By ANDREW JEFFERY

This post first appeared on Minyanville.

Price discovery. It sounds simple enough, right? If you separate out its component parts, you have “price” — the amount buyers are willing to pay and sellers are willing to accept — and “discovery” — the uncovering of that price.

But price discovery — a term which is bandied about in all corners of the financial markets — has a meaning far deeper than this cursory analysis.

In a financial sense, it’s defined as the point at which the free market — the natural interplay between supply and demand — converge on a single point where buyers and sellers can find mutual ground. There, you have price discovery.

In a practical sense, it happens every day; each time an economic transaction occurs. Coffee at Starbucks (SBUX) costs more than, say, coffee at any other establishment on the planet, because consumers have determined they’re willing to pay a premium for it. Starbucks, for its part, has generously sprinkled its stores on street corners around the world, matching supply with this persistent demand. The price, even though most of us scoff at the mere thought of forking over more than $4 for some contrived, flavored coffee-like drink, is what the market will bear.

So why then do financial-market participants make such a big deal about “true price discovery” in trying to analyze specifically when and where markets will bottom? The key is in the definition.

Let’s examine the housing market to see why this distinction matters, and how the dynamics effecting price discovery are so important.

Homes, unlike cups of coffee, are rarely bought and sold — other than when entire neighborhoods are turned over (which seems to happen with frightening regularity). But buying or selling a home typically involves uprooting one’s family, hauling boxes across town (or across the country), switching schools, changing jobs, and otherwise disrupting the flow of life.

When talking about the housing market, most pundits and so-called experts typically focus on the demand side of the equation. How low are interest rates? Did Wells Fargo (WFC) just tighten its mortgage guidelines? Are property values increasing or decreasing? How is the job market doing? On a more personal level, getting married, having kids, changing jobs, seeking out a slower (or faster) pace of life, or looking to trade up into a better school district or bigger home can all lead buyers to jump into the market.

Sellers, on the other hand, are typically hard-pressed to sell. Many of the same circumstances (jobs, retirement, family, etc.) lead a seller to enter the market, but leaving a home and the emotional attachment therein, is an extremely difficult decision to undertake without a very compelling reason.

In the current housing downturn, as social mood has swung violently towards risk aversion and shorter time preferences, the decision to sell one’s home has effectively become that of necessity, or nothing at all. In other words, the vast majority of sellers on the market right now are forced sellers — those who don’t have any choice.

So what does this all have to do with price discovery?

The destruction of a widely held economic belief — namely, that housing prices only go up –has thrown the interplay between supply and demand out of whack. Couple that with insane leverage, abnormally low interest rates, virtually non-existent underwriting guidelines, and massive government intervention in the form of Fannie Mae (FNM) and Freddie Mac (FRE) that caused the recent boom, and in reality, the fundamentals of supply and demand have been wonky for years, if not decades.

As these imbalances are worked through and the weakest hands are forced to fold, markets are slowly starting to heal. And even though massive loan-modification efforts and foreclosure moratoria are once again throwing true supply and demand out of whack, the free market is a powerful force: Certain real-estate markets around the country are beginning to show signs of healthy stabilization.

Price discovery is emerging, as housing prices return to more traditional measures of affordability where buying begins to make just as much sense as renting. To be sure, there’s a fear of losing equity as prices tumble, but the emotional pull of owning a home is, and always will be, a powerful force. Other markets, however, have a very long way to go.

Since founding Cirios Real Estate, I’ve spent a dizzying amount of time looking at local housing markets in California. And in trying to identify trends on a neighborhood-by-neighborhood, street-by-street basis, I’ve found one trend that’s 100% consistent around the state. And although California is a rather unique case, I know enough about markets around the country to be confident this is true there as well.

Markets that have seen the most extreme home-price declines are the ones where owners faced massive amounts of negative equity and foreclosures ran rampant. Virtually every sale in these markets over the past 2 years has been the result of a seller being forced to sell.

