WHAT’S NEXT? IT’S TIME FOR THE CONDO COMEBACK

By now, everyone knows that the housing market had an amazing year in 2013.  In Denver, price increase estimates range from 10.1% (most recent Case-Shiller) to an amazing 13.9% year-over-year increase (Zillow). 

But in the field, it’s not that simple. 

As I’ve advanced for years, there is not “one” single housing market in Denver, but at least three.  Those markets are essentially the entry-level market, the move-up market and the luxury market.  They are all different, and they all perform differently.

In simplest terms, the largest gains have been posted this year at the lowest price points.  In some areas of town under $200,000, homeowners have seen price gains as high as 15-20%.  At $1 million, however, any gains have been negligible. 

The biggest reason for this disproportionate gain at the lower price points has to do with the basic concept of “replacement cost”.  In most areas of Denver, the break-even point for builders starts at about $325,000, meaning they can’t build single family homes for less than this with any kind of profit.

So they don’t.

That means you have a limited and finite supply of the types of homes most people want – the affordable ones.  But at the higher price points, builders can build to meet (and exceed) demand fairly quickly, which means your upside on higher-end homes is capped by the fact there can always be an increase in supply.

Which brings us to the subject of condos.

For the past five years, condos have been the “red-headed step child” of the Denver housing market.  (For a detailed discussion about this, see my post from May 21, 2012, linked here, or my post from January 26, 2010, linked here).

With lenders unwilling to lend, homeowners walking away and HOA’s swimming in red ink since 2009, the Denver condo market has been a basket case.  Many associations have been unable to keep up with basic maintenance demands, newer associations have been awash in litigation and falling prices have sunk thousands of homeowners into negative equity positions.

In other words, it’s been a season of great opportunity for those who know what they’re doing.

It has been my contention that, because of these problems, the condo market has been lagging the housing market recovery in Denver by 6 to 12 months.  Now, with prices on single family homes soaring and the overall feel of the housing market completely different than it was 24 or 48 months ago, the condo market is next up for a major advance.

With price rising and defaults sinking, lenders are showing a new willingness to finance in the condo market.

Earlier this month I sold a condo listing to a buyer who came in with just a 5% down payment – a rarity since most lenders have required a 10% to 20% down payment on condos since the market tanked (or was blown up by FHA) in 2009. 

With FHA taking itself out of the picture, lenders responded by essentially eliminating low down payment options.  Without FHA to finance first-time buyers, investors took over the market.  And since most investors simply will not pay retail, selling a condo became nearly impossible for most private owners – unless they were willing to sell at a big loss. 

In 2010, Fannie Mae and Freddie Mac decided to impose their own set of restrictions, and with that, the freefall was underway.  

Foreclosures flooded the market, investors bought them for cheap, and the remaining “retail” owners were left with the difficult decision whether to sell short, walk away, or wait it out.

While FHA has yet to get back into the condo market, I believe that day is coming soon.

As Fannie and Freddie begin to relax guidelines (as illustrated by my 5% down payment buyer) and single family prices continue to move out of reach for many first-time buyers, the condo market is becoming much more viable.  And should FHA begin lending into more condominium communities again, the surge in buyer demand will be both sudden and dramatic.  

One last note - because HOA’s play such a large role in condo life, it’s important to emphasize that you MUST look carefully at the financials of each HOA before making any buying decisions.  Some are so deep in red ink their recovery may lag for years, but for others, who have navigated the downturn with prudence, forethought and fiscal discipline, better times are coming soon.

EARLY PREDICTIONS FOR 2014

It seems people are always intrigued by housing market predictions.  And it’s understandable, because we all want to know how the market is going to perform and whether we should buy, sell, invest or rent.

2014 is going to be an interesting year, in large part because it will follow on the heels of one of the most remarkable years for real estate in recent memory.

Assuming there are no major economic or political disturbances (war, terrorism, global banking failures, etc.), I think the first thing you have to do is dial back your assumptions and realize that the re-calibration of our market in 2013 was caused by a few unique one-time circumstances… specifically, that after seven years of massive foreclosures we finally ran out of homes to foreclose on… at exactly the moment some 83,000 households in the seven county Denver metro area that lost homes to foreclosure between 2005 - 2008 began hitting eligibility to get back into the market.

