In my first post, I said I was financially conservative. What does that mean with respect to financing a home purchase? It occurred to me that exotic financing terms are not exotic anymore. Interest-only, adjustable rates, and negative amortization have become so ubiquitous that nobody seems to remember why 30-year fixed-rate mortgages are used (or were used, they aren’t common in OC anymore). That is the focus of this post.
To be financially conservative is to be risk adverse. A fixed-rate conventionally-amortized mortgage is the least risky kind of mortgage obligation. If you can make the payment – a payment that will not change over time – you get to keep your home. A 30-year term is most common, but if you make bi-weekly payments (makes two extra per year), you can pay the loan off in 22 years. If you can afford a larger payment in the future, you can increase your payment and amortize over 15 years and pay off your mortgage quickly. The best insurance you can have to deal with unemployment or disability is a house that is paid off. As you can see, stabilizing or eliminating your mortgage payment reduces your risk of losing your house or facing bankruptcy. Unfortunately, payments on fixed-rate mortgages are higher than other forms of financing.
The interest-only, adjustable-rate mortgage (IO ARM) became popular early in this bubble when fixed-rate mortgage payments were too large for buyers to afford. In the bubble of the late 80’s, these mortgages did not become common, and the bubble did not inflate beyond people ability to make fixed-rate conventional mortgage payments. This is also why prices were slow to correct in the deflation of the early 90’s because most sellers didn’t need to sell, so they just waited out the market. It was a market correction characterized of large inventories, but this inventory was mostly not the “bad” inventory of must-sell homes. The few must-sell homes that came on the market in the early 90’s drove prices lower, but not catastrophically because the rally in prices did not get too far out of control; however, this bubble is different.
IO ARMs are risky because they increase the likelihood of losing your home. IO ARMs generally have a fixed payment for a short period followed by a rate and payment adjustment. This adjustment is almost always higher, and sometimes, it is much higher. At the time of reset, if you are unable to make the new payment (your salary does not increase), or if you are unable refinance the loan (home declines in value), you will lose your home. It’s that simple. These risks are real, as many homeowners are about to find out. People try to minimize this risk by extending the time to reset to 7 or even 10 years, but the risk is still present. If you had bought in 1990 with 100% financing on an interest-only loan and had to refinance in 1999, your house was probably worth less than you paid, and you would not be given the new loan. Even a 10 year term is not long enough if you buy at the wrong time. As the term of fixed payments gets shorter, the risk of losing your home becomes even greater.
The advantage of IO ARMs is their lower payments. Or put another way, the same payment can finance a larger loan. This is how IO ARMs were used to drive up prices once the limit of conventional loans was reached (somewhere in 2003 in OC). A bubble similar to the last bubble would have reached its zenith in 2003/2004 if IO ARMs had not entered the picture. In any bubble, the system is pushed to its breaking point, and it either implodes, or some new stimulus pushes it higher. Enter the negative amortization (Neg Am) mortgage (aka - option ARM).
The Neg Am / option ARM loan is the riskiest possible loan imaginable. It has all the risks of an IO ARM but with the added risk of an increasing loan balance. Using this loan, not only do you have the risk of not being able to make the payment at reset, but you are much more at risk of being denied for refinancing because your loan balance can easily exceed your house value. In either case, you lose the home. (According to Businessweek’s Map of Misery, 32% of new and refinanced mortgages in Orange County were of this type. See article Nightmare Mortgages)
The risk management measure not related to the mortgage terms is the downpayment. Most people don’t think of downpayments as a way of managing risk, but banks do. Downpayments reduce your risk in two ways: first, they lower your monthly payment, and second, they give you a cushion ensuring you can refinance (if necessary) should your house value decline. The problem with downpayments is obvious: few people save enough money to have one.
Eliminating downpayments through the use of 80/20 combo loans was another massive stimulus to the housing market. Lenders used to require downpayments because it required a borrower to demonstrate the ability to save. At one time, saving was considered a reliable indicator as to a borrower’s ability to make timely mortgage payments. Once downpayments became optional, a whole group of potential buyers who used to be excluded from the market suddenly had access to money to buy homes. Home ownership rates increased about 5% nationally due in part to the elimination of the downpayment barrier.
