Lest anyone forgot, Merced was the poster-child for the American sub-prime mortgage nightmare (2007-2010). The unbridled enthusiasm surrounding a new University of California campus built near cheap land attracted hungry housing speculators which drove Merced brokers, developers and planners to over-build and sell Merced homes propped up by extra Mello-Roos taxes and easy credit schemes. In the end, Merced housing and commercial real estate collapsed with some of the highest foreclosure rates and family displacements in the nation. The impact is still seen throughout Merced and Atwater after 12 years; blighted business corridors, vacant commercial spaces, forgotten building lots and a cityscape still littered with unused roads, addled utilities, taxpayer financed land/building fiascoes and missing or destroyed landscapes.
Yet things are incredibly better than even a few years ago. The Merced 2020 Project is projected to drop $1.3 billion in public-private investment into this town of 83,000. How much of that construction money actually stays here long-term is unknown though. That million square feet of new UC campus and the matching UC Downtown Campus Center compelled an elite few to rehabilitate Downtown further. Mountain-movers salivate over a future University Village, while at the same time we read of a continuing nationwide retail apocalypse. Better marketing and price discovery opened the doors to new risk-takers to enter Merced as evidenced by the 77 acre Merced Gateway project among other improvements. The velocity of some money churns nightly through Merced bars and restaurants and hotels and short-term rentals are filled with construction workers at least for another year. Heavier City traffic is a symptom of 667 recently issued housing permits – a metric far higher than other Central Valley cities. UC adds more than 500 net new students each year – and counting. Many people naturally want another Merced real estate boom declared in the frenzy.
So if school is out, the University is expanding and Bay Area buyers have cash – is it time for everyone to go into debt and buy Merced real estate again? What is the same and what changed since the last real estate free-for-all?
Here’s a few statistics to start. The Merced real estate market top was October 2005, when the median sale price of an existing detached Merced home was $344,615. By January 2010, that same statistical house bottomed to $96,666 and that does not include an unprecedented era of un-marketed shadow inventory held by the banks. According to the California Association of Realtors (CAR), the median price of a Merced home increased by 6.6% within the last year alone to $276,000 with the total number of County sales increasing over 22% for the same period. A consistent rise from the 2010 bottom. For those keeping score, the number days homes were on the market until an offer was received rose from 21 days to 26 days within the last year.
These general statistics won’t tell you the things that matter though; location, price per bedroom, cost per square foot, lot size, which school district or local crime rates. Real estate sales are also seasonal with Summer being the high so comparing late Spring to December does not a reportable trend make. Speculating on annual house appreciation alone is what got Merced into trouble in the first place. So let’s consider some other bigger ideas impacting Merced real estate.
One measure of affordability is considering the percentage of general working households that can afford a home in their market. Here again, the CAR has remarkable data looking at census records and home sales. The United States 1Q2019 general measure is 57% for traditional buyers — meaning 57% of working households can currently afford a home in their market. For California as a whole this estimate is only 32% when factoring Silicon Valley and other expensive coastal markets. Merced County falls into 47% – or nearly half the population makes enough to purchase a home – if they wanted. But this measures the County, not the City specifically and its growing student rental population impacting home prices and availability with the UC expansion.
Furthermore, the CAR benchmarks a First-time Buyer Housing Affordability Index (FTB-HAI). This measure attempts to describe households making a first-time purchase of a “starter-home” — those 667+ new homes popping-up around Merced. Often these buyers exploit special builder or government incentives and lower down payments. Here we actually see 64% of qualified Merced buyers can indeed afford a home compared to their peers the year prior at 62% — a small but useful indication that the local market is not overheating yet – also reflected in the longer 26 day offer window described above. Interestingly, the CAR measures the FTB-HAI median home price as $233,750 – not $276,000 for “traditional – 20% down” buyers – often those upgrading an old home for a larger one. Additionally, “affordability” does not necessarily consider the additional Mello-Roos taxes levied across Merced for still missing improvements. Could this 18% discrepancy be the background premium paid by all successful buyers desperate to catch the homeownership American Dream? Even the CAR statistics, as reported by regional brokers, can’t report exact data. An even murkier issue is new buyers are closing through the builder and those transactions are not all captured through the CAR/Multiple Listing Service system for analysis. So while “the real estate numbers” point in a cautiously positive direction, that perspective is still divorced from the emotional and financial reality of finding, looking at, negotiating for and purchasing a home. Every home and related transaction is different.
Stagnant Rates Across America
One item of particular concern across the country is the declining/stagnant homeownership rates post Great Recession. The 2005 peak was a 70% ownership rate, but as we experienced not everyone should finance into an unsustainable mortgage. Rates, especially among aged 35 or lower millennials barely edge in the 35% range – the lowest in generations and a clear indication that younger generations are struggling to meet or exceed their parents’ standard of living – a post World War 2 reversal to industrial America. Lower homeownership makes sense that after 12 years of foreclosures, short-sales, bankruptcies, structural underemployment few couples in their twenties and thirties are equipped financially or emotionally to start a family and purchase a home. One notable trend detected, according to the Washington, DC based Urban Institute, married households (aged 18-34) with children, dropped from 37% in 1990 to 25% in 2015 – a 32% drop within a generation. So much for the “gig economy” igniting a housing recovery – especially one with historically low interest rates. Recent media reports want to show a cautious transition from renter to home owner for this demographic, but the margin of error can often exceed reported values, especially across different American regions and California coastal cities. Sale compariables must be local. Sadly, the Republic might be quietly reverting into a nation of permanent renters among younger less-stable people. Add exploding student loan debts – now over $1.5 trillion – and you might have a long-term issue impacting housing, never-mind the loss of home equity retirement savings. The real world adjustment has been a gradual increase in household sizes across America – as older children move back in with their parents and three generations of family begin again to live under one roof – just the same way families lived prior to World War 2.
