Your Buyer's Loan Terms

Over the last several years, buyers have not concerned themselves with the day they were going to become sellers. Why would they? There was an endless demand for properties, and buyers were going to pay whatever was asked. Those days are gone. They are not coming back any time soon.

In one of my first posts, I talked about Financially Conservative Home Financing. There has been much discussion on these boards about the high debt-to-income ratios and adjustable rate mortgage terms now required if you chose to buy in today's market. For anyone considering buying a home right now, I would like you to think about the buyer who is going to buy your home from you at some point in the future, and more specifically, what debt-to-income ratio and loan terms will this buyer utilize. This is important, because the amount of money this take-out buyer will pay you for your home is completely dependent upon these variables. Your house is only worth what your buyer can pay for it. For you to get out at breakeven or better, your take-out buyer must be leveraged more aggressively than you are, or you must wait for fundamental valuations to catch up to today's pricing. In this post, I will examine both scenarios, and I will present a range of valuations for homes based today's income and prospects for the future.

Fundamental Valuations

As a primer, please read How Inflated are House Prices? In that post I discuss a simple method to calculate a house's fundamental valuation. In short, 160 times the monthly rental rate is a useful number. The monthly rental rate can be calculated as follows: Median Income / 12 (months) x debt-to-income ratio = monthly payment = monthly rental rate. For example, in Irvine in 2006, the Median Income was $83,891 / 12 = $6,990 monthly median income. Financial planners (and your banker) will tell you not to put more than 28% of your gross income toward housing (Realtors will tell you to put 55% or more if that is what it takes.) Assuming a more rational 28% debt-to-income ratio, the median monthly payment (and thereby the median rent) is $1,957. Based in a 160 multiplier, the median house price should be $313,120 or 3.7 times earnings. Since the borrower should have a 20% downpayment, it can be argued that the median home price should be $375,744.

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So how does all the above compare to reality? The median rent in Irvine is $1,660. This is going to include many 1 and 2 bedroom apartments and very little at 4 bedrooms and above. The housing stock in Irvine is generally larger and nicer than the rental units, so a median house rental of $1,957 is probably not too far off. If you go to OCRealEstateFinder or FirstTeam and search for rentals, you will find what I would consider a median type property renting between $2,250 and $2,500 a month. This means that most Irvine renters are probably spending more like 35% of their gross income on housing instead of the suggested 28%. So if you recalculate the theoretical median based on $2,500 a month, the median home price should be $400,000; add a 20% downpayment, and the median could be as high as $480,000. The last statistics I saw for the Irvine median home price was $687,000: No reasonable metric can be constructed to justify that price.

Fundamental Value Table

As you can see from the discussion above, there is a range of values which can be used as a "reasonable" fundamental valuation. For the sake of simplicity, I am going to use $360,000 which is the number I used in the post Predictions for the Irvine Housing Market.

Debt-to-Income Ratios

The table below shows the impact of debt-to-income ratio on house price.

Debt To Income Table

As you can see, the current debt-to-income ratio in Irvine is 60.8%. Even if you assumed ever buyer is puttting 20% down (which is laughable), the DTI ratio is 50.1%. Remember this is gross income; as a percentage of take-home pay, the number is much higher. Will your buyer be willing to spend that much of their income on housing?

Amortization

The above table shows the DTI assuming a 30-year conventional mortgage. Only 20% of loan originations in Orange County were conventional mortgages in 2006. People have bid prices up using interest-only and negative amortization loans. The table below shows the impact of these loan terms.

Amortization Value Table

This is where the action is. There are many factors which contributed to this bubble, but it is the combination of these loans with Southern California’s Cultural Pathology that really made this bubble happen. The biggest gamble current buyers are taking is the availability of future financing options. If defaults continue to increase at the current rate, these products will likely be eliminated: the banks are losing to much money. Will these loan terms be available for your future buyer?

Interest Rates

Mortage interest rates on 30-year fixed rate mortgages with no points are running about 6.4%. This is about 20% less than the historical average of 8% for home mortgages.

Interest Rate Table

As you can see from the above table. The higher interest rates go, the less a borrower can finance utilizing the same payment. If interest rates go up from the current 6.4% to the normal 8%, buyers will be able to bid 15% less than previously; therefore, house values will decline 15% as a result. If interest rates spike to 10%, house values decline 30%. What will interest rates be when your buyer wants to buy your house?

Appreciation over Time

I will use an appreciation rate of 3% to reflect the normal growth of wages and rental rates. It can be argued that appreciation will be higher, but it can also be argued that Appreciation is Dead.

Appreciation Table

Fundamental valuations are directly tied to wage growth. How much money will the buyer of your house be making in the future?

Future Value Table

Pulling together all of the above variables is a challenge. Below is a table which attempts to do so. Please click on the table to enlarge.

Future Value Full Table

To make it easier to read and follow, I have broken down the above table into three sections based on the DTI ratio of your future buyer.

Future Value 28% DTI Table

The most likely scenario is that your future buyer will pay from the second column in the above table. A 28% DTI is not just advisable, it may become a limit imposed by lenders — liar loans and high DTI ratios cause defaults and may be eliminated. Interest rates will likely climb back to their 50-year historical average of 8%. Notice that today's median home price is not reached in the 29 years shown on this chart if interest rates rise.

Future Value 32.2% DTI Table

If you believe the "sun tax" is alive and well in Southern California, and you believe lenders will allow DTI's in excess of 28% in the future, future values may be found in the above chart. This DTI is what house renters are currently paying in Irvine.

Future Value 60.8% DTI Table

Of course, there are those who believe we have reached a permanently high plateau, and buyers will continue to either utilize exotic financing or put 60% or more of their income toward housing (You have to believe those things to think prices can appreciate from current levels.) If you believe these conditions will persist, or occur again in a future bubble, then the above chart is for you. Who knows, maybe those of us who buy at the bottom can sell at these prices at the top of the next bubble…

Don't get greedy.