On the other hand, markets where job losses have been less severe have seen prices ramp up less severely during the boom; schools are better and fundamental desirability is higher. Sellers have broadly had the luxury of holding out, hoping the market would turn before they, too, would be forced to put their home on the market.

When there are no more forced sellers in a given market — or at the very least, the proportion of forced sellers and non-forced sellers returns to more normal levels — healthy stabilization can occur. And in order for this to happen, years of froth and excess must first be worked off. This can happen via 2 methods, which Toddo often discusses when analyzing the stock market: time and price.

Time can heal wounds as demographics shift and new buyers enter a given market, or low prices can bring investors out of the woodwork to snap up underpriced homes.

There isn’t some magic formula or complex property-valuation algorithm (sorry Zillow) that can determine where a given markets is in the bottoming process or where the best real-estate investment opportunities currently lie (to be sure, they’re out there). But with careful analysis of individual markets, trends can be identified.

Submarkets where price discovery — that is, the process of returning to an environment where natural supply-demand fundamentals can thrive — is further along pose a far smaller risk than those markets where sellers have been hunkering down, hoping the maelstrom would blow over their quiet streets.

So while pundits argue over whether the housing market has “bottomed,” we can all ignore their drivel, knowing this is a meaningless statement. Price discovery doesn’t happen on a national scale; the massive and disjointed real-estate market is made up of thousands of tiny micro-markets, each of which is at a different point along the highway of price discovery.

One of themes we harp on here at Cirios is how home price trends are becoming increasingly localized as individual real estate markets grope for a bottom.

Some areas, particularly the hardest hit by foreclosures, have seen fantastic price declines. Others, mainly the high end, are only recently feeling the ill-effects of job losses and our slumping economy. And while this dynamic makes for a tricky housing market, it also breeds opportunity for those savvy enough to identify which markets will be the first to stabilize and eventually rebound.

Take a look at the 2 graphs below showing price per square foot in Redwood City, CA.

The first shows all residential sales in Redwood City. The steep declines in 94601 and 94602 not only show price declines, but help illustrate how areas with high foreclosure rates — like these 2 zip codes — are seeing steeper price declines than areas that are holding up better. (For more on this subject, read about foreclosure sales effect price data.)

The second graph shows 1 segment of the market,
homes with living areas of 1,200 - 2,500 square feet.
While a somewhat arbitrary cutoff, the idea is to pick
like homes within each area to try and compare apples
to apples.

What we see is that in the second graph, is that the “spread” between each zip code, that is, the premium you pay to live in 94063 vs. 94601 or 94602 remained essentially the same throughout the boom and into the bust. Meanwhile, the first graph shows that price per square foot in 94063 (the least desirable part of town) almost touched 94061 (the most desirable part) right around the peak of the bubble.

So what does all this mean? 2 takeaways: First, be skeptical when you look at housing market data, since very small changes in data collection can lead to quite different results. Second, real estate always has been, is, and always will be local. No national, statewide or even citywide trends can capture what’s going on at the street level.

Want to see this analysis for your town? Contact Cirios Real Estate today!

This post first appeared on Minyanville.

Appraisers just can’t get it right.

During the housing boom, mortgage brokers, real-estate agents, and even borrowers sought out appraisals supporting the highest possible home price. Appraisers, fearful of losing business, inflated their valuation findings, which exacerbated the run-up in home prices.

Now, after nearly 4 years of home-price declines, appraisers are getting it wrong again — but in the other direction.

On May 1 — while the financial media focused on construing a blip up in housing data as signs of an imminent bottom — little was made of new appraisal guidelines that went live and immediately began to eat away at the core of the nascent housing “recovery.” To be sure, trade groups like the Mortgage Bankers Association and the National Association of Realtors (NAR) fought the revised rules, but to no avail.

Stemming from a lawsuit filed by New York Attorney General Andrew Cuomo alleging Washington Mutual (JPM) and First American Corp illegally conferred on the results of home appraisals with the goal of inflating prices, the new rules put up a Chinese wall between banks like Citigroup (C), Wells Fargo (WFC), Bank of America (BAC), and appraisers. The goal was to create an environment where appraisals would reflect an expert’s unbiased assessment of a home’s true value, rather than evaluations tailored to a lender’s desire to make a loan.

