DESERT LAW BLOG

A DISCUSSION OF LEGAL FLAT FEES: LARGE FIRMS VS. THE SOLO PRACTITIONER

The NYTimes has an article that has been on the top of its "Most Emailed" list the last several days talking about how large law firms think that the days of the billable hour may be coming to an end as clients' legal budgets are slashed and they are looking for ways to limit legal fees.

Clients have complained for years that the practice of billing for each hour worked can encourage law firms to prolong a client’s problem rather than solve it. But the rough economic climate is making clients more demanding, leading many law firms to rethink their business model.

The Times spoke to several prominent lawyers who indicate they are seeing more "flat fee" arrangements in their large firms for service performed, using alternative billing arrangements such as success fees and benchmarks.  While I'm sure some of this is happening, I am skeptical that this business downturn will be the end of hourly billing.  More likely, law firms are doing this to help out clients through the tough times and we will see the discussion about killing the billable hour end after the recession - only to be revived during the next downturn.  (Large law firms also have big marketing departments who do things like float stories to the media about the possibility of receiving flat fees at their firm - Call now!  This offer won't last!)

There are many difficulties with killing the use of billable hours in large firms.  As the article points out, it would require law firms to find another way to judge associate compensation and advancement other than by how many hours they bill - and big firm lawyers are notoriously bad with giving performance reviews.  Law firms also like change as much as I like cauliflower - it doesn't go down very well.  Lawyers by their nature are risk-adverse, so big law firms are not exactly places of innovation.  And charging flat fees is a big innovation for a large firm with many competing partner voices often having equal say in management decisions.  Attorneys using the hourly billing system for years aren't going to want to spend the extra time changing the whole system.

One of the other problems that large firms run into with flat fee arrangement is that it is very difficult to estimate fees for a complicated case or a transaction.  Only the most basic of case or transaction will require a set amount of time and effort.  The variables that come up during negotiating a large deal or in court are such that an attorney can easily spend twice as long working on a matter than they anticipate.  So in setting flat fees, lawyers would be forced to build in extra fees to cover for the possibility of an extended transaction or case - potentially raising instead of lowering fees. 

The cynical view is that flat fees may even create the reverse incentive for large law firms to spend as little time as possible on a deal - essentially cutting labor costs to make a larger margin.  Clients would inevitably shop a deal around to big law firms they use - getting flat fee "bids" from each firm.  The firm that wins the bid may not have the incentive to spend the extra time a deal or case often requires to get the best outcome for the client.  It should be noted that spending extra time on a transaction or case these days usually isn't just wasted - it is used to make sure that all aspects of a case or transaction have been considered and that the client is getting the best legal advice possible.

So, while it could happen - I think flat fees will be used by large firms on a case by case basis, but it will still be many years before we see widespread use by them.  If/when large firms do end up using them extensively, I think we will see the entire legal industry change rather drastically - with firms using junior attorneys on a contract basis instead of as associates (think construction subcontractors) and doing much more outsourcing of work to overseas legal service providers -something that is already growing increasingly popular.

Interestingly, while large firms debate whether to try out flat fees, small firms and solo practitioners already regularly use them.  As a solo practitioner, I can and do consider flat fees because I am the boss.  I don't need to get approval of a committee.  I know that for many of my clients who have limited budgets, having a flat fee allows them to know with certainty what a legal matter will cost.  For example, in forming a company for a client, negotiating and drafting a service contract or employment agreement or putting together documentation for a private securities offering, I can figure out a fair flat fee for clients.  I also know that by setting flat fees, I can compete for work with larger firms who do not use flat fees - or whose flat fees will necessarily be inflated by their much larger operating overhead costs and salaries.

As a solo practitioner, I do not have the incentive to try to spend as little time on a flat fee deal as possible.  The assumption by clients using a solo practitioner instead of a large firm is that they are going to be getting work that isn't quite as good or thorough (a faulty assumption for someone who, like me, has spent significant time being trained in a large firm).  So I in fact have the incentive to put more time than may be required into a matter to make sure my clients get the best outcome possible and hire me again.  Charging a flat fee allows me to do extra research or to consider other options without worrying about charging a client for unnecessary time.  If I am representing a client in an area of law with which I have less experience, charging a flat fee allows me to spend the extra time learning what I need to learn without having to charge a client for that educational process. (One of the biggest complaints clients have of large firms is they run up hourly bills using inexperienced lawyers - using their deals as training grounds).

