The big story of the weekend seems to be the "conservatorship" of Freddie Mac and Fannie Mae. The American taxpayer will now be liable to pay for all the losses on the toxic mortgages these two poorly-run entities insured.
This is the bottom line: Freddie Mac and Fannie Mae and insured billions of dollars in toxic mortgages. The losses on these mortgages will end up exceeding the amount of money these companies have. If these companies were to go out of business, the entire secondary mortgage market would collapse, and our real estate markets will be in turmoil as transaction volume would plummet from its already anemic levels. The government believes it has to take over these companies in order to have a secondary mortgage market. A government takeover means the taxpayers of the United States just became liable for all the losses on the bad loans insured by these two companies. When you pay your taxes, you are now paying for a portion of all the bad mortgages given to speculators, flippers, fraudsters and the like.
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It started off so well They said we made a perfect pair I clothed myself in your glory and your love How I loved you, How I cried... The years of care and loyalty Were nothing but a sham it seems The years belie we lived a lie I love you 'til I die Save me, save me, save me I can't face this life alone Save me, save me, save me... I'm naked and I'm far from home
The slate will soon be clean I'll erase the memories To start again with somebody new Was it all wasted, All that love? I hang my head and I advertise A soul for sale or rent I have no heart I'm cold inside I have no real intent Save me, save me, save me I can't face this life alone Save me, save me, ooooohhhhh... I'm naked and I'm far from home
Each night I cry I still believe the lie I'll love you, 'till I die
Save me, save me, oh, save me Don't let me face my life alone Save me, save me, ooh... I'm naked and I'm far from home
How do you measure the impact of the decline? Five hundred twenty-five thousand Six hundred minutes? Is it measured in hundreds of thousands of dollars? Is it measured in the toll it is taking on families facing foreclosure? Is it measured in the lost opportunities of those trapped in their homes? Is it measured in the devastation to our economy or our banking system? How do you evaluate the real cost? I don't have answers to these questions; I don't believe that anyone does.
I have been watching the carnage in all financial markets recently with a curious fascination. I have never before seen deleveraging on such a massive scale. Recently the values of nearly every asset class has been declining: stocks, bonds, real estate, and commodities. This is happening because money is leaving all of these markets for the safe haven of cash. There is often an increase in saving and a curtailment of debt in a recession. This one is particularly interesting because it seems to be a classic "Minsky Moment" where deleveraging is forcing the sale of all assets -- even good ones -- to repay debts. This is monetary deflation in action. Cash is King again.
We are quickly seeing the end of the spring buying season. Instead of a
rally, we have witnessed a brief flattening, a step on the staircase to
market oblivion. What lies in front of us is the fall and winter both
literally and figuratively. Prices will likely begin to fall again this
autumn, and the winter months may see a very cold headwind. Now that the housing bailout bill has eliminated downpayment assistance programs, everyone is now required to have a downpayment. Also, the FHA raised its equity requirement from 3% to 3.5%. Since very few people were saving money during our failed experiment with 100% financing, demand -- as measured by dollars available from lenders to qualified buyers -- is going to plummet. The REO supply from the ARM resets and lower prices is going to continue to dump large quantities of must-sell inventory on the market. The stage is set for another equity crushing drop.
How much is a property worth? The ultimate answer is whatever someone is willing and able to pay for it. With the remnants of kool aid intoxication still gripping the market, there is no shortage of people with the willingness to pay any price to own property, but with the constriction of credit, there is certainly less ability to pay for it. This is to be expected in the initial stages of a price decline. People's memories are of the rally and all the money people made, although we will start to see a reduced willingness to buy as the bear market grinds on.
Once the poison of kool aid has been purged from the collective consciousness of the populace, people will require a new motivation to purchase real estate: it is cheaper than renting. I first wrote about this phenomenon in the post How Inflated are House Prices? I later followed up with a more detailed analysis of the Rent vs. Own decision. Today's featured property is offered for sale at a price far in excess of its cost of ownership. This property is being offered for sale at $589,000, and it was available for rent in January at $2,300 per month. There is a comparable property currently for rent at $2,500 a few doors away. That puts the value between $368,000 and $400,000 for an owner occupant using a 160 GRM.
There is a group of nervous home sellers who are trying to sell their homes for enough to pay off their mortgages. Some of these were buyers toward the end of the rally that paid too much, and some are owners who bought earlier but mortgaged themselves into the same precarious position. They are wise to try to sell now if they can get enough to pay off their debts and save their credit. Today's featured property is an owner who extracted much of their equity, but they still have some room to maneuver before they go underwater. In my opinion, there feeble price reductions have not shown the aggressiveness necessary to move this property before the market leaves them underwater, but I guess they don't want to give it away.
The high end of Irvine's resale market peaked in early 2007 largely due to the availability of 100% financing to people with good credit. Once this form of financing was removed, so was all support of the inflated prices. Today's featured property is was a $1,050,000 property at the peak. The fact that it went into foreclosure in just over a year strongly suggests some fraud was involved. In order to avoid prosecution for fraud, the straw buyer must make at least 2 payments. Based on the timing of the foreclosure, it certainly appears as if the buyer made two payments then simply stopped and let the property go back to the lender in a foreclosure.
There have been some rumblings about the declining inventory numbers and the slight uptick in sales in Irvine. Perhaps it is signaling a bottom in pricing? This doesn't seem likely, particularly with the Alt-A and Prime ARMs due to reset over the coming few years. The fact remains that REOs continue to enter the market, and they continue to drive prices lower to find buyers. Until that stops occurring, prices will not stabilize much less appreciate. Today's featured property is 35% off its 2005 purchase price, and the lender recently reduced the price drastically to find a buyer.