The new rules affect loans guaranteed by Fannie Mae (FNM) and Freddie Mac (FRE), but since the 2 government-run mortgage giants effectively control the secondary mortgage market, they’ve become the defacto guidelines for the entire industry.

In order to separate lenders and appraisers, appraisal-management companies (AMCs), cropped up, offering banks access to a network of appraisers around the country. This makes the appraiser selection process random, preventing collusion. And while AMCs claim appraisers are selected using proprietary scoring algorithms that evaluate performance, the reality is that jobs are handed out on the basis of fastest turnaround time and lowest cost.

In short, we’ve traded bias for incompetence.

Readers of this column know that I have little, if anything good to say about the NAR — which is not only the Realtors’ trade organization, but a powerful Washington lobby. Nevertheless, earlier this week, when the NAR released data on existing home sales, their statement about appraisers’ role in killing purchase transactions was dead on the mark:

“The increase in sales is less than expected because poor appraisals are stalling transactions. Pending home sales indicated much stronger activity, but some contracts are falling through from faulty valuations that keep buyers from getting a loan. Lenders are using appraisers who may not be familiar with a neighborhood, or who compare traditional homes with distressed and discounted sales.”

Currently embroiled in this very scenario, my firm, Cirios Real Estate, is witnessing first-hand just how bad the new appraisal rules are.

Assessing a property’s value in’t rocket science, despite appraisers’ claim that their extensive training and years of experience make them the only people qualified to determine home prices. All it takes is access to the right information, an understanding of what drives desirability, and a little pride in one’s work.

That last criterion is perhaps the most difficult to find. Appraisers earn a flat fee for their services, giving them little incentive to provide the best analysis possible. Knowing they can now earn repeat business by turning around jobs in 48 hours and charging less than their competitors, there’s little reason to go the extra mile to ensure appraisals take into consideration only the best information to come up with the best possible results.

Sure — there are good appraisers out there with integrity that offer up great analysis. But as lower priced, lower quality work becomes the norm (thanks to the new appraisal guidelines), the best appraisers will seek greener pastures - as well they should.

Lawrence Yun, the NAR Chief Economist, finally got it right when he said, “Sometimes policy can lead to unintended consequences.”

Looking for great schools, rolling hills, big lots and a quick BART ride to the city?

Orinda and Lafayette, two of the most desirable towns in the East Bay, have all this and much more. Home prices remain in a downward trend, to be sure, but inherent desirability and established neighborhoods should keep these two from falling off a cliff, even as their high-end brethren around the Bay Area feel the pain of an tight jumbo loan market.

The graph below shows price per square foot for homes with 1200-2500 square feet, pretty middle of the road for these areas. Once you get above 2500 sqft, you start losing your marginal price per square foot and comparisons with smaller homes start to lose meaning.

What did that mean? Read more about Price per Square foot here.

Want to find out more about these two towns? Contact Cirios Real Estate today!

(click to enlarge image)

This post first appeared on Minyanville.

Where have all the flowers gone, long time passing?
Where have all the flowers gone, long time ago?
When will they ever learn, when will they ever learn?
- Peter Seeger

There’s an odd refrain cropping up in some of the nation’s most troubled housing markets — those where real estate professionals can’t help but raise their pom-poms in unison and declare this “the best buying opportunity, maybe ever.”

Here’s how it goes: Where have all the houses gone?

For months, buyers have been told the time to buy is now, what with interest rates at all-time lows, prices down in some markets more than 50%, and generous tax credits for first-time home buyers. These factors — along with aggressive advertising by the National Association of Realtors — have driven up demand, even as prices kept falling. Supply, meanwhile, has been severely limited for the past 6 months by foreclosure moratoria that were enacted at the end of 2008.

And as tends to happen when demand outweighs supply, many homes have been selling above their list prices as multiple-offer scenarios led agents around the country to wax lyrical of the boom days of yesteryear.

