SAN JOSE, Calif. — Drastic cutbacks in new-home construction have helped reduce inventories of homes for sale in California faster than expected, and falling home prices and low interest rates are making owning look like a better deal than renting for many, according to Richard Green, director of the Lusk Center for Real Estate at the University of Southern California.

That, coupled with the fact that home prices have fallen below replacement cost in many markets, means that "if you know you are going to live in a place for at least five years, it’s just silly" not to consider making the move from renting to homeownership, Green told Realtors meeting in San Jose Thursday.

Green said those three factors — shrinking inventories, better rent-to-price ratios, and price relative to replacement cost — help explain why he was the lone optimist on a panel of three economists presenting their outlooks for 2010 at the California Realtor Expo.

Green recognized an equal number of potential risks to the downside next year: unemployment, falling rents, and the potential for lenders to release a flood of "shadow inventory" onto the market.

Nevertheless, he said, "I am 70 percent optimistic that 2010 will be a year of recovery, particularly for housing in California."

Green called the relationship between home price vs. replacement cost "the basic fundamental of housing: Can you build them for what it costs to buy them?"

In California’s Inland Empire and many ZIP codes in Los Angeles County, home prices have dipped below replacement costs. With the exception of markets that are losing population, like Detroit, "home prices cannot stay below replacement costs forever," Green said.

In the greater Los Angeles and San Francisco markets, land as a share of a home’s total value is returning to a more sustainable 70 percent, after running up above 80 percent in some markets, Green said. In markets where land is more plentiful, such as Kansas City or Indianapolis, land accounts for closer to 20 to 25 percent of a home’s value, he noted.

The steep decline in home prices in many California markets means gross rent-to-price ratios are returning to historical norms, which — coupled with low interest rates — can make buying a better deal than renting, Green said.

While rents are falling, too, Green suspects that’s a "temporary phenomenon," with vacancy rates remaining low in job centers and construction of multifamily housing lagging behind population growth.

Unemployment looks to be of particular concern in California’s inland counties, where the workforce tends to be less highly educated and trained than areas like Silicon Valley or Hollywood, Green said.

Employment is back at 2000 levels, Green said, and inland California "is not a particularly attractive labor force to employers." Adding to a "really bad job picture," the number of students taking college preparatory classes in San Bernardino and Riverside counties is "really low," Green said.

Green believes the problems experienced by homeowners with subprime loans are "largely behind us," if only because most of those who were destined to default or end up in foreclosure already have.

The new foreclosure threat is prime loans, like those owned or guaranteed by Fannie Mae and Freddie Mac, where delinquency rates have tripled, Green said. …CONTINUED

A Congressional Oversight Panel created as part of the Troubled Asset Relief Program (TARP) last week issued a report that concluded the foreclosure crisis "has moved beyond subprime mortgages and into the prime mortgage market."

The report questioned whether the Obama administration’s Home Affordable Modification Program was too focused on subprime loans, and "targeted at the housing crisis as it existed six months ago, rather than as it exists right now" (see story).

To understand why borrowers with prime loans are getting behind on their payments and even walking away from their homes, Green said to imagine a hypothetical Riverside County couple with $150,000 in annual income who’d bought a $400,000 house with a 20 percent downpayment.

"He’s lost his job, she’s a state worker who’s been furloughed, and now they are only making $90,000," he said. If the couple’s house is now only valued at $240,000, and their $320,000 mortgage "is a real stretch," they might decide walking away is their best option, Green said.

The second major issue that continues to drive foreclosures in California is that about half of mortgages in the state have second or even third loans, Green said. He said he personally knows of one home that has six loans on top of the first mortgage. Second loans complicate the task of engaging in workouts with borrowers, and loan modifications often don’t solve the problem of homeowners being upside down.

Green’s solution is a government-backed debt-for-equity swap program that would essentially forgive part of a distressed homeowner’s loan by turning it into an equity stake for the lender. If the home’s value rebounds, profits from its sale would be shared by the lender and taxpayers.

