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Signs of life emerging in housing sector

Image: A sign advertising homes for sale is seen in Corona
A sign advertising homes for sale is seen Feb. 5 in Corona, Calif. California's shattered real estate market has brought heartbreak and ruin, but some investors, speculators and first-time home buyers are finding opportunities.Mario Anzuoni / Reuters
/ Source: Business Week

Last year the Cape Coral area of Florida had the highest foreclosure rate in the country. Banks moved to seize more than 1 in 10 residential properties in the Gulf Coast community of 165,000. The reverberations are still being felt. Newly built McMansions sit vacant, dusty monuments to the great real estate boom. Smaller homes have been ransacked. Apartment buildings have been boarded up. Former owners are stripping whatever items they can from their homes before the locks get changed, says Kirsten Prizzi, a local real estate agent at AC Global Realty. "Knobs, appliances. Someone was selling windows."

But a curious thing is happening in this blighted former boomtown: Buyers are swooping in. First-time home-owners are suddenly entering bidding wars with real estate speculators from as far away as Spain and Germany. Sales in February outpaced those at the peak of the boom, with some houses getting more than 50 offers and selling above their asking price. "I look for markets that are downtrodden," says Rich Lehrer, a retiree and self-proclaimed "emerging-market investor" from Wilmington, N.C., who wants to buy several properties in the area. "I'm expecting to get better yields than I would get on my cash."

Cape Coral isn't the only bright spot in housing land. Some of the very regions that led the U.S. housing market into the abyss are beginning to show signs of life. Sales on the Gulf Coast of Florida, California's Inland Empire near Los Angeles, and the Las Vegas metropolitan area surged by more than 80 percent in February vs. the same month last year.

So what's going on? In all of these markets, banks are dumping foreclosed properties, attracting cash-rich speculators looking for cut-rate bargains. "Why wait [for a bottom] if it's the right deal?" says Brent McAlee, a 31-year-old Las Vegas resident who recently paid $140,000 for a three-bedroom home that fetched around $350,000 a few years ago. He hopes to rent it out for $1,300 a month.

What's more, first-time buyers are finally rushing in, lured not only by plunging prices but also government incentives like ultralow interest rates and hefty tax breaks. Such sweeteners are just too tasty for some to pass up, at least in markets that have already plunged by 50 percent or more.

Frenetic buying in a few depressed areas doesn't mean the national bust is over — far from it. But it does herald the start of a new phase in the boom-and-bust recovery cycle. Economists might call it equilibrium: Prices have fallen so much in some areas that shoppers are getting interested again, improving the balance between buyers and sellers. That doesn't mean prices will surge anytime soon. But heavy buying should at least begin to put a floor under prices. "Are we at the bottom?" asks Christopher Thornberg, an economist with Beacon Economics. "We are getting close."

If Thornberg is right, one might expect other markets to begin the bottoming out process in the coming months. Just as California, Florida, and Las Vegas led the nation into the housing bust, those areas could provide the template for a national recovery. "One of the big problems we have across the nation is a lack of confidence," says Adam York, an economist with Wachovia (WFC) in Charlotte, N.C. "As these former bubble markets bounce off the bottom in terms of sales, it could give some hope to [other markets] that the declines are going to end."

Plenty of caveats are in order, because there are peculiar bear-market factors at work. The fact that inventories are falling precipitously in California — to just 6.5 months' supply from 15.3 months a year earlier — would seem to augur well. Historically, "prices respond very dramatically to inventory," says William C. Wheaton, director of research at the Massachusetts Institute of Technology's Center for Real Estate.

But inventories are falling fastest in markets where speculators and first-time buyers are driving the action. Those parties don't have to put their own homes on the market to make a deal. It remains vexingly difficult for home-owners who have bought in the past five or so years to sell one property and buy another.

On top of that, government incentives of up to $8,000 in tax credits for first-time buyers and low mortgage rates engineered by the Federal Reserve are luring shoppers who otherwise would be sitting out. If the government were to take away the punch bowl, markets that seem to be bottoming could well turn down again.

Hard-hit markets
What's more, banks have tightened their lending standards so much that only the most qualified buyers are finding it easy to get loans. Until financing loosens up, the housing market can't possibly take off.

It's best to view the brisk sales in some markets as glimmers of hope in a national market that seems likely to remain weak for a while. Sales continue to fall in many areas, especially those that didn't get hit until recently. In Charlotte, where home prices were rising until a few months ago, sales dropped 38 percent in February over the previous year. Nationally, the S&P/Case-Shiller index that tracks home prices in the top 20 metro areas was down 19 percent in January from a year earlier and 29 percent from its 2006 peak. "The market is still doing badly," cautions Robert J. Shiller, a professor of economics at Yale University and a creator of the index. But, he adds, "there's always light at the end of the tunnel."

