Inflated Expectations

Craig OuthierJune 1, 2013
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Valley home values are exploding once again. Good news for homeowners, or are we sitting on another bubble?

“Arizona Leads Nation in Housing Price Decline”
— Arizona Daily Sun,

August 25, 2011

“Phoenix Home Price Gains Lead the Nation”
— Phoenix Business Journal
October 23, 2012

Up and down. Hot and cold. Boom and bust. So it goes in the Valley’s manic-depressive real estate market, where home value trends are the bleakest in the nation one moment and the life of the party just 14 months later.

After crumpling like a deflated dinghy during the recession, Valley real estate looks buoyant again. According to the S&P Case-Shiller Index, which tracks the 20 largest metro markets in the U.S., Phoenix home values posted a 23 percent year-to-year gain in 2012 – the largest such spike in the nation. Experts currently peg Phoenix home values at 2005 levels, just two years before they peaked.

Of course, Valley homebuyers have climbed into this spinning tea cup before, and look where it got them. Freefall. Foreclosures. Upside-down misery. Is there any reason to think this boom is more sustainable than the last? Are we sitting on another bubble, or a mesa of permanent gains, like Phoenix enjoyed in the 1990s?

More real estate experts than not seem to think it’s the latter. And we want to believe them. So, in the interest of rational optimism, here are five reasons Valley folk might want to get back into the market.

Reason No. 1 – A Farewell to Foreclosures
It’s 10 a.m. on a weekday morning, and Rob Binkley is firing up his “command center” – in this case, a pretty pedestrian-looking workstation that includes a desktop computer, phone and several stacks of yawn-inducing paperwork.

Though hardly remarkable to look at, this office is where Binkley – as co-owner of – runs one of the Valley’s most prosperous trustee sale services. Tanned and surfer-haired, wearing shorts and a salmon-colored T-shirt he picked up on a backpacker jaunt to the Far East, Binkley doesn’t really fit the standard profile of a real estate mogul, but looks can be deceiving.

“Where’s that? Near the country club?” he says into a Bluetooth device as he pulls up Google Maps on his desktop. On the other end of the line, Binkley’s operative at the Maricopa County Courthouse rattles off the address of the latest foreclosed property to be put up for public auction in Phoenix. In seconds, the tract home in question appears on Binkley’s computer screen: nice front yard, pleasant tree-lined street, no obvious red flags. Based on this cursory online inspection, Binkley may dispatch one of the company’s two full-time drivers to eyeball the property in person before it officially goes up for bid. And then he’ll decide whether to bid on it.

Binkley and his business partner, Eric Weinbrenner, were among the first Valley entrepreneurs to build a business model around the foreclosure process in Arizona, back in the late ’90s when the number of trustee deeds – in essence, distressed homes repossessed by the lender – in Maricopa Country numbered about 3,000 a year. In 2010, there were 51,696 such foreclosures.

Yes, business is booming. But not like it was just three years ago, which is one of the reasons home values have recovered so robustly in Greater Phoenix.

Foreclosures are toxic to neighborhoods: They kill demand, create unwanted surplus and depress home values. As such, it was no coincidence the Valley’s bleakest days in terms of home prices coincided almost perfectly with its most severe glut of foreclosures. In March of 2011, the median price of an existing home in metro Phoenix dipped below $120,000 – its lowest point during the housing crisis, down from a high of almost $250,000 in 2007, according to Valley real estate tracker RL Brown Housing Reports. The same month, foreclosures shot above 5,000, their second-highest point ever.

By October of 2011, foreclosures had fallen by half – and Valley home values heated up in kind.  Good news for homeowners. Not super-great news for BuyAZ Foreclosures.

“I would estimate we bought and sold 40 houses a week [during the height of the foreclosure crisis],” says Binkley, who in most cases will flip a winning bid to one of the thousands of investors who use his website, charging a short-term interest charge until the buyer finds financing. “Now we do 25. The [foreclosure] market has slowed down a lot.”

Binkley knows the topic of foreclosures is emotionally charged. He realizes that some see the industry as opportunistic. But it’s also true that firms such as BuyAZ Foreclosures perform a valuable function, helping a wounded Valley real estate market heal itself by clearing away necrotized mortgages.

Those foreclosed homes are almost gone – at least in volume, the way they were from 2008 to 2011. But Binkley and Weinbrenner still expect to make a living; after all, even in a healthy market, there will always be foreclosures. Moreover, Weinbrenner expects the auction floor – currently crowded with deep-pocketed hedge funds – to thin out when the profit margins narrow, leaving the bulk of the buying to more nimble, local operations like BuyAZ Foreclosures. “I think the hedge funds will be gone in two years, when their cap rates start to go down.”

Neither Binkley nor Weinbrenner expect the foreclosure golden era of the last decade to return anytime soon. And why is that? “They aren’t handing out mortgages like lollipops anymore,” Binkley says, smiling.

Reason No. 2 – No Mortgages for Mimes
In September 2002, President George W. Bush spent two days in the Valley during a nationwide goodwill tour. He stumped for gubernatorial candidate Matt Salmon. He made noise about Saddam Hussein. And he pitched his bold vision for expanded homeownership in America.