Those factors, coupled with interest rates that were in the 3’s for much of the year, unleahsed a surge in values and appreciation that was extra obvious below $250,000, and which created enough equity for current owners of those entry-level homes to sell and use their equity gains to move up.

How much did values go up?  According to Case-Shiller, average home prices in the Denver metro area were up 10.1% over the past 12 months.  Core Logic puts the number at 10.2%, and Zillow says prices have increased an amazing 11.8% over the past year. 

What does that mean in real numbers?  Over $21 billion in equity gains for homeowners in the metro area over the past 12 months!

So what about 2014?  What does the future hold for real estate in Denver?

Again, predictions are usually exercises in folly, because there are just too many variables, but here’s what I am calling:

Below $250,000:  6% appreciation

$250k - $400k:  4% appreciation

$400k - $600k:  2% appreciation

$600k - $1 million:  Flat

Above $1 million: Minus 2%

Again, in my view, there were a number of “one-time factors” that caused our market to explode and essentially “recalibrate” to significantly higher values, especially at the lower price points.

The incredible inventory plunge coupled with the surge caused by “boomerang buyers” (foreclosure 1.0 buyers coming back into the market) really set the stage for the frenzied conditions we saw much of the year.

Going forward, buyers are going to be more cautious as rates and payments continue to creep higher, and builders are going to play a larger role in actually holding value gains in check by building far more homes in 2014 than they did in 2013.

To me, the magic number is somewhere around $325k, but that’s the price point where builders can start selling homes at a profit.  Below this number, you simply aren’t going to see any new inventory, and demand here will remain extremely strong.

Above $325k, however, new inventory will be a drag on the market because builders are once again drinking the Kool Aid and building like there’s no tomorrow.  If and when rates rise, the builders will be the first ones to feel it, and the higher end inventory that’s hitting the market by the day will be the hardest to sell if times get tougher.

Below $325,000, it’s hard to see many scenarios where values don’t hold.  You continue to have large numbers of both first-time buyers and boomerang buyers competing for finite inventory.  Rents continue to go up and there’s still value in the market when demand outstrips supply.

In my opinion, 2013 was a “once in a generation” market where unique events caused home prices to recalibrate quickly.  But the fact remains that higher rates, higher prices and higher payments are going to slow the surge in 2014, with the lower end of the market being the safest possible place and the higher end much more vulnerable to the instabilities of a still-recovering economy.

LAND BUBBLES

When people talk about surging home prices, they often think they're talking about the value of the structure itself.  But in reality, more often than not price increases are driven by land values, not home values.

John Burns Consulting, a major consultancy firm which works with builders nationwide to help them value raw land to be used in constructing subdivisions, recently released a report tracking land values in 50 major metropolitan areas of the United States dating back to 1982, 

The report looked at the median home price and then used county assessor valuations to determine on a percentage basis what part of the value was attributable to the house, and how much value was derived from the land.

In Denver, our peak "land value" year was 2001, when land value made up as much as 49.7% of the median-priced home's value.  By comparison, during the peak year of the housing bubble in Phoenix, land value made up 65.7% of the median-priced home's value. 

When land values become disproportionately high, goes the theory, there exists greater potential for a sudden and severe correction.

Today, land value makes up just 28.3% of the median priced home's value in the Denver metro area.

However, actual land value can vary widely from neighborhood to neighborhood.  Just last month, I helped a client research lot value for a small ranch home in the red hot Highlands area of Denver which sits on an 8,000 square foot lot.

Its land value, according to the Denver County Assessor - $279,300.

By comparison, my suburban home, which was built in 2005 and also sits on an 8,000 square foot lot and would sell for about the same price as the home in the Highlands (but is nearly three times larger), has a land value of $83,130.

So land really is the big driver in determining real estate values.  For that reason, home prices will almost always be more steady and predictable on the west side of town, where there is much less available land and more established neighborhoods, than in the boom/bust areas on the east side of town such as Aurora (particularly east of E-470), Parker and Commerce City.