Think about what terms and conditions your buyer will face, and you may save yourself a lot of problems today. Right now the market has been pushed up to unsustainable heights, and it will fall. Don't buy when the conditions are not favorable. If interest rates are low, debt-to-income ratios are high, and exotic financing is the norm, it is a bad time to buy. You want to purchase when credit is tight and values are depressed — this is coming soon. Be patient and wait for the conditions to be right because you want your buyer to buy from you when credit is loose and prices are inflated. Remember, your house is only worth what your buyer will pay for it.

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P.S. If you want to run this spreadsheet for yourself, below is a link. You can input your own income and house price assumptions and see what happens.

Buyer’s Loan Terms

72 thoughts on “Your Buyer's Loan Terms

  1. William Jones

    Great analysis! I would reword your conclusion slightly…

    Your house is only worth what your buyer CAN AFFORD to pay for it.
    —–

  2. lee in irvine

    “Remember, your house is only worth what your buyer will pay for it.”

    Actually, your home is only worth what a mortgage company is willing to loan a buyer to pay for it.

  3. No_Such_Reality

    Excellent analysis. It’ll be interesting to watch to see if the median income in Irvine and OC takes a hit in 2007-2010 as the RE fat money dries up.

  4. oc_fliptrack

    Actually, your home is only worth what a mortgage company is willing to loan a buyer to pay for it.

    My agent said that everyone moving to Irvine is rich and that they don’t use loans. What say you, Mr. Lee?!?

    🙂

  5. Mark

    Great in-depth analysis that 90% of Irvine-area homeowners don’t understand or even care to try. I would like to see more data used (if possible) than simply medians though. This analysis uses the median household income in Irvine, but what about the 75th percentile, 90th percentile, etc.? e.g. If the average/mean household income above the median is much higher, say $200,000, that alone might explain the median household income regression from the median rental mean.

  6. Steve the Dog

    Looks like either a lot of stated income loans or teaser ARMs with low low rates (option ARMs?).

    In any event, they will be having to pay the piper soon. Sort of like musical charis, but when the music stops their are no chairs.

    Stev the Dog

    woof.

  7. IrvineRenter

    Over the last 3 or 4 years, people have been able to borrow more than they can afford, so do you think it is affordability or what a lender is willing to loan?

    Basically, I would say it is the sum total a buyer can come up with at a closing from whatever source. As a seller, I would not care how F’d the buyer was.

  8. frank the tank

    The “median income cannot afford the median home” premise is often used by renters to argue that houses are overpriced. The problem with the statement is that it fails to take into consideration the fact that not everyone in the market is going to be a homeowner. You’re comparing all incomes with cost of homeownership when you should be comparing homeowner incomes with cost of homeownership. The fact is, there are a lot of renters out there who skew the median income downwards, so it’s not an apples-to-apples comparison.

    “For you to get out at breakeven or better, your take-out buyer must be leveraged more aggressively than you are, or you must wait for fundamental valuations to catch up to today’s pricing.”

    Even assuming homes are overpriced, this statement is false. For you to get out at breakeven or better, your “take-out buyer” must pay you more than you paid. You don’t know that a future buyer must use more leverage, less leverage, or any leverage whatsoever. They could pay cash for all you know. Additionally, this statement fails to consider that incomes, combined with lower interest rates, could “catch up” to today’s pricing before today’s pricing comes down. Human nature being what it is, in the majority of cases sellers would rather continue to hold rather than having to sell at a loss.

    What if It is surprising to me how much this blogger speaks of fundamental values, but the “financial analysis” is always tilted towards a flip mentality. What long-term home purchaser thinks about the financing options that will be available to his/her “take-out buyer?” Answer: only those who purchase with an eye to immediate resale, i.e., flippers.

  9. IrvineRenter

    The “median income cannot afford the median home” premise is often used by renters to argue that houses are overpriced… so it’s not an apples-to-apples comparison.

    I suggest you reread the section above about Fundamental Valuations. I went to great lengths to establish the comparative rental rates.

    Additionally, this statement fails to consider that incomes, combined with lower interest rates, could “catch up” to today’s pricing before today’s pricing comes down.

    I suggest you consult the tables above showing the growth of income and the impact of interest rates. I anticipated your argument, and it is clear from the data that it will take more than 20 years for incomes to catch up, and interest rates would have to reach new record lows to make any real difference. Maybe banks will start giving money away?

    Human nature being what it is, in the majority of cases sellers would rather continue to hold rather than having to sell at a loss.

    Here we agree, but the toxic financing is going to force sellers to sell. You are ignoring that problem.

    What long-term home purchaser thinks about the financing options that will be available to his/her “take-out buyer?” Answer: only those who purchase with an eye to immediate resale, i.e., flippers.

    I see you get the point of the post, but fail to hear its message. Long-term owners should be thinking about the take-out buyer because even long-term owners who buy at these prices are going to be underwater for a very, very long time.

    Thank you for your comments.

  10. Dr. Housing Bubble

    IrvineRenter,

    Excellent analysis. I haven’t seen one so thorough for months. Again, you are using rational logic and economic fundamentals in a bubble environment. A bubble by definition does not follow what you have painstakingly went through in gathering the data; in our current bubble people buy whatever they want because of delusional equity cookie monsters signing off on any loan with a drop of ink. Even Lereah just mentioned that we may have a housing led recession. Say it ain’t so!

    I posted an article about the man making $14,000 and being able to buy a $720,000 home. You want to talk about out of whack economics. The debt ratio here is…well there is no debt ratio because he CAN’T afford the home. And this has many more implications than the person losing his home. Housing stats get skewed because the ridiculous price is counted as a sale. Sales increase thus reducing true inventory. That is why the NOD and pending sales numbers are absolutely vital. These median price numbers are holding up because of the past 6 months of housing debauchery that permeated the market. It’ll be another 6 months until stats show the true reflection on the market.

    Dr. Housing Bubble

  11. SmartMoney

    Whether or not you flip, in a highly mobile society you better think about whether someone will ever be able to buy the home you bought.

