FORECAST - While we remain very optimistic about the long term real estate market, it appears obvious to us that prices are likely to continuing falling in the near term. An abundance of rental vacancies with a large disparity between the cost of renting and the cost of owning is encouraging prospective buyers to rent. It is also discouraging investors from purchasing. We believe that the change in the market will happen when a combination of lower vacancies, higher rents, and lower home prices encourages more renters and investors to start buying again.

Here are some of the major factors we believe are now having or are likely to have an impact on the real estate market.

1. California's population increases by about 500,000 people per year. This results in between 230,000 and 250,000 new households being formed each year in California. There were only 64,000 housing/apartment units started in the first six months of 2007. That equates to about 130,000 new housing units a year which is not nearly enough to meet the demand.

2. Rental vacancies are declining in most major metropolitan areas in the western United States.

3. California has an extremely slow planning process. It takes about two to three years of studies and planning to get approval for a new subdivision. It won't be possible to create new building lots over night when the market starts to turn around.

4. Government fees continue to increase and will limit new home construction. For example, the City of Yuba City recently enacted a new fee structure. When the new fees are fully implemented in a few years, total government fees will rise to about $70,000 to $75,000 per house. These fees are being collected to pay for sewer and water connections, building permits, new parks, fire stations, police stations, schools and levee repairs. Builders are even being charged a fee that goes into a special fund for “affordable” housing. While this seems high, many other communities charge higher fees than Yuba City and I hear no move to cut any of these fees. Forcing builders to pay higher fees will squeeze their profits even further and will limit new home construction.

5. The Federal Reserve has done a good job managing interest rates. Interest rates the last four or five years have been at their lowest levels in at least 35 years.

6. Some experts predict that a booming Chinese economy will generate enormous wealth and that much of this money will be invested in real estate in other Pacific Rim Countries. If this happens, it will be similar to what we saw in the early 1990's when the Japanese economy was surging.

7. The economy continues to grow at a modest pace.

1. Home sales remain lackluster and the supply of unsold homes in Yuba City remains high. There is currently a 12 month supply of homes for sale in Yuba City and a 12.9 month supply for the Yuba-Sutter area as a whole.

2. Builders are still sitting on a large quantity of land. History has shown that most builders will reduce prices in order to maintain sales volume in a declining real estate market. Expect a steady stream of new homes to be built in the near term while builders use up their existing land.

3. Many prospective buyers are choosing to rent instead of purchase. Their logic is simple. Why pay $1,700 to $2,200 a month in house payments to buy a home for $280,000? They can rent the same home for about $1,300 per month while they watch home prices decline.

4. Current home prices are keeping most investors out of the market. An investor buying a $280,000 home and making a 25% downpayment will likely face a negative cash flow of approximately $300 a month when the home is rented. That increases to about $1,600 a month between tenants (and does not include sewer, water, garbage and maintenance).

5. Problems in the mortgage market do not appear to be over. Declining real estate values combined with home owners having problems making their payments will likely force even more homes onto the market either as short sales or foreclosures. However they start out, most of these will eventually end up as foreclosures since 90% of short sale attempts locally are unsuccessful.

A report in the Wall Street Journal (November 24, 2007) pointed to a Bank of America study that indicated that most of the foreclosures to date simply were on loans that should never have been made and were not, as has been widely reported in the news media, the result of adjustable interest rate mortgages (ARMs) "resetting." The BofA study concluded that large numbers of ARM loans are resetting now but that the peak of the resetting activity will not take place until the second quarter of 2008.

In today's climate, lenders will not normally begin a foreclosure unless the borrower is at least four to six months behind in their payments. The foreclosure process is approximately four months long. Combined with the information about ARM loans resetting, this would indicate that we will likely see high levels of foreclosure activity through most or all of 2008 and quite possibly into 2009. This process may be hastened by borrowers defaulting on their payments before their loans reset.

6. Many lenders have been forced out of business. Most of the remaining lenders have tightened credit standards and have raised interest rates on their non-conventional loans. For instance, many lenders have stopped making "Stated Income" loans (sometimes referred to as "liar loans") to people whose income is based primarily on income that is reported on W-2 forms. Other loan programs have been similarly affected. These tightening credit standards are keeping some prospective buyers out of the market.

There are also some factors that are difficult to predict. The four most significant questions are about the economy, interest rates, lenders rewriting existing loans and possible government action.

Most economists don't believe that our economy will go into a recession. They acknowledge that the housing and financial sectors have been hit hard but point out that other sectors such as technologies and commodities (oil, metals, grains and etc.) are doing well and should continue to do well as economies in countries like China and India continue to expand.

The future of interest rates is also in some doubt. The expanding economy in China, India and other countries is causing commodity prices to rise. It is also causing wages in these countries to rise. Higher commodity prices and wages have caused production costs to rise. Higher production costs combined with a weakening Dollar could spark serious fears of inflation and lead to higher interest rates. While most economists acknowledge this is a potential problem, the consensus is that higher interest rates won't we a factor until at least some time in 2009.

There has been much talk about lenders rewriting loans to avoid having loan interest rates "reset." This is a truly complicated issue since most of the loans in question have been sold to investors or have been used as collateral for bonds issued against them. That means that the companies that service these loan have only limited ability to make changes to their terms.

Finally, there is Congress. Never underestimate the ability of government to take a bad situation and make it worse. Some of the proposals that we have heard coming out of Washington could have a severe long term negative impact on the housing market. Congress needs to keep in mind that they can enact legislation that will reduce borrowers' risk of failure but they cannot do it without limiting opportunity at the same time.

A recession or markedly higher interest rates could dramatically lengthen the current real estate market recession.

It could have a very positive effect if lenders are able to significantly rewrite loans to help borrowers through the next five to seven year period.

Congressional action could go either way depending on what they do.

While our market forecast has remained essentially unchanged for all of this year, we are definitely turning more bullish in our recommendations to home buyers. Our market forecast is also consistent with the most recent real estate market forecast released by the California Association of Realtors.

You can see the latest real estate market charts in our most recent Real Estate Market Newsletter.

So, is now a good time to buy or sell?