Is This the Return of "Normal"?

Today’s real estate market may seem dismal to most folks. But even when times appear darkest, there is always opportunity.

Seriously, there is.

“Buy on the fringe and wait. Buy land near a growing city! Buy land when other people want to sell. Hold what you buy!”

— John Jacob Astor

“The most important quality for an investor is temperament, not intellect… You need a temperament that neither derives great pleasure from being with the crowd or against the crowd.”

— Warren Buffet

There were 40% fewer homes for sale, and 30% fewer sold compared to historic norms last month. Yet 34.4% of all active inventory sold compared to the 29.7% average. Obviously, I’m excluding 2021 from all statistics. It was a unicorn year. In any case, we’ve reached a balanced market. No one has the advantage now.

Steven Thomas, a local quantitative economist, agrees we’re returning to normalcy, which is good. However, he also predicts that our new normal will mean fewer buyers and sellers, probably throughout this decade and possibly significantly longer. I absolutely agree.

Rising costs to finance remain a fly in the ointment, reducing the pool of qualified buyers. Yet while the Federal Reserve has kept its promise to continue increasing the fed funds rate, individual lenders are carving out niche loan programs with pretty incredible pricing. For example, today, a 30-year jumbo fixed rate loan is available at 5.25% - versus the current average rate of 6.5%. This saves $12,000 annually for the typical OC buyer. Knowing where to find these lower-cost loans is key to both seller and buyer success. (Call me for details on this loan, it won’t last.)

For non financial folks, the US prime rate is the fed funds rate + 3%. Prime is usually the benchmark for unsecured debts like credit cards and often home equity lines of credit (HELOCs) - but not mortgage rates. Mortgage rates are typically based on US Treasury bonds - not the prime or fed funds rate. So keep this chatter in mind as more of a barometer when you hear talk about fed rate hikes. Mortgage rates, particularly on jumbo loans, which are most common in OC, are usually lower than prime.

However, mortgage rates will continue to bob up and down as bond markets move less dramatically as the economy stabilizes. This appears imminent, based on the latest CPI reports, which hint at cooling inflation. Home prices will soften in some neighborhoods through year-end and will likely creep up again in 2023. Remember, real estate is hyper-local. What is true for the country, the state and even Orange County may not be relevant to a specific neighborhood. It’s best to compare all the macro data to the micro level.

Trust me, trying to sell at the top and buy at the bottom is less advantageous and virtually impossible to anticipate than striking the best deals possible during the here and now. But, with careful planning, you can buy now and not hate yourself for it. And selling now before any more price erosion makes a ton of sense in many communities, particularly those with the greatest price runup during the pandemic.

And which are these? I’m glad you asked.

Orange County had a 30% increase in median price from 2020 through October 2022. The top 10 cities below had the most significant proportional increases in value. The general consensus is communities with historic runups in value during the pandemic are also most likely to adjust downward.

These 10 cities all experienced 40% or more median price increases. Ladera Ranch rose 58%, San Clemente is up 54%, and Villa Park 53%, as is Laguna Beach. Irvine also came in at a whopping 51% increase.?

Bear in mind this chart reflects only statistical sales data and not external influences, such as community development, quality of schools and the like. Additionally, most luxury coastal communities had record-breaking sales of vacation or second homes. Those wealthier owners can weather shifting markets. So even though Laguna Beach had the fourth-highest price surge, I’m not suggesting a collapse in that world-famous beachfront haven. Affluent homeowners will more likely wait things out. A few may get out over their skis and need to sell. But there will be enough buyer competition for them that sales shouldn’t fall much, if at all.

Communities farther from the beach, lacking other conspicuous market influences, will likely see the swiftest and most dramatic declines. This makes Dana Point unlikely to see a downturn despite having a 39% increase. That entire community is being reinvented. So much so that I’ve been advising clients to invest there for the last 3 or more years. For this reason, I suspect they’ll continue to have steady increases through 2023. Thus, I still view buying property there as a wise long-term investment.