Pretend you are a home builder and you finally pay for permits on 100 new homes. Not only do you have to get your construction loan, build the infrastructure, deal with subcontractors and hire sale agents, but you also have to hope your buyer closes within weeks of final construction. In this environment, the builder might want to extend their own financing — especially if they can get a 20+% premium for their product — rather than relying upon an outside bank to finish the job. This “in-house” finance practice is supported by piles of money available from hedge funds, money market managers and the like — all offering terms competitive or “faster and better” than a buyer’s traditional commerical bank. In time though, underwriting can become lax as the builder and financier both want “a sale” on their books by any means necessary — increasing risks for everyone long-term. This was the genesis of the sub-prime meltdown as this shadow finance system grew to become counter-parties in funding and securities markets. The added benefit though for the financier-builder is that the mortgage can be kept close, meaning if there ever was foreclosure the builder could take the mortgage back, resell the paper or resell the property, or merely rent the home long term and until sales conditions better. While commercial banking was greatly reformed post Great Recession, the shadow banking sector remains opaque and ready for business at consumers’ long term expense and risk. Adjustable rate mortgages and other sub-prime products still exist. The national foreclosure rate was at a historic low – right before the subprime meltdown. There was no canary in the coal mine or slow melt-up in risk.
New Homes verses Existing
It’s also worth looking at what is actually being sold as a “starter home” in Merced these days and compare to established neighborhoods. Look through the models and the first thing you will notice is how indeed small the lots and bedrooms have become over the years. Factor in the prices verses the square footage and you will see how costly smaller homes can be for new families. The neighborhoods being approved by the City today are not the same as the ones you grew-up in. Now the front door is 14 feet from the curb of a busy street, your yard is the minimal set-back. Street parking is further strained as densities creep up and lot sizes shrink – could you play catch in your backyard with your kids the way you did when you were growing up? Beyond that, the City may allow new homes to be built without trees, or not match existing neighborhoods, no alternating elevations or even different exterior paint colors. Patches of stained wood-chips now substitute for lawns – only to be overgrown with weeds within weeks of closing. Some folks like to talk about Quality of Life in Merced. That starts with a home that dignifies the family, not stacks people like cord-wood for a few dollars more.
I would suggest the Merced middle class – the real core audience for new home purchases is still being squeezed financially. Bay Area speculators and record stock price headlines does not a local economy make. With the cost of new home construction rising 35% from 10 years ago (along with that drive-thru combo meal), ask yourself how many middle class household incomes have really kept pace with inflation? How many Mercedians (and UC students) are still receiving emergency food assistance? When you consider the greatest metric for Merced housing growth are 500 net new students each year – most of which subsist under financial aid programs – these students are apartment and room renters – not single family home buyers. The core basis of home purchasers (40%) used to be “move-up” buyers – trading their first house for a larger one. These folks have been shell-shocked with negative equity for a decade and only now are considering a break – if their incomes and job skills give them mobility. This macro-condition is forcing people to stay in their existing homes longer – from and average of seven years to nearly 11. And if you move, where do you move to that makes better financial sense – Texas and Washington?
Now more than ever the Merced real estate buyer needs to be aware. Like it or not, Merced has a dubious history with real estate. Hopefully strategic planning and smart growth will prevail over duplicating the usurious past.
Politicians, brokers and media pundits want to sell Merced’s “1% vacancy crisis” to justify more annexation, more government intervention, more building, higher prices and greater profits for a few – Crisis Capitalism at its best. Speculating on real estate, especially as a long-distance landlord is fraught with risk – witness the Great Recession. Some pointers; Don’t get emotional about buying that first (or any) home. Brokers and builders alike want you to get into that emotional confusion head-space gamblers call “on-tilt” – where you will do anything to “win” – and take that mortgage. Often the difference between monthly solvency and foreclosure is a few hundred dollars – lose part of your income and you are six months away from losing everything. Always remember debt is NOT money. Debt is a tool for certain smart people under the right circumstances, but the operative word here is “smart.” Mortgage is an old French translation for “death pledge” (mort gage) – think before you sign.
I think Merced is the most important city in California right now. We want to attract new entrepreneurs, new capital and new adventure. Part of that heroic journey requires maturity and a sober outlook that does not just improve ourselves, but improves our neighbors as well.
Let us not repeat the real estate mistakes we collective made leading to the Great Recession and after.
Eric Moore is a former real estate appraiser, banker, developer and advocate for the people of Merced. He has lived in Merced for 10 years.