Time to kiss the world goodbye Falling down on all that I've ever known
Malcom Gladwell wrote a book called The Tipping Point. In it he traces how social phenomenon including financial manias can spread like a disease epidemic. In many real estate markets, we are witnessing a new epidemic: walkaways. Statistics have shown that the rate of foreclosure rises dramatically when homeowners fall underwater. Some estimates are that as many as 12,000,000 homeowners are currently underwater, and as many as 20,000,000 will be before prices stabilize. These are alarming statistics for a banking industry already rendered insolvent by losses on their mortgage portfolios.
The tipping point with respect to walkaways is not difficult to understand. Many people bought at inflated prices because they thought prices would continue to rise. When prices went down, they examined their alternatives (something they should have done in advance) and realized it was much cheaper to rent than to continue making payments on the depreciating asset. Anecdotally, there also seems to be a correlation between how much money people put into the transaction and how far underwater they must fall before they give up. Several months ago, most of the properties I profiled were 100% financing deals gone bad. Some of these owners were not far underwater, but they were giving up anyway because there was no point in continuing to make payments and actually losing some of their money. However, lately I have been seeing more and more properties where the owners had put 10% down. Many of these properties, like today's featured property, were 10% or more below their loan amount before they gave up.
There has been much conjecture on the fate of Option ARM holders and whether or not these borrowers have given up already and sold into the declining market. Certainly many of the properties I have profiled have been Option ARMs. However, it doesn't seem likely that these people have given up and already sold. Why would they? For them, their current house payment on the teaser rate is actually less than renting. Plus, they can stay in the house for 7-12 months free-of-charge after stopping payments. Their incentive is to stay in the property until their recast, then quit making payments and ride it out. Most of these people have already given up, and their plan is to do just what I describe. They make up an enormous shadow inventory of unlisted properties that will be hitting the market as foreclosures. Some of these people might list at a breakeven price and hope, but with market prices putting them far underwater in many circumstances, most of these people do not bother.
The subprime implosion set the stage for the collapse of the more desirable markets like Irvine. The implosion of subprime lowered prices in all markets and made financing much more difficult to obtain. The lower prices has put all the Option ARM, Alt-A and Prime ARM holders in a precarious financing situation. Many will be unable to refinance because they are either underwater or they do not meet the more stringent standards. If they cannot afford the payment when their ARMs reset -- something that will be a particular problem for Option ARM holders -- they will go into foreclosure. It is only a matter of time.
I am still anticipating price declines this fall and winter. The economy is heading into a tailspin, unemployment is increasing, and credit is still tightening. These are not rally conditions. However, we will not see the full brunt of the foreclosure problem in Irvine until 2009 through 2011, and it will be a year or two beyond that before all these reseting ARMs become foreclosures and work their way through the system.
In Santa Ana, parts of Riverside County, and other subprime dominated markets, the worst is over. Prices there are down 50% or more in many of these areas. They may not see appreciation any time soon, but they are already seeing a recovery in sales volumes, and many properties are at or near the bottom in pricing. The same is not true for Irvine. The brunt of our problems are ahead of us, not behind us...
I was cryin' when I met you Now I'm tryin' to forget you Your love is sweet misery
For all our wisdom and collective experience, none of us knows what the markets will do next. Like an ocean current or a raging river, a financial market charts its own course. It is fickle and feckless and flows without regard to our hopes and dreams. The ebbs and flows of financial markets are meaningful to us, but in reality they are just movements in price; nothing more. Price rallies make homeowners blissful and renters bitter, while price declines make homeowners gloomy and renters gleeful. These feelings and emotions are independent of movements in price. The market just moves, that is all it does. It is benign, yet dangerous; it is indifferent, yet demonstrative; the market is a paradox which we must simply accept.
I was cryin' just to get you Now I'm dyin' 'cause I let you
When today's featured property was purchased in 2005, the owner undoubtedly thought they made the purchase of a lifetime. This property was certain to appreciate at 15% a year. It would be worth $2,000,000 soon enough. Now the owner is trying to forget this place. They listed the property at a short-sale price, they have proceeded to knock almost 20% off the asking price and still no takers.
Listing Price History
Date
Price
Aug 26, 2008
$535,000
Sep 05, 2008
$525,000
Sep 17, 2008
$515,000
Sep 25, 2008
$505,000
Sep 29, 2008
$495,000
Oct 07, 2008
$485,000
Oct 15, 2008
$465,000
Oct 20, 2008
$445,000
Oct 21, 2008
$435,000
Oct 27, 2008
$425,000
Of course, they are not alone. We have profiled another property nearby lately: 65 Weepingwood #97, Irvine, CA 92614. This nearly identical property was an REO, and the lender let it go for $385,000. Do you think today's seller will get 10% more? I doubt it.
