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Appraising Downtown Long Beach in 2008 

 

Michael S. Tarabotto

January 6, 2008
 
 

Downtown Long Beach as well as many major cities in Southern California will be faced with a common question in 2008. “Are we in a declining market?” The answer matters if you’re thinking about buying, selling or refinancing Downtown Long Beach real estate this year.

If you’ve been listening to the news lately, you probably heard that Nationally we have between 8 and 9 months of housing inventory. So what does this mean to Long Beach residents exactly?

Absolutely nothing…

What the news alludes to are Absorption Rates on a national level. But real estate is local. Hence, real estate absorption rate locally is what matter.

What are Absorption Rates?

 
In short, an absorption rate is rate in which existing listing inventory is being purchased or absorbed by buyers. Absorption Rate Analysis is the statistical means to measure these supply/demand characteristics of an area. It’s a simple division problem with two basic variables.

1. number of listings
2. number of sales

These variables can be defined in a number of ways that allow real estate appraisers and Realtors® to view the market from different vantage points. Here we’ll approach it in the way that Federal Regulators appear to want to see it done.

First, the listings and sales under analysis have to be of “like-kind” as the property in question (a.k.a. subject property), and they have to be in the same neighborhood.

If the subject is a 1920’s Craftsman, 1500 SF in size on a 5,000 SF lot in Downtown Long Beach - appraisers will probably research “like-kind” sales and listings that range between 1200 and 1800 SF in size, built up to 1940 or so. Lot sizes will vary so we won’t typically stress too much on that unless the area known premiums for specialty uses exist that result from size (i.e. equestrian/horse zoning…not very likely in Downtown Long Beach).

Then, we’ll find all available listings within the neighborhood that meet the criteria. For illustration sake we’ll assume we found 21 listings.

We then research closed sales in the past 12 months, in the same neighborhood, with the same criteria. Let’s say our research yields 36 closed sales.

We then divide 36 closed sales by 12 months which gives us a monthly absorption rate of 3 sales per month.

Finally, we divide the 21 listings by the absorption rate of 3 sales per month, and this yields an inventory factor of 7 months. That is to say, there is 7 months of inventory of like properties in the subject neighborhood.

 
Why does this matter?

As a general rule of thumb – when the absorption factor is greater than 6 months, banks consider there to be an “over-supply” of homes. That is, there are more sellers than buyers in the marketplace hence you’ve heard the term “buyer’s market". When the factor is below 4 months, it’s generally considered a “seller’s market” because there isn’t enough supply for the amount of buyers. The happy medium for most banks is between 5-6 months supply but of course, less than that is great too because the house they collateralized with the loan is probably appreciating in value. This reduces the banks exposure because there is equity growing in the property. This effectively lowers the ratio between the loan amount and the value of the home over time. Who willingly walks away from home equity, right?


So what happens when inventory balloons past 6 months?

A few things happen. Price reductions on listings tend to occur to attract buyers. Sometimes – depending on the market – the reductions can be extreme thereby deflating values of surrounding properties. The reason this is a big issue to banks is that, if inventory grows to the point that reductions are undercutting the value of the collateral they used to give you the loan (your house), then they risk over-exposing themselves and their investors.

So let’s assume you qualified for a 100% loan for a purchase – and the property is in a “declining market” with excess inventory – the bank in theory is loaning more than 100% of the property value. Since no one can predict how long excess inventory will last, banks will often curtail some of that risk by reducing the maximum financing allowable under the loan program you qualified for. (Speak to a reputable mortgage advisor on this issue for clarification).


How does this effect appraisals outcomes in 2008?

Banks already are demanding an even higher level of scrutiny of absorption rates from appraisers. Banks are also demanding higher quality valuations in general to secure their interests and that of their investors. This may be prudent if we consider the fact that if banks suffer too many losses – we may find ourselves paying cash for our next house. While market transition from previous highs of years earlier, this means that more often than not appraisers will likely find excess inventory in most markets and have to report it to the banks. This is done in the appraisal report when appraisers check “declining markets” in the neighborhood analysis.

If and when banks asks for an additional 5 percent down on your next purchase because of excessive inventory, don’t be surprised and just remember that for that little extra the bank may exposing itself by 100% to 120% of the value of the property in the years to come. Not a bad deal if we look at it this way. 

How do you get Absorption Rate information if you’re thinking about buying or selling?

Call Laurie Manny. No one knows Long Beach better than Laurie.

Read also:  Insights about Valuation and Social Psychology - The Appraisal Process

Michael S. Tarabotto CRA, CREA
California Appraisal Solutions Corporation
661-254-7877 Office
818-301-0499 eFax
818-825-3319 Mobile/Text
http://appraisalsolutionscorp.com

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