IF BARRON'S IS RIGHT...

Last Sunday, the national edition of Barron’s featured a recovery-themed front page article ranking its top 50 housing markets in the United States.  Based on income, unemployment, job growth, demographics and housing permit activity, Barron’s ranked Denver #4 on that list, projecting that values in our area will increase a whopping 16% over the next 36 months.

While I am often leery of generalized market assessments (the lower end of the market, for example, has outperformed the high end of the market during our recovery and will continue to do so for the foreseeable future), let’s just assume that their three year prediction of 16% appreciation is accurate for a $200,000 home.

Here’s what that means, in real numbers:

SCENARIO 1:  $200,000 home purchased in 2012 with FHA down payment of 3.5% and 30-year fixed rate loan at 3.5%
- New FHA base loan amount of $193,000
- Principal and interest payment of $881.82 (excluding taxes, insurance and FHA mortgage insurance)

SCENARIO 2:  $232,000 home purchased 36 months from now with FHA down payment of 3.5% and 30-year fixed rate loan at 5.5%
- New FHA base loan amount of $223,880
- Principal and interest payment of $1,293.41 (excluding taxes, insurance and FHA mortgage insurance)

If Barron’s projections are accurate, housing costs (under this example) could increase by as much as 47% on a $200,000 home over the next 36 months.

Even if you tempered Barron’s assessment, scaling back the appreciation to 10% and basing your payment upon a 30-year FHA fixed rate of 4.5% (which is an optimistic view of where rates will be in 36 months), your monthly payment would be $1,094.52, which is still 24% higher than it is today.

The bottom line is we are operating in a window of time where rates and payments have never been lower, and the upside for buyers has rarely been higher.

Just twenty months ago, distressed homes (foreclosures and short sales) made up 45% of the Denver market.  Today, less than 10% of the listings on the market are short sales and foreclosures.

Over the past year, overall absorption rates have fallen in half, from 6.09 months of inventory in September of 2011 to just 2.91 months of inventory today. 

There’s no more distressed inventory, hardly anything is for sale, buyers are everywhere and rates are below 4.00%.  What do you think that means for prices going forward?

The factors which created downward pressure on prices for five years have reversed.  This is a market garnering national attention for its upside, with interest rates at record lows, and affordability at an all-time high. 

It’s not the time to quibble over pennies.  It’s the time to find a house, write a solid contract and set yourself up for the next 10 years.

LEARN YOUR CRAFT

“Learn your craft well enough to teach it.”  
                                     – Sun Tzu, “The Art of War”

One of the reasons I have written this blog for the past six years is that it forces me to really think about my craft.  There is a difference between “peripheral” knowledge and “actual” knowledge.

Peripheral knowledge is an awareness that the market has improved over the past 12 months.

Actual knowledge says listings are down 35% from one year ago, the ratio of “Active to Under Contract” home has fallen from 2.71 to 1.39 and the absorption rate for homes under $250,000 is just 1.76 months.

Many real estate agents try to skate through life working off peripheral knowledge.  My feeling is that if you are going to invest $200,000… $300,000… or $400,000 in a home, you might want to know what’s going on in a bit more detail.

One of my mentors, the late Jim Rohn, often taught in his seminars that if you were given the opportunity to teach a class, you should take it.  I have acted on that advice repeatedly through the years.  At my old brokerage in California, I taught classes regularly on lead generation, database management and technology skills. 

When I relocated to Colorado, I immediately put together a “Mastermind” group of fellow agents who met weekly to brainstorm and share ideas.  And for several years I’ve been consistently involved with many different networking groups, taking a leadership role and giving presentations wherever and whenever the opportunity arises.

If you’re going to get up before a group of people, whether it’s for 10 minutes, 45 minutes or 3 hours, you have to prepare.  And preparation means “knowing your stuff”.

It’s easier just to show up.  It’s easier simply to tell clients that the market is “better”, and hope that your simplistic answer will suffice. 

But I think excellence is found in the details, and that by taking time to force yourself into a place of actual knowledge and competence, you become far more worthy of trust and confidence.

UNDERSTANDING A CHANGED MARKET

I was going through some old files over Labor Day weekend when I found a copy of a letter I sent to many of my clients just about one year ago.

That letter, which was actually a three page discussion about the significant changes taking shape in the market last fall, was entitled "UNDERSTANDING A CHANGING MARKET."

Today, nearly 12 months later, I thought it would be worthwhile to revisit some of those comments I made last year and provide some updates with what is happening now, as the “Denver Recovery” remains the focus of much discussion around the country today.