The combination of IO ARMs, Neg Am / option ARMs, and 80/20 combo loans took what would have been a bubble like the 90’s and turned it into an uberbubble (look at it as a bubble built on top of a bubble). In the early 90’s in California the median home price dropped from around $200K to $175K, about a 12.5% decline. The current bubble is about three times as large. Does that mean a 37.5% decline is coming? Only time will tell.
When I say I am financially conservative, I am saying I will only finance a home with a fixed-rate conventionally-amortized mortgage and a sizable downpayment. The reason for this is simple stress management: I don’t want to spend the next several years worried about my loan reset or house value or future salary raises. I will buy someday, not because I want to make a fortune in Southern California real estate, but because I want to have a stable housing payment, and a stress-free life.
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P.S. For all of you who see this entire post as common sense (which it is), check this out: Don't Buy Stuff You Can't Afford
Address: 7 Green Hollow, Irvine, CA 92620 (Northwood Pointe)
Plan: 3004 sq ft - 5bd/4ba
MLS: S470910 DOM: 51
Sale History: 7/28/2006: $1,230,000
6/6/1997: $337,000
Current Price: $1,249,900
Here we've got a plan 3 in the Bainbridge tract built by California Pacific Homes in Northwood Pointe. It was purchased at the peak(?) in the summer of 2006 for $1,230,000 and subsequently listed 5 months later at $1,249,900. Ummm... prices have gone DOWN in the last 5 months, not UP. But sure, I understand that no one wants to lose money. From what I can gather, it was purchased with 20% down and in December 2006 they refinanced the 80% and took out a 10% HELOC. There's definitely some room to bring the price down on this depending upon how motivated the sellers are.
Is this is a greedy flip or a corporate relo? Who knows? But I do know that the pictures put up for this home on MLS are of horrible quality which is surprising since the agent is a pretty big producer in Irvine. If you are going to sell your home for $1.25mil, you need to make sure that the agent you are paying a fat commission to is spending money on marketing your property correctly - one small part of that is putting up high quality pictures on MLS.
If sold for the asking price of $1,249,900 and assuming 6% in selling costs, the sellers are looking at a $55,000 loss! Surprisingly (at least to me), another plan 3 sold for $1.35 mil in April 2006. Maybe these sellers tried to catch a falling knife when they bought this past summer.
Address: 18 Oroville, Irvine, CA 92602 (Northpark)
Plan: 2402 sq ft - 4bd/3ba
MLS: S476394 DOM: 8
Sale History: 8/1/2005: $1,039,000
12/2/2002?: $660,000
3/19/2002: $539,500
Current Price: $1,089,000
This Plan 2 in the Mendocino North tract built by Lennar Homes in Northpark was most recently purchased on 8/1/2005. It's been about a year and a half and now the home is back on the market. From the pictures, the home looks pretty sweet but almost $1.1 mil for a 2400 sq ft house??
It looks like it was purchased with almost 35% down. Can anyone confirm or deny that? If so, these sellers definitely have room to negotiate. If sold at the current asking price and assuming 6% in selling costs, there'll be a $15,000 loss for the seller.
The latest sale I've found for this plan just closed escrow on 2/14/2007:
- 19 Vacaville - Mendocino North Plan 2 - Sold for $1,050,000
$1,050,000 puts us back around the prices in summer 2005. We'll have to wait and see what 18 Oroville ends up selling at.
Hello Everyone,
I would like to say a special "thank you" to Zovall and IrvineSingleMom for inviting me to join them as a poster on the Irvine Housing Blog. I have not been a reader or contributor to housing blogs very long; in fact, my wife regrets ever showing me these blogs as I spend too much time with them. I would like to take this opportunity to tell you a bit more about myself and summarize my outlook for the Irvine real estate market.
First, I need to remain anonymous. I will share some facts about myself and some generalities, but for reasons of paranoid self-preservation (I wear a tinfoil hat); I must keep my identity a secret.