This cursory analysis of the nation’s housing market — while sufficient for the financial punditry complex, eager to call a bottom (again) and certain real-estate agents looking to make a quick sale — is woefully inadequate for any buyer interested in buying an actual home rather than a data point.

Take these 2 California markets for example — a pair that couldn’t be more different if one were located on the moon:

Bakersfield, a central-valley farming and oil town best known for jockeying with Fresno for the right to be called “the armpit of California,” was besieged by the housing-market crash early on.

Subprime lending flourished here during the boom as home builders like Lennar (LEN), Centex (CTX), and DR Horton (DHI) showered once-quaint communities with sprawling suburban developments. The town made national press for one of the worst real-estate markets in the country — prices have fallen an astounding 48% since just last year.

In Bakersfield, the above characterization of the housing market isn’t altogether inaccurate. Prices have fallen far and fast, and homes bought by all-cash investors can offer a tidy return as rentals. Three-bedroom homes for $40,000 will do that to a market. And with inventory constricted by foreclosure moratoria, properly priced homes don’t stay on the market for long.

Indeed, supply of unsold homes sits at a mere 2.6 months, according to a local appraiser group — a far cry from the nationwide level of around 10 months. That’s not to say, however, that imminent appreciation is on the horizon: A flood of foreclosures looms, threatening to further depress prices.

Kissed by a gentle sea breeze and the Midas Touch, Laguna Beach, California is a seaside town 164 miles to the southwest and best known for hidden surf breaks and snobby adolescents.

The setting for the once-popular TV show The OC, Laguna was also the locale-du-jour for mortgage brokers and real-estate agents who struck it rich during the boom. Nearby Irvine — once the mortgage-banking capital of the world — made Laguna’s palatial cliff-side homes ideal for brokers eager to solidify themselves in the Orange County mortgage scene.

Prices rose to absurd levels for what were, to be sure, beautiful homes in a pristine location.

Laguna is now crashing back to earth.

Supply of homes above $1 million now stands at an astounding 24 months, as just 49 have sold this year with a whopping 313 currently on the market. List prices are gapping down as buyers struggle to find jumbo loans. Big banks like JPMorgan (JPM), Citigroup (C), and Bank of America (BAC) won’t touch the stuff, since they can’t unload them onto Fannie Mae (FNM) and Freddie Mac (FRE). So desperate sellers are being forced to get creative with their marketing.

One recent sale included a 350 Ferrari Modena, and a short sale less than a mile away is being offered for $8,995,000 — nearly $3 million below its original list price of $11,990,000.

These 2 wildly divergent markets are a microcosm of the country’s current real-estate dilemma: While low-end markets grope for a bottom (hoping the aptly described “pig in the python” of shadow supply doesn’t derail their nascent recoveries), high-end markets careen back to earth.

And as price discovery works its way through well-to-do areas, the mix of homes sold will continue to shift back towards more expensive sales, pushing up median and average-sales-price data. This dynamic will present the misleading conclusion that the country’s housing market is recovering, even as actual prices continue to fall.

Indeed, as many frustrated buyers wonder where all the houses have gone, most would be wise to sit tight for a few months until banks get around to unleashing a mountain of supply back onto the market — they’ll soon find out.

By ANDREW JEFFERY

This post first appeared on Minyanville.

Mortgage guidelines have become increasingly strict — not to mention regimented — as the private secondary-mortgage market has all but disappeared in the past 24 months. But according to the Wall Street Journal, appraisals are increasingly becoming one of the biggest hurdles for new purchase and refinance transactions.

In the wake of the recent collapse in home prices, appraisers have come under fire for bowing to lender demands during the boom, offering up property values more aligned with lenders’ wishes than with reality. In 2007, the state of New York sued Washington Mutual — now owned by JPMorgan (JPM) — for colluding with a subsidiary of First American Corporation to overinflate home values.