Providing homeowners with a bit of equity in their homes reduces the incentive for them to walk away, and could diminish the looming threat posed by lender’s shadow inventory, Green said.

"We did it back in the 1930s, with the Home Owners’ Loan Corp., and the redefault rate was about 10 percent," Green said.

Green said he’s been pushing the idea for awhile — and even has the ear of a "good friend" in the Obama administration, former USC colleague Raphael Bostic, who was confirmed in July as assistant secretary for policy development and research at the Department of Housing and Urban Development.

Ken Rosen, chairman of the Fisher Center for Real Estate and Urban Economics at the University of California, Berkeley, is another advocate for debt-for-equity swaps.

Although Green’s worried about the potential for increased foreclosures among homeowners with prime loans, he sees light at the end of the tunnel. 

For years, Green said, "I’ve been the gloomy one on the panel" of economists put together by the California Association of Realtors for the annual Expo.

"Compared to these guys, I’m going to be the most optimistic guy you’ve heard for a long time," Green said in following presentations by Glenn E. Crellin, director of the Washington Center for Real Estate Research at Washington State University, and Jack Kyser, chief economist for the Los Angeles County Economic Development Corp.

"People ask us if (the recovery will be) a ‘V’ (shape) or a ‘U’ (shape)," Kyser said. "We tell them its going to be a lazy ‘L.’ Residential seems to be bottoming out, but commercial will struggle into 2013." …CONTINUED

Office vacancy rates are well above 20 percent in troubled markets like San Jose (27.2 percent) and the Inland Empire (23.5 percent), Kyser said. Commercial vacancy rates of 10 percent are considered a better balance between supply and demand, he said. Industrial vacancy rates in those markets are just above 12 percent, compared with the 5 percent that’s considered balanced, Kyser said.

Citing numbers from the California Department of Finance, Kyser said media reports that California residents are fleeing the state in droves are overblown. Although in-migration has tapered off, the state continues to see natural population growth with births outnumbering deaths.

The "smoke and mirrors" that state lawmakers used to create this year’s budget included deferrals that "will have to be made good" in 2010, Kyser warned, noting that other cities are considering following Vallejo, a city east of San Francisco, in filing for bankruptcy.

"The bottom line is keep the faith, we will recover — California is the best place to be," Kyser said.

Crellin said that while he’s been "vilified by bloggers in the state of Washington for being an industry shill," he was worried that now, at the beginning stages of a recovery, "I am less optimistic than I had been previously."

He noted that after the housing crash of 1978 — which began the year after Crellin began his career with the National Association of Realtors —  it took 20 years for the national market to regain its peak.

"The question remains when will we ever get back to the level of home sales nationwide" attained at the 2005 peak, Crellin said.

Crellin thinks the recovery, when it comes, will "look more like a W," with a double bottom, and that "2010 is not going to be (a year of) salvation for the real estate industry."

Reviewing home-price data from multiple sources, including NAR, the Federal Housing Finance Agency, the Standard & Poor’s/Case-Shiller price indexes, IHS Global Insight, and First American CoreLogic, Crellin singled out mortgage insurer PMI Group Inc.’s market risk index.

"It hasn’t gotten media attention, but I really like what they are trying to tell us," Crellin said — the likelihood that prices will be lower in a given market two years from now.

In most California communities tracked by that index, "They are telling us the pain is going to be with us on the price side for at least two more years," Crellin said.

Crellin said expectations for this year and next "really start with whether the tax credit (for first-time homebuyers) is renewed or not."

A survey of 1,400 Realtors in Washington state revealed the credit was claimed on 45 percent of 6,500 recent transactions, and that as many as 70 percent of those purchases wouldn’t have happened without it, Crellin said.

The tax credit is important because it provides sellers with little equity in their homes to re-enter the purchase market, and "give the housing market the kind of multiplier effect we are used to seeing," Crellin said. "In the Washington market, we are continuing to run on empty."


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