The Irvine Housing Blog has an unwritten policy concerning privacy that needs to be stated.
We do not use names. We do not have an ax to grind with any particular homeowner. The stories we convey are representative of many faceless owners and borrowers in Irvine and around the country. We uncover the microeconomic factors that underpin the major macroeconomic problems facing the country and the world today. There is no need to reveal names, although since these names are in the public record, we could do so if we chose to.
We post information from the public record. All the sales and mortgage information is a matter of public record. There is no expectation of privacy concerning this information. If the owners of the properties we profile have a problem with that, I suggest they take it up with the state legislature. Of course, that will not go anywhere because our entire real property transaction system operates on the public nature of this information. Up until the real estate bubble, there weren't any real stories found in these public records, so very few people bothered to write about it. Now there is, so now we do.
The information is accurate. There may be instances where the public record is in error, but not very often. I occasionally read about bloggers being threatened with libel lawsuits. This is crazy. First, for the printed word to be libelous, it must be inaccurate. What we post is not. Second, the inaccuracy of this information must be reasonably known to the person printing it. Since we post only what is in the public records it is either accurate, or there is no way we could have known it was inaccurate. Either way, we are not being libelous. If someone wants to bring suit anyway, I suggest they read California Civil Code Section 425.10-425.16: the anti-SLAPP legislation.
I can understand that some people find this information embarrassing. Of course, they should have thought of that before they did something that they might find embarrassing later on. Those who are obsessed with "keeping up with the Jones" and worried about what the neighbors think are the most prone to abuse their HELOCs and pretend they are rich. These are the people who feel the most embarrassment because they obsess on what they believe other people think about them. There is an old adage which says, "you wouldn't worry about what other
people think about you if you realized how little they did." I cannot control people's reactions to these posts, nor do I want to. Quite honestly, I don't give them a second thought after the post has had its day. I am certainly not going to stop blogging because someone might be embarrassed if their illusion of wealth and prosperity is exposed for what it is.
I am not trying to embarrass people. If these stories could be told in a way so nobody was embarrassed, I would do so. Unfortunately, there is no other way to tell these stories, and the lessons these stories teach to individuals and society are important. If these stories are not told, another generation might be tempted to abuse their HELOCs and refinance themselves out of their homes. If these stories are not told, another generation of lenders may repeat the mistakes of the bubble and risk a catastrophic implosion of our financial system. If we do not learn the lessons of history, we are doomed to repeat its mistakes.
Today's featured property was purchased right at the peak with 100% financing. Of course the owners are walking away now, and the lender is absorbing the loss. For those keeping score, this on is being offered for 27.6% off its peak purchase price.
They said it was the land of milk and honey Now they say it's the land of money Who ever thought they'd ever make that stick It's unbelievable you could get this rich this quick.
Isn't
this whole situation a bit surreal? It is almost unbelievable that we
are witnessing such a catastrophic crash in our financial markets
coupled with a dramatic economic slowdown. The root cause of all this
turmoil is the behavior of owners like those I profile every day. So
many people took on so much more debt than they can afford to service,
and the geniuses on Wall Street securitized these toxic loans and
poisoned the entire world economic system. Think about this for a
moment: if the many borrowers in the bubble markets had not
borrowed so much money to inflate this massive housing bubble, our
current economic problems would not have occurred. There are many
responsible parties, and it always takes two to tango, but if the
demand for toxic loans had not been present, the toxic loans would not
have been issued.
It's unbelievable it's strange but true It's inconceivable it could happen to you
Why would anyone be selling right now? Prices are 20% off the peak, and there are a number of REOs to compete with. Homeowners who are not distressed are not selling now -- perhaps with the exception of those who recognize prices are going lower. Measurements of distressed properties only consider REOs and short sales; however, there are a number of overextended homeowners who are trying to get out before they become one of these statistics. These homeowners are just as distressed, but if they can manage to get out now, they will not lose all their remaining equity and good credit. Like the truly distressed properties, these owners will sell. They will either sell now while they do not meet the technical definition of distress, or they will sell later when they do. For most of these homeowners, hanging on is probably not an option. Most have more than doubled their mortgages, and when their ARMs reset, they will be unable to make the payments. So when pundits say our inventory is not distressed, they may be technically correct, but many of what appear to be organic sales are truly distressed sales. And even many of those that are not distressed are choosing to sell now because prices are dropping, and they know they will be able to reenter the market at a lower price point. A significant portion of the non-distressed sales are still highly motivated.
Today's featured property is for sale because it is distressed. It does not fit the classical definition because it is not a short sale or an REO, but the long-term owners of this property got caught up in the financial mania, and they doubled their mortgage. Now they have an Option ARM about to explode, and they are hoping to sell before it does. They made mistakes when they got caught up in a financial mania, but selling now -- before they lose everything -- is the best decision they could make.
