People still ask us why there are so many short sales in Phoenix and why we believe the trend will continue for years to come. We have a lengthy answer we are happy to offer. However, while taking a continuing education class from Desert Sage Seminars I read a great article Jon Kitchen, the owner of Desert Sage, wrote on the subject.  I gave his wife Dana a call and she graciously said I could re-post it here on UrbanConnectionRealty.com.

Bubble, Bubble, Boil and Burst… a look at the Phoenix Real Estate Market 2004-2007

Unfortunately, the rate of foreclosures has risen over the past few years, and as typical cycles go in the real estate market, this cycle needs to run its course before we see the rate of foreclosures go back to a “normal” level. With the failure of the sub-prime mortgage market in late 2006 and 2007, and the resulting downturn, the rate of foreclosures has increased. That, along with the failure of many lenders who offered sub-prime loans, created a great deal of uncertainty in the real estate market.

First let’s look at why the rate of foreclosures has increased. We can point fingers to the problem, yet certainly there is not one single cause. Amongst many factors, the problems in the sub-prime market contributed to the increase in the rate of foreclosures, but other factors were at play.

What is a sub-prime loan? It is a type of loan that some lenders offer from time to time to borrowers who have less-than-perfect credit. Typically, these borrowers would have several negative ratings on their credit reports and a resulting lower FICO score. In addition, the sub-prime market was a vehicle for lower wage earners to purchase a home.

While these borrowers were often excluded from the “prime” or “A” paper loans (industry terms for type of loan), the sub-prime market made loans available to the marginal borrowers. For many years, this was an option and did not cause any problems. And, for many years, and even through the failure of that market in 2007, sub-prime loans were at or less than 5% of the total loans initiated per year by the mortgage industry. Thus, they make up a very small part of the total, but would have a higher failure rate, due to their nature.

All was well until late 2004. As the real estate market heated up in most parts of the US, lenders gambled and relaxed some of their standards. They started offering more risky loans to marginal borrowers, and in many cases offered what many considered to be dangerous loans to otherwise non-credit worthy borrowers. Simply put, lenders loaned money to borrowers who in many cases, never should have bought a home. Loans of this nature offered $0 down payment, teaser interest only payments that adjusted or “reset” in a year or two. That meant that these borrowers bought a house for $185,000 in 2005, put nothing down and borrowed the full $185,000. Their payment might have been $742, which might have been less than the rent they were paying; hence the appeal. Many lenders promised that once the loan was ready to reset in a year or two, they would refinance into a more conventional loan, and certainly would be easier since the value of the property would go up. Or so they thought.

In addition, that same period of time saw a substantial influx of investors into the real estate market. They were attracted by many factors, and certainly the promise of rising values was one. Many investors who bought early in the cycle were able to buy houses in a speculative manner and flip them; meaning they would buy and immediately sell to another person. The investors were further enticed by the relaxed standards in the lending industry providing them with financing that previously was not available.

So, here were average home buyers, lured by $0 down and low payments, and investors attempting to grab as many properties as possible. Both of these sets of buyers competed for a shrinking inventory of properties, so the laws of supply and demand took over. Prices started to climb, while the builders scrambled to build as fast at they could. Buyers were competing for properties and often a seller would receive 5, 10, 15 offers or more.

The rest is history. Many of the first group of buyers, from late 2004 and early 2005, who bought with a risky loan, found their payment reset after a year or two, to a much higher payment. Slowly, they fell behind and the foreclosures began. At the same time, many investors who bought intending to flip, soon realized that the pace of sales slowed, and as a result, could not sell the house at a profit. Some bailed out immediately, some tried to rent the property, some held on, yet ultimately, many of those investors simply walked away. As the inventory of available properties started to climb, and sales started to fall, values started decreasing from their 2005 levels. The cycle was in full swing by early 2007 and continued through the year, as more and more lenders failed, buyers stayed away and the inventory of existing homes climbed significantly. For example, in June 2005, the Arizona Regional MLS system showed about 6,600 listings. In June 2007, that number swelled to over 40,000 listings.

This scenario occurred all over the country in late 2006 and 2007, resulting in a flood of foreclosed homes on the market, resulting in numerous vacant properties and a sales pace that literally crawled to halt.

This article tells the story through 2007. Since then we have simply been riding the downward wave as the market tried to find a sustainable bottom. Today, November, 2011, most would say we’ve reached that bottom. At least for a while. Foreclosure numbers are falling and the coming tide of short sales should not rout home values like their cousins, the bank owned foreclosures. The next year or two will tell us much as the economy either gains strength or not, push-inflation catches up with the FED or not and the job market stabilizes, or not.

My crystal ball says Arizona will fare better than many places. We have a fairly diverse economy and many young tech and health care based businesses call or will soon call the greater Phoenix area home. Simply states, the key to the downtown, north central and greater Phoenix real estate market and home values is jobs, jobs, jobs.

The Urban Team at Realty Executives
7600 N. 16th Street, Suite 100
Phoenix, AZ 85020
602-234-5777
Gene@UrbanTeamAZ.com