks are real and which are just fishing expeditions. The currency of the market—offers—will be debased: buyers will be back to making offers with Confederate money, exactly what got lenders in trouble in the first place. This strategy must be the manifestation of some immutable law of the marketplace: squirrelly behavior from one party in the market, in this case lenders, encourages, requires, demands squirrelly behavior from the others.
Here's another indication of the discrepancy of the impact of short sales. The average size of other (older) homes since Q1 2004 has ranged from 1309 to 1407 sq.ft. The average size of the twenty-eight short sales listed before 12/31/07 and still active as of 1/18/08 is 1175 sq.ft. So short sales are about 13 percent smaller than the average older home. Buyers with smaller incomes buy smaller homes. Smaller homes are usually found in traditionally entry-level neighborhoods.
Another factor may also influence short sale prices. There's a reason so many listings protest "NOT a short sale". (In fact, I'd discourage listing agents from using the word "short" anywhere and for any reason in their non-short sale listings.) Given their reputation—and nothing travels faster than a bad rep—you won't be surprised to learn that agents may be avoiding short sales like the plague. Yesterday this showed up in my Outlook inbox:
Today this appeared: "Five Common Myths of Short Sales." A leading real estate instructor assures me that short sales are really as easy as pie and, for a modest fee, will teach me the ropes.
So it looks like the word is out: don't touch short sales. These days buyers are a rare and precious commodity, and it's the equally rare agent who's willing to jeopardize his relationship with a bona fide buyer by getting her entangled in a house that a) is probably listed way too high, and b) probably won't close, and c) even if it does close, won't be a better deal than the non-short sale home down the street, and d) whether it closes or not, will have everyone tearing their hair out. Not the best client retention program, nor is it likely to garner referrals from that client.
Perhaps we've discovered that the market demands a "short sale discount" to compensate both buyer and buyer's agent for the extra time, effort and tenacity required. Not just the buyer, but also the buyer's agent, is the market for any home. The agent's time, effort and tenacity cost money. In fact, some agents say that time is the only thing they sell (I'd like to add "expertise" to this, at least in most cases). And certainly the buyer's time, effort and tenacity are also worth money (or at least carry an opportunity cost) although not every buyer realizes this.
Yet lenders refuse to give the market the short-sale discount it rightly demands. Predictable results ensue. Trace the history of Santa Clara short sellers and time after time they start out priced far too high, then slash their list price often to well below what they paid only a year or two ago. And still they can't find a buyer. And not because Santa Clara prices have plummeted. The average sale price of a Santa Clara home thirty years old or older declined only about 4 percent Q4 2007, compared to Q4s 2006 and 2005 (I compare Q4s because prices typically decline late in the year).
On the other hand, we need to take this "short sale discount" with a grain of salt. A short seller can hack at his list price as recklessly as he wants, but neither he nor the buyer has any guarantee that the lender or lenders holding the loans will accept any offer that low low list price attracts. That's the real problem with short sales: the disconnect between what the ostensible seller (the homeowner) says and what the de facto seller (the lender) will agree to.
There's something else in the average sales price chart that grabs my attention—big time: the homes of short sellers and motivated sellers sell for virtually the same price. This suggests that the homes in these two categories are extremely similar, which suggests that these homes are in the same neighborhoods, which suggests that these sellers have the same demographics. The absorption chart tells us that the success rates of short sellers and motivated sellers are also virtually identical, and identically miserable, at .18 and .16. This suggests that today's short sellers and motivated sellers operate under the same constraints. Which suggests that these two categories of sellers are one and the same or, more accurately, the same sellers distributed along the same edging-toward-the-abyss spectrum.
Which plants a broad hint that today's motivated seller is tomorrow's short seller. And if today's short seller is tomorrow's bank-owned property, then we've got a whole lot of bank-owned property in the pipeline.
Should be an interesting year or two in Santa Clara.
Finally, let's drill down deeper and see who these short sellers are and what might have made them so.
In looking at the fifty short sellers who passed through the Santa Clara market, successfully or (usually) unsuccessfully, in the last four months of 2007, these characteristics stand out.
