You could hear women lamenting, children crying, men shouting. There were some so afraid of death that they prayed for death. Many raised their hands to the gods, and even more believed that there were no gods any longer and that this was one unending night for the world." —Pliny the Younger, circa A.D. 97 to 109, describing the Vesuvius eruption.
Ancient Pompeians, “poured their savings into their houses. Wealthy people enriched their homes with elegant courtyard gardens decorated with frescoes of plants and flowers and an abundance of modern conveniences…” Similarly, denizens of the O.C. take much pride in their modern day villas.
Herculaneum has been described as, “…a dream town. Overlooking the Bay of Naples, it was the aristocratic dwelling of a wealthy elite, a cluster of fabulous villas and gardens.” The residents there must have felt lucky and privileged, not unlike residents in some modern day Irvine Ranch villas…with option ARMs…the dream will end suddenly…
I posted about the ugliness of the option ARMs in the forums, but it was suggested that I post about it on the blog as well. I think this is the most misunderstood loan in the industry which makes it even more misunderstood by the victims borrowers. Worse yet, the lenders who made these loans failed to properly assess the interest rate risk by overdosing on Kool Aid.
Most borrowers thought that short term interest rates wouldn't increase 2%-3% in less than three years. This loan has a mandatory recast in year five, but if rates increase at a faster rate that recast happens sooner. A recast is when the loan will reset and the borrower will have to start paying principal and interest. It also will be amortized over 25 years if the recast happens in year five.
Lenders thought it was a good idea to let anyone sell this loan... and sell it on the fact that they can make 3% yield spread premium on the back end. Yield spread premium is paid by the lender to the broker. The amount is determined by the broker by adjusting the rate higher or lower. The higher the rate the more YSP the broker will make. However, with option ARMs it is how high the margin is. The real interest rate is the margin plus the index. Option ARMs use many different indexes, but a common index it the MTA.
Like volcanologists, who ask, “…How large will the eruption be? We ask, how big will the option ARM disaster be? Explosive, like Vesuvius, or effusive like Kilauea?
Volcanologists believe that technology will enable them to predict when an eruption is about to occur. But, they are still unable to pinpoint the eruption’s likely size or character. However, the impending Option Arm disaster is quite easy to predict…
These data point towards a Vesuvius sized disaster...
For the first example, I used a $500k loan amount, 2.75% margin, 1% minimum start payment and calculated the approximate MTA index with the first payment starting in January 2005.
As you will notice, the minimum payment only goes up 7.5% a year. That is, in year two, the payment went from $1608.20 X 7.5% = $1728.82 but the real interest rate increased nearly a full 1% higher. The minimum payment doesn't even cover the interest and this deferred interest has added over $9200 to the loan balance.
Year 4... the OMFG year:
In August 2008, the payment recasts because the loan has reached the maximum negative amortization of 110% of the original $500k loan amount. Now the victim's borrower's payment more than doubles from $1997.86 to $4132.53 because they are forced to pay principal and interest on the new balance of $550k.
I don't know about you, but if my house payment were to double it would be one hell of shock. Some in the business will say that some of these loans had a max of 115% of negative amortization. Great! That only delays the pain until December of 2009-- one month before the mandatory five year recast. However 115% means the balance is now $575k and the payment will be $4393.27 and that is assuming interest rates do not change.
Here is what the loan looks like after 30 years. As if someone would actually be able to keep it:
In January, of 2005 it would be fairly easy to get a 30 year fixed rate loan for 5.75%. The total interest paid would be $550k for a total of $1.05mil. The option ARM loan costs about $336k more than the 30 year fixed over the life of the loan. However, that is if interest rates stayed the same as they are now. Of course, it could go down but it can just as easily go up over that time frame.
Some will argue that they will sell or refinance before any problems arise. I say good luck with either right now, but that is another story. If the home could be sold for $625k this December, the option ARM owner has a loan balance of roughly $540k and has made payments of roughly $62k. This would equal (excluding fees and commissions) a net of $23k. The the thirty year fixed owner would have a loan balance of roughly $479k and made payments of roughly $105k. This would equal (excluding fees and commissions) a net of $41k.
Now here is what this loan looks like when the victim borrower got whacked. To get the 3% YSP (this is the $15k rebate the lender pays the broker for the loan and has to be disclosed) the broker needs to up the margin to about 3.85% and stick them with a three year prepayment penalty. I cannot even begin to tell you how many chop shop brokers that used the 3% YSP as motivation for their "loan officers" to sell this loan. I moved the first payment up to July 2005 because this is when people really started to sell this loan. It also shows a more accurate adjustment of the MTA index.
