Monthly Archives: February 2008

A New Drug

I want a new drug

One that wont make me sick

One that wont make me crash my car

Or make me feel three feet thick

I want a new drug

One that wont hurt my head

One that wont make my mouth too dry

Or make my eyes too red

One that wont make me nervous

Wondering what to do

One that makes me feel like I feel when Im with you

When I’m alone with you

Kool Aid Man

I want a new drug

One that wont spill

One that dont cost too much

Or come in a pill

I want a new drug

One that wont go away

One that wont keep me up all night

One that wont make me sleep all day

I Want a New Drug — Huey Lewis and the News

.

.

Right when I start to think sellers are accepting the reality of the new market, I come across a listing that makes my jaw drop at the greed and clueless irrationality of my fellow man. Today’s seller needs a new drug because they have clearly overdosed on the kool aid…

1 Lorenzo Front 1 Lorenzo Kitchen

Asking Price: $1,395,000IrvineRenter

Income Requirement: $348,750

Downpayment Needed: $279,000

Monthly Equity Burn: $11,625 at least

Purchase Price: $860,000

Purchase Date: 3/26/2004

Address: 1 Lorenzo, Irvine, CA 92614

WTF

Beds: 4
Baths: 3
Sq. Ft.: 2,601
$/Sq. Ft.: $536
Lot Size: 8,670 Sq. Ft.
Type: Single Family Residence
Style: Contemporary/Modern
Year Built: 1987
Stories: Two Levels
Area: Westpark
County: Orange
MLS#: S517499
Status: Active
On Redfin: 44 days

One of largest entertaining back yards in community. Low HOA fee. Highly artistic customized upgrades with oak wood cabinets and granite counter tops through out, stainless steel appliances, cove & recessed lighting in the kitchen & 1st floor BR, wine rack in kitchen. 18’X18′ travertine flooring, wood & carpet flooring, Granite shower walls, frameless glass cover enclosure of master BR shower, 3 French door openings in Living room & 1st floor Br, 2 French doors in family & living Rooms, Granite counter top with top grade grill for built in private B. B. Q. Built in out door granite bar. Professional Landscaping.

How many times does the word “granite” appear in this listing?

.

.

It has been demonstrated on the blog over and over again with listings all across the spectrum of housing that we are in a market decline, and pricing is back at 2004 levels for those few properties that are actually selling. But no, this property is different, this property has increased in value over 60% during the last 4 years. Forget the fact prices have dropped almost 20% from the peak; it is as if that never occurred. This property has been appreciating at 15% a year just like it did during the height of the bubble when they bought it. OstrichDo these sellers have their heads in the sand, or is it somewhere else? The cognitive dissonance is truly remarkable. It takes courage to put a listing price out there like this. This price clearly insults the intelligence of every buyer in the marketplace. Aren’t they worried about insulting potential buyers? No wait, I suppose potential buyers should be worried about insulting them with a lowball offer, right? This property would be fortunate to sell for what they paid for it. Can you imagine their reaction if they got an offer for what it is worth in today’s market? What would happen if they got a real lowball offer for perhaps what this place will be worth at the bottom — I’m guessing 50% off their asking price? Anyone want to go mess with them? It is the only buyer interest they are likely to see at this listing price.

.

.

That concludes another week at the Irvine Housing Blog. Come back next week as we continue chronicling ‘the seventh circle of real estate hell.’ Have a great weekend.

🙂

Affordability

It’s time you made a stand

For a fee, I’m happy to be

Your back door man, hey

Dirty deeds done dirt cheap

Dirty deeds done dirt cheap

Dirty deeds done dirt cheap

Dirty deeds and they’re done dirt cheap, yeah

Dirty deeds and they’re done dirt cheap

Dirty Deeds Done Dirt Cheap — AC/DC

.

.

Affordability

Affordability is a measure of people’s ability to raise money to obtain real estate. It is often represented as an index that compares the cost to finance a median house price (50% above and 50% below) to the percentage of the general population with the income to support this house price. For instance, in Orange County California in 2006, only 2.4% of the population earned enough money to afford a median priced home. When affordability drops below 50%, there is a problem in housing; when it drops to 2.4% there is either a severe shortage of housing, or a housing price bubble; most often, it is the latter.