First, let’s start with a look at where things stand in terms of inventory.  As of this writing, the overall number of homes for sale in the Denver MLS stands at 10,827, a 38% decline from the 17,583 homes on the market one year ago and a 54% decline from 2010, when we had nearly 24,000 homes for sale. 

Less housing inventory is almost always a stabilizing factor when it comes to prices, and when you have steady demand and falling inventory, prices almost always rise.

So what’s happening with demand?

Last month, there were 4,181 homes that went under contract, up 19% from the 3,386 that went under contract during the same period one year ago.  The number of contracts written last month increased at every price point, including a strong surge in the $250,000 to $400,000 price range, which is great news for a segment of the market that has really just been treading water for the past few years.

Below $250,000 (undeniably the hottest sector of the market), there are just 3,115 homes for sale, compared to 5,875 at this time last year.  That is a 47% drop in inventory in the most sought-after price range!  Contracts here are up 14% from a year ago, although I am confident that the increase would be even higher if there were simply more desirable homes on the market.

As I said last year, the decline in inventory is basically attributable to two factors.

First, foreclosures are down roughly 75% from Colorado’s worst year, 2007,  In the Denver metro area, we are on track for about 8,000 completed foreclosures this year, a huge decline from the 27,000 we had just five years ago.

Second, our economy is functional, but hardly robust.  Historically speaking, first-time buyers make up about 40% of the market.  So-called move up buyers make up the next 40%, with the remaining 20% consisting of downsizers and investors.

In analyzing the numbers, we have plenty of first-time buyers and lots of people trying to downsize, plus a large contingent of investors who are picking off rental properties with once-in-a-lifetime cash flow potential.  The missing link remains clear – the move-up market remains far, far below historical levels.

What does this mean?

In short, it means the homeowner in a $250,000 home who normally would sell to buy one for $375,000… isn’t selling.  He has neither the equity (yet) or the confidence in the economy to take on such a move, and so he stays where he is. 

That lack of entry-level inventory, coupled with the disappearance of foreclosures (80% of which affected homes priced below $250,000), explains why there is hardly anything for sale.

Short sales and foreclosures, which made up 45% of the inventory in the Denver MLS in January of 2011, are just 14% of our inventory today.  Distressed inventory, which undermined prices and destroyed neighborhoods, has pretty much vanished. 

That is great news for homeowners, neighborhoods and prices.

Absorption rate is a statistic real estate economists use to assess the overall health of a real estate market.  In general, six months of inventory is considered to be a “balanced” market.  Less than six months of inventory indicates a shortage of homes, and over six months represents a buyer’s market.

Look at this incredible change between August of 2011 and August of 2012, by price point:

PRICE                                  AUG 2011                            AUG 2012

0 - $250k                              3.64 months                       1.70 months

$250k - $400k                      6.11 months                       2.51 months

$400k - $600k                      8.60 months                       3.73 months

$600k - $1 million             15.84 months                      7.71 months

$1 million and up             37.60 months                     18.09 months

At every price point, absorption rates have fallen by more than 50%.  The Denver market is actually very healthy all the way up to about $600,000, although there is still much more demand for a $200,000 home than a $400,000 or $600,000 home. 

One last figure I track closely is what is known as the “Active to Under Contract” ratio.  In short, this ratio shows how many homes are on the market and still looking for a buyer compared to each one currently under contract.

Economists will tell you that a 2 to 1 ratio (2.00) is healthy.  This would mean there are approximately 2 homes for sale to each one under contract. 

At the start of 2009, this ratio (marketwide) was 4.75 to 1.  One year ago, it was 2.77.  Today, it is 1.39, meaning there are just 1.39 homes on the market for each one that has a contract on it.  That is much tighter than the 2 to 1 ratio economists describe as “balanced”. 

The one-year change in the ratios speaks for itself:

PRICE                              AUG 2011                     AUG 2012

0 - $250k                             1.58                                 0.73

$250k - $400k                      3.34                                 1.44

$400k - $600k                      4.87                                 2.24

$600k - $1 million               8.93                                 4.02

$1 million and up              16.59                                7.85

You can clearly see how tight the market is today below $400,000… how it softens up to $600,000… and then how it breaks down after that.  Still better than a year ago, but the obvious takeaway is the dramatic shortage of inventory below $400,000.

THE ZILLOW EFFECT

If you work in the trenches, know anyone looking to buy a house, or subscribe to a newspaper, you probably already know the market in Denver has turned.

Yet, almost every buyer I work with arrives with a residual psychological hangover, a fear-based caution caused by too many years of declining values, distressed inventory, broken promises and financial hardship.  