1. A huge percentage (84 percent) had Hispanic surnames. The 2000 U.S. Census identifies 16 percent of Santa Clara residents as "Hispanic or Latino of any race". The Census Bureau's 2006 update, the American Community Survey, estimates this number at 17.7 percent. This leaves us three possibilities:
one or both censuses grossly underestimate the number of Hispanics or Latinos in Santa Clara
the Santa Clara Hispanic or Latino community increased from 17.7 percent in 2006 to 84 percent in 2007
the Santa Clara Hispanic or Latino community is suffering disproportionately—almost five times as much as the census numbers would suggest—from the fallout from risky loans
2. Virtually all Santa Clara short sellers purchased with 100 percent financing.
3. As the following chart shows, most short sellers purchased in 2005 and 2006.
The smaller number of short sellers who purchased in 2006 may simply mean that this class hasn't had as much time to "season" or get in trouble.
4. Virtually all short sellers had first loans described by RealQuest, the real estate information aggregator I use, as adjustable 30- or (sometimes) 40-year loans. Not fixed 30-year; adjustable 30-year. I'm not entirely sure what this means, but a loan agent I spoke with suggests that these may be option ARMs, with the borrowers qualified at an ultra-low teaser rate that adjusts upward in a matter of months.
5. Only fifteen (30 percent) had had Notices of Default filed by lenders, which suggests that, contrary to what you might expect, only a relatively small percentage of short sellers are in foreclosure. This may be why so few of them can persuade lenders to accept short sales. Borrowers may not have much leverage until they look like they'll be trouble.
6. Almost all short sale homes are owner-occupied. Not tenant-occupied, not vacant, but owner-occupied. In fact, the proportion of owner-occupied short sales seems higher than it is for non-short sales. Which means no speculators. Did another bubblehead article of faith just bite the dust? Oh yeah, I forgot: every homebuyer is a speculator.
7. It looks like twelve, or almost one quarter of these short sellers, refinanced at least once over what has been for almost all a very brief period of home ownership. I'm not going to trot out the "homeowners using their homes as ATM machines" cliché popular these days—this same statistic also means that three out of four Santa Clara short sellers didn't ka-ching—but it does raise the specter of homeowners walking away with tens or hundreds of thousands of dollars of equity in their pockets that either disappeared shortly after it was withdrawn or was never there to begin with.
8. While short sales have shown up in almost all parts of Santa Clara, two characteristics seem closely related. First, the frequency of short sales tends to decrease as you travel from 101 to 280, from north to south. Since sales price in Santa Clara tends to increase as you go from north to south, the positive correlation between lower price and higher number of short sales is predictable. And second, two neighborhoods in particular have been hit by short sales: a tract of very small, very starter homes north of Monroe near Lawrence called Green Vale, and the older neighborhoods of Northside Santa Clara. These two neighborhoods are some of Santa Clara's most consistently affordable. Again, it's no surprise that they've been hit especially hard by short sales.
Let's wrap this up by drilling even deeper to look at two particular short sales which I think summarize the challenges facing short sellers and their buyers these days. These two sales will, I think, tell you all you need to know.
Home A is a small three-bedroom/one-bath home located in a pleasant midrange Santa Clara neighborhood. The home sells in December 2006, off the MLS, for an apparently market-correct $644,500 and with 100 percent financing. By July 2007, only eight months later, homeowner has gotten in over her head, calls agent and tells him she has to sell right now ("must close in forty-five days!"). Agent responds to homeowner's urgency by listing the home at $500,000. Now, remember, it sold just eight months before at $644,500, and in July 2007 Santa Clara prices are as high as they've ever been. $500,000 is a blow-out price. Listing agent's fax machine—they love to fax offers down there—must be running out of paper every half hour. Still, it takes this super-motivated seller and her super-aggressive agent from July 16 to September 21—sixty-seven, count 'em, sixty-seven days—to get into contract, at a time when the average days on market is thirty-nine. And at a time when no one lists their home 22 percent below market. They still don't. Once in contract, the home closes October 13, fairly quickly. Look at this timeline and it isn't hard to spot the likely hold-up: the lender or lenders took almost sixty-seven days to approve the sale. Remember, buyers normally expect a response in a day or two or even less.
