Today's featured song was sent by a local musician who is an avid reader of the blog. I bet you can guess his name...
The crash at the end of a speculative bubble can be brutal. So far, the price decline in Irvine has been measured and orderly compared to the drops in less desirable markets. I was recently looking at properties in the Palm Springs market, and I found some of the new neighborhoods that were the carnage is simply breathtaking. Check out some of these listings at around 50% off their new home sales price of 2 years ago:
I could list more, but I think you get the point. The Palm Springs market may have some chance of recovery as baby boomers may want to go here when they begin to retire soon. If you want to see carnage in a market that is not likely to recover any time soon, take a look at Hemet/San Jacinto:
The interesting thing about all of these properties is that they are selling for less than replacement cost. With asking prices around $85/SF, that is the cost of construction of the box itself. Even if the lots were free, a builder could not build and sell a house on it and make any money. There will be no new construction in these markets until prices rise above replacement costs, and then it will only occur on already finished lots selling at an extreme discount. There will be no new development or construction of finished lots until prices rise back above $130/SF. That is about 50% above current values. As you can see, replacement cost does not put a floor below prices. Ultimately, the lack of new construction will create a shortage, and prices will rise due to supply constraints (assuming the financing is available). However, since we overbuilt in many of these fringe markets, it will take some time to absorb all the existing inventory.
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stacked behind the door are the photographs of yours. in the basket
down the hall there's a soccer shirt that i borrowed.
the end isn't the
end. the end isn't the end of this.
picking out the darkened hair from
each and every happy moment. i've come to terms that have been laid
bare, quiet sleeping angels in my bed.
the end isn't the
end. the end isn't the end of this.
so don't you disappoint yourself
again, you'll be back home.. you disappoint yourself
again, you'll be back home.. you disappoint yourself
again, you'll be back home.. before too long..
these discussions with
myself, the kinds of things that don't tend to help. pacing back and
forth with my guitar, looking way up high on a shelf.
Some time ago, I wrote the post Timing Does Matter, to document the financial impact of properly timing the market. Today's featured property owners show how a family should manage their mortgage, and the benefits that can be obtained in retirement if you sell near the peak of a massive speculative bubble. I commend today's sellers. They are the role models I will emulate in my own life.
Isn't real estate supposed to be like vintage wines that get better with age? Rare vintage wines can get very expensive, and unless they turn to vinegar, their prices do always go up. Well it appears the 2006 vintage homes are all turning to vinegar now because they certainly are not appreciating in value.
Today I want to relay a story to you that was told to me by a real estate developer currently buying property in one of our most blighted California bubble markets. His company is purchasing this particular property from the bank for far less than the original loan amount. Do you remember the residual land value calculations from Land Value 101? This particular property was ready for the construction and sale of houses in 2003. The original prices were $400,000 in this particular market. By 2006, houses were selling for $700,000. When sales volumes plummeted, the builder gave up and let the property go back to the bank. The developer ran a proforma using a $275,000 house price. As you can imagine, this did not leave a large residual land value. The bank took the offer. This developer knows he can build and sell houses profitably for $275,000 in this particular market. If prices increase, he stands to reap a windfall. His only real concern is the competition from the REOs, particularly all the previously built homes in this subdivision he is undercutting by over 50%. He knows he is probably going to cause more walkaways, but prices are what they are, and as long as he can build and sell $275,000 houses, it isn't his problem.
Fortunately, for those living in Irvine, the developer is financially stable, and it is concerned about long-term house prices and probably will not cut prices over 50% to move homes. As we noted with the problems in Columbus Grove, those who are off the Ranch are not so lucky. Today's featured property is another of the bad 2006 vintage properties in Woodbury. This seller is really being hosed by his competition as he owes $184,000 more on his property than his comparable neighbor is asking for sale.
Speculation is a battle. The forces of greed and fear drive the financial markets, and the speculator attempts to profit from these moves. Speculation is not investment, although most do not understand the distinction. Speculation is the battle of the individual against the herd. For those who understand it and have learned to move against the emotional forces of fear and greed, there is opportunity to profit. For those who follow the herd, there are brief moments when profits are available, but few have the discipline to take them. Most speculators are slain by the market.
Like many others, I have a disdain for pure speculative flips.
People who buy properties, make no improvements, and attempt to resell
it for a profit simply inflate market prices. There is no value added.
People who rehab old or run down properties do a community service, and
they earn the money they make. However, flippers are merely financial
parasites profiting by constricting supply at reasonable price points.
Of course, flipping is a dying art, and those who are attempting it now
are losing money which makes for great schadenfreude.
Flipping is much more difficult now, not just because prices are
dropping, but because the constriction of credit and the tightening of
financing terms makes it much more costly and difficult to do. The
Option ARM with 100% financing was the ideal tool for the flipper. It
allowed him to enter the market with none of his own money, it
greatly reduced the carrying cost of the property, and it gave him downside protection in the event prices fell. With these conditions in
place, it is no wonder speculative flipping became the pastime of every
would-be Donald Trump in California.
Another behavior enabled by loose credit during the bubble was
cash-out serial refinancing. With the ability to get access to cash
from the property without selling it, there was no need to sell the
property, and many speculators held their properties and withdrew their
cash as needed. Houses were treated like savings accounts earning a
very high return. Of course, they were not withdrawing free money, they
were adding huge amounts of debt, but since the debt service costs were
low, and since nobody thought they would ever have to pay this money
back out of their income, cash-out refinancing became the rule rather
than the exception.
Today's featured property is an example of a speculative cash-out
serial refinancing flip-flop. The speculator bought the property with
100% financing using a 1-year ARM, took out some cash, refinanced with
an Option ARM, took out some more cash, and now they are walking away.
One of the myths about Christopher Columbus and his voyage to discover a quicker trade route to the East was that he had difficulty getting crewmen to serve because they believed the world was flat, and if they sailed far enough, they would fall off. Similarly, one of the myths about residential real estate is that prices always go up, and if they rise too high, they will not fall off. The people who bought in Columbus Grove did so right at the peak, and the continuing activities of the builders finishing off the community pushed their resale prices off the edge of the flat earth. The drop there has been remarkable.
The Columbus Grove experience shows what happens when large amounts of must-sell inventory is concentrated in one place. When prices become extremely inflated, and the market finally starts to fall, it creates a downward spiral that does not abate until prices are at fundamental valuations. However, the rate of decline is largely dependant upon the amount of must-sell inventory in specific areas. So far, the areas that have fallen the quickest have been those with large percentages of subprime loans (Santa Ana,) large numbers of new homes (Columbus Grove,) or both (Riverside County). This does not mean that the neighborhoods like those in Irvine are immune from the crash, it will just take longer here, and since it will take longer, they may not fall quite as far on a percentage basis because rents and incomes will be increasing as prices fall (we hope). Irvine and other neighborhoods will fall in time, most likely when all the Alt-A and Prime ARMS reset.