    If you want to adopt the philosophy that you should overpay for a tiny starter condo because you can overpay in a few more years for a slightly larger condo, and onward and upward in a climb to a better and more appropriate home for your family circumstances, then you have to resell. If you need to relocate, you have to sell. If you are not in your ideal final home, you will have to sell, and there are precious few who are in their ideal homes when it costs almost seven figures for a modest box that has nothing specific to recommend it over thousands of other modest boxes in the same general area. If you want a home on a cul-de-sac, with the ocean view, on a hill, large enough for a growing family, or any of a dozen other simple, reasonable expectations, you are not going to be able to buy it here when you need it unless you have a massive inheritance or a legacy trust or substantial savings from a few fantastic deals where you sold your businesses early.

    I chuckle at the mentality that there will always be exponentially growing numbers of extraordinarily wealthy people moving to Irvine able to pay cash for the overpriced homes to perpetually prop up the bubble. That sounds nice, but the numbers of required highly financially established newcomers to buy the volume of wildly inflated homes in Irvine alone will not be found in this country, where the savings rates are negative. And from overseas, they tend to do the math that we here in America find so distasteful and perplexing when we could just sit back and listen to a real estate agent promise us the impossible . . .

    I have no idea where people get the idea that economies operate in vacuums, either. Renters and homeowners are not two seperate groups, and financially savvy people have always and will always sift between the two as the economics changes. Irvine does not operate on a different model of economics from the rest of the country or neighboring communities, either, and all of the price dropping in other areas informs the “hedonic calculus” of those considering a purchase here: length of commute, quality of schools, connection to the community, price per square foot. It is all just finding the best situation possible, and for many, they have realized decided that the best situation under the current numbers, at least, is in a different state altogether!

  12. bought_high

    I wonder if 2 income families essentially throws your logic a little out of line (or are those incomes represented in the median income).

    But all in all, it seems like your logic is straightforward and understandable. But to really prove the point – why not rewind the clock and point out reasonable times when the magic 160 number acutally holds true. Or more accurately, when the interest rate (30 year fixed) allowed the median income to buy a median home at 28% DTI (house debt only). From my 12 years in california, I don’t remember that time – or maybe i wasn’t looking 🙁

    Since I own a house, I hope the sunshine tax holds for a lot longer – but again, I have bought for a longer-term investment. It just seems that my long-term is going to be pretty long to break even – or become rent savings…

  13. Hm owner

    Irvine Renter I am impressed with your presentation. I would like to present a different angle.

    Your Average salary does not indicate the higher income earners who are really the ones who can afford to buy a home in Irvine. 15% of the Irvine population makes about $220,000 average and the 85% remainders make $61,910 average thus final average would still be $85,624.

    At the current sluggish market there are 578 total listings. The population in Irvine is 202,079 and the average household is 2.78 that calculate to 72,690 dwellings or families in Irvine.

    15 % of the total 72,690 households are high salary earners equate to 10,903 eligible buyers out there who can afford the $767,900 homes or higher. The current 578 listings is a 5.3 % ratio of the high income population. Furthermore the listings are way less than 1% of the entire Irvine households.

    30 % of the population is Asian and your thesis would not apply because most Asians culturally buy with cash and does not believe in paying interest. They are well known for bargain hunting and would negotiate until the price is below the market rate. Real estates are cheap here compares to Tokyo, Shanghai or Hong Kong. This group of buyer is extremely picky and will look and look and look until they find the house with the best Feng Shui. Patience is the virtue of the Asian buyers. Do not expect a quick sale with these buyers. One would expect to see them a lot.

    The Irvine real estates do not seem to target the masses. However, there is always someone out there who can afford it. The market is different now and it takes curb appeal to sell. These buyers are buying curb appeal. Most of the older listings that sat are the one absolutely that have “ZERO” curb appeal and asking for a lot.

  14. Hm owner

    Irvine Renter,

    Thank you for the link. You are right! I am still new at this. I really enyoyed all your posts.

    I got my listing from the Coldwell banker’s MLS site.

    Copy and Paste this link to see why the totals of listings are way off by 200%

    http://www.californiamoves.com/property/propertyresults.aspx?rpp=10&sort1=listprice&mls=&thumbs=1&PType=SFAM&page=1&MinBed=0&CommunityIDList=&MaxPrice=999999000&CityIDList=c2711&sortord=D&sort2=city&Zip=&Street=&sqft=0&PropSearch=0&CountyIDList=218&MinPrice=0&MinBath=0

    What do you think of the Higher Income theory?

  15. Green Cactus

    @ HM owner

    – don’t confuse median and average …
    – the 85 percentile earners are not necessarily interested in buying homes that cost >$767k (think of them as wanting an 85 percentile home, not the median home)
    – Asians are not interested in Irvine because it’s cheaper than Shanghai, Tokyo or Hong Kong
    – In the land of tract homes, how does feng shui even make it into the equation?
    – If you are paying cash for a home, you don’t want your equity to instantly evaporate

  16. lendingmaestro

    In response to the Frank the Tank’s comment….

    Who says that renters make less money per month than homeowners??

    I originate, sell, and process loans at high volumes (although volume is significantly lower this year) and I can tell you this…
    I can count on 1 finger the number of homeowners that I could qualify for a full-doc loan in California this year. It’s so bad in fact that I have to do No Ratio loans, where income is not even stated on the 1003 application beacuse an underwriter would laugh his/her ass off. “Hmm..let’s see…Bank teller making 6 grand a month…..”

    My fiance and I together made 178k last year and I have a 684 mid fico and hers is 748 (asian, lol). And I could only qualify for a purchase of 433k full-doc!!!

    I am not about to buy a 1 or 2 bedroom box and pay over 3 grand a month when I can rent for half the price and not have almost a half million in debt.

    My financial net worth is based on the amount i have saved vs the amount I owe to creditors, not how many cheaply built stucco homes I own.

  17. SoCalwatcher

    Great work!!! Lots of data and it all makes sense. Bubble deniers have a hard time arguing when the numbers make sense and the hypothesis is dead on.

  18. Pianist

    lendingmaestro:

    Just curious…why is your FICO so low? Really, anything below 750 in my book means you either have excess debt or don’t pay your bills on time. I’ve seen hundreds of FICO scores of highly educated, high income earners and most are at >750.

