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Analysis of the UCLA Anderson Forecast from September 2006 and other information on Real Estate Prices.

Dec 6/2006
This Analysis is primarily focused on the Real Estate aspects of the UCLA Anderson Forecast as well as information from some recent newspaper articles. It is not definitive and any editorial commentary reflects the things the author found most interesting or compelling. This is not intended to be an exhaustive review of the Forecast and this summary therefore has its limitations. For a full exploration of the subject, it is best to read the Forecast itself. (Go to to subscribe).

General Economic Conditions:

The Forecast expects weak GDP growth and mild inflation. As a result, the forecasters expect a modest decline in the Federal Funds rate by mid-year 2007 to 4.5% from the current 5.25%. "Rate cuts along with still strong business investment, an improving trade picture, and some easing in oil prices along with an end to the free fall in housing construction will enable the economy to avoid recession and return to a 3.5+% growth path in 2008."

The Forecast reports that there were substantial nonresidential construction gains, which will continue, primarily being fueled by high demand for commercial real estate by investors throughout the globe. This should continue, although at a reduced rate, through 2007.

According to the Forecast, the housing market is in a cyclical decline. Housing starts will bottom out in the 1.5 million-1.6 million range, which represents a normal, not a depressed, level for housing activity (thus a "cyclical decline", not a "bursting bubble). Declines in housing starts typically run in excess of 50% from peak to trough. The forecast projects a decline in starts of around 30-35%.

Home Prices:


Although the first half of 2006 continued the slowing trend in housing sales activity which began in the second half of 2005, in California, in the absence of a general economic recession, home prices are unlikely to experience significant declines. However, since builders are much more willing to lower home prices than owners, the handful of areas where new homes account for an above-average share of total sales activity could see some price declines. Year-over-year growth in median sales prices in the San Francisco Bay Area and Southern California has slowed to single digits. San Diego and several counties in the Sacramento region have actually seen declines in median sale prices.

In the Southern California real estate recession of 1991-1995, median prices of NEW homes had a sharper run-up before the recession and a sharper decline afterwards, falling 24% in around 3 years. RESALE homes (homes built before the recession and sold during the recession), had a less sharp decline (around 16%), over a longer period of time (around 4 years) and did not recover as quickly as the new homes. The Forecast believes that the reason new homes dropped further and more quickly is that builders of new homes cannot carry unsold inventory nor take the depreciation hit on renting a new home. Therefore, builders will respond to a fall in demand by lowering the price, while resellers of homes (mostly consumers) may simply retreat from the market. Builders are always motivated sellers, while consumers often have the option to "stay put" or rent out property rather than sell it.

Most sales of homes are in the "resale" market rather than the new home market. This makes sense because there's a lot more old housing stock than newly built stock.
Since there is no significant economic distress in the economy in 2006, the number of motivated resellers is not high, which is keeping prices relatively stable in that part of the market.

In regions where the bulk of the sales are new homes, prices are stagnant or declining. San Diego and Sacramento have seen a high rate of new home construction and prices are falling as developers seek to liquidate inventory. In Riverside County, new construction made up 40% of the sales in 2005. This is a county to watch. If the demand does not keep up with the supply, the developers may engage in price cutting to liquidate inventory. Actual declines were reported in San Diego (2.1%), Sacramento (3.5%) and Orange County (.8%) in the third quarter of 2006 (Los Angeles Times, November 21, 2006).

The builders are reacting by taking out fewer construction permits, which will continue until the excess inventory is absorbed. This will limit supply and possibly keep prices from falling dramatically. However, there will be a negative impact on the jobs front. Over the next 2 years, the Forecast predicts that there will be 100,000 jobs lost in the construction industry. This means that there may be fewer qualified buyers to purchase the housing stock that is for sale, and may result in some people having to sell their homes in a distressed state, which can also reduce prices.

The Forecast summarizes that there will be no recession in California as the manufacturing and service industries should experience enough growth to absorb the construction job losses. Home prices in California should stay flat through 2008 with a "handful" of regions with above average levels of new construction (Sacramento, San Diego and Riverside) potentially seeing moderate price declines.

The Los Angeles Times reported on November 21, 2006 that "California is a step ahead of other parts of the nation because it was the first region to start experiencing double-digit price gains in 2000 and the first to start tapering off."