I have lived in Irvine since 2003, and I lived in San Diego from 2001 to 2003. I sold my house in Florida before moving to San Diego and I chose not to buy in 2001 because I thought the prices were too high. Little did I know a massive speculative bubble was about to take off. I am fairly financially conservative: I am unwilling to finance a home with exotic terms (meaning other than a 30 year fixed rate mortgage). I carry no debt, I pay no interest, and I am in a position to purchase if the price and the terms were to my liking. I get annoyed at being called a "bitter renter." These facts about me influence my perspective and come through in my posts.
I have a Masters Degree in Land Development (there is actually a degree in this), and I work in the real estate industrial complex (REIC). I am an entitlement project manager for a local real estate developer. My job is to take raw land and obtain permission to build houses on it. Because of my line of work and the people I am in contact with on a daily basis, I have a unique perspective into the wholesale side of the real estate market. My company buys raw land, often from individuals, but sometimes from other investors or companies. I do my thing, and then my company sells entitled lots to builders: they are our only customers. Irrespective of what the builders may say in public statements, I see what they actually do in their private dealings. I cannot and will not share details of the projects I am involved with or specifics of deals I see, but I can and will convey general happenings and trends I see in this market as it reveals a lot about the future of home prices.
I do not have an incentive to lie in order to hype the market. My livelihood is tied to the real estate industry, but my income is not derived directly from residential real estate transactions. Realtors, mortgage brokers, and many others depend on these transactions to survive; therefore, they have a strong incentive to convince buyers to step forward even if it is not in that buyer's best interest. I have no such incentive. I can provide an objective analysis of the market from an industry insider's perspective without being tainted by transaction dependency.
Also, I have a fascination with financial markets. I became particularly interested after losing money in stocks in 2000, and I devoted much time and attention to the workings of financial markets in general and the markets for stocks and real estate in particular. As a hobby of sorts, I trade stocks using a self-created automated trading strategy with Tradestation.com (I am not opposed to speculation in liquid assets like stocks). My posts will focus on real estate, but I may draw upon experiences or concepts from other financial markets in my analysis or examples.
There are many reasons to post to a blog like this. It is nice to have a forum where I can share my experience and insights with others, and there is an element of camaraderie and entertainment too. However, the passion behind my posting comes from my desire to stop people from being ruined financially by buying in today's market. I am a housing bear, and I make no apologies for it. If I can save even one potential new buyer from bankruptcy, I will feel good about what I have done here (Sorry, I don't have much sympathy for current F@cked Borrowers - FB's. I have compassion for ignorance, but disdain for avarice). That being said, why am I such a bear?
The Future of the Housing Market
I would like to share a series of posts from other blogs that summarize my reasoning better than I could:
Evidence of a California Housing Bubble
Risks of a Serious Home Price Decline
Housing in 2007
What is a Bubble?
There's a Housing Bubble -- A Fact-Filled Opinion
In summary I would note a few basic facts/opinions:
1. Price levels are determined by the balance between supply and demand.
2. Demand was increased by sub-prime buyers and loose lending standards. This was the primary mechanism which inflated this bubble.
3. The previous demand stimulus is being removed from the market.
4. The supply of homes for sale is increasing, and it will continue to increase. This supply will drive prices lower.
5. Prices will decline until fundamental valuations bring new buyers to the market (like me).
I would like to expand on #4 above because it is the most important point moving forward. Look at housing inventory as being like cholesterol: a high level is usually bad, but the ratio of good inventory to bad inventory is even more important. Good inventory is discretionary sales inventory. These are sellers who would like to sell if they can get their price, but they really don't have to sell. An inventory of for sale homes made up of good inventory, even if there is a lot of it, will not drive prices down. A large amount of good inventory may slow the rate of appreciation, but it won't take prices down. In contrast, bad inventory is composed of those homes on the market that must be sold at whatever price the market will bear.
Bad inventory has three main sources: life-changing moves, homebuilders and foreclosures. Life-changing moves are people who must sell a home due to job relocation, layoff, divorce or other factors. Homebuilders must build and sell homes, or they will go out of business. These two sources of bad inventory are ever-present, but usually a small enough percentage of the overall market that they don't take prices down.