Today's featured song was sent by a local musician who is an avid reader of the blog. I bet you can guess his name...
The crash at the end of a speculative bubble can be brutal. So far, the price decline in Irvine has been measured and orderly compared to the drops in less desirable markets. I was recently looking at properties in the Palm Springs market, and I found some of the new neighborhoods that were the carnage is simply breathtaking. Check out some of these listings at around 50% off their new home sales price of 2 years ago:
I could list more, but I think you get the point. The Palm Springs market may have some chance of recovery as baby boomers may want to go here when they begin to retire soon. If you want to see carnage in a market that is not likely to recover any time soon, take a look at Hemet/San Jacinto:
The interesting thing about all of these properties is that they are selling for less than replacement cost. With asking prices around $85/SF, that is the cost of construction of the box itself. Even if the lots were free, a builder could not build and sell a house on it and make any money. There will be no new construction in these markets until prices rise above replacement costs, and then it will only occur on already finished lots selling at an extreme discount. There will be no new development or construction of finished lots until prices rise back above $130/SF. That is about 50% above current values. As you can see, replacement cost does not put a floor below prices. Ultimately, the lack of new construction will create a shortage, and prices will rise due to supply constraints (assuming the financing is available). However, since we overbuilt in many of these fringe markets, it will take some time to absorb all the existing inventory.
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stacked behind the door are the photographs of yours. in the basket
down the hall there's a soccer shirt that i borrowed.
the end isn't the
end. the end isn't the end of this.
picking out the darkened hair from
each and every happy moment. i've come to terms that have been laid
bare, quiet sleeping angels in my bed.
the end isn't the
end. the end isn't the end of this.
so don't you disappoint yourself
again, you'll be back home.. you disappoint yourself
again, you'll be back home.. you disappoint yourself
again, you'll be back home.. before too long..
these discussions with
myself, the kinds of things that don't tend to help. pacing back and
forth with my guitar, looking way up high on a shelf.
Some time ago, I wrote the post Timing Does Matter, to document the financial impact of properly timing the market. Today's featured property owners show how a family should manage their mortgage, and the benefits that can be obtained in retirement if you sell near the peak of a massive speculative bubble. I commend today's sellers. They are the role models I will emulate in my own life.
Isn't real estate supposed to be like vintage wines that get better with age? Rare vintage wines can get very expensive, and unless they turn to vinegar, their prices do always go up. Well it appears the 2006 vintage homes are all turning to vinegar now because they certainly are not appreciating in value.
Today I want to relay a story to you that was told to me by a real estate developer currently buying property in one of our most blighted California bubble markets. His company is purchasing this particular property from the bank for far less than the original loan amount. Do you remember the residual land value calculations from Land Value 101? This particular property was ready for the construction and sale of houses in 2003. The original prices were $400,000 in this particular market. By 2006, houses were selling for $700,000. When sales volumes plummeted, the builder gave up and let the property go back to the bank. The developer ran a proforma using a $275,000 house price. As you can imagine, this did not leave a large residual land value. The bank took the offer. This developer knows he can build and sell houses profitably for $275,000 in this particular market. If prices increase, he stands to reap a windfall. His only real concern is the competition from the REOs, particularly all the previously built homes in this subdivision he is undercutting by over 50%. He knows he is probably going to cause more walkaways, but prices are what they are, and as long as he can build and sell $275,000 houses, it isn't his problem.
Fortunately, for those living in Irvine, the developer is financially stable, and it is concerned about long-term house prices and probably will not cut prices over 50% to move homes. As we noted with the problems in Columbus Grove, those who are off the Ranch are not so lucky. Today's featured property is another of the bad 2006 vintage properties in Woodbury. This seller is really being hosed by his competition as he owes $184,000 more on his property than his comparable neighbor is asking for sale.
Speculation is a battle. The forces of greed and fear drive the financial markets, and the speculator attempts to profit from these moves. Speculation is not investment, although most do not understand the distinction. Speculation is the battle of the individual against the herd. For those who understand it and have learned to move against the emotional forces of fear and greed, there is opportunity to profit. For those who follow the herd, there are brief moments when profits are available, but few have the discipline to take them. Most speculators are slain by the market.
Like many others, I have a disdain for pure speculative flips.
People who buy properties, make no improvements, and attempt to resell
it for a profit simply inflate market prices. There is no value added.
People who rehab old or run down properties do a community service, and
they earn the money they make. However, flippers are merely financial
parasites profiting by constricting supply at reasonable price points.
Of course, flipping is a dying art, and those who are attempting it now
are losing money which makes for great schadenfreude.
Flipping is much more difficult now, not just because prices are
dropping, but because the constriction of credit and the tightening of
financing terms makes it much more costly and difficult to do. The
Option ARM with 100% financing was the ideal tool for the flipper. It
allowed him to enter the market with none of his own money, it
greatly reduced the carrying cost of the property, and it gave him downside protection in the event prices fell. With these conditions in
place, it is no wonder speculative flipping became the pastime of every
would-be Donald Trump in California.
Another behavior enabled by loose credit during the bubble was
cash-out serial refinancing. With the ability to get access to cash
from the property without selling it, there was no need to sell the
property, and many speculators held their properties and withdrew their
cash as needed. Houses were treated like savings accounts earning a
very high return. Of course, they were not withdrawing free money, they
were adding huge amounts of debt, but since the debt service costs were
low, and since nobody thought they would ever have to pay this money
back out of their income, cash-out refinancing became the rule rather
than the exception.
Today's featured property is an example of a speculative cash-out
serial refinancing flip-flop. The speculator bought the property with
100% financing using a 1-year ARM, took out some cash, refinanced with
an Option ARM, took out some more cash, and now they are walking away.
It started off so well