The simplest way to envision affordability is through simple supply and demand diagrams like those found in introductory economics textbooks. Affordability is the the demand curve. There are a small number of buyers who can afford very high prices, and many buyers who can afford very low prices. There is a limit to how high buyers can push prices. This limit is usually determined by lenders who provide the bulk of the money for a real estate transaction. During the Great Housing Bubble, these limits were nearly eliminated. In terms of the demand curve, the loose credit standards and low interest rates shifted the demand curve dramatically to the right. Thus many more people were enabled to buy and they were able to do so at much higher prices. Once prices started to rise, they were bid up to levels were affordability was at record lows by historical measures.

Demand Curve

The supply curve is the opposite of the demand curve: sellers will make very few units available at low prices, and sellers will make a great many available at higher prices. Wherever these two curves meet is where supply and demand are in balance and market transactions are taking place. In the initial stages of a market rally both transaction volumes and prices are increasing rapidly. In the Great Housing Bubble, this was caused by a dramatic expansion of lending and credit. As a price rally matures sellers become reluctant to sell because the asset they own is going up in value quickly, and they don’t want to miss the opportunity to profit. This limits the supply on the market. In terms of the supply and demand diagram, this shifts the supply curve to the left which pushes the balance between supply and demand to a higher price point. The combination of the demand curve shifting to the right from the increased liquidity of the lending environment coupled with the supply curve shifting to the left because of seller reluctance, the intersection of these two lines moves prices dramatically higher. However, once these two forces come into balance, their intersection is at a point of low transaction volume. There are fewer buyers who can afford the higher prices, so transaction volumes begin to fall.

Supply and Demand

The first sign of a troubled real estate market is a dramatic reduction in volume known as buyer exhaustion. There are simply not enough buyers able or willing to push prices any higher even at the lower transaction volumes. In a residential real estate market, this phenomenon is particularly pronounced at the entry level. The imbalance between supply and demand first becomes apparent at the bottom of the affordability scale with entry-level buyers because these buyers are not bringing the profits from a previous sale with them to the next property. Affordability is less of a problem for existing homeowners in the move-up market due to this equity transfer.

Sub Prime Move Up Chain

The real estate market can be visualized as a massive pyramid. There are very few multi-million dollar properties at the top of the pyramid, and a large number of relatively inexpensive entry-level properties forming the base. Like any structure, if the foundation is weakened, the structure may collapse. In the same way, housing markets collapse from the bottom up due to problems with affordability.

The foundation of a residential real estate market is the entry-level buyer. Entry-level buyers are generally young people starting to form new households. When a homeowner wants to sell their house and move up to a nicer one, someone needs to buy their house. If you follow this chain of move-ups backward, eventually you come to an entry level buyer. If there are no entry level buyers pushing the sequence of move ups, the entire real estate market ceases to function. The entry level market was initially boosted the moment 100% financing became available because many more people were enabled to purchase; however, it was imperiled at the same time because of the change in savings incentives. This market was subsequently destroyed the moment 100% financing was eliminated because few entry-level buyers had a downpayment and very few people were in the process of saving to get one. In the past, people would rent and save money until they had the requisite downpayment to acquire a house. The barrier to home ownership was not the ability to make payments; it was having the necessary downpayment money. When downpayment requirements go up, the number of people capable of buying a house declines dramatically, particularly for entry-level buyers who must save this money rather than transfer it from a previous sale. Since few potential entry-level buyers were saving money during the rally, sales volumes suffered dramatically in the wake of the bursting real estate bubble.

The way real estate markets collapse from the bottom up due to affordability has some unique issues for reporting on the declines. The most widely reported measure for real estate prices is the median sales price. This is the price level where 50% of the transactions occurred above and 50% occurred below. This measure has weaknesses, but over time it does a reasonable job of documenting overall prices and trends in the marketplace. One of the problems with a median as a measure of house prices is a lag between when a top or a bottom actually occurs and when this top or bottom is reflected in the index. During the beginning of a market decline, the lower end of the market has a more dramatic drop in volume than the top of the market. This causes the median to stay at artificially high levels not reflective of pricing of individual properties in the market. In other words, for a time things look better than they are. At the beginning of a market rally, transaction volume picks up at the bottom of the market at first restarting the chain of move ups. During this time, the prices of individual properties can be moving higher, but since the heavy transaction volume is at the low end, the median will actually move lower.