Collusion between appraisers and mortgage brokers, real-estate agents, banks, and borrowers helped fuel runaway price appreciation. In response, Fannie Mae (FNM) and Freddie Mac (FRE) — the 2 government-owned giants that control around two-thirds of the mortgage market — issued new guidelines dictating how lenders can select and evaluate appraisals. The new policies went into effect May 1.

To help facilitate the new, tighter rules, lenders are using appraisal management companies, or AMCs, which employ networks of appraisers around the country to provide what purport to be unbiased value analysis. All this, of course, comes at a cost which is ultimately borne by borrowers.

And, in what could be considered ironic if it weren’t so repellent, appraisers are crying foul.

This from a group whose moral backbone during the housing boom most closely resembled that of a jellyfish - one seemingly incapable of preventing its members from being wooed by banks into committing fraud.

An appraisal is simply one person’s opinion of a home’s value on a given day. And although that person is licensed to provide such an opinion, the very nature of an appraisal renders its usefulness as a true risk management tool questionable at best.

The growing use of AMCs, opponents argue, reduces appraisal quality even as it increases costs. Appraisers are selected based on proprietary quality scoring mechanisms employed by each AMC, which may or may not be a good measure of reliability. And since AMCs take on average a 40% cut on the total appraisal fees and lenders demand quick turnaround, appraisers are working for less on a tighter timeline.

Sure, fraud may be reduced, but incompetence could more than make up for that as AMCs scramble to employ barely capable appraisers in order to ensure complete geographic coverage for their clients.

The real losers in all this — as is the case when poorly conceived regulation is aimed at making up for past mistakes without proper consideration for the root cause of those mistakes — are homeowners, who must now pay more for a property valuation mechanism that isn’t likely to be much better than the old one.

Both the National Association of Realtors (NAR) Existing Home Sales index and the Commere Department’s New Residential Sales statistics showed continued increases in home sales activity in April, prompting some to wonder whether the elusive bottom is approaching.

One important aspect of these statistics worth noting is that these increases have come largely at the lower ends of the price spectrum. Evidence points to some mild increases in mid-range activity, but according to NAR economist Lawrence Yun, “high-end home sales remain sluggish.”

So volume and median prices are both increasing. Does this mean we have reached a bottom? Probably not. These improved numbers are likely a result of several factors, not the least of which is a constriction of supply in the market due to foreclosure moratoria in place over the last several months. Furthermore, looking at regional numbers shows that some regions are not fairing as well as others. In the West region, existing home sales volume was up in April but median price fell, indicating the bottom has not yet arrived.

From a brighter perspective, increased volume will eventually clear out excess supply and lead to a bottoming of prices. Looking at local markets provides evidence that this process of supply reduction and price stabilization may already be occuring. If you’d like to know what prices and supply are doing in your local market, contact us at Cirios Real Estate for a complete evaluation.

Cirios Verdict: DEAL

San Francisco isn’t for everyone, but with the rental market still expensive relative to just about everywhere but New York, buying a condo or TIC (Tenant in Common) is a pretty viable option. It didn’t used to be, but low-end condo and TIC prices are falling, as overbuilding, lower rents and the general economic malaise is hitting developers where it hurts. No, not there. Their pockets.

As a result, some of the smaller units in older, renovated buildings are being offered at reasonable prices. To be sure, its likely they’ll keep getting cheaper, but some are starting to get interesting.

In particular, S1 listed on the CLEAR below is a lower unit in the same building, which sold for $440,000 after being listed at $410,000. And while we believe TIC and condo prices will keep sliding in the near term, prices will be supported as they come more in line with rents in the area.

Address: 3322 16th Street #6, San Francisco, CA 94114
Status: ACTIVE
List Date: 3/31/09
List Price: $469,000
Cirios Value: $485,000
List Price vs. Cirios Value: 3.4% under-listed.
For a complete Cirios Valuation, click here for our CLEAR report, or on the image to the right.

Have a home you’d like Cirios to use for our next House of the Week?
Make a comment below or email us!