At the same time, it is still difficult to gauge flat fees for larger transactions that I handle which require a lot of negotiation and often have hidden problems that require unexpected extra work.  In negotiating and documenting more complicated commercial real estate or corporate transactions in particular, it is very difficult to set a fair price due to the many unexpected twist and turns of a deal that can vary the time spent greatly.  So I sympathize with large firms in this regard.  However, if a client is a repeat client and is doing their standard deal, charging a flat fee becomes easier.  Either way, I always at least consider using a flat fee. 

So, as I progress in my practice, my goal is to use flat fees on a more regular basis - both to earn business and to allow me to become an even better attorney.  Large law firms will survive the downturn and they may even eventually turn to using flat fees on a more regular basis.  But for now, if you want to get great legal service and also know what it will cost you - your best bet is to call someone like me and I will see what I can do to accommodate you.  Paul Kingsley is a Phoenix business and real estate lawyer.

SNELL & WILMER GOES HOLLYWOOD

Phoenix-based law firm Snell & Wilmer announced yesterday they are opening a new office in Los Angeles with eight attorneys lateraling from a smaller Santa Monica firm.  Snell is one of the oldest law firms in Phoenix and is a regional player with offices in Phoenix, Tucson, Las Vegas, Orange County, Denver, Salt Lake City and Los Cabos, Mexico (their previous newest location).  So it's a fairly big move for them into another large market.

Full press release is here (pdf).

AS ANTICIPATED - OPTION ARMS SEE RISE IN DEFAULTS

That anticipated Option ARM problem I wrote about last month is already starting to become a reality...

CONDOMINIUMS AND PHOENIX NOT GETTING ALONG

So the big craze for the last several years was for developers to purchase one of the many apartment communities in Phoenix metro and to "subdivide" them into condominiums and sell them off.  Other developers decided to start from scratch and build condominiums from the ground up.  More than a few of these projects made it about half way (or less) before the market for condominiums fell apart in Phoenix - wrecking the pro formas of these developers.

This leaves a stark choice for the condo converters - maintain the condominiums as apartments until they can be sold, do a fire sale or auction of the remaining units or simply liquidate in bankruptcy.  All three are happening.   Many developers allowed existing tenants to stay in converted condominium units until they were sold - a smart choice considering what has happened in the market.  Although rents are falling all over the Valley, damaging net operating incomes, having some form of income allows these developers to continue to satisfy their debt obligations acting as landlords.

Other condo developers (of both conversion and new builds) are going the fire sale/auction route.  The Republic has a story today about two new-build condominium/townhome projects in Scottsdale that are struggling to find buyers - one of which has decided to auction remaining units.  The starting bid prices they are asking at auction versus the price originally marketed at is stunning - from $340,00 to $520,000 versus previous asking prices of up to $1.5 million.  It's typical to see those kind of percentage price drops in lower priced condominium conversions as well.

This isn't an unusual occurrence as developers with a heavy debt load from purchase of an apartment complex for conversion or from construction loans need to figure out a way to pay their lenders.  The alternative, as some developers are being forced to do, is to go through foreclosure by their lenders (or more typically bankruptcy).  Needless to say, it is going to be a long while before Phoenix area developers start building condos again and even longer before they try conversions.

Interestingly, the article points out a trend that I have seen in my real estate legal practice, Canadian buyers on the lookout for deals in Phoenix.  I assume that Phoenix is a fairly popular place to be a Canadian snowbird, but Canada has not been immune from the economic crisis (although it's not nearly as bad as the U.S.).  And the Canadian dollar has dropped against the U.S. dollar - weakening Canadians' buying power in the U.S.   Nevertheless, it appears that Canadians have the money to buy and see Phoenix as a great place to purchase distressed properties during this downturn.

Auction information for the Artesia property mentioned above can be found here.

NEW HOME SALES FALL OFF A CLIFF

New home sales numbers were announced today and they recorded the lowest level since records started being kept back in 1963.  Here is a chart prepared by Calculated Risk showing the numbers (click for a larger picture):

As you can see it hasn't been pretty.  Arizona has always relied on new home sales as a big economic driver - providing realtor, contractor, mortgage broker and other ancillary jobs.  Many of those jobs are now gone and the big builders in Arizona are going bankrupt.

Calculated Risk has a few more charts and commentary today here.

UNEMPLOYMENT NUMBERS BY STATE

The Wall Street Journal has a handy interactive map that shows state-by-state unemployment numbers.  Arizona is just below the national unemployment average and generally falls in the second tier of states for rate of job loss.  Check it out here.

Keep in mind that this map uses Bureau of Labor statistics, which does not count people who have given up searching for work and people who are underemployed (of which there are many these days).