  19. frank the tank

    lendingmaestro — it’s a fact that, by and large, renters have lower incomes than homeowners. I was surprised that you would dispute this until I read your entire comment. The fact that you can count on 1 finger the number of homeowners that you could qualify for a full doc loan this year speaks more to the people that are going to you for loans than the income levels of homeowners vs. renters.

    I’m happy that you’re comfortable with your financial net worth and your 684 FICO.

  20. frank the tank

    “I suggest you reread the section above about Fundamental Valuations. I went to great lengths to establish the comparative rental rates.”

    No, you simply took the monthly median income (this includes both renters and homeowners) and multiplied by what you think is reasonable to spend on housing (28%) (not accounting for the tax benefits of owning, compared with renting) and then multiplied by 160 to arrive at what you think the median home should cost. It’s still an apples-to-apples comparison because you’re basing it on the median income of everyone, not just homeowners, who have higher incomes.

    As for your charts, they are very colorful, and I’m sure it took you a long time to create them, but they are flawed insofar as they are based on the median income of all households, a 30 year fixed mortgage (some people swear by the 30 year fixed, but these loans are never going to be 100% of the available options), and a DTI ratio that fails to account for the tax benefits of holding a mortgage.

  21. lendingmaestro

    I pull at least 8 credit reports a day and less than 2% of the scores I see are 750+

    There are many, many factors that can negatively impact a credit score.

    Too much credit, too little credit, proportion of revolving debt. Time accounts have been established. Erroneous late payments, identity theft, medical collections, etc…

    A 684 is not a low score. I have no mortgage lates or installment lates.

  22. lendingmaestro

    I also talk to doctors, lawyers, and other business professionals that have a hard time qualifying full-doc. The mortgage is only one of several, sometimes many debts. The fact of the matter is that prices are just not in line with incomes. The affordability index has been in the single digits for a long time. I also think that many affluent wealthy people in Irvine (especially the conservative asian block) save their money and are not bothered by having a bigger home than the Joneses next door.

    Also there is no direct correlation between income and homeowners. The more money you make, the more affordable a given home is but that doesn’t mean homeowner A makes more than Renter B.

    The type of people that call me for loans is in no way reflective of the quality of my company or the loans I originate. If Suzie Q calls in and wants to buy a 450k condo with 45k income as a hairdresser, I can’t control that. I’ll chuckle inside and give her a reality check, but I can’t control her calling. A high credit score in no way denotes intelligence. I said this many times before.

    Many of the people out there who make 200k plus a year are no more financially responsible than those who make 20k per year. Doctors, in my experience, are horrible with money and overall have some pretty low FICOS compared to other professionals.

    Anyways the point of my post was to highlight the fact that many people who earn a good living in california cannot afford the homes they are in or the homes that they are looking to buy.

  23. Bkshopr

    Green Cactus,

    You are right the Asian buyers do not choose Irvine because homes here are less expensive here than Hong Kong, Tokyo or Shanghai. It is the Irvine school system who can teach their kids to prepare for colleges that attracts them.

    The housing sticker shock is felt by you and me but not to the Asian from oversea. By selling their homes in their native country they have plenty to spend here and with left over.

    Many learn about Irvine through the mouth of a relative. Many wealthy Asians from oversea are not aware of the housing bubble here and buy a property in Irvine usually recommended by his or her relative. There are many Asian realtors in Irvine that are multi-lingual. Some buyers complete their transaction here during their 2 week stay.

    Many Irvine home buyers used to be poor in China. They became very wealthy by manufacturing the products you and I use daily.

    USA has an immigration law that allows any foreigner to apply for immigration status as long the individual has a total of one million dollars in investments. This could be in real estates or business. In addition, a person must have financial documentation for living expenses for 2 years and also must remain unemployed for 2 years unless one is a boss of his company that can generate jobs. This is the reason why there are many Chinese owned companies here that do a lot of business with China. Many Chinese basically are interested in the green card status and with no intention to live abroad and go back to China to make much more money. The green card is a guarantee freedom when their government is not to be trusted. Corrupt government officials sent their sons and daughters here to study with a nice place to live so the younger generations can escape pursecution.

    UCI has the highest Asian student enrollments than any other colleges in the nation.

    The home purchase in Irvine qualifies as the investment and the additional flip-flop investment will help solidify the immigration status. The Yuan is not stable in China because through out history the changing in government had deflated the currency. Transferring foreign money into the US real estates market is the safest way to secure money. Foreigners may not qualify to invest in mutual funds and stocks like you and me. The Chinese is afraid that money in stocks and mutual funds could evaporate into cyber space. When they are in the country for 2 weeks they can’t touch or feel their mutual fund while a house and land is very tangible.

    While we are concerning about the 20% deflation in the market, the Chinese still see this as an opportunity for a long term investment. Eventually if one holds on to it long enough it will rise again.

    Good Feng Shui is applicable for any size home, office, vacant land, boat slip, interior of a boat, theatre, shopping center, an out house and even a burial plot.

    Good Feng Shui is also applicable for timing and dates for important events. The worst time is the month of April. The pronunciation for the word “4” rhymes with the word “death” in Chinese.

    Many disasters occurred in the month of April than any other months in history. For examples, The 1906 SF earth quake, Chernobyl Nuclear disaster, Oklahoma bombings, Titanic, The American Civil War, Columbine and Virginia Tech shooting.

  24. Bkshopr

    Green Cactus, You are right the Asian buyers do not choose Irvine because homes here are less expensive here than Hong Kong, Tokyo or Shanghai. It is the Irvine school system who can teach their kids to prepare for colleges that attracts them. The housing sticker shock is felt by you and me but not to the Asian from oversea. By selling their homes in their native country they have plenty to spend here and with left over. Many learn about Irvine through the mouth of a relative. Many wealthy Asians from oversea are not aware of the housing bubble here and buy a property in Irvine usually recommended by his or her relative. There are many Asian realtors here that are multi-lingual. Some buyers complete their transaction here during their 2 week stay.

    Many Irvine home buyers used to be poor in China. They became very wealthy by manufacturing the products you and I use daily. USA has an immigration law that allows any foreigner to apply for immigration status as long the individual has a total of one million dollars in investments. This could be in real estates or business. In addition, a person must have financial documentation for living expenses for 2 years and also must remain unemployed for 2 years unless one is a boss of his company that can generate jobs. This is the reason why there are many Chinese owned companies here that do a lot of business with China. Many Chinese basically are interested in the green card status and with no intention to live abroad and go back to China to make much more money. The green card is a guarantee freedom when their government is not to be trusted. The home purchase in Irvine qualifies as the investment and the additional flip-flop investment will help solidify the immigration status. The Yuan is not stable in China because through out history the changing in government had deflated the currency. Transferring foreign money into the US real estates market is the safest way to secure money.

    Foreigners may not qualify to invest in mutual funds and stocks like you and me. The Chinese is afraid that money in stocks and mutual funds could evaporate into cyber space. When they are in the country for 2 weeks they can’t touch or feel their mutual fund while a house and land is very tangible. While we are concerning about the 20% deflation in the market, the Chinese still see this as an opportunity for a long term investment. Eventually if one holds on to it long enough it will rise again.

    Feng Shui is applicable for any size home, office, vacant land, boat slip, interior of a boat, theatre, shopping center, an out house and even a burial plot. Good Feng Shui is also applicable for timing and dates for important events. The worst time is the month of April. The pronunciation for the word “4” rhymes with the word “death” in Chinese. Many disasters occurred in the month of April than any other months in history. For examples, The 1906 SF earth quake, Chernobyl Nuclear disaster, Oklahoma bombings, Titanic, The American Civil War, Columbine and Virginia Tech shooting.

  25. Melissa

    Just one point. Your comment about US immigration law is just flat wrong. They have to invest at least $1,000,000 in the US in a way that creates jobs for Americans (i.e., by starting a business) and also in a way that risks their investmetn. They can’t just come over here and buy a $1M home and get a visa. Plus, this allowance is for 10,000 people annually only. On top of that, no where near 10,000 people actually use this provision to come to the US. This law does not account for very many people being in the US and is not a material factor when we are talking about the housing market.

  26. Melissa

    Okay, after further quick research, the provision you are referring to is INA §203(d). This allows people to invest in or establish a business enterprise that employs at least 10 americans. Sometimes there are exceptions to the $1,000,000 amount that allows people to invest less. It was established in 1998 and since then, the amount of people that have used it has ranged from a low of 59 in a year to a high of 1361 (as of last year, I believe).

  27. IrvineRenter

    This is the passage to which I was referring…

    “So how does all the above compare to reality? The median rent in Irvine is $1,660. This is going to include many 1 and 2 bedroom apartments and very little at 4 bedrooms and above. The housing stock in Irvine is generally larger and nicer than the rental units, so a median house rental of $1,957 is probably not too far off. If you go to OCRealEstateFinder or FirstTeam and search for rentals, you will find what I would consider a median type property renting between $2,250 and $2,500 a month. This means that most Irvine renters are probably spending more like 35% of their gross income on housing instead of the suggested 28%.”

    In my calculations which permeate the tables, I used a $2,250 for a comparative median rent even though the actual median rent is $1,660. I made this adjustment because when you look at product actually available on the market, you see that you can rent a median priced home for about $2,250.

    It seems to me you have a standard argument you put forward concerning the median rent not corresponding to the median home price. You are correct that they do not correspond; however, you failed to notice I did not make this mistake, and all the calculations are adjusted accordingly.

  28. IrvineRenter

    bought_high,

    The DTI was between 24% and 30% between 1994 and 1999. It was also this low in 1986 and 1987. This is where the bottom forms because lenders tighten credit after manias and won’t loan at 60% DTI like there were just a few short months ago.

    The income figures presented are household income which includes multiple person households.

  29. No_Such_Reality

    and multiplied by what you think is reasonable to spend on housing (28%) (not accounting for the tax benefits of owning, compared with renting)

    Frank, you need to educate yourself. Don’t believe IrvineRenter, don’t believe me when I say 28% is a long established guideline for successful mortgage debt management. But maybe you’d like to listen to my friend Chuck. He writes at the following location http://www.schwab.com/public/schwab/research_strategies/market_insight/financial_goals/mortgage_lending/borrowing_smart.html?refid=P-1013587&refpid=P-1006658

    More maybe Quicken Loans, since they point it out too (wow imagine one of the subprime-exotic kings telling you about it), see section 3, located http://www.quickenloans.com/mortgage/articles/buying_home/buying_first_home.html

    Or maybe Prudential California Realty located http://www.prurealty.com/FGArtDebtIncomeRatio.aspx

    Or maybe CNN Money http://money.cnn.com/magazines/moneymag/moneymag_archive/2004/03/01/362327/index.htm

  30. IrvineRenter

    SmartMoney,

    I always enjoy reading your comments. You obviously “get it.” Thank you for taking the time to write such detailed and well-thought-out responses.

  31. IrvineRenter

    I saw your post about the man making $14,000 buying a $720,000 house.

    http://drhousingbubble.blogspot.com/2007/05/yearly-income-14000-purchase-of-house.html

    Stories like that one — extreme as they are — really tell the story of this bubble. When those who would like to buy at reasonable prices that we can afford are competing in the market against people like the man in the story who obviously cannot afford it, the rational are better off losing the bidding war.

    I have been seeing the same thing you have in the market. The volume at the bottom is totally gone, so the median creeps up as only the higher priced homes are selling. Even as these homes sell for less (which they are) the median is still showing gains because the low-end is gone. There are a lot of foreclosures in the pipeline right now. I suspect this fall we will see our first panic selling as REO’s destroy the comps and start pushing prices lower quicker.

    Thanks for stopping by…

  32. IrvineRenter

    Hm owner,

    You are correct in that the market is determined by the fringes, and there are certainly high income households in Irvine. Combining those two facts, however, does not make for high house prices. When the comparable sales begin to be set by bank REO’s, prices will drop. There is no group of wealthy people or high wage earners that will come in and rescue the market. Why would they. If prices begin crashing in markets all around Irvine, a rational buyer would just buy a nicer property nearby for less money. Irvine is nice, but people will not pay double for a comparable property simply because its Irvine.