Economic data is inherently backwards looking. Forecasts, estimates and any other prediction of the future is a stab in the dark likely based on an esoteric predictive model and a bunch of educated guesses. And of all the economic phenomena, the hardest of all to predict is the cusp, the turning point.

Nevertheless, despite the cards being stacked against them, bold economists are stepping out on the proverbial limb and saying the housing market is healing and more than three years of declines are running their course. Their analysis is based on looking at history, then some extrapolation of how millions of unique economic actions, geopolitical strife, global financial markets and unpredictable political feuds will play out.

The future, as they say, is yet unwritten.

Consider these two reports, both written in the last 48 hours:

From Bloomberg: Existing Home Sales Hover Near Average. “Sales of existing US homes in March stayed near a four-month average, and prices rose from February, a sign the housing recession has stopped getting worse.”

Now, from Housing Wire: (a great place for housing-related news and analysis) Delinquencies and Defaults Up, Up and Away. “Delinquencies and defaults are on the rise, due mainly to a handful of circumstances, including the backlog from recent foreclosure moratoria, a jump in unemployment and even a slight rise in marital spats. Prime loans 60+ days delinquent increased by 69.6% from November 2008 to January 2009.”

Which data do you think is more predictive of how the housing market will perform in the future?

Existing home sales - transactions that happened 20-50 days ago, meaning contracts were signed back in January or February; or a spike in defaults which will turn into foreclosures, bank owned properties and more homes on the market later this year?

We rest our case.

DO NOT believe the hype: The housing market is still in decline, any stabilization theories are fallacy.

By ANDREW JEFFERY

This post first appeared on Minyanville.

Simply put: There are too many homes in America.

Travel to the outskirts of Phoenix, California’s inland empire — or even suburban Washington, DC — and you’ll find scores of vacant homes, for-sale signs, and soon-to-be ghost towns. Sprawling Lennar (LEN) cookie-cutter developments, Pulte Home (PHM) condos jammed against freeway sound barriers, mostly vacant strip malls - these are not the relics of dynamic social progress.

There are many who believe that superfluous developments in the so-called exurbs must be razed for housing supply to return to anything like sustainable levels.

But few expect the bulldozers to reach the urban downtown. Just as the “subprime” mortgage problem began in areas where economic fundamentals fell hopelessly out of sync with home prices, so too will urban renewal rise from the ashes of these communities.

Take Flint, Michigan, a city looking to shrink itself just to stay alive.

This once-proud industrial town 65 miles north of Detroit is embracing a trend which may eventually spread to cities throughout the United States: In response to seemingly endless economic woes, government officials in Flint are considering hastening the town’s decline in order to rebuild anew.

The New York Times reports that city leaders have floated a plan whereby certain dilapidated neighborhoods would be razed to the ground, consolidating residents and businesses closer to downtown. The aim is to reorganize the population around fewer, more sustainable communities, thereby pushing run-down homes and empty lots to the outskirts of town.

While uprooting citizens is a prickly political topic, the county Treasurer and advocate of the shrinking of Flint grimly noted that “Not everyone’s going to win. But now, everyone’s losing.”

Foreclosures, the latest in a series of economic epidemics to sweep Flint, are causing formerly vibrant communities to turn to dust. Genesee County, of which Flint is the largest town, in addition to Indianapolis and Little Rock, Arkansas, are tackling the foreclosure issue with county land banks. These publicly-funded institutions buy unwanted properties and rehabilitate them before squatters and vandals can take over.

Contrast this government-led form of community development with the policies now operative at Wells Fargo (WFC), Citigroup (C) and Bank of America (BAC) to leave bank owned homes vacant and ripe for vandalism, and you have an example of government policy that can speed up the recovery of a local real estate market.

And while Flint’s situation may be unique in that it faces the twin headwinds of the auto industry’s demise and the ongoing housing market collapse, it’s root troubles are emblematic of towns across the country: Cities, expectant of growth that never came, supported development that proved unsustainable.

Myriad solutions have been proposed to solve this country’s housing nightmare, but the simplest, and indeed the most effective may be to simply reduce supply the old-fashioned way, with bulldozers.