Is someone getting the best, the best, the best, the best of you?
The conventional wisdom in real estate is to buy the most desirable properties in the most desirable neighborhoods because those properties cannot decline in value. When you look at real estate prices in some of the beach communities, you see this idea was taken to its extreme. For as overvalued as Irvine was at the peak relative to rents, Newport Beach, Corona Del Mar, and other beach communities were even more overvalued.
Buying the best of the best is supposed to be an insurance against loss. However, when people truly believe real estate cannot go down in value, there is no price that is too high. It doesn’t matter how much you pay if you cannot lose money in the deal. All you have to do is wait and sell it to someone else who also believes it cannot go down at a higher price. High-end neighborhoods were particularly prone to buying based on this erroneous belief, and the degree of detachment from fundamentals is truly extraordinary.
Today’s featured property was purchased at a ridiculous price in 2004. It was bought new in 2002 for $768,000, and it was sold to the current owner in 2004 for $1,365,000. A 77% increase in price in just two years. That 2002 owner made some serious money. The 2004 owner is not so lucky.
When you evaluate this property, it certainly appears to be the best in the neighborhood. It is at the end of a cul du sac, it is across from the main park, it is large, and it has a large yard. If there is a better property in this neighborhood, I can’t find it.
There’s somethin’ wrong with the world today The light bulb’s gettin’ dim There’s meltdown in the sky
Fringe markets are those regions where properties are less desirable due to proximity to large employment centers. These markets develop as people are priced-out of the more desirable markets closer to work. Eventually, employment centers also migrate to these fringe market areas, and development pushes even further into the wilds.
When Irvine was first developed, it was a fringe market. The primary employment centers were in the LA basin, and those who bought in Irvine commuted to these far-away employment centers. As Orange County continued to develop, it became a strong employment center of its own.
There are still fringe markets even in Orange County. San Clemente and Rancho Santa Margarita are examples. There is limited employment in these sub-markets, and people commute to employment centers.
Fringe markets have characteristically volatile house prices. People only live in fringe markets because they are priced-out of more desirable areas, so when prices drop in the better areas, people leave fringe markets, and prices really plummet.
Proximity to employment is not the only defining characteristic of a fringe market. Even within primary markets like Irvine, we have fringe neighborhoods that experience greater price volatility because they are undesirable for other reasons. One such neighborhood in Irvine is Columbus Grove.
Columbus Grove was developed at the peak of the housing bubble, and it was overpriced from the beginning. The continuing activity of the builders coupled with the ubiquitous toxic financing has resulted in many home sales of the must-sell variety. This created a nasty downward spiral in prices.
Columbus Grove also suffers from its proximity to powerlines, underground toxic waste, a nearby cement factory, and other elements which make it less desirable. The combination of inflated prices, huge numbers of must-sell homes, and low desirability has caused prices to absolutely crater.
Every single homeowner there has a property worth less than the paid for it, and the vast majority are hopelessly underwater on their mortgages.
Tell me what you think about your sit-u-a-tion Complication - aggravation Is getting to you
Actually, conditions like these make for ideal places for vultures to be active. When we do reach the bottom, the best deals will be in neighborhoods like this one. Unfortunately for the flipper who owns today’s featured property, we are not at the bottom.
If chicken little tells you that the sky is fallin’ Even if it wasn’t would you still come crawlin’ Back again? I bet you would my friend Again & again & again & again & again
When I first started writing for the Irvine Housing Blog in February of 2007, I wrote a series of posts culminating in Predictions for the Irvine Housing Market. I updated that post in I Was Wrong, Its Worse... When I first suggested that prices might crash, there was a certain amount of incredulity in the very idea of a dramatic price crash. In order to float the idea with a minimum of being called crazy, I wrote a post titled, What if Prices Dropped to Fundamental Values. In that post, I presented a series of projections for the Orange County median home price. I put it out there as a hypothetical because I was afraid predicting a catastrophic crash would cost me credibility with readers. Even this hypothetical was shocking to many (read the comments and you will see).
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How crazy did people think I was?
“Let’s not get too carried away. First of all we probably should not
really make economic prediction more than one year ahead. As
IrvineRenter said, this is just an “what if” analysis. It makes an
interesting game for bubble sitters but IMO we should not read too much
into it.“
“I am not agreeing that the blow off downturn will look as drastic.“
“I have been following all your posts for quite sometime. I think your price dropping theory is way too unrealistic.“ I hate to tell you who said that one…
“After tweaking your model, it seems that prices would need to fall
30-35% to return to fundemental values, not 50%. Considering the
factors above, it seems likely that once prices started falling by
significant margin that the pool of sellers would start to dry up.
Only folks that absolutely were forced to sell would consider it, which
would look more like a long, slow leak than a collapse.“
“I just don’t agree it will be as bad as you think. I *hope* you’re right ... but I just don’t see it.“
“If I had to guess, I’d say 15-20% overall drop in housing values over the next 2-3 years max.“
“While I agree wait for a couple of years (may be two) is a good idea, but I just can’t image the prices will gone down so much.“
“Your long-term forecast appreciation is just pure speculation.“
Sorry Cassandra I misunderstood Now the last day is dawning Some of us wanted but none of us would Listen to words of warning
So how did I do with my crystal ball? Well, DataQuick just released some updated numbers, and with the help of Jon Lansner and Lee in Irvine who has been tracking DataQuick numbers, I can provide an update:
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As you can see (consistent with the theme of I Was Wrong, Its Worse...) I was too conservative in with my dire predictions. At the time, I was predicting an unprecedented drop in prices. I did feel I was being conservative despite the conventional insanity of the day. I did not believe the median could drop so quickly. Perhaps I should have stood behind my predictions in How Bad Can Bad Get?