The first six months and 2006:
Take a look at when the loan recasts. I wouldn't want to be at their house for Christmas:
This is what it must look like when that reset hits:
Now here is the rub. Let's pretend this victim borrower bought this place for $625k, put 20% down, and today it still is worth $625k. I know it's pure fantasy, but play along with me. Since December is month 30 they still have their three year prepayment penalty of about $25k, $5k of loan fees and $50k added to the balance making the LTV 93%. Anyone know a lender doing jumbo cash out refi's up to 95% LTV?
Of course, they could wait until July when their prepay is up and pay $26k+ in monthly payments but their loan balance hasn't changed much and they still would be at 90% LTV. Anyone know of a lender doing jumbo rate an term refi's at 90% LTV and do you think they will be doing it in July 2008? What happens if the price of the home goes down 5% or 10%?
Worse yet, what if they only put 10% down? Then they would be upside down right now. If the price went down 10% they would owe $50k more than the home is worth. Get the jingle mail ready, because the only other choice here is to pay more than everyone else for a depreciating asset.
This is just the beginning of a scenario that is about to get a lot worse. I think that after reading this you will think that this chart underestimates how soon the option ARMs are going to start recasting.
Also, for some more info on the acceleration in the default rates Calculated Risk has a great post on the subject and as usual some great charts. All I can say when I see those charts is: "Ground, she movin' under me. Tidal waves out on the sea. Sulphur smoke up in the sky. Pretty soon we learn to fly."
Weekends are a bit different at the Irvine Housing Blog. We don't get as much traffic as during the week because everyone has a life, and hopefully, they are out living it on the weekend. We are. It is a good time to try out different things and see how people like it.
Today, you will probably think I am a realtor. Today's property I am profiling simply because I think it is beautiful. It is ridiculously priced, and it has been on the market a long time, but it is a beautiful home. I will probably never be in a position to own something like it, but it is nice to dream...
7 Meryton Irvine, CA 92603 Beds: 5 Baths: 4.5 Sq. Ft.: 3,400 $/Sq. Ft.: $721 Lot Size: 0.41 acres Type: Single Family Residence Style: Traditional Year Built: 1995 Stories: Two Levels View(s): Hills, Panoramic, Trees/Woods, Has View Area: Turtle Rock County: Orange MLS#: S491216 Status: Active On Redfin: 151 days Unsold in 90+ days Opportunity knocks! This elegant estate offers the ultimate in privacy and resort-like grounds. Situated on a cul-de-sac & w/ only one neighbor, this spectacular home showcases incomparable detailing & sophistication thruout. Perfect for entertaining, it even includes putting greens w/ 6 holes! Granite countertops in kitchen, powder & thruout master, custom wall color, sculpted carpeting & more. It's in a great location and is incredibly private. Move in for the holidays!
Opportunity knocks! An opportunity to overpay for real estate.
Actually, this house has a good lesson about sales and marketing. This house is well presented and it has everything someone could want in a home, and yet it isn't selling. THE PRICE IS TOO HIGH!!! It appears that all the marketing in the world cannot overcome a price tag that is simply too high.
Everyone on Grandview street in Turtle Ridge sees nothing but blue skies, hears nothing but birds singing, and thinks nothing but happy thoughts. Nothing is going to interrupt their rosy view of the housing market -- not even reality. Apparently there is nothing that cannot be overcome by a positive attitude and large doses of kool aid.
Perhaps I pick on Turtle Ridge too much. It is certainly an easy target. Whenever I want to profile a WTF home, I need look no further than Turtle Ridge. There are so many to chose from, and the prices are so ridiculously high, that I have to stop myself from profiling every home for sale in this neighborhood. Perhaps it really is that valuable? Perhaps not.
Today I am going to look at two more properties on Grandview. The 25 Grandview property I skewered back in September has lowered the price by $500,000. He must be experiencing some severe kool aid withdrawals. The two neighbors are still on the sauce.
Beds: 5 Baths: 5.5 Sq. Ft.: 5,700 $/Sq. Ft.: $877 Lot Size: 0.3 acres Type: Single Family Residence Style: Mediterranean, Other
Year Built: 2006 Stories: Two Levels View(s): Catalina Island, City Lights, Coastline, Ocean, Panoramic Area: Turtle Ridge County: Orange MLS#: S507242 Status: Active On Redfin: 30 days
From Redfin, "Fabulous panoramic view of city lights, ocean & Catalina Island is this Luxury Estate built by Luxury Laing builder, featuring Dual master Suites(junior on main floor). 5 bedrooms suites with thier own baths. Huge upstair's Bonusroom/balcony. Richly appointed Gourmet Kitchen/center island with top of the line granite slab counter top, complete with elegant cabinets. L. room, F. room, D. room open into gorgeous courtuyard /F. place creating an excellent flow for all your entertainments. Sparkling pool & spa"
top of the line granite slab counter top? Now we have to distinguish these granite tops from the run-of-the-mill granite tops everyone else has.