That light could be growing brighter in Las Vegas. Home sales began to drop in Sin City before they fell in most other parts of the country. Now Vegas is deeply mired in recession. Unemployment has risen to 10.1 percent, far above the national average. More than 80 percent of the homes for sale are distressed properties, either those where the owner faces foreclosure or those already owned by a bank. Median prices have fallen from $315,000 in June 2006 to $155,603 today, roughly the same level as in 2002.

The lure: low interest rates
Those dizzying price drops are attracting the likes of Mark and Claudia McLaughlin. The couple, who work for the New York State Corrections Dept. and live in Westernville, N.Y., plan to retire in Las Vegas in six years or so. They're eager to find a place while prices are still low. In late March they went house hunting with an agent, checking out 18 homes between $75,000 and $100,000. "We figure we'll buy something now and get a good price on it," says 55-year-old Mark McLaughlin. "We'll rent it out, and it'll pay for itself." They won't need to sell their upstate New York home for years, by which time that local market might have improved.

The Garvins, too, are doubling down while keeping their current home. In 2004, hotel finance manager J.D. Garvin and his wife, Nona, a nurse, paid $202,000 for a 1,200-square-foot townhouse in Las Vegas, which would probably sell for half that today. After the birth of their first child last year, they decided they needed more space. So in late January they bought a 3,800-square-foot home for $300,000 in the suburb of Henderson, Nev.

With prices still low, the Garvins decided to find a tenant for their first home rather than sell it. The rent almost covers the monthly mortgage on their first property. Says 30-year-old J.D. Garvin: "We feel good about the fact that we're paying a little bit more than the other mortgage — and the house is three times as big."

For the Garvins, who weren't eligible for the government tax credit, record-low interest rates were a big enticement. With the rate on their 30-year fixed-rate mortgage at 4.75 percent, the payment on their $292,000 loan is around $1,600 a month. Nationally, the rate on a 30-year fixed-rate loan averages around 4.85 percent, the lowest on record.

In California, politicians are adding to the federal inducements. The legislature has passed a $10,000 tax credit available to anyone who buys a newly built home. (Existing homes don't qualify.)

The tax break lured Marisol Monroy to make the switch from renter to owner. Monroy had been sitting nervously on the fence for more than a year as friend after friend faced foreclosure in Southern California. In March the married mother of three bought a four-bedroom home in a new development in Fontana, part of the once-bustling Inland Empire. Her monthly payment, including taxes and insurance: $2,100, only $600 more than the rent on her three-bedroom apartment in Placentia. Monroy figured her kids would hate moving but says they're excited to get into their new home: "They're counting down the days on the calendar."

Real estate investors are sensing their moment, too. Speculators get a bad name during boom times for driving prices into the stratosphere. But in the depths of a bust, they're needed to help clear out inventory and stabilize prices. John Hoehl has trekked down from Vermont to scope out investment properties in Cape Coral — where some foreclosure properties are selling for just $30,000. So far, he's bid on three properties, scooping up a three-bedroom house on the water for $150,000. "At this rate we're going to see a big shortage of inventory by summer, and that will trigger prices to rise," says Paula Hellenbrand, president of the Cape Coral Association of Realtors. Local agent Marc Joseph of has bought two boats to take prospects in search of waterfront properties on "foreclosure cruises."

The buying would be brisker still were it not for the banks. Financing remains a wet blanket both for first-timers and speculators. With banks toughening their lending standards, it helps for first-time buyers to come with as much cash as possible. Dean Brittingham and her partner, Nancy Rocks, put a solid 20 percent down on a $350,000, Mediterranean-style home in Santa Rosa, Calif.—and they still had problems. An investor had bought the three-bedroom house just a few months before for $187,000. The quick flip on the distressed property raised red flags for their mortgage lender, which insisted on a second appraisal. As the couple jumped through that hoop, they missed a deadline and decided to start the process all over at a different bank. The two finally closed on the property in March. "Our agent said it's a brand-new time," says Brittingham. "Everything's different."

Speculators, too, are dealing with tight financing — sometimes by looking beyond banks. During the boom, Robert Close made a tidy profit building homes that cost as much as $640,000 in the Inland Empire. Now he's focused on working with a small group of investors to buy and fix up foreclosed properties. Because many banks won't lend money for homes that need major repairs, Close pays cash — or turns to what's known as "hard money," independent financiers who charge interest rates as high as 12 percent.

But Close says he can make money even with such high interest rates — a sign that prices may be too low. He typically shells out $75,000 for each house, plus $20,000 for repairs. He then rents it out for up to $1,500 a month, producing double-digit returns on his investment. In the past seven months Close has picked up 34 properties, taking care to avoid the homes he built. "I guess I'm superstitious," he says. "I don't want to press my luck." That kind of cautious speculation is a far cry from the go-go days. But after a three-year bust, it's a sign that some markets might be moving in the right direction.