A perfect storm for San Diego’s real estate market

By Zach Todaro
Since 2008, the spectre of distressed properties has dominated the marketplace in San Diego County. Toxic loans, unsubstantiated leverage and irresponsible business practices were all equally responsible for derailing the red hot Southern California real estate market.
As of April 2011, this market has suffered through three years of foreclosures and short sales. Due to our high average home values, and upper-echelon cost of living, California was one of the first states to see an explosion in mortgage defaults. Along with Florida, Nevada and Arizona, this state has one of the highest percentages of distressed sales as a function of total home sales. The media paints this as a dismal indicator of market strength.
While it is true distressed sales often sell at lower prices than the average resale, there is a fundamental underlying truth to these numbers that 99 percent of market pundits are either not aware of or choose to ignore. If you take anything from this discussion, remember this phrase, “the first in will be the first out.”
We begin with this assumption: since the housing bubble burst, the quality of home loans issued have improved dramatically. With new regulations, and banks tightening their lending practices, high-risk products like zero down and no documentation loans are no longer available to consumers. Most mortgages now are almost entirely based on “active income,” in short a regular paycheck. $5 million in the bank but no active income? No job? Good luck finding financing with a low interest rate. Because of these changes, it is reasonable to assume that the number of defaults and thus distressed sales will decrease dramatically.This means that with mortgage defaults lowering, there is a finite amount of distressed property as a result of the downturn, available to the consumer. And what have all the media outlets been telling us? Californians have been voraciously buying up this property at a rate nearly unmatched across the country. This poses several questions: how much of these properties have we burned through, how many are left and how do we compare to other states? And what will happen when the market runs out of these properties?
The numbers don’t lie, and what we are starting to see is the beginning of what could be the perfect storm for the real estate market in San Diego.
While the inventory is still high, the rate at which these bad loans are turning into distressed properties is lowering dramatically. Compared to this point last year, in 2011 the number of pre-foreclosures in San Diego County has dropped 23 percent. The number of defaulted properties scheduled for sale is down 26 percent. Take a look at the statistics for North Park and Kensington below, they reflect these regional and national trends.
Statewide, numbers this low have’’t been seen since late 2008, when the federal government first stepped in and began regulating how banks were dealing with loan defaults. “The drop in filings, and the rise in cancellations, is surprising,” says Sean O’Toole, CEO and founder of ForeclosureRadar.com. “Banks have had time to resolve robo-signing issues, so we should be seeing exactly the opposite results, with lenders starting to catch up from recent delays.”
So what does this all mean? There are only several possibilities, any of which should be welcoming news to current and potential homeowners. The first is that in California, and other “foreclosure states,” the majority of toxic loans have been dealt with, and the majority of distressed properties sold to either the banks or third-party cash investors. As these properties become no longer available, buyers will have to rely on the traditional equity resale inventory, which currently carries a much higher average sale price. This will set favorable new comparables, which should resonate throughout the market.
The second possibility is that the banks are anticipating the thinning inventory of distressed properties, and are chosing not to sell the current inventory at reduced prices to third-party investors, and to delay foreclosure on the remaining homeowners in default. If the number of distressed properties available drops dramatically, banks would be in a prime position to ride the wave of rising home values, strategically releasing foreclosed properties to the market in a controlled fashion.
One would likely see this trend in a market by market analysis, in that compared to last year, a desireable neighborhood like North Park saw a 25 percent increase in properties going back to the bank, even while the number of properties scheduled for sale decreased 41percent! Statewide in 2011, the number of properties that went back to the bank has dropped nearly 17percent when compared to last year, suggesting that the distressed inventory is beginning to dwindle, and that banks are holding onto property in desireable areas, in anticipation of the flood of defaults being reduced to a trickle.
In either instance, releasing a motherload of bank owned “shadow inventory” to the market, at a time when home values are primed to rise, makes little sense. Downtown San Diego for the first time in nearly three years experienced more equity resales in the first quarter than either short sales or bank-owned deals. As Californians, having been the first to get into this mess, could we be the first ones to emerge? The numbers below show that along with Arizona and Nevada, we may be on the right track.

Zach Todaro is a Realtor with Willis Allen Real Estate, representing clients in the greater San Diego area. Zach can be reached by email at ztodaro@gmail.com and by phone at (619) 302-9239.