If I had a crystal ball, and knowing what I know about various municipalities, I’d stack rank the cities most likely to decline as follows:

1. Ladera Ranch
2. Stanton
3. Lake Forest
4. Villa Park
5. Irvine
6. Laguna Niguel
7. Rancho Mission Viejo
8. San Clemente
9. San Juan Capistrano
10. Laguna Beach

Family-friendly Ladera Ranch is a total outlier. Prices have increased there every month all year long, whereas prices steadily fell monthly countywide beginning in April. Hence their 58% runup may hold up longer than logic would dictate. Some enclaves, like Sunset Beach and Orange Park Acres, have already seen precipitous devaluation. Their heyday was decidedly short-lived. And Silverado Canyon got no love at all - no significant gains or losses.?As I always remind folks, real estate is hyper-local. There is no singular answer to the perennial question, "how's the market?"

That’s the thing about homes; they’re more mercurial animals than say commercial or industrial real estate. Changing lifestyle priorities juiced up values unexpectedly at the onset of the pandemic. Some, like the unprecedented demand for 5 or more bedrooms, may be here to stay. Our collective focus on family and healthier living may continue to sustain values in communities like Emerald Bay and Ladera Ranch, where facilities for outdoor recreation are plentiful.

How will buyers and sellers succeed when there will be fewer homes to buy and fewer buyers competing for them?

Everyone will need to get familiar with the granular details of local markets. Gone are the days when sellers priced high to see what buyers would tolerate. Sales statistics show that homes priced at or just below market yield the highest net income to sellers. Conversely, homes with more than one price reduction are now proving to net sellers far less profit than had they started with a lower price. The game has definitely changed. A very thoughtful pricing strategy is now a mandate for sellers. Buyers will not tour homes they perceive as overpriced or engage in back-and-forth counter offers. And the longer a home remains on the market, the more buyers will view it with wariness. Sellers need to start out with a price reflective of the current market. In many cases, that will be lower than the most recent closed sales.

Buyers must get fully underwritten loan preapprovals to guarantee the best finance terms. Changes in loan rates while a buyer is in escrow killed more deals this year than I’ve ever seen. As mentioned last month, there is sometimes the opportunity to negotiate seller-paid loan fees as long as they’re not ridiculous. This should be part of the buyer strategy from day one. It’s also wise to have a plan B loan scenario on deck with lenders in case there are adverse changes to rates or terms while a buyer is in escrow, or worse, they pull the loan program altogether. That can happen.

Many people are unaware that until a loan is funded lenders can revoke their commitment to lend. It can be a very one way street.

Now that things have cooled a bit, we expect market time to extend even more, which indicates that normalcy is returning. [See note below.]

As of this writing, market time is 96 days. But the median days on market is 40 days for active listings and 21 days for those sold in the past 30 days. And, of course, homes placed under contract within the most recent 30 days fall in between at 38 days.

I know this is a lot to absorb, so I’ll bottom-line it for you.

• There will be fewer homes for sale and fewer buyers buying them. Period.
• Prices may fall in some areas, some of them more than others. But not more than 10% at most. All prices will likely start creeping up in Q2 2023.
• Finance rates are higher than at the beginning of the year and plateau a bit. Yet there are really well-priced loans available based on each type of scenario. Buyers need to find their ideal specialty loan options.
• Waiting for rates to drop is a fool’s errand. If they do, it won’t be enough to justify missing out on a home you love, with so few homes for sale.
• Only “delicious” homes will sell. Period. Make your home look like a model home, or prepare for a greatly reduced initial list price - well below market.
• Buyers won’t view or write offers on homes they think are even slightly overpriced. So don’t.
• Just because buyers won’t have as much competition, sellers are also not desperate. So don’t be silly with offers.

There is a strategy for every market. Let’s talk about yours.

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