Affordability is the ultimate limit of any asset bubble. If prices are so high that no buyer can afford them, there are no transactions and thereby no market. The fear of many buyers in a financial mania is that prices will remain elevated to the absolute limit of affordability permanently. People who have this fear will put every available resource into getting a house before this happens. This becomes a self-fulfilling prophecy as prices get bid higher and higher by fearful buyers. If prices were to remain at the upper limit of affordability for a long period of time, the rate of price increase would slow dramatically until it only matched the rate of wage growth and inflation. If prices are not rising in excess of inflation, there is little financial incentive to buy because when affordability is very low, it is much less expensive to rent, and the extra money going toward a housing payment is not generating a financial return. If there is no financial incentive to pay more than the cost of rent, people stop buying, and prices fall back to levels where they are affordable again.

.

Rent

You dress me up, I’m your puppet

You buy me things, I love it

You bring me food, I need it

You give me love, I feed it

And look at the two of us in sympathy

With everything we see

I never want anything, it’s easy

You buy whatever I need

But look at my hopes, look at my dreams

The currency we’ve spent

I love you, you pay my rent

I love you, you pay my rent

Rent — Pet Shop Boys

.

.

Why rent when you can own for twice the cost?

That is the question today’s seller needs to answer. Today’s featured property is being offered at $1,120,000. If you divide by 160, you arrive at the monthly cost of ownership of $7,000 a month. There is a house in the same neighborhood that is a very similar comparable for rent at $4,500 a month — which I suspect is negotiable. So why would I spend $2,500 a month extra for today’s featured property? I can’t think of a good reason, but then again, I could not understand why people were willing to pay a 100% premium for ownership during the bubble either.

18 Arizona Front 18 Arizona Kitchen

Asking Price: $1,120,000IrvineRenter

Income Requirement: $280,000

Downpayment Needed: $224,000

Monthly Equity Burn: $9,333

Purchase Price: $451,000

Purchase Date: 1/15/1999

Address: 18 Arizona, Irvine, CA 92606

Beds: 5
Baths: 3
Sq. Ft.: 3,337
$/Sq. Ft.: $336
Lot Size: 6,700 Sq. Ft.
Type: Single Family Residence
Style: Other
Year Built: 1999
Stories: Two Levels
Area: Walnut
County: Orange
MLS#: S518715
Status: Active
On Redfin: 36 days

This Great Home Located in Prestigious Gated Harvard Square Is The End Unit and Has a Great Lot Size. Spacious Living W/ 5 Beds Plus Open Bonus Room and 3 Full Baths w/ New Travertine Floors. Main Floor Bedroom and Full Bathroom. Large Family Room and Breakfast Nook, Light and Bright. Open Kitchen w/ Granite Countertop/Backsplash, Oversize Pantry. Hardwood & New Polished Travertine Floors Thru Downstairs. Designer New Paint and New Berber Carpet. New Baseboard Thru the House. Jacuzzi-Like Bathtub in Master Room. Large Size Backyard w/ Covered Patio, Fruit Trees, Vegetables and Stone Water Falls. 3 1/2 Acre Community Park In The Center of The Community w/ Pool, Children’s Play Area & Much More. Enjoy This Community’s Amenities.

Why Is This Written In Title Case?

.

.

Here is a seller betting on the high-end-is-immune theory. As I look at listings around town, I am noticing a great deal of this. The people who own the largest homes in the neighborhood are clinging to their $1,000,000+ asking prices while properties all around them are dropping like bombs. Good luck with that asking price.

Our comparable rental is 10 Indiana:

10 Indiana Front10 Indiana Yard

Rental$4500 / 6br – 6 bedroom Home with Incredible Pool

If we assume the above comparable is market rent, then the featured property is worth $720,000. Given that they paid $451,000 back in 1999, $720,000 seems about right.

$1,120,000 well, if you have enough kool aid…

New Market

Theres a brand new day on the horizon

Everythings gonna be just fine

Theres a brand new day on the horizon

And the whole worlds gonna be mine

Im gonna tell old trouble,

hed better be moving on

Happiness is going to take his place

around here from now on

The old dark clouds are gonna roll away

The sun is gonna shine

And the whole worlds gonna be mine

Im gonna tell old heartaches,

pack his bags and go

Ive decided that I dont want him

hanging around no more

Dont you know I said everythings

gonna be just fine

cause the whole worlds gonna be mine

There’s a Brand New Day on the Horizon — Elvis Presley

.

