Housing Market Prepares for a Downturn

 It's been a long day coming.  We finally have a relief from bidding wars and over pricing of real estate.  The fact that the nation saw a 6% decline in average real estate price and the Bay Area saw a 4.5% decline gives testimony to the strength of Silicon Vally and the shortage of housing.  

What does this all portend?  On Friday Mr. Powell speaks at an annual conference in the Rockies to give his credentials on being a "Hawk" on interest rates.  A big turn around from the past, and a delayed one of course.  With the rising of interest rates ahead of us the mortgage market will adjust to high mortgage rates.  High mortgage rates will convert to either higher down payments or a reduction I offering prices and sales prices.  Or, a search for homes within the buyer's approval range. Call it a redistribution of population.  A fact of life in human evolution.

There has already been a sharp drop in the ratio Sales Price to List Price and an extension of Days on the Market.  Woodside has been the most notable with a decline of sales below list of 94% for July.  The rest of our cities have seen the same, but nothing below list to date.

The major risk before the market and buyers is the US Mortgage Lenders are Starting to Go Broke.  It all starts with the Capitalization of Non-Bank Lenders.  They traditionally create mortgages which they keep in their inventory to sell to institutional investors and Fannie Mae.  The risk they bear is that they have or had more demand for mortgages than capital.  That led them to borrow.  Doing so using a high leverage rate.  That creates a risk to the market value of their portfolio as rates rise.  Just like any speculator knows, leverage works both ways.  To highly leverage investors it is dramatic.  Let us use a 4% average portfolio in a 5.5% market. The converts to 72.73% of par value.  The average loan was made at 100% or par.  The non- bank now has a margin call.  They either raise money in the after market or file for bankruptcy.  The usual request will go to Fannie Mae for "help" to bail them out the the problem.  Until that happens loans are not going to be available from non-banks and mortgage brokers will have only the major banks to go to for quotes. The major banks have cut back on lending and staff. Their preference is why give you money and loans when we have our own mortgage broker employees?  Unless, you can give us a discount.  Either way the lender will eventually pay for it.  

"There’s no systemic meltdown coming this time around, because there hasn’t been the same level of lending excesses and because many of the biggest banks pulled back from mortgages after the financial crisis. But market watchers nonetheless expect a string of bankruptcies broad enough to trigger a spike in layoffs in an industry that employs hundreds of thousands of workers, and potentially an increase in some lending rates. More of the business is now controlled by independent lenders, and with mortgage volumes plunging this year, many are struggling to stay afloat."  Bloomberg Financial 

The problem in going to Fannie Mae is that they have a maximum loan they will buy.  The jumbo lenders have a deep problem without deep pockets to go to.  

How will this all play out will be of interest. It does have some similarity to the decade of the 1970's when inflation, high interest rates and a declining stock market all created a financial crisis.  During that decade the Real Estate Investment Trust industry had Mortgage REITS.  They had a handsome plan of borrow short and lend long.  It all came a crashing end, when the short market rose above the long market and it cost them more to borrow that to lend.   Bankruptcy and massive liquidations tore apart this market and in general they ceased to exist.

For buyers the first process is to find a lender who is willing to give you a loan commitment based upon your income and a set mortgage  Be aware that if rates rise the commitment has a bow out clause with the contingencies within the commitment.  Next, buyers must remember to make offers contingent upon appraisal and financing.  The worst position to be in is the appraisal comes in below the offer and rates have risen when that contingency is not applied.  The buyer makes up the difference.  Unless the contingency is within the offer the buyer stand to loose their "Full Faith Deposit".  A very bad situation to be in.  Once the contingency is in place the option is to submit a modified offer in line with the new appraisal.  If not accepted, the buyer gets their Full Faith Despot back (usually 3%)

For sellers, the concept of "I want what my neighbor sold his house for" is dead. So too is the Zillow and Redfin guesstimates.  They look at a computer program of past sales.  The past sales do not represent the current market.  Trust the price your agent recommends and to be certain take 10% off what ever it is.  While you may not like it there is little chance you will see an uptick in valuation as long as rates increase and the fear of recession is in the media.

Contact Gary McKae at 650-743-72-49 or gary.mckae@exprealty for your listing or purchase.