The Inland Empire Real Estate Market Warms Up

Prior to the collapse of the U.S. housing market in 2007-2008, there was a widespread belief among many mortgage lenders and borrowers that home prices would not fall sharply, even in overheated markets. It was assumed that homeowners would simply prefer to wait to sell their houses until the market recovered, rather than trying to unload their properties into a falling market. However, things turned out differently from what most people anticipated. The median home price in the Inland Empire − one of the epicenters of the housing crash in Southern California − dropped from $397,000 in the second quarter of 2006, to $165,000 in the second quarter of 2009, experiencing a 25.4 percent compound annual decrease (See Figure 1). The collapse of housing prices was also reflected in a sharp rise in notices of default starting in 2007, reaching a peak of nearly 30,000 units in the first quarter of 2009 (See Figure 2).

The Inland Empire’s housing market, however, has improved over the last three years. According to property records tracked by the real estate firm DataQuick, the Inland Empire saw the median home price rise at the end of 2012, after two years of precipitous decline, followed by four years of stagnation. The median price stood at nearly $210,000 in the fourth quarter of 2012, a 20 percent increase from a year earlier (See Figure 1). The median price increase indicates that the housing market might have turned the corner. “Most every gauge shows prices are up significantly over the past year, even after adjusting for changes in the types of homes selling,” DataQuick President John Walsh said to the Los Angeles Times.
As the economy and job growth have improved, the number of borrowers behind on mortgage payments has fallen dramatically by the end of 2012. Notices of default fell to 6,225 units, a 33.4 percent decrease from last quarter and 40.64 percent compound annual decrease from the peak in first quarter 2009 (See Figure 2).
“U.S. housing recoveries almost always have been ignited by rising demand from families and individuals looking for a place to live. This recovery is different,” wrote Nick Timiraos in the Wall Street Journal. Investors – including some big Wall Street players – have played a major role in recent home-price surges. Blackstone Group, a private equity titan, and other real-estate firms, strongly believe that home prices fell too far in the hardest-hit markets. They are mostly buying distressed properties at bargain prices, renovating them with the intention to rent them out for a short-term profit and/or holding on to them for a long-term price appreciation. Buying and fixing up probably the worst houses on the street and then turning them into quality and affordable homes is what they call “a new investment strategy.”
The decline in distressed properties – comprised of foreclosures and short sales – is another reason why the region’s median home price is up. Short sales, where homeowners who owe more than their property is worth convince the bank to agree to sell the property at a loss, constituted 28 percent of existing home sales at the end of 2012. Foreclosed properties accounted for nearly 30 percent of existing sales in the Inland Empire in 2012 compared with 94 percent in 2008 (See Figure 3). Banks in the state of California don’t have to get foreclosure approval from a judge, which makes the foreclosure process easier and faster in California than in other states. Thus, the foreclosure process has likely worked its way through the market in California. The pronounced drop in foreclosure rates reflects the fact that a large portion of foreclosures have made their way through the system.
If prices continue to rise, more homeowners will have an opportunity to escape their negative equity positions, which will allow them to sell their properties and potentially increase supply. “A meaningful rise in the supply of homes on the market should at least tame price appreciation,” Walsh said.
However, rising prices are likely to keep real estate in California out of reach for many buyers. According to the California Association of Realtors (C.A.R.), to qualify for a median-priced, $353,190 home, a homebuyer needs to earn no less than $66,940 a year. The monthly payment on that property comes out to $1,670, assuming a 20 percent down payment.
Homes are selling faster. The median number of days on the market for homes at the end of 2012 was 73, down from 99 days one year ago. Affluent domestic and international cash buyers – largely investors – are diving into the market to scoop up homes taking advantage of favorable home prices. Nationwide, 32 percent of homes are now sold to cash buyers. The continuation of record-low interest rates is also fueling the market. The rush of investors into the housing market is dictated by the fear of missing out on cheap homes. The Wall Street Journal reports that “Sellers are calling the shots right now,” said Carolyn Williams, a real-estate agent in Dana Point, California. “What’s out there is gobbled up with anywhere from five to 25 offers.”
The number of existing homes in the Inland Empire listed for sale in 2012 totaled 65,510, up 1.12 percent from a year earlier but still down 9.7 percent from 2009, leaving would-be buyers chasing a shrinking supply of homes (See Figure 4). Many homeowners, worried that prices have not yet improved sufficiently, are still reluctant to list their homes. This lowers the supply of existing homes on the market and drives prices up.
Unlike the existing home sales, sales of new homes in the Inland Empire remained low over the last two years, totaling 5,111 in 2012. This shows that home builders are not yet ready to expand new home sales. When the market declined, builder confidence also fell. New-home builders are sensitive to rising labor and material costs and a short supply of ready-to-build lots. They now take more time and consider all options before building, and are more careful to choose features that keep prices within reach of more home buyers.
At the beginning of 2013, the Consumer Financial Protection Bureau (CFPB) issued new mortgage rules, which will go into effect in January 2014. The rules force lenders to ensure that borrowers have the ability to pay back the loan. To qualify for a home mortgage, buyers must have a substantial down payment, good credit history, minimal debt, and a secure income. Such strict lending requirements are likely to lead to more stringent standards for mortgage borrowers.
The Inland Empire’s housing market has improved over the past three years. More and more people in the area can now afford to buy a median priced home. The only problem is that the inventory of housing is too low these days. “Sales would be even higher if inventory were less constrained in REO-dominated markets, particularly in the Central Valley and Inland Empire, where there is an extreme shortage of available homes,” said C.A.R’s President Le Francis Arnold.
The housing market will continue to recover in 2013. Most economists and real estate experts expect the U.S. prices to rise in 2013 due to strong investor demand, low interest rates, and shortages in home supply. As Le Francis Arnold writes, “Sales will be stronger in higher-priced areas, where there are more equity properties and a somewhat greater availability of homes for sale.”