    I have seen variants of the “Higher Income Theory” put forward by housing bulls all the time. The statistics are what they are: households only make so much money.

    http://factfinder.census.gov/servlet/ADPTable?_bm=y&-context=adp&-qr_name=ACS_2005_EST_G00_DP3&-ds_name=&-tree_id=305&-redoLog=false&-all_geo_types=N&-geo_id=16000US0636770&-format=&-_lang=en

  33. IrvineRenter

    lendingmaestro,

    I appreciate your posts. People do not want to accept the fact that credit terms are tightening and this is going to impact home prices. In my analysis I made the point that lenders are going to be burnt and they will begin to care again about qualifications and the ability to repay the money.

    As a professional lender, let me ask your opinion: do you think credit will tighten to where full-doc, 28% DTI, 20% down will become the only realistic, affordable option (paying a huge premium for exotic financing makes it not an option even if it technically exists)?

  34. w0lfgang

    Thank you! More than anything else, I value your ability to simplify and educate your readers. Keep the good stuff coming!

  35. IrvineRenter

    It just seems that my long-term is going to be pretty long to break even – or become rent savings…

    I don’t mean to rain on your parade. I really do hope you are happy in your home and you can afford it. Californian’s have created real estate bubbles 3 times in the last 40 years, so they will probably do it again. Prices will likely drop to fundamental valuations, but they may not stay there…

    I appreciate that you post here are provide the input of a recent home buyer.

  36. numb3rs

    good post and i agree w/ most everything you have to say.. but there are glaring maths errors in the way you calculate a down payment.

    example:

    “the median home price should be $400,000; add a 20% downpayment, and the median could be as high as $480,000.”

    if you are carrying a 400k loan and you’ve put down 20%, the purchase price of your home was 500k (400,000/.8), not 480k.

  37. IrvineRenter

    You are correct. I should go back and change the formula. I added this more as an afterthought to see if there is any justification for thinking the fundamental value might be higher than the DTI calculations would suggest. It isn’t a calculation that permeates through the rest of the analysis. Thank you for pointing this out.

  38. No_Such_Reality

    if you are carrying a 400k loan and you’ve put down 20%, the purchase price of your home was 500k (400,000/.8), not 480k.

    True, however the loan is still $400K, the difference is Joe Sixpack needs to have $100,000 in the bank for the down payment instead of $80,000.

    If anything, I think that makes the $500K home less attainable, not more.

  39. Riche12ich

    Good post IR. Been reading here a little while and this breaks down the current Irvine RE story pretty well. It sums up everything for the masses (the majority of the population; average joe earners) and it seems like some readers try to refute it based on the premise of the outliers (ie. Top 10%-15% Earners; Full Cash payers; etc.), which there will always be exceptions to the rule.

    Now the next step I’d like to see an analysis of when and where it would be almost optimal to buy based on level of income versus supply and demand & interest rates. If housing prices decrease to “where they should be” (whether via interest rate increases, downturn in the economy, credit tightening, or foreclosure fallout), the demand will quickly outstrip supply of homes for sale and also would-be sellers would be more apt to ride the trough to either turn a profit, cash flow, etc. Hence, you’ll be less likely to purchase the house of your dreams since there will be more buyers you’ll be competing with for the limited inventory no? (I’m assuming inventory won’t be added by builders at the bottom since it makes no sense for them…)

    Keep up the good work.

  40. frank the tank

    SmartMoney, you obviously do not “get it.”

    Your commentary regarding “exponentially growing numbers of extraordinarily wealthy people” is a rant often misdirected towards anyone who doesn’t share the same doom and gloom view of Orange County real estate that renters do. It’s a claim that I never made, yet you chose to attack it as if I had.

    Renters and homeowners certainly are two separate groups. Most financially savvy do not “sift between the two as the economics changes.” Most financially savvy people are long term homeowners who do not attempt to time the market. Even in a housing downturn, financially savvy people understand that the transaction costs of selling, moving, renting, and then repurchasing at some later date when economic conditions become more to their liking simply makes no sense. (Not to mention the tax consequences.)

  41. frank the tank

    So, buying really only made sense in 7 of the past 30 years. Do you see why your “logic” is flawed (notwithstanding colorful charts)?

  42. graphrix

    IR – Another great post! Calculated risk would be proud of the excellent charts. I am also amazed at your time management skills when you have a very detailed and well written post as this. Not to mention the time to work, for family and your hidden talent of photography it is great that you are willing to share your thoughts.

    I know I said I would have the jobs post done soon. Ironically it took a setback once I looked into the payroll data the other night. For those who claim wages have been increasing might be surprised when I finally get done with my post.

  43. tourbillon

    First, real estate investment does not qualify one for immirgration visa.

    Second, Chinese Yuan, otherwise known as the RMB, is going up against the dollar. Right now, it is somewhere close to 7.7 RMB to 1 dollar, it use to be around 8.6 or 8.8. The optimal ratio is somewhere between 4 and 6. Why would you buy today if you know your money is going to worth more tomorrow.

    Third, no rich Asian wants to live in OC or US, period only middle class or poor people want to live in US. The main reason, tax and immigration visa issue. Countries like France, Germany, Canada offer much more attractive terms as far as getting a citizenship is concerned, and they don’t tax their citizen globally like US. Most rich Chinese/Taiwanese I know have business outside US, if they become American citizen, the oversea income will be taxable

    Fourth, UCI has a large Asian student body because again, most of the Asian people in OC are either middle class or poor, they can’t afford private school. I have yet to meet one UCI Asian student that come from money. If you are interested in finding rich Asian kids, try USC.

  44. ripcord

    In regard to the thread about “rich Asians” buying homes because of the schools in Irvine, let me add my two cents: Asians are not stupid.