“We can put light where there’s darkness and hope where there’s despondency in this country,” he later told a crowd. “And part of it is working together as a nation to encourage folks to own their own home.”

To realize his vision of an “ownership society,” which he hoped would jump-start a stagnant economy and win favor with minority and low-income voters, Bush and Secretary of the Treasury Harry Paulson began to draw down lending standards in the mortgage industry. They also set up a mechanism by which homebuyers could purchase property using a government loan as a down payment. Take out a loan to get a loan – just the sort of inventive public-private lending scheme the country needed to get the economy humming.

For a while, it worked – until an overburdened levy of sub-prime and adjustable-rate mortgages split at the seams, plunging the nation into the worst financial crisis since the Great Depression.

“Basically, the availability of mortgage credit allowed folks to buy homes they couldn’t afford,” Valley real estate analyst RL Brown says. “Folks who wouldn’t qualify by any rational standard of mortgage underwriting.”

Brown says that’s no longer the case – another reason the current recovery looks more stable than the collapsed bubble that preceded it. Tougher regulations, less easy credit. Stiffer restrictions on lending have also discouraged runaway speculative borrowing by “flippers” who relied solely on capital appreciation – i.e. the bubble – to make money.

“A typical flipper bought a home with a minimum down payment and a double escrow so it sold with no money invested. That was his m.o.,” Brown says. “But recent changes [to lending guidelines] have enticed a different type of investor. I’d call him more of a professional than a flipper. Solid cash-buying investors looking for rental properties. These guys fix the house and typically have professional [rental] management. So they’re not as disruptive to the marketplace.”

Lending rules are also keeping unreliable borrowers with foreclosure histories out of the market, although not every such borrower is treated the same. According to Mike Orr, director of the Center for Real Estate Theory and Practice at the W.P. Carey School of Business at Arizona State University, some foreclosed folk may face a relatively brief three-year
lending blackout following their foreclosure. Others may have to wait longer.

“The worst thing is a strategic foreclosure,” he says. “That’s someone who’s not in true distress but chooses to give [an upside-down] house back to the bank instead of paying for it. People were doing that in large numbers during the crisis. Weighing their duties to the bank or to their family. Reneging on a loan because they thought it was the right thing for their relatives. Those people could be locked out for seven years. They might do things to disguise [the duplicity], but it’s usually fairly obvious to a lender.”

The upshot: Today’s homebuyers – the ones fueling the recovery – are a sturdier breed than those that came before them.

Reason No. 3 – No Two Bubbles Are Alike
Orr knows bubbles. An Oxford-trained mathematician, he left England to work in Silicon Valley during the dot-com boom of the late ’90s. “I could see Yahoo! from my window,” Orr says, with a touch of sardonic glee. “I saw everybody getting filthy rich.”

He was also there in the wake of 9-11, which “stripped out funding for startups” and exposed the dot-com industry’s empty innards. So he moved to Arizona. “The cost of living was so much lower here,” he says. “I bought two houses in Arizona because I had so much left over from the house in California. I read a few books. I got into real estate.”

As a mathematician, Orr excels at running data through logarithmic machinery and making predictions about the behavior of complex systems – like real estate. He did that during the housing boom and concluded the financial industry was massively overdrawn. So he sold his second home in 2005 and watched the bubble burst from the outside.

The bubble that Orr anticipated was generic in nature, which is to say, it wasn’t limited to Arizona. It was a national phenomenon, certainly worse in some markets than others, but fairly universal. That alone made it something of an aberration in the annals of bubbles, says Yale economic professor Robert Shiller, a frequent contributor to The New York Times and CNBC. “The only other example [of a national bubble] that comes to mind was in the late 1940s,” he says. “Soldiers coming home all wanted houses. So even before the war ended, speculators started buying up houses, anticipating that demand. But it wasn’t that easy. Financing was scarce. So they went into holding patterns with no one buying the homes.”

According to Shiller, housing booms and busts are typically regional events. One example: the famous Florida land bubble of the 1920s, during which “salespeople from all over the country were trying to sell swamp” that they spuriously passed off as developed land with the help of “binder boys who would go around with loose-leaf binders showing beautiful developments.” Hence, the phrase “And if you believe that, I’ve got some swamp land in Florida I want to sell you.”

Arizona has its own pre-bubble history of booms and busts – most recently in the late 1980s and early 1990s during the savings and loan crisis, Brown says. “The end result is that savings and loan institutions started getting out of the housing business, and that had for many years been the backbone of lending for the housing industry in Arizona. It left a void for financing sources for housing. Banks had primarily been involved in commercial lending.”

Ultimately, the home market was rescued by locally owned Valley Bank, which “made a commitment to try to fill the gap as a lender of last resort,” according to Brown.

So here’s the thing about bubbles: They’re typically man-made phenomena, byproducts of neglect. And no two are alike. Arizona may yet have another one in its future, but it will certainly be different – and, one would assume, less severe – than the bubble that shrank home values 60 percent between 2007 and 2011. 