Next up for your inspection is Home B, a large and sharp four-bedroom/two-bath home that sells in January 2004 for $555,000. Over the next three-plus years the home serves as collateral for almost a million dollars in loans. It's hard to believe that even a refinance appraisal would value this home at $992,200, but it's likely that the property, when it next appears on the market in May 2007, is encumbered at close to the list price of $817,500. Market value is $100,000 less. The market reacts with studied indifference. The home is quickly withdrawn—oops, my bad—then re-appears the next month with a difference broker and a different strategy: a door-buster list price of $599,000, or about $200,000 below market. This should shake loose a few offers. Entire forests are leveled to write the offers that flood in on this home. Remember, the home still shows as an active listing on the MLS as offers pile up on the short-sale processor's desk. "Many offers in hand", pleads the listing agent—no mas!—adding "working with bank". A snappy ninety-eight days later the home is in contract.
Brr.
All of this grief makes me wonder why any agent would even accept a short sale listing, let alone pay good money to a trainer to learn how to crack this market niche. Sure, short sellers are "must-sell sellers", as the trainers' ads say, but no one knows whether they can sell. And sure, I'd gladly list the home of any former buyer of mine who has to sell short. But that's unlikely, given the neighborhoods I usually work in.
Doesn't the real estate industry have an obligation to roll up its sleeves and help short sellers? After all, the entire industry is culpable, right? My guess is that most of the agents who put short sellers where they are, deliberately or not, are either out of real estate by now or have one foot on the banana peel. Like Salvador, the agent I mentioned above, these agents work mostly or entirely in neighborhoods where not much is selling these days and not much will sell in the near future. No sales = no income = no career in real estate. Once again life addresses an overpopulation problem with its usual ruthless efficiency.
But, okay, let's say that somehow every agent bears responsibility for every short seller. After all, we all supposedly made a ton of money during the boom. Never mind that NAR numbers show average agent commission income going down over the past few years. Yes, it's a little more complicated than that—a few agents made money hand over fist, while the rest competed with a torrent of new agents nibbling away at their business. But now that the opportunists are bailing from real estate sales, let's ask the survivors to pay for the sins of the few now back stocking shelves at K-Mart.
And while we're at it, let's pass the collection plate and ask everyone else who made a few bucks off the housing boom to chip in. Appraisers, home inspectors, loan agents, title companies, home improvement stores, furniture stores, the media...local economies...regional economies...the national economy...even the global economy. If the housing boom lifted our economy out of recession and helped it find its groove until the August 2007 credit meltdown, then everyone benefited from it.
That's right, John Q. and Mary Bubblehead. Even you, the people who hooted longest and loudest at the red hot real estate market, had a piece of the action without buying a home then, now or ever.
As America's Number One Bubble Blogger says, "It's simple!"—not.
Suddenly a bail-out doesn't sound like such a bad idea!
Finally, how long will real estate markets such as Santa Clara feel the fall-out from bad loans?
Well, if I knew the answer, I wouldn't be selling real estate. I'd be writing a highly successful, nationally distributed newsletter. So no one knows. We're outside the models, remember?
But let's use some numbers from bond rater Standard & Poor, who estimates that the default rate for subprime loans originated in 2005 will be 8.5 percent, in 2006 18.8 percent, and in 2007 17.4 percent. We can work with these numbers, up to a point. These days not every defaulting homeowner is a subprime borrower, but subprime default rates are far higher than those of prime borrowers. While we don't know that every distressed Santa Clara homeowner is a subprime borrower, we do know that almost all are Hispanic, and that most subprime borrowers were persons of color. And S&P's predictions do correlate with our own data, which show a dramatic jump in overextended borrowers beginning with the class of 2005. So we can make vague and sweeping generalizations that are probably as good as anything else you'll find on this topic.
If the twenty-six Santa Clara short sellers from the class of 2005 are the full extent of the mortgage mess fall-out for that market, then we can expect about fifty-eight short sellers from the class of 2006 and about fifty-three from the class of 2007. These short sellers would increase current Santa Clara inventory, already swollen 75 percent from Q4 2006 to Q4 2007, by thirty-two sellers in 2008 (9 percent) and twenty-seven sellers in 2009 (7 percent). This projection assumes that it takes about two years for bad loans to go from origination to either default or short sale or both. If the failure rate speeds up, then the impact of these loans will also accelerate.