L. F. D. room? Is that where they do their kool aid?
Beds: 5 Baths: 5.5 Sq. Ft.: 5,900 $/Sq. Ft.: $881 Lot Size: 0.36 acres Type: Single Family Residence Style: Mediterranean
Year Built: 2006 Stories: Two Levels View(s): City Lights, Coastline, Ocean, Panoramic, Has View Area: Turtle Ridge County: Orange MLS#: S500308 Status: Active On Redfin: 83 days
From Redfin, "Incredible Panoramic Views from Ocean to City Lights. One of the Nicest Plan 2AX to come on to the Market. Extra Deep Backyard with a Spectacular Pool, Sunken Sit-Down Firepit and a Covered Outdoor Kitchen for Entertaining and Enjoying Spectacular Sunsets and Views. Large Expanded Jr Master Suite Downstairs with an Tranquil Expanded Loggia. Rare and Large Wine Rm. Upstairs the Main Master Suite with its Sitting Rm and Extra Long Deck, 3 Other Bedrms w/ Baths + Bonus Complete this Fabulous Home."
This second kool aid drinker can probably hold out forever. He will need to in order to get this asking price, but with 50% down, he shouldn't be facing near the financial distress of his neighbor above who borrowed 90% of $3.4M. How would you like to make that mortgage payment? Yikes!
As a departure from my normal Friday sign off, I would like to leave you with the words of Frank Sinatra (and the link to the music video.) They express how I feel when writing for the Irvine Housing Blog.
Now this could only happen to a guy like me And only happen in a town like this So may I say to each of you most gratef'lly As I throw each one of you a kiss
The summer wind, came blowin' in from across the sea It lingered there to touch your hair and walk with me All summer long we sang a song and then we strolled that golden sand Two sweethearts and the summer wind
Like painted kites, those days and nights, they went flyin' by The world was new beneath a blue umbrella sky Then softer than a piper man one day it called to you I lost you, I lost you to the summer wind
The autumn wind and the winter winds, they have come and gone And still the days, those lonely days, they go on and on And guess who sighs his lullabies through nights that never end My fickle friend, the summer wind
Today, I am coming out of the closet: I am a Frank Sinatra fan. I have been carrying this secret shame since high school. When everyone else was blasting some obnoxious noise from their car stereo for all to hear, sometimes I would roll up my windows and crank Frank Sinatra. I am so white.
Back to the song...
Isn't the market like a fickle summer wind? Doesn't everyone have fond memories of great summer selling seasons gone by? So what happened in 2007?
Beds: 2 Baths: 2.5 Sq. Ft.: 1,508 $/Sq. Ft.: $365 Lot Size: - Type: Condominium Style: Mediterranean Year Built: 2000 Stories: Three or More Levels Area: Oak Creek County: Orange MLS#: S506892 Status: Active On Redfin: 30 days
From Redfin, "Absolutely Pristine Detached 2 BDRM + LARGE LOFT w/ Elegant Upgrades in Gated Oak Creek! Enjoy the RICH HARDWOOD FLOORS * NEW CARPET * HUNTER DOUGLAS SILHOUETTES * PLANTATION SHUTTERS & CUSTOM PAINT! Fantastic Floor Plan has 1st Floor Bdrm/Bath * Spacious Family Room w/ Terrace * Dining Rm * Spacious Kitchen w/ Corian Counters & SS Appl * Main Floor Laundry Rm & Pituresque Backyard! Enjoy the Award Winning Schools & Resort Style Amenities!"
Even the best still have issues with their CAPS LOCK sticking INTERMITTENTLY.
What is Pituresque? Is this place a Pit?
A bit slash happy, and fond of asterisks, but only 2 exclamation points...
If this seller gets their asking price, they stand to lose $105,000, assuming a 6% commission. Will they get it?
The selling season has past. Fall is here, Halloween is coming, and the winter doldrums are right around the corner. Buyers are hard to find. Good luck.
The falling leaves drift by the window, the autumn leaves of red and gold, I see your lips, the summer kisses, the sunburned hands, I used to hold. Since you went away, the days grow long, and soon I'll hear old winter's song But I miss you most of all, my darling, when autumn leaves start to fall
As the busted 2007 summer selling (listing?) season has transitioned to a paralyzed fall market with persistently high new and resale inventory, the fact that Orange County real estate can decline in price is no longer deniable. The precipitous drop in sales creates a serious conundrum for most homebuilders: they have to balance the need for cash flow with the desire to maximize profits (or at least minimize losses) on their investments in land purchases and in-process construction. The homebuilders working with TIC have the significant added wrinkle of not fully controlling their own pricing.