    Why do I say this? It seems to me that saying Asians will rescue the Irvine market because they want their kids to go to Uni High at all costs is an insult to the intelligence of the Asian community. I don’t care how much money a person has, tossing it down a storm drain is STUPID. In my experience, Asian buyers are MORE careful and conservative with their money than most other people.

    I sold my house in Irvine to an Asian couple from Taiwan. They paid mostly cash, with a small mortgage. They in no way threw their money away. They were TOUGH. They new darn well that the market was going south, and negotiated accordingly. They didn’t for one second act like idiot Polyannas handing over their hard-earned foreign cash to the white man.

    It is true that Irvine is desireable. We all love the place. It is also a true statement that it will always command a premium over most neighboring towns and regions (NPB not withstanding), because, quite simply, Irvine has a lot to offer. IrvineRenter’s wonderful love letters to the different Irvine Villages show this (BTW, when is your Turtle Rock posting coming? I want to download all the pictures you take for my wife… she is in serious Turtle Rock withdrawl right now!). That said, the bubble in Irvine is a simple asset bubble that has nowhere to go but down. There just aren’t enough buyers or money around to support these prices now that the suicidal financing has gone away, and those that do have money (like our friends the “rich Asians”) are quite saavy and aren’t likely to be interested in catching falling knives.

  45. lendingmaestro

    As far as credit tightening is concerned I am not sure how far it will go. We still offer 100% financing for purchases but not refi’s. You also need 680 fico. We have a 1 loan option up to 100% w/ no MI. We still have the 80/20 option but only FULL-DOC. No stated 80/20 because the market for 2nd’s on Wall Street has evaporated. Also we lowered the max purchase price to 417,000 from 750,000. This is HUGE! This is going to have a massive impact on California.

    I can tell you that I haven’t closed a purchase transaction of any kiind in over three months, but I get calls for purchases everyday. People calling me with 525 ficos and 2500 in their life savings wanting to buy a home for 250,000. They get upset and offended when I refuse to pull there credit report.

    Banks are in a tough spot. We’ll continue to originate new loans as long as the investors on Wall Street have an appetite. We don’t hold the credit risk but we do service the loan which means we may be looking at more REO’s. Whenever guidelines tighten in the marketplace a given bank will need to grab extra marketshare to offset the decrease in loan origination.

    I’m actually drafting a proposition that proposes we create a property management division. Bank owned properties are owned free and clear by the bank. As we build our REO portfolio, if we have a mgt system in place to manage rentals we can maximize our REO properties.

    Do I see a day when you’ll need 20% down for all purchases? It’s possible but not probable. 10% down is right around the corner. DTI levels have actualli ncreased to 55% for some loans. Until real wages catch up to consumer prices you’ll continue to see high DTI ratios.

  46. IrvineRenter

    Credit seems to tighten little by little. Market forces want to loosen credit as much as possible (which we have seen) while those who assume the risk want to tighten it as much as possible (which we are seeing now). Ultimately those who assume the risk will prevail, it is just a matter of how tight they make it.

    The max purchase price reduction from $750,000 to $417,000 is an amazing drop, particularly here in California, it eliminates most buyers. I am not surprised you haven’t originated any purchase mortgages with that cap.

    The REO’s we have been seeing are almost all 100% financing, mostly 80/20’s. The piggybacks are a total loss. I am not surprised Wall Street has lost its appetite.

    The downpayment number is going to be critical. Nobody has one. There was no incentive to save over the last several years, so nobody did. We may not see 20% down simply because the market would die; although, with 20% or greater drops on the horizon, the market may force 20% down for the lender cushion.

    Tightening credit is a vicious circle few understand. I look forward to your updates…

  47. Mexifornia Mortgage Broker

    Irvine Renter,

    I have only been able to read the comments on the blog and I salute you for your effort. I hope that some of the people have the common sense to take into consideration these realities when they make a decision to purchase a property next time around. Then again we are taking about hope.

    Lending Maestro,

    Do you see the lenders becoming landlords? I though that was going to be their only option, but I am getting objections to that idea. Most of the loans issue under the subprime umbrella were not Fannie Mae or Freedie Mac insured, therefore what other options do the investors have? I have seen them trying to put on the market REO’s at almost the same price than what the property was purchased for and it just sits there. What are your thoughts on the matter?

  48. lendingmaestro

    Lender’s don’t want to become landlords, but we need to be prudent and make pre-emptive steps to insure our profitability. If we have unload properties for loss that is an option. But we’d be foolish to ignore the option of renting or leasing-to-buy the REO properties in our portfolio. It may not be a viable option, but I am suggest that our corporate officers at least consider the idea.

  49. Mexifornia Mortgage Broker

    I agree, their business is to lend money, but when the circumstances change and you are left with a boat load of invetory, what other options are there?

    By the way, did Freedie Mac or Fannie Mae ever insured loans generated under the subprime umbrella and if they did what the was the criteria, conforming loan limits and such?

  50. No_Such_Reality

    Actually, from 1993 to 2003, the DTI numbers work well. That’s ten years and 1986 to 2006 is only 20 years. So that’s half of the last twenty years.

    If you want to push back 30 years, you go to 1976 and what you get from then through the early 80s is double digit inflation and mortgage rates in the low and mid-teens. Perhaps you remember stagflation of the late 70s. But wait, it get’s better, 1976 to 1978/79 meets DTI, as does 86/87. That’s five more year meeting DTI. So 15 of 30 years meet DTI guidelines. What follows in the years after those are exceeded? Bubble and collapse.

    Look here http://www.thebubblebuster.com/orangecounty/summary.html

  51. No_Such_Reality

    I see them trying it, but I wonder how the cashflow will work for them? I biggest problem I see is a large under-performing asset.

    If the going rate for 2b/2ba is RSM is $1600 and falling and the bank was holding a $400K loan take back on it, that’s a 5% return before any expenses. Factor in HOA and property tax and it’s down to 3.2% and you still have management & maintenance, not to mention vacancy allowance.

  52. IrvineRenter

    I doubt they will want to hold these properties due to the risk of further deterioration in values. Since they are nowhere near their cashflow value, they don’t make a good investment. If a bank holds a bad investment which doesn’t cashflow merely in the hopes of a market recovery, they are not acting in the best interest of shareholders. It may even open them up to lawsuits in that regard. Plus, I believe government regulators have issue with banks holding real estate in their portfolio as it encourages predatory lending.