JONES WALKER LAW FIRM OPENS IN PHOENIX

New Orleans-based Jones, Walker, Waechter, Poitevent, Carrere & Denegre LLP, corporate counsel for Freeport-McMoRan, has opened up a new office in Phoenix.  The move follows Freeport moving their corporate headquarters to Phoenix from New Orleans after their merger with Phoenix-based Phelps Dodge in 2007.  The Phoenix office of Jones Walker will initially be staffed by two attorneys.

Press release from Jones Walker is here.

FED ADOPTS PRINCIPAL REDUCTION PROGRAM FOR HOME LOANS

The Federal Reserve picked up a major portfolio of home loans when it bailed out Bear Stearns and AIG.  The Washington Post writes that they are now initiating a new home loan modification program for those loans that focuses on principal reduction - a tactic many (including me) feel is the best way to stem the tide of foreclosures.

The Fed is emphasizing reducing the amount of principal owed by people at risk of foreclosure, particularly those with a loan balance that is more than 125 percent of the estimated value of their property. Private lenders have been reluctant to renegotiate loans that way, as some of the institutions that own those loans, in the form of mortgage-backed securities, stand to lose money and therefore object.

This gets to the heart of the matter - banks (and investors in mortgage-backed securities) lose money if they write down principal and have to recognize that loss on their books - which further hurts their capital positions.  So instead they try to do as little as possible in a modification and often only delay the inevitable foreclosure - costing the bank or investor even more money than if they had just written down the principal.  Furthermore, as the article points out, investors in MBS typically need to approve principal write-downs, so mortgage servicers often are not allowed to modify loans in a way that would prevent foreclosure.

For example, the Federal Deposit Insurance Corp. has tried to use its control of California bank IndyMac, which it seized last summer, to do loan modifications, but has been frustrated by investors in those loans being unwilling to reduce the amount of principal owed.

To remedy this problem, bankruptcy cramdowns are now being considered in new legislation circulating in Congress.  This would put principal write-downs in the hands of judges, not the banks - and the banks (and MBS investors) are generally not happy with that idea.  The alternative, of course, is for banks and investors to undertake principal reductions voluntarily, which they do not yet seem willing to do.  Perhaps the threat of bankruptcy cramdowns will incentivize them to do this.

Still, the amount of home loans owned by the Fed is only a small fraction of the amount of total loans outstanding and, according to the article, homeowners typically will not know whether their loan has been acquired by the Fed and is eligible for this new program.  But the hope is that by initiating a true principal write-down strategy, it will provide some empirical evidence of whether principal write-downs will be effective and will serve as a model for other government programs and the private sector.

Update:  More coverage and commentary from HousingWire, including the letter from Bernanke, can be found here.

ANOTHER ARIZONA HOMEBUILDER SUCCUMBS

Fulton Homes declared Chapter 11 bankruptcy today.  It appears they will attempt to continue operating, seek to reorganize and emerge from bankruptcy.  Whether they are successful in coming out of bankruptcy in one of the worst housing slumps in Arizona history remains to be seen.   Tempe-based Fulton, founded by Ira Fulton, is one of the largest and oldest builders in Arizona and is a major philanthropist in the community, particularly for education.

Short article from the Republic is here.

Update:  Further coverage from the Business Journal here.

Update #2:  Some more from the Republic here and here.

W HOTEL SCOTTSDALE TO REMAIN OPEN DURING FORECLOSURE PROCEEDINGS

As anticipated, operations of the W Hotel Scottsdale will not be impacted by the disputes between the developer, builder and lender (see here, here and here).  The Phoenix Business Journal has a story today with comments from Starwood Hotels (the manager of the W) and they indicate it will be business as usual:

“The W is not involved in the dispute and we’ll continue to manage the W Scottsdale,” said K. C. Kavanaugh, vice president of public relations for Starwood Hotels and Resorts, based in White Plains, N.Y.

Kavanaugh said Starwood has received numerous phone calls from future hotel guests who are wondering whether they should book a reservation after reading about the pending foreclosure action on the chic hotel that opened in October. She said she wanted to set the record straight that the hotel is open for business and will remain that way.

The Notice of Trustee's Sale is now online and can be read here (pdf).  Scott Klundt from Quarles & Brady is acting as the trustee in the foreclosure proceeding.  The article today also indicates that Snell & Wilmer is representing Starwood.