Today’s featured property is a short sale in Woodbury. Irvine is a bit behind the rest of OC with its price drops, but with the ARM Problem still facing us, a problem 60 minutes just discussed at length, it certainly looks as if prices will continue to fall…
We are starting to see an interesting phenomenon in the housing market: knife-catchers changing their minds. The first one I noticed was in Quail Hill back in October. It was purchased by a flipper who put a large sum as a downpayment but then tried to sell quickly at a breakeven price. The only reasonable explanation is that it was purchased as a flip, and the owners changed their minds.
Changing your mind on a stock purchase is relatively easy. Stocks are very liquid, and transaction costs are very low. However, changing your mind about a real estate transaction is not so easy. Real estate is very illiquid in a declining market, and the transaction costs are very high. If you quickly change your mind about real estate, you will lose money. Of course, it is common to price it just above your purchase price and hope someone just a little more foolish than yourself comes along to bail you out. In a declining market, the greater fool is harder to find.
In the world of large real estate transactions, buyers do an enormous amount of due diligence to completely understand what they are buying and the state of the market they are buying it in. It is not uncommon for buyers to spend hundreds of thousands of dollars on property research and still walk away from the transaction. This is prudent because wealthy real estate investors know how illiquid these investments are, and they know how costly it is to change their minds later. Small-time residential real estate speculators know none of this. For many, the extent of their due diligence is walking the property with a salesman. Some will get the necessary inspections to accurately determine the status of the property, but many will not. Most amateur speculators simply don’t care: real estate always goes up you know.
The comedy of errors is amusing to us, but it must be very troublesome to the speculators who lose tens or hundreds of thousands of dollars of their own money. Many of the knife catchers who have been speculating have invested large downpayments, mostly because the banks wisely forced them to. The bagholders for the next leg down in the markets will be the knife catchers, and the money lost will be their own.
Today’s featured property is one such knife catcher who appears to be changing his mind on the viability of this investment. Is it too late?
Everyone seems to be worries that prices will never fall to affordable levels, despite the fact we are witnessing unprecedented price declines everywhere. Those of you desirous of a high-end Irvine property have not seen the price drops you would like to see, so you conclude they will never get there. If you widen your view a bit, you see properties declining in value all around us and even within Irvine at the low end.
If you are watching the high-end market, these will be the last to fall because this is where knife catchers are most active. The high-end watchers of the IHB are a microcosm of the market. Even among this group, there are people willing to jump in at different price points. Each person capable of buying has a different degree of kool aid intoxication. Each potential buyer has a different tolerance for fear of being priced out—which is still the primary motivator of knife catchers. If you only make lowball offers, you may never get filled, and you will never own. This reality gets amplified into the fear of being priced out, and through this fear, people raise their bids.
Pause for a moment… Reflect on the emotions you felt when you read, “If you only make lowball offers, you may never get filled, and you will never own.“ Did you feel the fear? How strong is it? Will you act on this fear? If you are introspective enough to have these emotional awarenesses, you can gauge your own level of kool aid intoxication. We are all different, and the most fearful are the most likely to become knife catchers.
Personally, I rely on my analytical skills to keep my emotional responses under control. I have faith that market pricing will fall to levels consistent with rental parity. It is a faith backed up by market data pertaining to previous market bubbles. I also recognize that even if prices do not reach rental parity, and if I never own, I will be better off financially by renting. It is a win-win. Intellectually, I recognize this truth. Emotionally, I have to let go and trust my intellect. It isn’t always easy.
For those who have been waiting for prices to reach rental parity, there are still signs the market is heading that direction. Before we get “there,“ we need to identify what “there” is. In a stable real estate market, rental parity is a general guide, but not all market segments stabilize at rental parity. The low end, composed of undesirable condos and other properties where owner-occupants are rare often trade at prices below rental parity. The less desirable it is, the closer it trades to investor cashflow levels (GRMs from 100-120). The median type property that owner occupants desire trade near rental parity. This is particularly true for “starter homes,“ those nicer condos and small 3/2s. The above median properties often stabilize just above rental parity (+10%.) This happens for a number of reasons: 1. The longer ownership period of these homes justifies a higher investment premium. 2. The limited supply makes them scarce. 3. Rents are more variable at the high end as most people who can afford the higher rents generally own instead.
In the market bubble of the late 80s, the low end of the market got bid up to rental parity, and the high end was pushed well above. When prices crashed in the early 90s, the high end crashed first, then the low end got hammered. With the low end already at rental parity and within levels of affordability, it made sense for the high end to crash first. Once the more desirable properties were at rental parity, there was an exodus from the low end that caused prices there to plummet. I mention this because I believe this is how the next stages of the drop will play out.
Since the Great Housing Bubble saw an unprecedented degree of price inflation, both the low end and the high end prices became elevated far above rental parity. As the low end comes down to rental parity, it is starting to find some support. At this point, we are looking much like the market in 1991—the low end is nearing rental parity, and the high end is still grossly overpriced. If history repeats itself, the low end may stabilize temporarily near rental parity while the high end declines. Once the high end drops to rental parity, the low end will take another drop down to investor cashflow levels. Is it going to happen that way? Who knows, but that is my best guess.
Today’s featured property is a 3/2 that appears to be at rental parity here in Irvine.