  53. Mexifornia Mortgage Broker

    Irvine Renter,

    “Plus, I believe government regulators have issue with banks holding real estate in their portfolio as it encourages predatory lending.”

    Doing risky loans was not in the best interest of the shareholders, but they did it anyways. Look at WaMu, they top the list of lenders in percentage that facilitated loans to wanabe investors and second-home buyers. I wander how that is going to affect earnings? Furthermore, how does a bank holding real estate encourages predatory lending? From what I know, when a buyer makes an offer for a REO, the buyer chooses where he/she is going to get the loan from to purchase said property. The bank holding the REO cannot dictate to the buyer that where the money comes from for the financing. Can you elaborate more on that Irvine Renter?

    No Such Reality,

    Anyway you cut it, things do not look pretty for the lenders or the investors holding the notes on these properties, but when the ship is taking water you have to take measures. Sometimes some measures are not going to solve all your problems, but what other options do they have?

  54. lendingmaestro

    fannie and freddie have done BILLIONS in sub prime. You can get what’s called an except plus approval from fannie mae with a 500 fico. Fannie and Freddie have been generating expanded approvals for several years now for low fico borrowers

  55. IrvineRenter

    Mexifornia Mortgage Broker,

    Allowing banks to hold REO’s will encourage predatory lending because banks will quickly realize they can acquire good properties by simply loaning money to unstable borrowers to buy said property and later foreclose on it. Predatory lending can happen because banks want to obtain an asset secured by their note.

    In our current market, this kind of predatory lending makes little sense because the bank would acquire a depreciating asset, but markets change. When banks start turning profits off their REO’s regulators will take notice.

  56. Mexifornia Mortgage Broker

    Irvine Renter,

    You said it yourself, current market conditions make this practice unfeasible and it will take years for things to change and make it feasible, therefore it is not an option and regulators would only take notice if the practice was happening in the first place. You are talking about a hypothetical that is not likely to happen anytime soon. Besides, regulating powers can only reach so long, regulators can regulate institutionalized banks. Such was the case of Freemont when they got the Cease and Desist letter from the FDIC. But that was not the case with New Century because they were not an FDIC insured lender in the first place.

  57. Mexifornia Mortgage Broker

    Lendingmaestro,

    So there you go, lenders will just turn around and file an insurance claim with either Fannie Mae or Freedie Mac and they will take the hit and the property.

  58. IrvineRenter

    Yes, a lot of the conventional wisdom about REO’s may be useless in this situation, particularly with so much of this paper being held in CDO’s. Do you know what provisions most of these CDO’s have concerning REO’s? I would imagine procedures for liquidations must be spelled out. I have a hard time imagining an investor in debt being willing to take ownership of a rental property instead.

  59. lendingmaestro

    Can’t file claim against them because the bank is the institution that originated, underwrote, and approved the loan. If Fannie Mae or Freddie Mac found that a particular bank was not doing their due diligence and allowing bad loans to be funded then Fannie and Freddie would cease to allow that bank to underwrite conforming products. If fraud is involved then Fannie or Freddie can pursue litigation against the lender.

    Fannie, Freddie, or another firm on Wall street buys the loan from the lender at a specified lump sum–they do not buy the property. The investor then sells bonds to offset the the purchase of the loan. If a borrower fails to pay the mortgage and the property is foreclosed on then the lender will get back the amount still owed and the difference will go to the homeowner. If it is a short sale then the lender will be forced to write off the loss. If the foreclosure occured during a prepayment penalty period the investor must be paid the prepayment penalty by the lender. The lender then relays this charge to the homeowner. If it was a short sale then there is no equty to pay the prepayment penalty.

  60. Mexifornia Mortgage Broker

    Irvine Renter,

    The issue regarding CD’s only applies to lenders who were FDIC insured such as Freemont and Indy Mac, but when it comes to the conventional subprime lender such as New Century or Option One that is different because the investors are hedge funds, insurance companies, pension funds and such. I believe that this fact alone will give rise to different attemps at minimizing looses either through the note holders becoming landlords or dumping the properties for way less than what they are owned just to cut their financial bleeding.

  61. sunsetbeachguy

    Melissa:

    Great post.

    That one is going to leave a mark on bkshopowner.

    All I hear is crickets.

    1,361 rich Asians for the entire US.

    HA!

  62. Trooper

    Maybe bkshop is a REALTOR and that bs story about getting a green card is his schtick to hook Asian buyers !

  63. lendingmaestro

    Freddie and Fannie were commissioned by the Federal government to purchase mortgages and collateralize them as mortgage-backed securities. Fannie and Freddie were the first to do this. All they due is purchase loans from banks so that those banks can continue to write more loans for people. There is far more outstanding mortgage debt than bank deposits. If investors like fannie and freddie didn’t exist, we wouldn’t be the same country that we are today.

  64. Mexifornia Mortgage Broker

    Good thing that we are in the same page, but one thing that you omitted regarding these two institutions is that they also insure loans. How else do you explain that fact that these two properties in Perris are being listed on the Fannie Mae website as Fannie Mae properties? They are 2869 Discovery Court, Perris, AP#306-840-033 and 671 Poinsettia Way, Perris, AP#306-682-002. The loan for the first property was originated by Countrywide and the loan for the second property was originated by Lyon Financial.

    Here I am going on assumption and I am brave enough to admit that my knowledge on these matters has limits. I believe that these two institutions follow the same conforming loan limits when they insure a loan, in other words they will not insure a loan for a single family residence if the loan is greater than $417,000. That is why I think we will not see that many Freddie Mac and Fannie Mae REOs here in the OC.

  65. awgee

    No one knows what the provisions are of most of the CDO’s because they are over the counter with little to no regulation and no oversight body. Each CDO is different and if the holder, (hedge fund), is leveraged based on the isupposed value, they sure as heck aren’t going to want to be holding on to real estate and trying to rent it out. What a mess.

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