A home's overall value really does depend on location, location, location.

An educated buyer should understand that land value, not house value, is where bubbles are created.  As a percentage of overall value, land values in Denver today are more than 40% lower than they were during our peak value years, which tells me we've still got a ways to go before anyone should worry about a bubble.

SWITCHFOOT

Last night, I took a group of friends, family and past clients to see Switchfoot in concert at CCU in Lakewood. 

I’ve seen Switchfoot before, a couple of times, and I love their energy, passion and creativity.  But as I’ve gotten older, I’ve changed the way I assess the effectiveness of people (and rock bands).  I look less at what people do, and more at how people create change and have impact. 

Long ago, I internalized the belief that the effectiveness of your life is based upon the quality of your communication.  And so I study communication.  I study delivery.  I study message.  And when I see a person, group or rock and roll band that has effectively mastered the art of communication, I take note.

Last night’s show was an interesting small-venue hybrid event, part documentary, part autobiography, part rock concert.  On this tour, Switchfoot launches each show with a documentary film chronicling 12 months on the road with the band, including trips to Australia, New Zealand, South Africa and Bali.

There are numerous personal interviews, concert scenes and unique behind the scenes footage of the band on the road.  The movie ends with an overview of Switchfoot’s annual “Bro Am” surf event, a one day summer beach festival that raises money for children's charities in the band’s hometown of San Diego.

The movie also serves as a platform to promote Switchfoot’s involvement with the Clean Water Project, AIDS orphans in Africa, and charitable foundations around the world.

But it’s also a narrative about purpose and brotherhood, about how a group of men can stay together for 17 years while band members are getting married, having kids, raising families and balancing real life events. 

The only way to stay unified for that long is to have shared vision and a mission that goes beyond rock and roll.  And so Switchfoot has built a message around its music, a message of hope and action and impact and redemption.

Some interesting takeaways from the documentary:

The movie’s first scene shows the band at a heavy metal mega-concert in Australia, where Switchfoot shares the bill with Steel Panther, Slash (from Guns ‘n’ Roses fame), and 20,000 hardcore metal fans… an environment hardly consistent with the band’s traditional white collar fan base.  The band calls this “the most difficult show they’ve ever played”, which is compounded when technical difficulties kill the mic and cause the crowd to turn against them.

The point of playing this show, according to lead signer Jon Foreman: to intentionally seek uncomfortable situations where you can take your message to a new and unfamiliar audience.  For us, that could mean working in a homeless shelter, approaching a difficult peer group at school or working to engage with anyone who sees the world differently.

There is also a heavy surfing theme throughout the movie.  The band admits (being from San Diego) that its true passion is surfing, and there’s footage of the band surfing some of the most famous surf-spots in the world (often with professional surfers who regularly tour with the band, and who sometimes jam onstage with them). 

But surfing is more than an idle pastime.  It’s the shared interest and joint passion that has inspired the band to stay together for nearly two decades.  It has allowed them to build a brotherhood, and it keeps touring interesting, exciting and inspiring after playing over 1,000 shows together.

Switchfoot has always focused on making a difference, and there are portions of the film directed at their work with the Clean Water Project (one in six people on earth do not have a reliable clean water supply), AIDS orphans in Africa and homeless kids in Southern California. 

There are also some poignant scenes of the band with their families, with kids riding bikes and playing instruments and growing up in a busy and increasingly fast-paced world.  Band members talk at length about how simply playing music on the road would not be enough to justify leaving wives and kids for weeks at a time.  There has to be more purpose, more meaning, to giving up such valuable time to interact with fans and strangers in cities hundreds and sometimes thousands of miles from home. 

The movie provides a unique framing for the band’s vision and purpose.  As one of Switchfoot’s signature anthems proclaims, “we were meant to live for so much more”. 

And that’s why I was excited to see Switchfoot in person last night.  We are meant to live for so much more, and whether your platform is music or teaching or volleyball or dance or selling real estate, you can have impact if you are intentional about it.