“How do we know values won’t plummet again?” they often ask.

It’s a good question, and one worth exploring in more detail.

There are actually several arguments you could make in support of future price stability, including strict new licensing requirements for mortgage lenders, an absence of new construction and demographic changes that cry out for more housing inventory.

But I want to focus on two big ones that are game changers.  One is at the government level, and the other is at the individual level.

At the government level, the fact is that the Federal government is up to its eyeballs in mortgages and loan guarantees.  Between Fannie Mae, Freddie Mac and FHA, the Federal government now has a financial stake in nearly 90% of all mortgages originated today.

When the banking industry imploded in 2008, largely under the weight of ridiculously loose mortgage lending practices, the government became the financier of last resort though its sponsorship of the two GSEs and FHA.  

Almost overnight, the role of the Federal government in housing exploded, creating massive liability for the taxpayer and leading to unprecedented overhauls in regulation and lending standards.

With Fannie and Freddie incurring nearly $200 billion in losses from bad loans made during the last boom, the lesson has been learned.  No more risky loans to marginally qualified buyers. 

Since bottoming out in 2008, Fannie and Freddie have radically revamped underwriting standards and as a result of making good loans to qualified borrowers, they two GSEs have already repaid over $46 billion back to the treasury. 

There is no way, however, that any single entity should be holding 90% of the nation’s mortgage loans.  A downturn in values would be utterly catastrophic to the already fragile economic condition of the US government, and it would likely plunge us into a full-blown Depression. 

This is reason number one why the market won’t tank again.

The second reason I can’t see values plummeting again is because of what I call “The Zillow Effect”.  Simply put, clients have access to infinitely more raw data about housing than they have ever had before.  For the first time ever, the housing market is almost fully transparent to the consumer.

Today, I would estimate that half of my clients have the Zillow app on their iPhones.  Using this app, clients can instantaneously pull sales history, assessment information, comparable sales data, and read MLS information directly from their phones. 

It’s incredibly empowering to clients, and frankly, this technology was almost non-existent during the boom years of 2000 – 2005.  Back then, buyers relied on real estate agents for data, and many agents were far more committed to paychecks than protecting their clients from making poor decisions.

You wonder why one-third of the agents in Colorado have quit since 2007?  There are several reasons, including a scarcity of transactions, downward pressure on commissions, and the brutal and often fruitless practice of trying to negotiate short sales.  But the biggest trigger for this exodus, in my opinion, is the pressure of being under an intense microscope with skeptical clients who (rightfully) won’t stand for anything less than full and complete disclosure.

If your business model has been based on anything less than character, competence, hard work and personal integrity, chances are your business is in shambles.

The reason my business has grown exponentially, the reason I have been named a Five Star Professional by 5280 Magazine each of the past three years, the reason I am closing more transactions than ever… is because I have always operated with transparency.  

Transparency will promote you, or transparency will expose you, based upon your ethics.

When a new market emerges, a transparent market where consumers have access to as much data as you do, you can’t fake your way to success.  You either know what you’re doing or you don’t.  You either have your clients’ back or you don’t.  You either tell the truth, or you are quickly exposed to be a fraud.

Truth be told, the real estate market of 2012 is far, far healthier today than most people are willing to acknowledge.  If you can trust the data, if you know the data, if you have a skilled negotiator on your side, and if you can get a mortgage at less than 4.0%, what is there to fear?  

MULTIPLE OFFERS

Amazing how much can change in 12 months.

One year ago, we were all sitting in classes discussing short sales and foreclosures.  Today, the hot new class is what to do when you have four offers on your brand new listing.

Legally, multiple offers can present some challenges to real estate brokers.

Does the seller need to be made aware of every offer that comes in, even after an offer has been accepted?  (Yes)

Are agents prohibited from telling other agents the price of competing offers?  (No, as long as the seller approves and everyone is notified)

Will some agents make “moonshot” offers to get a property under contract, knowing that the appraiser will likely rein the price back down to current market value?  (Yes, but there’s a poison pill good listing agents can drop into a counter offer to eliminate this practice)

In short, even though a hot market is obviously better than a cold market, every market has its challenges and good agents must adapt to whatever conditions are prevailing.

If you are working with buyers, there are things that can be done to improve the quality of your offer without necessarily raising the purchase price:

-  Eliminate or limit the appraisal contingency, with language such as “appraisal contingency only applies if property appraises $10,000 or more below contract price."

-  Take the entire down payment a buyer plans to make and convert it all into the earnest money deposit (a $12,000 deposit looks a lot more serious than a $2,000 deposit, and it’s all refundable if the buyer terminates based on a contract contingency).