.

What a wonderful, upbeat song. A new day is dawning; a new market is coming; life is grand… Ahhh, isn’t denial a wonderful thing?

Today’s featured property would like to see a new market because the current market is taking all their equity. These are the listings that really grab me because these people are actually losing their own money rather than the lender’s. Every penny of the first $200,000 lost on this property comes out of their pocket.

2 New Market Outside 2 New Market Kitchen

Asking Price: $550,000IrvineRenter

Income Requirement: $137,500

Downpayment Needed: $110,000

Monthly Equity Burn: $4,583

Purchase Price: $580,000

Purchase Date: 10/7/2004

Address: 2 New Market, Irvine, CA 92602Rollback

Beds: 3
Baths: 3
Sq. Ft.: 1,500
$/Sq. Ft.: $367
Lot Size:
Type: Condominium
Style: Contemporary
Year Built: 2001
Stories: Two Levels
View(s): Mountain, Park or Green Belt
Area: West Irvine
County: Orange
MLS#: P618074
Status: Active
On Redfin: 38 days

Turkey Turnkey home!!! Highly desirable townhome by builder William Lyon. This is Andover’s largest model, and shares only one wall as an end-unit! Immaculate 3bed/2.5bath/1500sqft. with a loft. Upgraded carpets, hardwood floors, appliances, central heat and A/C. Prewired with Cat-5 throughout the home and loft for a functional home office. Custom drapes, in-ceiling surround sound, and epoxy flooring in garage. Master bedroom has walk-in closet, and custom privacy door. Professionally landscaped patio. Steps to Pool-Spa-Tennis amenities. .. and of course the unparalleled West Irvine Schools: Myford Elementary, Pioneer Middle School, and Beckman High! A very SMART choice. Act now.

It only shares one wall? Now the degree of attachment is becoming a selling point?

unparalleled West Irvine Schools? You mean the ones in Tustin’s school district? Perhaps a bit misleading? Perhaps intentional?

.

.

If this seller gets their asking price, they will lose $63,000 after a 6% commission. It will be all their equity that is lost.

Think back to October 2004 when the rally was seeing some of its steepest price increases. Did anyone who bought then think there was even the slightest chance of losing money on the deal?

I don’t care what the median shows, when you look at individual properties reselling in the market (like Case-Shiller does) we are clearly passing through 2004 prices. The bubble built on the bubble created by negative amortization loans and the complete breakdown of lending standards has been deflated. Now we are approaching the bubbly prices of 2004 when our 90s-type bubble would have popped. If the 90s are any guide, we are due for another 20%-25% decline from here over the next 5-7 years. Although, with the tsunami of foreclosures about to hit the market, I would not be surprised to see a 30%-35% further decline in 2-4 years. I really is different this time: it is much worse…

.

The Credit Crunch

Fine Line: Sub-Prime Decline – The Richter Scales

.

.

The Credit Crunch

In 2007, the financial markets were abuzz with talk of a “credit crunch.” It was portrayed as some unusual and unpredictable outside force like an asteroid impact or a cold winter storm. However, it was not unexpected, and it was not caused by any outside force. The credit crunch began because borrowers were unable to make payments on the loans they were given. When lenders started losing money, they stopped lending: a credit crunch.

New Century Financial is the poster child for The Great Housing Bubble. New Century Financial was founded in 1995 and headquartered in Irvine, California. New Century Financial Corporation was a real estate investment trust (REIT), providing first and second mortgage products to borrowers nationwide through its operating subsidiaries, New Century Mortgage Corporation and Home123 Corporation. The company was the second largest subprime loan originator by dollar volume in 2006. April 2, 2007, the company filed for chapter 11 bankruptcy protection. The date of their financial implosion will be regarded as the day the bubble popped. The death of New Century Financial has come to represent to death of loose lending standards and the beginning of the credit crunch. Subprime lending was widely regarded as the culprit in starting the cycle of credit tightening, and New Century has been linked to this problem, but the scale and scope of the disaster was much larger than subprime.

The massive credit crunch that facilitated the decline of The Great Housing Bubble was a crisis of cashflow insolvency. Basically, people did not have the income to consistently make their mortgage payment. This was caused by a combination of exotic loan programs with increasing payments, a deterioration of credit standards allowing debt-to-income ratios well above historic norms, and the systematic practice of fabricating loan applications with phantom income (stated-income or “liar” loans.) The problem of cashflow insolvency was very difficult to overcome as borrowing more money would not solve the problem. People needed greater incomes not greater debt loads.