VENTURE INVESTMENT IN GREEN TECHNOLOGY START-UPS RISES IN 2008

The NYTimes parses the 2008 venture capital numbers from the NVCA and finds that while fundraising and investment were down significantly in 2008 (particularly in the 4th quarter), green technology start-ups continued to fair well in attracting venture capital investment - raising 52% more in 2008 than 2007.  According to their data, this amounted to $4.1 billion invested into 277 "clean tech" start-ups in 2008.  Solar/photovoltaic technology start-ups accounted for nearly half of that money - a good sign for Arizona solar companies looking to grow.

CASE-SHILLER REPORTS ANOTHER RECORD DECLINE FOR NOVEMBER

S&P/Case-Shiller released their housing price index today for the month of November 2008.  We again set a record with an 18.2% year-over-year price drop for the 20-city index.  Phoenix housing prices fared the worst again on a month-to-month and year-over-year basis:

Phoenix and Las Vegas were hardest hit in November, with prices down 3.4 percent and 3.3 percent, respectively. The two cities also have the worst returns over the one-year period, with prices falling 32.9 percent and 31.6 percent, respectively.

As I have mentioned before, Case-Shiller has a fixed basket of homes that it tracks, controlling the mix of homes it surveys for its index.  This prevents shifts in the type of housing stock being sold (smaller, lower-priced homes these days) from skewing their index.  So it is regarded as one of the more accurate indices.

The article from CNBC can be read here and the S&P press release (including charts and graphs) can be found here (pdf).  Calculated Risk has more charts and analysis here (including a chart showing a 42% overall drop in prices in Phoenix from our peak).

Update:  Karl Case, in an interview today, says he thinks that the U.S. housing market may bottom in 2009, noting that new home starts were at a 5 decade low in December and inventories fell from 11.2 months to 9.3 months from November to December.  Again, remember he is calling for a national bottom, not addressing specific markets that are expected to lag significantly in finding a bottom (i.e., California, Nevada, Arizona and Florida).

MORE HOME SALES DATA OUT TODAY

Home sales volume up nationwide in December (owing to distressed sales), but still down year over year for December in Phoenix, while prices continue to tank (note the red on the chart here).

There are many different analysts releasing data these days that all give statistics that are a little different - but point towards continuing price declines and increasing sales due to those declines.  This is positive for the market as housing stock needs to devalue to a price where it bottoms.  And the faster the devaluation, the more people seem to be buying and the sooner we will clear inventory and find a bottom. 

The problem of course is that lots of sellers had given up and taken their homes off the market and may decide that it is time to list again - keeping inventories high.  And banks are holding inventories of foreclosed homes that they are slowly putting back onto the market - again keeping inventories up.  The hope is that banks aren't holding back a large inventory of these foreclosed homes and then will suddenly dump them en masse later this year or next - creating an echo devaluation after we think we have found a bottom (something that happened in some parts of California back in the 1990's).  And foreclosures haven't abated and may in fact be getting ready to increase again.  All the job losses announced daily aren't helping things much on the foreclosure front either.

November '08 numbers from Case-Shiller come out this week and will show us the continuing effect of a very bad 4th quarter.

TPI COMPOSITES RECEIVES SECOND ROUND FUNDING

The Republic and Business Journal both reported today on Scottsdale-based TPI Composites successfully raising second round financing in the amount of $20 million from the private equity wing of GE Capital (one of TPI's strategic partners) and a couple of other equity firms.

TPI uses their composite technology to manufacture light rail and maglev rail cars and for military vehicles.  More recently they have moved heavily into the production of wind turbines for electrical generation, having just opened up manufacturing facilities in Mexico, China and Iowa.  Mexico and China make sense because of their cheap labor, but Iowa?  For those of you who haven't been back to the Midwest lately, it is becoming the hot thing to build those huge wind turbines in the middle of corn fields on the flat (and windy) midwestern plains.  So Iowa makes sense and I am sure they are happy for the manufacturing jobs in the Midwest.

I'm not quite sure the reason or history behind why the corporate headquarters are in Scottsdale, as all of the manufacturing facilities are in far away states or countries.  But it is good to see a company based in Arizona taking the lead in alternative energy production - even if it is a form of energy which we don't have much of in the state.  With TPI's most recent round of funding, they are certainly well positioned to be able to take advantage of the extended tax credits for renewable energy and the expected bump up in funding for renewable energy platforms from the Obama administration.

MORE COVERAGE ON THE W HOTEL FORECLOSURE PROCEEDINGS

This time from the Business Journal.

NAHB SAYS HOUSING TO CONTINUE DECLINING

The National Association of Home Builders' (NAHB) chief economist predicted a housing bottom in the middle of 2009 and a very slight rise going into 2010 at the International Builders' Show in Vegas today.  Of course that is a national prediction, not for the most heavily hit areas like Phoenix.  As I wrote last week, many economists see Phoenix in a slump for another two years.

