To members of Congress, President Bush, President-Elect Obama, fellow Americans, and current and future residents of the Phoenix area, the state of the Phoenix residential real estate market is “weary but hopeful.”

Numerous challenges including an onslaught of short sales and foreclosed properties, deteriorating home values, and the onset of a global recession have rocked the Phoenix real estate market to its core. Indeed, recessionary concerns are large on people’s minds and add much uncertainty to the market. These challenges have yet to fully play out in the marketplace so that their full impact is felt and measured.

Government efforts are underway to resolve the current credit crisis though their target and implementation vary by the week. Some efforts are specific and being done by departments whose sole purpose has always been associated with the housing market while larger departments work on grander problems with much less clear and intentional aim. For these, it is too difficult to ascertain their net benefit to the Phoenix residential real estate market.

But there are bright spots in the local marketplace. Prices have adjusted substantially downward since the downturn began, buyer activity for 2008 showed strength, and the market shows some inclination that market forces are working to slowly evolve this housing market to a better state. In addition, the Phoenix real estate market is becoming more affordable once again, as affordability was the first casualty of the price appreciation the area experienced several years ago. Many buyers sense that there are deals in the marketplace whether a purchase is to be their primary residence, a second residence, or an investment property. And the Phoenix area’s population continues to grow as more out-of-state residents and companies decide to call the Valley of the Sun home.

In summary, the Phoenix housing market has been “beaten down but is not to be beaten” and holds hope for improvement in the coming year.

Times Have Been Difficult for the Phoenix Housing Market

The Phoenix housing market is moving into its fourth year of the downturn. As such, it is important to look back on its causes briefly in order to look forward.

The Phoenix housing market was victim to excessive speculation and false assumptions that fueled a frenzied pitch in home and real estate demand. This demand spurred rapid appreciation of homes in the greater Phoenix metropolitan area and in other parts of Arizona. This rapid appreciation culminated in as much as a 47% rise in home property values over a 12-month period.

The acceleration of appreciation took hold in the latter half of 2004 though the necessary drop in inventory to support this market change could be seen as early as March 2004. Pricing likely peaked in September 2005. By that time, inventory had begun to swing the other way again but how far it would rise was not known. Though sales prices peaked in 2005, by no means had prices declined substantially until well into 2006.

Inventory rose dramatically with more than 50,000 properties available for sale by 2007, a staggering figure. Arizona was designated a “Declining Market” by Fannie Mae in 2007 as well. This designation had the near-immediate impact that borrowers using conventional loan products would have be required to put significantly more money down (typically, from 5% to at least 10%) to purchase a new home. Due to this increase, borrowers quickly moved to take advantage of FHA loans whereby borrowers only had to put 3% down on a new home. As for foreclosures and short sales, these finally took full hold in the market toward the end of 2007.

In 2008, FHA loans have been a significant lending source for activity in the housing market here. Down Payment Assistance usage took off as well though this program was eliminated October 1st. Sales activity has shown some strength with a peak in activity in September (likely due to the rush to use down payment assistance before the cutoff). In addition, the sales activity has been weighted more heavily at the lower bands of the market consistent with the raised FHA limit of $346,250.

Since September, activity has been slowing. This is due to that month being a peak associated with down payment assistance usage, due to broader economic concerns, and due to the onset of the holiday season.

The Extremes of the Local Market

Parts of the Valley are experiencing the worst-case scenario in terms of the impact from the downturn.

Short sales and foreclosures have hit towns on the outskirts of the Valley the hardest. These are towns such as Queen Creek, Buckeye, Surprise, and Maricopa to name a few. These areas share a common thread – high speculative investor activity concentrated in new build communities.

These towns grew exponentially as homebuilders sold homes as quickly as they could produce them. In fact, new build development saw such prolific investor activity so that many areas that were largely built in the 2004-2006 timeframe have been subjected to a heavy turnover activity and a heavy decline in valuations.

Today, in some communities such as Maricopa, foreclosures and short sales fuel more foreclosures and short sales. Because home values have dropped to 40-55% of their 2006 values, any homeowner who is suddenly faced with a need to move, i.e. a job relocation or loss, medical hardship or other reason, there is no choice but to pursue a short sale or walk away from the property altogether. Of course, these actions will have a severe consequence to the homeowner’s credit.

Separately, Scottsdale, known as a favorite destination for its resorts, golfing, and shopping among out-of-state visitors, is trending at a low 7% of listed properties being under contract for purchase. This is likely due to average home prices in Scottsdale being much higher in general while much of the current buyer activity is taking place well below this point.