-  Consider taking your home inspector to the initial showing so you can remove the inspection contingency from the contract at the time the offer is submitted (an “as-is" offer)

For sellers, the strategies are different.  For example:

-  Round-robin countering.  With multiple offers, choose the buyer you want to work with first and give them four hours to respond to your counter.  If they don’t respond, move on to #2.

-  Ask for as many contingencies as possible to be removed from the contract.

-  Make all or part of the earnest money non-refundable upon acceptance.

-  If buyers insist on leaving contingencies in, ask for a higher earnest money deposit or “tiered earnest money”, with additional amounts due at different checkpoints so that the buyer’s motivation can clearly by tracked.

In short, the rules of this market are very different from any we have seen in the past several years.  And while not every home draws multiple offers within hours, the ones that are priced right with a great location are almost always subject to competition very quickly.

If your agent is not actively adapting to the realities of our new market, one where inventory is down 40% and contracts are up 20%, one where the percentage of distressed homes (short sales and foreclosures) has fallen from 45% of the market in January of 2011 to just 14% of the market today, you might want to reconsider your relationship. 

With rates in the 3’s and bank-owned inventory (mostly) a thing of the past, it’s time to gear up for a new phase of the housing cycle.  The phase called “recovery”. 

CAPTURING LEADS VS CULTIVATING RELATIONSHIPS

Every week, I get three to five calls from telemarketers offering to “sell me leads”.  I also get calls from scores of web vendors promising to “capture” visitors who come to my site, while other sites encourage me to bid (a la Ebay) on existing “red hot” leads that they have generated.

I don’t know about you, but I am not looking to be sold leads, and I certainly don’t want to capture anyone.  I have never viewed prospective clients as commodities to be bought and sold. 

A successful, long-term business is built through relationships, not by capturing strangers.  The goal is to create value, not take hostages.

Part of what causes so many real estate agents (and brokerages) to have poor reputations is that too much attention is paid to the transaction and too little attention is paid to the people involved. 

When the clients you work with have been “sold” ,“captured”, or auctioned to the highest bidder… really, how much hope is there for the relationship?

I have built my business by referral, one satisfied client at a time.  That means my goal is to work with people who have been referred by people who know, like and trust me because they know I’m competent and they know I care about the well-being of my clients. 

I spend a lot of time talking with my clients about “exit strategy”… in other words, making sure you can get out of whatever you’ve gotten yourself in to if circumstances should change down the road.  Sometimes, if there’s not a viable exit strategy, then the deal never happens. 

But that’s for the best. 

The goal for anyone committed to long-term sales success should be to focus on the “happily ever after”, not merely the here and now.  I need clients who love me every bit as much 12 months from now as they did when we were together at the closing table.

And that rarely happens when you’re bought, sold or captured. 

REAL ESTATE ECONOMISTS DESCEND ON DENVER

The National Association of Real Estate Editors wrapped up its 46^th annual convention at The Brown Palace Hotel in Denver this weekend.  The convention, which featured hundreds of editors from newspapers, real estate magazines and industry websites, focuses on coming trends and technological innovation.

Lawrence Yun, head economist for the National Association of Realtors, said in a speech on Friday that demand is so strong for housing right now that many areas of the country could see 10% appreciation over the next 12 months.  He cautioned, however, that appreciation would probably be less than that if builders re-enter the market on a large scale.

New construction has essentially been grounded for the past five years.  Here in Colorado, nearly three-quarters of the builders who were building homes in 2007 have shut down, left the state or declared bankruptcy.  The process to jump start new home construction can take up to 24 months from the time financing is secured, as builders must clear zoning hurdles, build infrastructure and hire subcontractors before the first foundation is poured.

Stan Humphries, lead economist for Zillow, said that the recovery would look more like a “stair step” than a steady climb.  As demand pushes values higher, homeowners who have had little or no equity will jump into the market and list their homes, which will cause appreciation to stall.  Once those homes are sold, there will once again be a shortage, leading to more gradual appreciation. 

The one consistent theme among economists is that there is demand that is real and which figures to last for several years.  There are three main reasons for this, according to the economists:

-  Millions of adult children (ages 25-34) eager to buy a home after moving back in with their parents during the recession

-  A strong influx of first time buyers who are being encourage to take advantage of low rates and high affordability

-  The return of “first generation” foreclosure households coming back into the market after six or seven years on the sidelines

The one commonality with all three of these groups is that they figure to be far more interested in affordable entry-level housing than in luxury, high end homes. 

That suggests that appreciation gains will continue to be strongest below the median price, while the higher end of the market may take longer to recover.