Phoenix has also seen a lot of job loss.  From the article:

"The single most important trigger event for delinquencies is unemployment," Nothaft said. "Clearly there will be more significant job losses over 2009 and that will contribute to delinquencies on loans of all types." Particularly troubling, he said, is that even prime borrowers with conventional, conforming fixed-rate loans are defaulting in higher numbers.

That is Phoenix in a nutshell.

Speaking about harder hit markets, the more pessimistic economist for mortgage insurer PMI Corp says that is it a good possibility that it prices will continue to slide into 2010 nationwide, with more than half of the top 50 metro areas having a 50% or more chance of the slide lasting until the end of 2010.  Notably, he puts Las Vegas' chance of having another two years of price decline at 90%.  Las Vegas equals Phoenix - except we don't have the huge economic generator called "The Strip."

Update:  Here is the decidedly more gloomy recap of the same event in the Las Vegas Review Journal today.

W HOTEL SCOTTSDALE MAY BE FORECLOSED UPON

HSH Nordbank, the construction lender for the recently opened W Hotel in Scottsdale has jumped into the fray, filing a Notice of Trustee Sale to foreclose and take ownership of the property away from the developer - Triyar.  As I wrote a couple of weeks ago, the builder, Hunt Construction, has already filed a $20 million lien against the W for unpaid fees for their construction.  I am anticipating Triyar may go bankrupt to try to slow down the foreclosure process and to reach a settlement with their lender and builder.  It is likely that the builder's claims are subordinated to the lender's, so Hunt may end up with the short end of the stick.

The foreclosure proceeding isn't likely to affect the hotel operations as the lender and operator (Starwood) of course want to keep as much money coming in as possible.  Still, it's a tough time for hotel owners in Scottsdale as occupancy is reportedly way down.

The article from the Republic can be read here.

VENTURE FUNDRAISING DOWN IN 2008

The Boston Globe reports venture capital fundraising nationwide from limited partners was down 21.4% in 2008 according to numbers released from the National Venture Capital Association.

The fourth quarter saw the largest drop with $3.4 billion raised versus $8.4 billion raised in the third quarter of 2008 and down from $11.7 billion in the fourth quarter of 2007.  That third to fourth quarter drop-off was about the same percentage drop reported in private equity numbers earlier this month by Dow Jones Private Equity Analyst (which also includes venture firms in its analysis under the "private equity" umbrella).

Press release from the NVCA with some historical numbers can be read here (pdf).

CONGRATULATIONS PRESIDENT OBAMA!

It's a great day for our country as we once again complete a peaceful transfer of power to our new chief executive, President Barack Obama.  It also marks a time I wasn't sure I would see in my lifetime (and I'm not that old) - the inauguration of the first African-American President.  Regardless of party or ideology, today is a day for all to be proud of the United States of America as we again show the rest of the world what democracy is all about.  I don't think that something like this is possible anywhere else in the world at this moment in history.

President Obama has quite a task ahead of him with two wars and the worst economic crises we have seen since the Great Depression.  Following a very well-run campaign and transition, I'm confident he will be up to the task.  Nevertheless, no matter what he and our other leaders do, I believe we have a long hard road ahead of us to pull out of a devastating economic slump.  Things aren't going to change overnight for our economy I'm afraid.

But it is still a time for optimism and new ideas in Washington and I want to wish President Obama best of luck over the next four years.

On a related note, our Governor Janet Napolitano was confirmed by the U.S. Senate today as the new Secretary of Homeland Security and will be resigning her position as Arizona Governor shortly.  Secretary of State Jan Brewer will inherit the position of Arizona Governor tomorrow.  She and the Arizona Legislature will have some very tough choices to make in dealing with a massive budget deficit - a problem shared by many states.  I want to wish her the best of luck as well figuring out how to balance the needs of the state versus our severe budget crunch.

MORTGAGE CRAMDOWN LEGISLATION NOW UP IN THE AIR

The Hill is reporting today that President Obama has indicated that he opposes including the cramdown legislation I previously wrote about (here and here) in the stimulus package over concerns it will cost Republican votes.  It sounds like Obama is trying to get as many Republicans on board to vote for the stimulus package and putting anything too controversial in there is being reconsidered (although no doubt there will be a lot that Republicans don't like in the bill).

It sounds like there is some disagreement between the President and Senate Democrats on this according to the article - so stay tuned to see if the legislation is included...