From a different point of view, properties priced above $400,000 in value account for just 12% of the closed transactions in 2008, though they make up 23% of available properties. From a “Pending” or under contract status perspective, only 4.2% of properties priced above $400,000 are currently in escrow to be purchased. Drilling lower into the market, available properties priced below $200,000 account for 51% of closed transactions in 2008.

Clearly, the heavy concentration of sales is at the lower bands of the market which means that home owners with homes priced above $400,000 will require different selling strategies than those priced well below $400,000. Based on this, one can see why the more affluent communities like Scottsdale and Fountain Hills are struggling in comparison to other parts of the Phoenix area.

The Bright Spots

Ironically, some of the most active sub-markets of the Phoenix housing market is in those very areas where short sales and foreclosures are the most prominent. The precipitous drop in prices is fueling stronger buyer activity in places like Queen Creek and Maricopa.

Queen Creek currently has nearly 23% of listed homes under contract which is the highest rate for the Valley. Maricopa currently has 19% of listed homes under contract. Avondale, in the West Valley, currently has 18.5% of listed homes under contract.

In terms of the more central Valley areas, Chandler and Gilbert are doing relatively well also. Chandler, located between Tempe and Gilbert in the Southeast Valley, is currently at 16% of available properties being under contract. Gilbert is trending at 17.7% of listed homes currently being under contract.

Where the Deals Are and How They Are Won

The deals in the Phoenix marketplace come from three different sources: foreclosures, short sales, and well-positioned sellers.

Foreclosures currently make up approximately 38% of homes currently under contract in the Phoenix area. These properties are often priced very low from the start as the lender that owns them is truly trying to liquidate these properties from their books.

Foreclosures are easier than short sales in that the buyer is dealing with a single owner that has ready decision-making power to approve or reject an offer to purchase. The downside is that the lenders can be harder to deal with than a common homeowner, can’t be emotionally negotiated with and are in fact single-mindedly focused on the bottom line, and will require ‘As-Is’ and other contract documentation that tries to eliminate any future liability.

Short sales likely account for 10-18% of properties currently under contract for purchase in the housing market here. Short sales are the most difficult transactions as often they involve the buyer, the homeowner, the first mortgage lender, a second mortgage lender or other lien holder on the property. There could also be HOA liens and tax liens associated with the property. Though the homeowner may sign off on an offer, it is really the lender(s) that have to approve the transaction and provide lien releases as they will be shorted some amount of money through the process.

Like foreclosures, there are great deals that can be obtained, but a short sale has additional downside risks. Namely, the process could take several months before any approval from the lender(s) is obtained if it is obtained at all. As a result, many home buyers will be left disappointed through this scenario.

Lastly, the deals in the Phoenix area are found with the traditional committed seller who has appropriately positioned their property based on its condition, location, and competition. These represent the best transactions in that the buyer often has more power to negotiate, full property disclosures are often made available, and sellers may be more reasonable to cover the cost of repairs or other items that come up during the inspection process.

An adage in the Phoenix market for sellers is this,”There are reasonable buyers for reasonable sellers,” meaning that a seller can find a buyer if they position their property well and treat the transaction flexibly and earnestly.

To win a strong value, the name of the game isn’t the lowball. The right strategy is knowing what makes a “great deal” and positioning accordingly to get it. That positioning may include the low ball but not necessarily. Buyers who expect to lop off an additional 10%+ off the price for any property and win the home will find this strategy doesn’t work well and they will often lose out on great values as other buyers step in to purchase them.

Separately, for the pure investor who has a strong cash reserve, the Trustee’s Sale or Maricopa County foreclosure auction could present an excellent opportunity to obtain properties more cheaply than on the open market.

Market Outlook for 2009

The Phoenix residential real estate market will continue to see serious challenges and changes moving into 2009. Indeed, properties that do not compose one of the three areas mentioned above – foreclosures, short sales, and well-positioned sellers – can expect to experience additional price declines as their positioning is not in keeping with current market conditions. Foreclosures and short sales will continue though many will be watching for some level of abatement and how this may spread across the Phoenix real estate market. The current recessionary climate poses additional risks and its influence could dampen real estate activity.

Property owners for homes priced above $400,000 will carry additional risk and may experience sharper price declines to adjust to the changing market. All home sellers will continue to face stiff competition to sell their homes. Opportunities for buyers to obtain strong values in the marketplace will continue.

Finally, the impact and potential benefit of the current federal government bailout will be more visible over the next six months. If successful, these programs could help to stabilize credit markets, ease economic concerns, which in turn would benefit the housing markets.

Overall, the Phoenix housing market will continue to slowly work through the issues it currently faces.

The Phoenix residential real estate market is “weary but hopeful” for the coming year.