But recall that certain price ranges and neighborhoods have been hit harder than others. If all the projected short sellers come from owners of older housing stock, as they have so far, then the supply of that housing stock will be disproportionately amplified as the rate of short sellers increases. If in a typical year (whatever that is, but let's say 2006) about 86 percent of Santa Clara homes on the market are thirty years old or older, then the projected percentage increase in this inventory due to short sellers is over 10 percent in 2008 and over 8 percent in 2009.
Bear in mind that, unless lenders get their act together and start dealing with short sellers efficiently, short sellers will be more a shadow market than a real one. And even if lenders turn over a new leaf, it'll take time to dispel the negative reputation that makes short sales so uncompetitive now.
So I'm going to surmise that short sales won't compete for buyers as much as their numbers suggest—until they become bank-owned property.
Up until now there've been so few bank-owned properties in the immediate area that it's hard to gauge their likely future impact. However, from what little I've seen and from what an agent in my office who's selling REOs (Real Estate Owned, another name for bank-owned property) in Fremont tells me, bank-owned homes are usually priced to sell. No, this doesn't mean that banks are giving homes away, especially in an area with a strong economy. It does mean that bank-owned homes sell quicker, which is a good thing: if the Bay Area economy doesn't falter, producing its own crop of defaults, quick sales will contain the impact of bank-owned inventory on prices. Banks are known as efficient sellers. For them, home selling is strictly business; there's no emotional attachment, no naive belief that "the right buyer" will come along if they just hang on another six months. I know of at least one Fremont REO that had multiple offers, suggesting that, even if banks slash prices to cut and run, there's still enough demand locally to keep some sort of floor on home prices.
What effect will all this bank-owned inventory have on Santa Clara prices? To answer this question I went back to two other crisis points in local real estate history. In Q4 2001 most of our market was reeling from the triple-whammy of national recession, tech bust and the effect of 9/11 on (among other things) consumer confidence. Q1 2003 was another low point, as the invasion of Iraq convinced many buyers that Armageddon was imminent. Yet going back reminds me of just how un-volatile the Santa Clara market, and other local markets in this price range, have traditionally been—until now, perhaps. The pool of entry-level buyers has always been larger, steadier and less buffeted by weakness in the financial markets—until now, perhaps. It was the techies in the upper-middle class cities who felt the bust more (and apparently worried more about Armageddon). While Palo Alto prices declined 10 or 15 percent during these periods of crisis, Santa Clara prices held or even went up.
I suspect that this time we'll see the reverse, or something close to it. Because even if you discount the effect of short sale inventory, as it artificially inflates inventory and deflates absorption, other market indicators say that Santa Clara and similar markets are as depressed as they've been in recent memory.
So should buyers avoid these markets until the all-clear signal is given?
My projections suggest that anyone with a timeline of more than two years will be able to sell in a stabilized market, which coincides with the projections of responsible market observers. (On the other hand, some people think the mortgage crisis will bomb real estate back to the Stone Age, but then, some people always think like that.) Buyers might want to luxuriate in what's already a buyer's market.
What about all these bank-owned homes that we're almost certain are going to clutter the market and that we think may drive down prices? One of the paradoxes of the market (which is why real estate is rarely "simple") is that bank-owned property sends two signals to buyers. One is "real estate bad", which sidelines many a buyer until the "real estate good" signal propels them straight into a seller's market. But bank-owned property also sends the siren call of "bargain", and nothing gets the adventurous into the market quicker than the prospect of a fast buck. It's irrelevant whether bank-owned property really is a bargain, or just looks like a bargain because it's priced correctly while Ma and Pa Seller down the street rock contentedly as they hold out for the top dollar they never get.
This downturn isn't driven by the usual culprits, overbuilding and a failing economy, at least here in the South Bay and on the Peninsula. My guess is that REOs will get buyers, or at least the tip of the buyer spear, back into the market. Once they're in, and as the credit markets inevitably sort themselves out, and as the impending rise in conforming and FHA-guaranteed loan limits has a salubrious effect in high-priced areas such as ours, the tide will begin to turn and other buyers will begin to follow.
Should you be looking at short sales now? A February 11, 2008 posting on InmanBlog by Inman's Matt Carter says that "the reality is that short sales don't appear to be a big part of Countrywide and other loan servicers' foreclosure prevention strategies. Instead, they're focused on repayment plans, loan modifications such as interest rate freezes, and refinancing".
In other words, how much free time do you have, and how much frustration can you endure?