The wheels of progress keep turning here at the Irvine Housing Blog. Some of you may have noticed that we have introduced a new rent versus own decision calculator. It is still a work in progress, but it is good enough to put on the main site. We hope to add some formatting and create a stand-alone version for people to download and use.
Our goal was to create an accurate and detailed accounting for the true cost of ownership. This is a point-in-time calculator. You are not asked to make assumptions about inflation or appreciation. There are no projections for the future. People who invest in real estate (I am not talking about stupid amateur speculators) always look at the stabilized cashflow in the first year of ownership. If it doesn't make sense in year 1, then it isn't an investment, it is a speculative gamble. There are a variety of rent versus own calculators out there. Most are put up by realtors. They are totally biased and ignore costs and exaggerate benefits. Some are put up by bubble bloggers that are biased the other direction. We want to be accurate.
Most of the underlying assumptions are documented in the post Rent versus Own. Most of the inputs are in the left-side column, and most of the outputs are on the right (the exception is the HOA fees which are plugged in directly on the cost side). Play with these assumptions at your own risk. As I documented in the Rent versus Own post many of the costs are underestimated, and many of the benefits are overestimated. The most common mistakes are to ignore maintenance and replacement reserves and to overestimate the tax savings. The true tax benefit is not the highest marginal tax rate you pay.
The primary function of the calculator is to determine the true cost of ownership to compare to a base rent. However, we have added a reverse calculation that allows renters to put in the rent they are currently paying and show them how much house they can afford. Since this is not a spreadsheet calculation and we could not iterate to run the calculations backward, we cheated: we use a percentage of rent that goes to the cost of ownership beyond the payment and subtract this from the rent to compute the purchase price, downpayment and loan amount. You will see the two methods produce very close results both forward and backward.
Any comments or suggestions for improvement will be appreciated.
In other news, I wanted to remind everyone that we are having an Irvine Housing Blog party and book signing at 6:30 on Wednesday, November 12, 2008, at JT Schmids at the District. All who wish to be a part of the IHB community and meet others
in the community are encouraged to attend. We may have staff writers and photographers from OC Weekly in attendance to write a story on the IHB community. You can avoid the pictures and remain anonymous if you wish. Participation is voluntary.
Look for an interview with me in the Irvine World News on Wednesday and the OC Register on Thursday.
I was having a conversation about current events and the massive deleveraging we are witnessing globally and I realized something rather remarkable: most residents of California have seen their new worth decline 40% or more over the last 2 years. Think about that for a moment. The California median home price is down 40% according to the California Association of Realtors. Since houses are almost always hugely leveraged, many homeowners have lost all the net worth they once had as equity in their houses. The stock market is more than 40% down in the last year. Anyone invested in the market either directly or through their retirement plans is down 40%. Stocks, bonds, real estate, commodities, and currencies: nearly every asset class is down, and down big. The only group that has not seen a huge decline in their net worth has been renters who are mostly in cash.
What is going to become of this huge "reverse wealth effect"? There have been many studies on how much people spend when their stocks or houses appreciate. I don't think anyone have every studied what people do when every asset they own declines significantly in value. I don't know if it has ever happened before. You have to imagine this will create a giant sucking sound in our economy. The only people who aren't impacted by this and who don't care are the Amish. Maybe there is something to be said for the simple life...
We have talked about cash being king. Right now, it really is.
As I walk through the valley where I harvest my grain I take a look at my wife and realize she's very plain But that's just perfect for an Amish like me You know, I shun fancy things like electricity At 4:30 in the morning I'm milkin' cows Jebediah feeds the chickens and Jacob plows... fool And I've been milkin' and plowin' so long that Even Ezekiel thinks that my mind is gone I'm a man of the land, I'm into discipline Got a Bible in my hand and a beard on my chin But if I finish all of my chores and you finish thine Then tonight we're gonna party like it's 1699
We been spending most our lives Living in an Amish paradise I've churned butter once or twice Living in an Amish paradise It's hard work and sacrifice Living in an Amish paradise We sell quilts at discount price Living in an Amish paradise Amish Paradise -- Al Yankovic
I was having a conversation about current events and the massive deleveraging we are witnessing globally and I realized something rather remarkable: most residents of California have seen their new worth decline 40% or more over the last 2 years. Think about that for a moment. The California median home price is down 40% according to the California Association of Realtors. Since houses are almost always hugely leveraged, many homeowners have lost all the net worth they once had as equity in their houses. The stock market is more than 40% down in the last year. Anyone invested in the market either directly or through their retirement plans is down 40%. Stocks, bonds, real estate, commodities, and currencies: nearly every asset class is down, and down big. The only group that has not seen a huge decline in their net worth has been renters who are mostly in cash.
As I walk through the valley where I harvest my grain