When more money and debt was created than incomes could support, one of two things needed to happen: either the sum of money needed to shrink to supportable levels (A shrinking money supply is a condition known as deflation,) or the amount of money supported by the available cashflow needed to increase through lower interest rates. Given these two alternatives, the Federal Reserve chose to lower interest rates. The lower interest rates had two effects; first, it did help support the created debt, and second it created inflationary pressures which further counteracted the deflationary pressures of disappearing debt and declining collateral assets. None of this saved the housing market.

Credit availability moves in cycles of tightening and loosening. Lenders tend to loosen credit guidelines when times are good, and they tend to tighten them when times are bad. This tendency of lenders often exacerbates the growth and contraction of the business cycle. In the decline of The Great Housing Bubble, the contraction of credit certainly played a major role in the decline of house prices. Lenders continued to tighten their standards for extending credit for fear of losing even more money. This meant fewer and fewer people qualified for smaller and smaller loans. This crushed demand for housing and made home prices fall even further.

One of the biggest problems for the housing market was caused by tighter lending standards was the reinstatement of downpayment requirements. During the bubble rally, 100% financing was made widely available. This made it unnecessary for people to save money to get a house. People respond to incentives. This is basic economic theory. The availability of 100% financing removed the incentive to save for a downpayment. People responded; our national savings rate went negative. Potential homebuyers who ordinarily would have been saving money for a downpayment to get a house, stopped saving, borrowed money and went on a consumer spending spree. This created a situation in the aftermath of the bubble crash where very few potential entry-level buyers had any saved money for the newly required downpayments. This created very serious problems for a market already reeling from low affordability, excess inventory, and a large number of foreclosures.

100% Financing

Once 100% financing became widely available, it was enthusiastically embraced by all parties: the lenders suddenly had a huge source of new customers to generate high fees, the realtors and builders now had plenty of new customers to buy more homes, and many potential buyers who did not have savings were now able to enter the market. It seemed like a panacea; for two or three years, it was. There was a problem with 100% financing (which was masked by the rampant appreciation brought about by its introduction): high default rates. The more money people had to put in to the transaction, the less likely they were to default. It was that simple. The borrowers probably intended to repay the loan when they got it, they just did not feel much of a sense of responsibility to the loan when the going got tough. High loan-to-value loans had high default rates causing 100% financing to all but disappear, and it made other high LTV loans much more expensive, so much so as to render them practically useless. It was all part of the credit tightening cycle.

Besides stopping people from saving for downpayments, 100% financing harmed the market by depleting the buyer pool. In a normal real estate market, first-time buyers are saving their money waiting until they can make their first purchase. There is usually a steady stream of first-time buyers that enters the market each year as they saved enough for their downpayment. When 100% financing eliminated the downpayment requirement, it also eliminated any need to wait. Those who ordinarily would have bought 2-5 years in the future were able to buy immediately. This emptied the queue. This might not have been a problem if 100% financing would have been made available to everyone forever; however, once downpayments came back those who would have been saving were already homeowners, so there were few new buyers available, and any potential new buyers had to start over saving for their downpayment. What was worse was those late buyers who were “borrowed” from the future buyer pool overpaid and many lost their homes. This eliminated them from the buyer pool due to poor credit for several years. Everyone who thought 100% financing was a dream come true found it to be a nightmare instead.

Conclusion

Credit availability moves in cycles. During the Great Housing Bubble, credit was loosened to a degree not seen before, and it facilitated a price bubble of epic proportions. During periods of credit contraction, lenders seek to avoid risk and they make fewer loans. This causes inflated asset prices to drop precipitously. The last period of stability at the bottom of the credit cycle saw 20% downpayments, 28% DTI requirements, and high FICO scores. Is there any reason to believe credit will not tighten to those levels again given the losses the lenders are experiencing? This cycle of credit contraction leading to asset deflation feeds on itself until lending standards become too tight and overly cautious when asset prices are their lowest. Of course, this is when credit should be made available to purchase assets at bargain prices. As safety and sanity returns to a financial market, lenders see they became too conservative and loosen their standards allowing more money to flow into capital markets: the whole process starts all over again…

.

.