Reason No. 4 – Less Naivete
The housing bubble was, among other things, a reality check. In the gold-rush stampede to buy homes and make money, consumers forget basic rules of physics and economics. Like “what goes up must come down” and “you never get something for nothing.”

Orr saw eerie similarities to the dot-com bubble. “The thing they had in common was that people stop believing in ordinary facts,” he says. “The old wisdom no longer applies. In the case of Silicon Valley, it was the idea that a company could lose money every year and still be worth something. During the housing bubble, it was the idea that home values would go up every year and you’d never lose money. Well, an empty home costs you money if nobody is living in it.”

Shiller, the Yale economist, is an authority in delusional, gold-rush-style economic behavior. He even wrote a book about it: Irrational Exuberance. “A house is not a cash machine,” he says. “You have to maintain it, improve it. Unless you actually want to live in the house and it pays you in kind by virtue of the fact you love it, that’s great – but it doesn’t pay you in capital appreciation because they make more of them.”

Shiller believes the real estate crisis was a scathing rebuke of the “efficient markets” theory of economics espoused by some of his colleagues: “It’s the idea that markets are more intelligent than people or governments, and you should just let them be.”

So did consumers emerge from the crisis any wiser? Valley real estate analyst Brown thinks so, at least in the short term. “I suspect there were lessons learned,” he says. “During that run-up of prices, it gave everyone comfort, sort of a guarantee that you could sell tomorrow and make money. I think those presumptions are gone.”

It should be pointed out that not everybody lost equity during the housing crisis. Savvy investors navigated the fallout successfully, and some got back into the market after it bottomed out, scoring cheap deals. Unfortunately, the recession did not put most consumers in a risk-taking mood. “There’s irrational exuberance, but there’s also irrational pessimism at the bottom of the bucket,” Orr says. “By 2009, all the gas went out of the bubble, and dispassionate investors with cash start snapping things up. People who buy now will probably do OK, but not like if they had bought a few years ago.”

Reason No. 5 – A Seller’s Market
There’s a reason Valley home prices have experienced wilder swings and more up-and-down turbulence than any other market.

“When I think of Arizona, I think of it as different from, say, California because it’s easy to start building,” Shiller says. “In California, you have congestion and zoning laws, and it’s difficult to start building.”

As a high-growth region with comparatively low home prices, the Valley became an attractive destination for investors when the national housing bubble started to inflate, according to Shiller. “Phoenix was a little late to get on the bubble, but when it did, enthusiasm worked up so fast that construction couldn’t keep up with demand. At least initially.”

Construction kicked into gear, and the Valley became a speculation hotbed. Home prices spiked more than 50 percent during one willy-nilly 12-month period in 2005-2006. Then the foreclosures kicked in, credit markets dried up, and the Valley was left with a glut of home-starts that nobody wanted. Up and down. Boom and bust.

According to Orr, the Valley’s homebuilding industry still hasn’t recovered – even with sufficient demand. “Builders still haven’t ramped up to normal levels,” he says. “They could probably triple the current number of home-starts, and that would be about right. They’re currently at 800 a month. And they were building 2,400 in 1996.”

Orr says a labor shortage is partly responsible for retarding the Valley’s once-humming construction industry. “It’s slow because [homebuilding] is very labor intensive. You need skilled labor, and a lot of that disappeared from Arizona because there was no work for it to do. And a lot of undocumented labor no longer felt welcome. Those drywallers and roofers packed up and left. [The market] is quite competitive. A lot people went up to Alberta, where just cleaning the trucks can net you six figures.”

On the flip side, the unmet demand for home-starts has helped elevate and stabilize home prices in the Valley, creating an incipient seller’s market that should hold even as homebuilding recovers.

“There are good, solid reasons why we should trust the recovery,” Orr says. “What we’re experiencing now doesn’t meet the criteria of bubble-like behavior.”

Caveats and Take-Aways
Certainly, there are prohibitive factors that may yet stall Arizona’s housing recovery. Unemployment is still high by historical standards at 7.9 percent, though circumstances here are certainly less dire than those in other states that felt the sting of the housing bubble, like California (9.6 percent) and Nevada (9.3).

Some naysayers cling to the suspicion that banks are holding on to massive, secret caches of foreclosed homes they will gradually reintroduce into the market, tapping the brakes on any meaningful housing recovery. “It’s a myth that banks are hiding houses,” Orr says.

Shiller, known to be somewhat skeptical of the recovery, stops short of calling the current upward trend a bubble – but neither does he think that home prices will rebound to 2006 levels. “In five years, I would say home prices will be about where they are today, maybe a little higher. I certainly don’t think you’ll see big annual gains. You stand a better chance of making a lot of money in the stock market.”

For longview-minded prospective homeowners who simply don’t want to find themselves underwater after purchasing a new home, “same in five years” might be good enough. So go ahead and buy that new home, Orr says – just don’t expect a 2006-style windfall. The buy-low, sell-high window might already have shut. “The truth is, it’s been time to buy since the spring of 2009,” he says. “Today, [buying conditions] aren’t as favorable as they were two or three or four years ago, but they aren’t bad.”

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