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The Mortgage Debate Continues…

house-question-small.jpgA client of mine has been reading a lot of the doom and gloom real estate mortgage crunch articles, and has been sending be some emails that reflect his concern. He’s been keeping up with the Case Shiller Index and believes that all data points to an upcoming crash in the San Francisco real estate market. He also pointed out that Robert Toll of the Toll Brothers, a luxury home builder (that does not build in San Francisco) who is typically quite optimistic about the market has stated that the pool of potential home buyers will shrink and that some people may have problems closing on their loans. I replied to his email after doing some research of my own, and thought the response was worth sharing with others. So here it is:

Hi… sorry for taking a few days to respond to your last email. I actually wasn’t familiar with the Case & Shiller Index… and so, I asked a lot of other real estate agents, including my sales manager who has been in the business for 25 years. None of them had heard of the index. Honestly… that alone makes me think that it’s difficult to put too much stock into their finding. But the thing that makes me think the numbers are somewhat useless, is that (as pointed out) the index only tracks single-family homes (not condominiums which represent half the transactions in San Francisco), is imperfect in factoring out changes in property values due to improvements versus actual market appreciation, and includes San Francisco, San Mateo, Marin, Contra Costa, and Alameda in the “San Francisco” index… which in my mind is their greatest error. Cities like San Pablo, where 40% of the sales on the market right now are foreclosure sales and you can buy a single family home for half a million dollars are lumped into the same index as San Francisco. After the big boom of 2003-2006 came to a halt all across the Bay Area, and across the country… the San Francisco housing market still kept going strong. Bidding wars and multiple offers haven’t slowed down much in any desireable neighborhood… though you won’t see a single family home in the Bayview area sell for $750K like it did during the big boom.

While there are many factors that truly affect the market including the cost of money, the most basic principles driving any real estate market are supply and demand. The supply in SF is limited and always will be. And the demand is there… even since my last email to you, I have started working with 3 new buyers. The cost of a loan, depending on the loan amount (let’s say $700K loan or so) went up about $400-500 dollars a month. If interest rates where to double or triple, as they did in the 80’s when the Fed increased rates to offset inflation, I can guarantee you that there would be a slowdown in sales, and that sales prices would be affected to some degree. But the Fed seems to be ready to lower rates again in the next month or so, and historically, election years have always brought along a lower interest rate with them, leading most people to believe that the spike we saw these last few weeks will fall back close to where it was, and put borrowing rates back in the mid 6% range. However, one thing to keep in mind is that even in the 80’s with double digit interest rates, the real estate market still continued to plug along and new alternatives such as seller financing became very popular as they allowed sellers to earn a hefty profit on the money they loaned.

I don’t follow the Toll Brothers either. They don’t build in San Francisco, so I don’t see a personal need to keep up with them. To be honest, there are too many indexes, and too many experts to keep up with all of their opinions, which by the way, are typically all contradicting each other… sometimes subtly, and sometimes much less subtly. The only real way to judge the condition of the market is by looking at whether properties are selling, and if they are… for how much? In San Francisco’s case, the answers are “yes” and “a lot!”

Robert Toll’s assessment that “Nevertheless, tightening credit standards will likely shrink the pool of potential home buyers,” and that the “Mortgage market liquidity issues and higher borrowing rates may impede some customers from closing, while others may find it more difficult to sell their existing homes.” is likely true to some degree… but keep in mind… he is referring to the entire country, and there are places where his statement will ring true, and there are places, like San Francisco, where his less than optimistic predition will barely be noticeable.

To summarize, market data presents the fact that high demand markets with low inventory, especially in areas that have high median incomes such as San Francisco, Seattle and New York just don’t feel the same impact that the rest of the country feels when money costs more. But none the less, if you are looking for a short term investment with guaranteed return, real estate has really never presented that.

The real answer to your questions is this… If your objective is long term there is very little support for a theory that you will lose in real estate, especially in the San Francisco real estate market.