The National Perspective:

Ed Leamer, Director of the Forecast, states that "though sales rates have plummeted, prices overall continue to push upward, though at a much slower rate. Leamer states that "it's a volume cycle, not a price cycle." What he's saying is that the number of sales is in a cyclical decline, but prices will not necessarily follow. In Leamer's analysis, one of the biggest issues in the slowdown in the market will be the impact on national GDP, which may suffer a decline causing stagnation in the economy.

Historically, there has been a close association between the job market and the housing market. Usually, employment and home prices move up and down together. The exception was the 2001-2003 period when low interest rates allowed more people to qualify for loans even though employment fell overall. The Los Angeles Times, on October 8, 2006 reported that the vast majority of buyers and sellers (95%) are motivated by the same reasons they always have been: a job change, someone has died, a divorce, or having children.

Of course, all real estate markets are essentially local. Since Budget Finance Company is now in 4 states (California, Washington, Oregon and Arizona), it is important to look at trends in states other than California (Which still represents a majority of our lending base).

In Phoenix and Florida's eastern coast, prices actually declined in the third quarter of 2006, according to the National Association of Realtors (Los Angeles Times, November 21, 2006). The same article states that nationwide, the median price of a resale home fell 1.2% with about a third of the 148 U.S. markets surveyed posting year-over-year declines. We will be watching our markets carefully and looking at listing prices as well as more recent sales to more accurately estimate values.

The Forecast also addresses the difference between "nominal" prices and "real" (inflation-adjusted) prices. This summary does not go into that level of analysis. However, to the extent that people's living expenses are increasing due to inflation, if their incomes do not follow, they may not be able to qualify for a mortgage or continue making payments on an existing mortgage (which generally adjust no more than once a year, if at all, and adjust based upon a rate which is only tangentially related to inflation). This "macro-level" of analysis is not being addressed in this summary.


Condominiums historically have been the "canary in the coalmine" for real estate cycles-they are generally the first to fall in price and the last to recover.

In October, 2006, the Boston Globe reported that condominium prices in downtown Boston declined 6.9 percent in the three months ending Sept. 30, the second consecutive quarter in which slumping sales drove prices down in the once-hot downtown market. Prices declined in 8 of the 12 central city neighborhoods in Boston, ranging from Back Bay's 4.2 percent drop and Beacon Hill's 1.9 percent drop to a 2.5 percent rise in South Boston and a 3.1 percent rise in the emerging Fenway neighborhood.

A review of DataQuick Reports on home resale activity (not new housing) shows that condominium prices in the five counties in the Los Angeles area were as follows: Los Angeles County increased by 0.2% from September, 2005 to September, 2006. San Bernardino was up 5.1% during that same period. During that same period Orange County condo prices were down 3.3% and Riverside County prices were down 10.7%, San Diego prices were down .5%, Ventura County was down 1.9%, and Santa Barbara County was, down 9.1%
For this reason, Budget is watching its condominium loan underwritings very closely and looking at trends in listing prices in the entire residential real estate market.

A Short Coda on Rental Housing:

In our last posting, we spoke about the "slinky effect" of rental housing and how the rent/buy equation lags housing prices until housing prices become so high that rents are cheap by comparison. At that point, demand for rental property goes up and prices of rentals begin to rise with that demand.

On October 11, 2006, the Wall Street Journal reported that the "bidding war" which characterized the market for home purchases over the last several years, may now have shifted to rental housing. Nationally, rental vacancy rates were just above 5.3% at the end of the second quarter of 2006. The article cites a couple in New York who is renting an apartment for $6,500 per month. To purchase the unit would cost them $10,500 per month. If this becomes the norm, more people will rent than buy (although the tax benefits of purchasing mitigate some of the benefits of renting).

On October 19, 2006, the Los Angeles Times reported that apartment rents in California are up 6% in the third quarter. The average rent in Los Angeles and Orange counties rose 7.4% during the third quarter. In Ventura County, rents increased 7.6% during the period. Riverside and San Bernardino counties also rose 6%. In Silicon Valley (Santa Clara county), rents rose 10.4% on the resurgence of the tech sector. Rental occupancy is at 96.2% throughout Southern California. San Diego County had the lowest increase, with 3% reported in Oceanside.

At some point, depending upon the state of the economy and the price of mortgages, the buy/rent alternative will again favor purchasing, which will then contribute to a rise in single-family home prices once again.
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