The final, and most important, source of bad inventory is foreclosures. This is where the action is. When foreclosures increase above levels where the market can absorb them, prices decline. When foreclosures increase dramatically, prices decline dramatically. This is what is going to happen over the next 2-3 years as all the sub-prime borrowers and over-extended homeowners buckle under the weight of their mortgage payments. Foreclosure statistics are the numbers to watch.
P.S. I promise future posts won't be so long.
Yup, he's officially joined the team! If you don't know who IrvineRenter is, check out several of his forum posts. He's been pretty active on the blogosphere and has made some great contributions. But I'll let him introduce himself in more detail. For now, let's all give him a warm welcome!
Originally posted November 6, 2006
Address: 61 Chantilly, Irvine, CA 92620 (Woodbury)
Plan: 1824 sq ft - 2/2.5
MLS: U6603358 DOM: 25
Sale History: 7/25/2005: $689,055
Prior Listing: 06/20/06 — $832,000 (64 DOM - MLS U6601754) - Reduced to $799,000
Prior Listing: 08/24/06 — $765,000 (48 DOM - MLS U6602644)
Current Price: $749,000
Here we've got a Plan 1 condo in the Treo tract built by Brookfield Homes in 2005. The Treo tract is located in the village of Woodbury. It looks like this condo was purchased from the builder on July 25, 2005. The flipper couldn't wait even a year before trying to sell the home (hoping to make an easy $142k)!
The funny thing here is that the seller is playing the infamous Re-List game. The current listing is actually the 3rd listing since June. If you add up all the DOMs, you realize that this home has been on the market for 137 days (as opposed to the 25 days you might be led to believe).
At the current price (and assuming 6% in selling costs), our flipper stands to make about $15,000 in profit.
It might be a little tricky for our flipper to unload this property as there are another FOUR plan 1's for sale:
- 87 Chantilly - $699,000 from the Builder?
- 75 Chantilly - $705,000
- 49 Concierto - $725,000
- 61 Concierto - $769,900
We'll get a better sense of the motivation in the weeks ahead 
UPDATE #1 - February 20, 2007
The featured home in this post (61 Chantilly) was taken off the market on 12/1/2006. But that's not much of an update, so let's see what is going on with the other Plan 1's in the Treo tract:
- 87 Chantilly - Status is Accepting Backup Offers - $659,000
- 75 Chantilly - $675,000
- 49 Concierto - $699,000
- 61 Concierto - Pending sale - Price shows $769,900
- 50 Townsend - $724,900
- 56 Townsend - $668,800
Once again, the builder is leading the way down (40k less than just a few months ago). Who else in this tract can afford to sell for $659k? The pending sale at 61 Concierto seems a little strange. Either the agent hasn't yet updated the pending price or some GF is paying WAY too much for this home.
It's February and there are already 6 Plan 1's here. I wonder how many Plan 1s were built by Brookfield Homes. If 61 Chantilly decides to play the relist game again, they are going to have an even harder time selling now.
Originally posted: January 4, 2007
Address: 108 Mosaic, Irvine, CA 92603 (Quail Hill)
Plan: 3500 sq ft - 5/4.5
MLS: S466112 DOM: 51
Sale History: 4/24/2006: $1,725,000
2/17/2004: $1,043,500
Current Price: $1,749,000
The Sienna tract built by Standard Pacific is one of the higher end neighborhoods in the village of Quail Hill. As you can see from the Sales History, the original owners made a killing thanks to a little bit of luck.
The new owners listed the home about 6 months after they bought it. The notes say the seller is relocating. That's just gotta suck. They are facing a loss of about $80,000 (assuming 6% in selling costs) if they get their asking price. Is this home worth more (even $24,000 more) than it was in April 2006? I don't think so. :(
UPDATE #1 - January 23, 2007
This is pretty quick for an update but I just noticed the price on this home has already been lowered twice:
Price Reduced: 01/16/07 -- $1,749,000 to $1,729,000
Price Reduced: 01/22/07 -- $1,729,000 to $1,693,000
The new asking price will inflict the seller with a loss of over $133,000! Will the $56k price drop help sell this property? Time will tell. New home pricing in the Serra tract in Portola Springs starts at about $1.4mil for similar square footage.
The private remarks state: "Seller is relocating...submit offers. Special financing incentives available on this property through SIRVA Mortgage SELLER EXTREMELY MOTIVATED...SUBMIT ALL OFFERS...MUST SELL BY FEB. 5TH."