SMALL HOMEBUILDERS FEELING CREDIT CRUNCH IN ARIZONA

The NYTimes has a story tonight that focuses on the plight of small and medium-sized private homebuilders who are being foreclosed upon by banks in record numbers.  Notably, they highlight long-time Arizona homebuilder Brown Family Communities, which effectively went out of business this past October due to their banks pulling credit and foreclosing on much of their property. 

The Arizona Republic covered this in a brief story back in October here, noting that BFC was not late on any payments, was not on the Arizona Department of Real Estate list of "builders in financial trouble" and was a well-regarding company that had been operating for over 30 years in the Valley.

Brown Family Communities' story is a familiar one in Phoenix as many homebuilders, large and small, purchased land planned for future projects and either land banked it or began to put in infrastructure for development of single family home communities.  At the time, buying land as early as possible seemed advisable as land speculators were swarming Phoenix metro driving up land to a price that would make cost of development difficult.  Banks were even lending up to 50% LTV on raw land - something you won't find today - further stoking the increase in land values.

As people stopped buying new homes and prices rapidly dropped in Arizona, the many builders who purchased large quantities of land for future projects or had land in mid-development got stuck with land and homes they couldn't sell easily, loans that they could not refinance and/or loans that could be called upon lower appraisal values.  The NYTimes article notes:

Many loans in the building industry are of short duration, coming up for renewal at least once a year. This allows banks to take a fresh look at the financial health of a borrower, as well as the assets securing their debt. A steep fall in cash flow or a decline in the value of the collateral — usually building lots or half-built houses — can mean an automatic default, whether a borrower has missed payments or not.

According to the article, this is what happened to BFC.  They had purchased hundreds of acres of land on the west side in Buckeye and Goodyear in anticipation of the boom continuing and got caught in the downturn.  It's a common story in Phoenix these days as well-known small and medium-sized builders that have survived some pretty rocky times in Phoenix real estate history are not making it through this difficult period, laying off hundreds at a time.  Driving into the outskirts of the city, one can see many partially-built developments with paved streets lined with dirt lots, weeds and "For Sale" signs on whatever homes were built and sold (and then often foreclosed upon).

The article makes brief mention of a request for federal bailout by homebuilders, trying to stoke buyer interest in new homes.  Although it would create new jobs, this is the last thing we need right now in Phoenix.  Our inventory is still very high and builders are just going to have to take their lumps for a few years or find other work until inventory clears and prices hit bottom.  Hopefully the ones that do survive maintain the institutional knowledge of what can happen in a housing boom and will not make the same mistakes 10 or 20 years down the road.  Phoenix will go back to a rapidly growing city soon enough, but it is going to take a few years to get back to normal growth again.

PHOENIX METRO HOME PRICES CONTINUE RAPID DECLINE

John Wake at ArizonaRealEstateNotebook.com put together this handy chart based on MLS data through the end of December 2008 in Phoenix metro.

It show a very vivid picture of what has happened over the past several years in Phoenix.  From November to December, media Phoenix home prices dropped another $10,000 all the way down to $145,000.  John has some additional analysis of the chart on his website here.

Note that the median price may be skewed a bit lower at this time since almost half of current sales Phoenix are distressed/foreclosure sales, typically at the lower end of the price range in the market.  Adding in a bunch of lower price sales of smaller houses tends to depress the median, just as people tending to buy much larger and more expensive houses back when credit was plentiful tended to overstate the median by a bit.  Looking at an index like Case-Schiller gives a better idea of changes in price since they control their indices to report on the same mix of homes for resales.  The problem with C-S is that they report several months behind.

Lagging indicators (such as past price) usually aren't as good as leading indicators to figure out what is going to happen next.  To see where the market is going to go, the better numbers to look at in John's chart are volume and inventory.  He breaks down what he thinks they mean on his website.  Other things to look at that impact housing are the Arizona unemployment rate, mortgage interest rates and mortgage volume.  If you want to look at historical numbers, look at historic rent costs vs. housing price and median income vs. housing prices.  We have a ways to go down in housing price in Arizona before we get back in line with those last two ratios I mentioned - and the faltering Arizona rental market and job market will likely keep it that way for awhile.

A LITTLE BRITISH SATIRE

Bird and Fortune on the financial crisis...

Part 1

Part 2

(h/t Calculated Risk)

FORECLOSURE CRISIS HITTING ALL LEVELS IN ARIZONA

As I have written previously, it's not just homeowners with subprime loans that are being foreclosed upon these days.  Alt-A, Option ARMs and now even Prime loans are increasingly resulting in foreclosures - meaning that the foreclosure wave has hit all levels of incomes and classes in the U.S., and particularly in Arizona.  And a second large wave of foreclosures is expected to hit the market starting this year and over the next two years as a huge wave of negative amortization loans recast, more jobs are lost and more people simply decide that walking  away from their home is their best option.

The Washington Post has a good story today that relates some of the human side of the foreclosure fallout, focusing primarily on California. There, many people who had great incomes who could responsibly purchase homes are now very far underwater, losing their jobs and defaulting on their loans.  This creates a domino effect as values in neighborhoods are drastically reduced and buyers refuse to purchase anything other than a property priced at foreclosure levels - making it nearly impossible to sell homes.  Homes there are worth literally hundreds of thousands of dollars less than the mortgage principal amount.

While the article focuses primarily on California, it could have been written about Phoenix just as easily.  The Phoenix metro area had one of the highest run-ups in valuations (50% in a year at one point) and many people who purchased responsibly are now caught very far underwater on their home loans.  For most, this means they will be in their house for many years until the house is again worth as much as the loan amount (10 to 15 years I estimate for many), or as long as they have a job that allows them to pay the mortgage.  For others, this means making the financial decision to use the protection of Arizona's anti-deficiency statutes to walk away from the house and deal with repairing their credit instead of paying on a home that is underwater.

The foreclosure crisis is a sad story in Arizona that is now affecting people in even the most exclusive neighborhoods - not only in their home values, but in many jobs lost due to the disappearance of mortgage broker, realtor, construction, banking and other jobs related to the industry.  The same industry that generated much prosperity in the state is now dragging it back down to earth and creating some very difficult times for many Arizonans.  It's a difficult situation that Arizona will be dealing with for at least the next three years on the macro level and for a decade or more at the family level.

I encourage you to read the article as it does a good job of painting a picture of what is happening out there at the family level today.  I think a lot of people who do not live in a state that had such a severe run-up in prices and subsequent drop have a hard time grasping the devastating and wide-ranging effects of the real estate bust in areas such as Phoenix and it hopefully gives some better perspective on the situation.

BIG BOX VACANCIES IN PHOENIX LEAVE DIFFICULT CHOICES FOR LANDLORDS

On the heels of Circuit City's announcement today that they would liquidate their remaining 550+ stores nationwide (they were already in the process of this in Phoenix), the Republic has an article about big box landlords in Phoenix struggling to find tenants to fill recently vacated stores or newly built space.  Mervyn's, Linens n' Things and Circuit City have left the largest gaps in the Phoenix metro's retail power centers.

The shift in strategies for many of these landlords is to start to accept tenants that are not traditional or which were not seen as favorable during boom times.  This includes dollar stores and other discount retailers and even very non-traditional uses such as schools and churches.  From the article:

"(Lease) prices are coming down. . . . We're getting a lot of callbacks from big landlords that before wanted nothing to do with a dollar store. In the last six months or so, they've really started coming on to us," said Ted Flood, real-estate manager for Dollar Tree.

Other talked-about examples include a year-round Halloween store inside a shuttered Circuit City, or a cowboy-boots retailer in place of a defunct Shoe Pavilion. Schools and churches also could fill vacancies.

Unfortunately, the wave of retail bankruptcies and liquidations is just starting as consumer spending plummets. There will be lots of vacant retail space in Phoenix metro before it is all over.  I often drive by a brand new Mervyn's that was open for no more than a year before it shuttered.  Another 50,000+ square feet of complimentary commercial space was built on the Mervyn's commercial corner - and everything still sits empty today. 

Don't be surprised to see some pretty interesting (read: non-traditional) stores in retail power centers in Phoenix metro over the next couple of years. 

Update:  Another article about retail vacancies from Bloomberg last week is here, noting vacancy rates at malls and shopping centers are at 10 year highs and expected to go much higher.

Paul Kingsley is a Phoenix business lawyer and real estate lawyer.

ARE ARIZONA REGIONAL AND COMMUNITY BANKS NEXT TO FAIL?

One of the fears of economists (and of course we, the taxpayer) is that regional and community banks will start to fail at an increasing rate.  Some of the regional banks who needed it have been able to take advantage of the TARP bailout money given to banks.  But that money isn't indefinite. 

Many of the smaller banks have escaped the fate of the massive banks so far because they were not caught up in derivatives trades and other financial markets that have caused so much pain on Wall Street.  They were also able to get rid of their residential loan portfolios through securitization, thus leaving them less exposed to the downside of the residential real estate collapse. 

However, regional and community banks are well-known for making commercial real estate and construction loans. This is the bread and butter of many of these banks as they have relationships with local developers and know local projects, often making them best suited for writing commercial and construction loans. 

Many economists anticipate that 2009 will see a significant increase in commercial loan defaults as companies go out of business, occupancy rates rise, and rents fall.  Falling rents often lead to a borrower defaulting on their loan covenants (failing to meet the debt service coverage ratio).  And many construction loans that were written by these smaller banks for development projects are coming due, with developers having no way of paying them off due to a combination of bad credit markets and low, or no, occupancy.

So 2009 may be the year that we see a lot of regional and community bank failures due to commercial loan defaults.  Yesterday, M&I Bank (well known in Arizona) announced what was described as a "surprising" fourth quarter loss, saying one of the reasons was a "surge" in commercial and construction loan defaults, especially in the states of Arizona and Florida.

Expect to see a lot more of that in 2009, with the only question being how many of these banks does the federal government save, and how many does it let go under.

Update:  Calculated Risk has some additional information on the regional bank difficulties expected in 2009 here - the key point being that many of these banks have a fair amount of exposure to commercial real estate loans which are going bad.

HOWELL JACKSON SUPPORTS EMINENT DOMAIN FOR BAD MORTGAGES

Dean of Harvard Law School, Elena Kagan, has been nominated to be solicitor general by President-elect Obama, leaving the spot open at my alma mater.  Today, HLS Professor Howell Jackson was named Acting Dean there. 

I did not have Professor Jackson for any classes when I was there, so I don't know him personally.  But interestingly, he is a person cited by the NCRC as lending support to using eminent domain to take over bad mortgages on the cheap - a topic I wrote about yesterday.

From the press release:

As Harvard Law Professor Howell Jackson points out, eminent domain can solve the barriers related to first and second liens by directly purchasing all mortgages on targeted properties.

Somehow I don't think the step up in titles for soon-to-be-acting Dean Jackson is going to convince Congress to go through with the idea.

Update:  Here (RealPlayer) is a webcast of a panel discussion moderated by Dean Kagan and involving Professor Jackson, among others, discussing the economic crisis and bailout.

MORE DETAIL ON GRAY V. KLUTZNICK

From the Republic this afternoon here.  Previously on this blog here.

FORECAST FOR ARIZONA RESIDENTIAL REAL ESTATE RECOVERY BEGINNING IN 2012

The annual ULI Real Estate Trends Conference in Phoenix is today and the economic forecasters there grimly predict another year of falling residential home prices in 2009, no growth in 2010 and 2011 and then the beginning of a recovery in 2012.  These are some of the same guys that last year accurately predicted the big fall of prices in 2008.  Article from the Republic is here.

This jives with what I feel is probably in store for the Phoenix residential market (although I'm no expert).   With so much inventory out there and foreclosures still setting records, I doubt we will see a bottom until near the end of this year.  And that bottom doesn't mean we are going to bounce back up - it simply means we will bump along about flat in values for quite awhile as the rest of the economy recovers.  Until the Phoenix job market comes back, it is going to be hard to generate any momentum to get back to the normal 5-8% valuation growth rates in Phoenix.  So that "recovery" in 2012 may only mean that we are seeing some sort of growth in values, but not much.

This does not bode well for the many people who are way underwater on their mortgages and may need to sell their house in the next three to five years.  By the end of 2009, they will be even further underwater and for many of them, it will be a decade or more before they are back to even.  This hurts mobility of the work force, prevents growing families from buying move-up housing and generally stunts the growth of the economy.

The good news is that home resale volume is up year-over-year as people are starting to snap up short sales and foreclosures.  Almost all of the increase in resale volume is attributable to foreclosure sales.  And people should remember that Phoenix metro has a lot of different sub-markets that may bottom out sooner or are holding their value better than others.

Nevertheless, I'd probably sit tight for at least 6 more months before wading back into the residential market - and even then, only if I got a smokin' deal in a good neighborhood.  And of course, be very wary of realtors these days who tell you that you don't want to miss the bottom.  The bottom isn't here yet in Arizona, and when it arrives, you are likely to have plenty of time to be selective and buy very low.  There are plenty of homes out there.

YES THERE WERE LOTS OF FORECLOSURES IN 2008 IN ARIZONA

Foreclosures were up 203% year-over-year in Arizona in 2008, coming in at a total of 117,000 - the third highest in the nation behind California and Nevada.  Article from the Business Journal is here.  Many more are on the way in 2009.