January 1, 2008

“My wife and I have made ZERO from our real estate business this year” a friend told me as we crossed paths in the locker room at a local gym. My friend manages a large Sonoma county office with more than 30 agents. Watching the current economic storm we speculate about what the New Year in real estate will bring. Most of my peers in the business are still looking for a bottom. Are we in the quite eye of the hurricane or has it passed through? Is it time to face the devastation and clean up? The winds of change have caused us to question the fair market value of real estate.

Unemployment is heading up. People are anxious. I know that the confidence of the consumer will have a big effect on what happens down the road. The individual is the principal operating unit of economic activity but individuals make up the pack and herd mentality is the norm. We don’t want them spooked. Consumer confidence and the ability to produce are what will shape this next year.

Two things have to happen in my opinion. Incomes will have to rise and prices will have to fall. Mortgage rates remain low and prices are falling back in line with affordability. Real estate values are uncertain as we start this New Year. The “sub-prime” mess happened because we made loans ignoring this reality; i.e. people did not have the income needed to sustain their obligations. Over exuberance from rising home prices created easy to get real estate loans and flattened under qualified borrowers. Prices have to align with income. We’ll be stuck until they do.

Pay your obligations as agreed. Don’t take on more debt than you can handle. Credit will rule the markets this year. Understand that your credit worthiness is measured by test results from a test you never agreed to take. The documented earnings from a well paying job may not be enough to satisfy the repayment demands required on a new loan.

A home down the street sits empty, offered for sale at thousands less than maybe you paid 12 months ago. The financial shelter of owning a home comes into question. Homeowners are confused when comparable values are unstable and so are lenders. Banks are taking big discounts to get unsold foreclosures (REOs) off of their books.

Once, reliable fair market values were the strongest support for a real estate loan decision. Today, credit worthiness, how well a borrower has kept their promises in the past, trumps the home loan approval process. When all is swept away, truth remains like a rock to cling to. Facts are the rocks of truth from which investment decisions are washed over. Reliability wins in a turbulent market. Integrity is the glue that holds our life together and it is what FICO scores (credit scores) attempt to measure.

Our homes remain the place where everything seems to begin and end. It is not required that we own a home, just that we have the right to its quiet enjoyment. It’s where we raise up the next generation and pass on lessons of survival. It’s where our basic rules of life, morals, ethics and values are learned. It’s where we lay our head at the end of a days work. It’s where we wait out the storms of life.

You will be more vulnerable to economic forces as a tenant. Protect your good name with good credit and set aside some savings for a rainy day. The power of market capitalism, competition and the invisible hand described by Adam Smith’s economic thesis has built empires, toppled dictators, and hoisted individuals to produce abundance. It is a force for good. Yet still there are those who question the justice of unfettered competition, its rewards and its damages.
Competition makes life better by making each of us stronger, engaged and on the lookout. It means that there are winners and losers… sorry. Competition occurs naturally between living organisms which coexist in the same environment. Animals compete over water supplies, food, and mates. In addition, humans compete for attention, wealth, prestige, and fame.



Competition gives incentives for self improvement. If two watchmakers are competing for business, they will lower their prices and improve their products to increase their sales. If birds compete for a limited water supply during a drought, the more suited birds will survive to reproduce and improve the population. Fear motivates us to act, to observe, to be conscientious and to compete for resources.

In his new book the Age of Turbulence, Alan Greenspan writes “The spreading of a commercial rule of law and especially the protection of the rights to property has fostered a worldwide entrepreneurial stirring.” This is good for the developing world but it puts our kids directly in the path of competition. We must educate and train them, commit resources to improving our educational systems.

Individual human beings create value through production. We acquire some security when we agree to the common causes of civilization. We increase our security when we are able to own property. In a democracy, we subscribe to common values and are the arbiters of property rights and the rule of law. Change is part of life. Turbulence is a byproduct of hurried change.

When common sense isn’t common anymore values get compromised. Turbulence results and it disrupts the status quo. Accepted norms become displaced as we run for cover. The edges of right and wrong get fuzzy. Fat and happy, most of us yearn to maintain the status quo and go along to get along. We hunker down and hold on as the winds of change pass over us. In the swirling winds of nonsense change sweeps in unreal expectations and many are tempted to “try it” and see what happens. The rocks of truth remain but individuals become vulnerable when seduced by untruths. When common sense based on known facts is disregarded we set are set up to take a fall.

I never know where the bottom or the top of the cycle is no matter how much I read and study. As of the 1st of December, home sales rose for the second month in a row, although they are still not far from the record low set in September. There was a reverse in trends as the number of sales of single-family, re-sale homes rose 5.3% from the month before, but they were down 25.5% year-over-year. Year-to-date, home sales are down 22.2%. It feels like we have not seen the bottom yet.
Anxious under qualified buyers were eager to make deals with over exuberant lenders who granted easy credit just 24 months ago. This vulnerable segment of the population started this cycle. This caused the condo market to rise rapidly. It’s contracting today. The median price for condos slumped, dropping 20.3%, down 13.2% compared to last November. These numbers can, and do, swing wildly because there are so few sales. Under qualified buyers cannot get financed today. There might be some low hanging fruit priced at new lows waiting to be picked. Condo sales were up 31%, month-over-month, but down 32.1% compared to November 2006. Year-to-date, condo sales are down 16.4%.
Thinking of buying? Now might be a great opportunity even if things go down a bit more. The median price for single-family, re-sale homes in Sonoma County fell 2.5% from October, and was off 11.5% year-over-year. The average price for homes rose 5.7%, month-over-month, and was down 4.9% compared to last November. The median price is now down 19.2% from the high of $618,450 reached in August 2005. This wont stay this way. There are some bargains of a life time to be had… today!
While the invisible hand sweeps the complacent and the incompetent aside, it invites those with initiative and integrity to enter in. Enjoying the results of your efforts and generating some profits is at the heart of the capitalistic model. When this market turns around it will do so without much fanfare. It will take a minimum of 90 to 180 days before the statistics can be gathered, analyzed and reported.
Please call me to discuss your ideas about real estate. If you need a loan, want to buy or sell I can assist you. We enjoy opportunities in our free market place and a degree of abundance that the rest of the world envies. Free enterprise and competition makes us all stronger. Property ownership is the bedrock of our abundance from which opportunity grows. Pride of ownership makes our community vibrant, alive and healthy.
Richard Paille’