Since the fear of being 'priced out forever' has convincingly departed prospective homebuyers, many have accepted the proposition that remaining in a current home or renting might not be such a bad thing after all, at least until some more of the price excess is eliminated. The term "wait and see" is showing up in more and more mainstream media (MSM) real estate stories referring to the position of buyers in this standoff. Interestingly, I've heard with increasing frequency anecdotal suggestions that since transaction numbers are so low, perhaps so many buyers are now on the sidelines that once prices show any sign of stabilizing, everyone at once will come rushing in to purchase and it will be off to the races with happy days and increasing medians all over again. This is the "pent up demand" theory. Although it shouldn't be a big surprise to hear realtors make this comment, some relatively rational colleagues and friends of mine have also wondered this out loud.
Well, my analysis of news in and around Irvine developments shows that this is almost certainly not going to happen. I would argue that any pent up demand is being countered with similar, or probably more, pent up supply. Many of these have been discussed on the forums, but here is my working summary of projects that are imminent and/or postponed. All will contribute to pent up supply in the months and years ahead:
Above- William Lyon's Ivy: "bold" attached product. Are the salespeople keeping themselves occupied watching satellite TV?
Above- California Pacific's Sienna detached condos, models still under construction...laid out like Decada and its predecessors. Is it my imagination, or did they manage to place these even closer together?
In Woodbury, CalPac's Andalucia single family homes appear delayed ("early 2008" the letter says), but I'm not sure of what their original opening date might have been.
Orchard Hills- This entire development, originally slated to begin sales in late 2007, is officially postponed more than a year to 2009. Don't be surprised if the opening is not early 2009 or the delay goes even longer. The Orchard Hills Apartments opened this summer, and do not appear to have incentives, so they may be leasing better than I predicted. The retail shops also opened on schedule, but how long will they be willing to pay TIC lease rates without progress building the community that was (presumably) supposed to be their primary market?
The Great Park (former El Toro MCAS)- Lennar has become rather quiet regarding progress and planning at the Great Park; apparently enough so to cause questions on behalf of the City of Irvine as to whether they are still committed to the original proposals. Keep in mind that Lennar won the bid for this property at the apparent peak of the market, in mid-2005.
"In Irvine, Lennar's plans to build thousands of homes around the planned Orange County Great Park have been pushed back, and the city has not received an updated timeline from the developer since 2005.City officials said Lennar had projected that it would have 781 homes for sale by next year, though the developer said it vowed only to have that number of home sites ready for construction.A plan unveiled by Lennar last summer to nearly triple the number of homes from 3,625 to 9,500, while cutting back on commercial space and adding 400 acres to the park, hasn't even been discussed with city officials."
The Orange County Business Journal(registration required) quoted company officials as saying "I don't think anyone has seen the bottom yet...[but] Lennar will be ready when the rebound comes" in reference to the housing market and their Orange County plans.
The new Village of Stonegate, north of Woodbury, has two signs from CalPac: Palmeras and Mirasol. I couldn't find any details about either. One or both could even be apartments.
The grading and laying of utilities at Stonegate appears not too far behind similar work at Orchard Hills.
In the Villages of Columbus, William Lyon's Mirabella luxury townhomes and Ainsley Park paired homes are "Coming soon." From the brief description on the VOC website, it appears Mirabella is the Columbus Square successor to Kensington Court. Interestingly, they list a higher starting price point than Kensington Court (Columbus Grove, Irvine), which seems implausible given the change in the market and Tustin address.
A few interesting nuggets of industry rumor: Lennar is reportedly contemplating an end-of-year auction for at least some of their properties at the Villages of Columbus. Their end of fiscal is November, so this would likely occur in the next 30 days if true. Also, The Irvine Company is floating proposals for some kind of post-sale price guarantee to try to coax buyers off the fence. Details are very sketchy, and even if true, timing is unknown.
So the bottom line question should be: Will the buyers waiting for the market to get worse outlast the sellers waiting for the market to get better? For the sellers to win that battle, it assumes plausible the argument that the market is capable of postponing itself back to prosperity. Don't bet on it.
Frank had it right, didn't he? Fundamental things apply.
(Click on either image below to enlarge)
From Goldman Sachs...
It is one thing when some crackpot bubble blogger says the market is overvalued and due for a fall. It is quite another when Goldman Sachs, one of world's largest investment banking and securities firms, says the same thing.