From the info I have, it looks like they put 50% down. If that's true, all I can is WOW! In this case, the sellers will lose a lot of their own money (as opposed to situations like this or this).
UPDATE #2 - February 20, 2007
Another quick update.
Price Reduced: 02/07/07 -- $1,693,000 to $1,667,000
With 6% in selling costs, the loss will be over $158,000!
Discuss here
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Address: 35 Hidden Trail, Irvine, CA 92603 (Turtle Ridge)
Plan: 3675 sq ft - 4/4.5
MLS: S446750 DOM: 241
Sale History: 7/13/2006: $2,250,000
Price Reduced: 07/19/06 -- $2,499,000 to $2,350,000
Price Reduced: 09/19/06 -- $2,350,000 to $2,225,000
Price Reduced: 01/04/07 -- $2,225,000 to $2,150,000
Current Price: $2,150,000
Thanks to waitingtill08, we've found our first flip inside The Summit at Turtle Ridge! This is a Plan 3 in the Cirtus tract built by Brookfield Homes. It was first listed on the market on June 26, 2006. That is BEFORE they even closed escrow on the purchase on July 13, 2006! Doesn't that smell like a flip to you?
The description reads "Corporate relocation. Outstanding panoramic view - city lights, ocean. Highly upgraded with hardwood floors, crown molding, plantation shutters, custom built-ins. Main floor master bedroom. Extra large bonus room." This makes you think that the seller is relocating. When I looked into the title, it says that the owner is Prudential Relocation Inc. Hmm, sounds like it's actually a company that specializes in Corporate Relocation. The property is listed by Prudential California Realty so I suppose this all makes sense now.
Each of the price reductions on this property have been pretty substantial. I couldn't find any mortgage information for the home and it wouldn't surprise me if a behemoth like Prudential actually owned it outright. Anyone know how these Corporate Relocation companies work?
Instead of wishing for a $250k profit on the home like they did in July 2006, they are now wishing for no more than a $100k loss! Assuming 3% in selling costs, this flop will be a loss of around $164,500! Oh, and don't forget the carrying costs on this beast. The MLS listing says that it is Vacant.
So what else is available in the Citrus tract right now?
Maybe I'm just jaded by the prices of the last couple years.. but $2.15 mil for a NEW 3675 sq. ft. house in Turtle Ridge Summit with an OCEAN view? It doesn't sound that bad. Has anyone seen this property? Is there really an ocean view? You would think they would have tons of pictures of the view huh? Unfortunately, the only one of the yard on MLS is the one at the top of this post.
This months OC Metro has a cover story talking about how "homebuilders are working hard to bring buyers in the door."
Some blame for the rapid appreciation is placed on speculators but I didn't notice anything mentioning the suicide loans.
" All the speculation had a variety of disruptive effects on the market, he says, including an “artificial demand” that fuels price increases, as well as “a less-engaged community.
“Neighborhoods get homes that sit empty until buyers can resell,” he says. “And that’s not good for (buyers) who are striving for a great place to live.” "
There are some quotes from a few of the builders, Taylor Woodrow, Centex, Standard Pacific, and Brookfield Homes, that are worth reading.
" Forsum, whose firm offers homes ranging from the $200,000s in Corona and $600,000s in Buena Park to the multi-millions in Newport Coast, said that foot traffic at the company’s developments “has not really been the problem. It’s really a lack of urgency on the part of prospects – how to get them to buy.” So the firm has been offering some “targeted incentives” that range from mortgage help to design upgrades to a reduction in lot and view premiums – but not, he stresses “wholesale discounts.”
Those don’t appear necessary, “because things have picked up, and we’re very encouraged. There’s a market out there for sure, a demand by customers, and we’re in a position to give it to them. We can sell a clear and present value proposition.” "
It seems like the builders don't think they'll have to lower prices any more. I've definitely noticed that foot traffic has increased since 2007 started (due to the price cuts). The quote above makes it sound like there are a lot of people looking but not necessarily buying. But then it says that things have picked up. So... what is the dealio?
Found this today via the Irvine World News:
