You have the power. It is A Buyer's Market. Did you ever think you would see properties under $200/SF again? How about $162/SF? Today's featured property caused one commenter yesterday to opine, "This must be bottom." Is it? The price drops have been so dramatic and come so fast on many properties that people can't get their mind around the valuations. A property selling for 26% off its peak purchase price of just two years ago seems cheap. When viewed through the lens of 2006 prices, it is. However, when viewed through from the perspective of fundamental valuations, a property like today's featured property is still overpriced. People did not put much effort into understanding prices when they were rising, after all, prices always go up -- not. People assume that market prices are fair value and any discount from that price a bargain. When viewed from a broader perspective of valuations based on rents and incomes, the degree of price inflation becomes clear, and the amount prices have yet to fall also becomes apparent. Today's featured property is probably closer to the bottom than to the top, but at $559,900, it still requires a rental rate of $3,500 a month to reach a breakeven threshold for an owner-occupant. Does this look like a $3,500 a month property to you?
Is the sky really falling? I guess it depends on whether or not you associate falling real estate prices with the end of the world. Real estate prices are falling, and they will continue to do so until prices are affordable again. With all of the talk about stabilizing the housing market, people overlook the benefits of affordable housing. If people can live in a property and only spend 28% of their income on it, they have money left over for other uses. The economy will benefit from lower prices as discretionary consumer spending will increase. Of course, if you believe in perpetual Ponzi Scheme financing, we can always fuel our economy on ever-increasing debt loads justified by inflated real estate values. However, we just tried that, and so far the results haven't been too encouraging. We grossly misappropriated resources to non-productive uses, we overbuilt home improvement shopping centers, and we employed too many people in real estate related professions. The inevitable collapse of the Ponzi Scheme has left us deeply in debt, with an insolvent banking system, and with an economic recession. It will take many years for the California economy to readjust from the housing bubble just as it did in the early and mid 90s. The allocation of resources must change, and it will not be a pleasant process. I hope the California economy that emerges is rooted in something productive rather than another unsustainable Ponzi Scheme.
Today's featured property is another loser in our real estate game of musical chairs. When the music stopped, today's owner had taken out all the equity and left the lender is without a chair.
There have been some rumblings about the declining inventory numbers and the slight uptick in sales in Irvine. Perhaps it is signaling a bottom in pricing? This doesn't seem likely, particularly with the Alt-A and Prime ARMs due to reset over the coming few years. The fact remains that REOs continue to enter the market, and they continue to drive prices lower to find buyers. Until that stops occurring, prices will not stabilize much less appreciate. Today's featured property is 35% off its 2005 purchase price, and the lender recently reduced the price drastically to find a buyer.
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.
Remember during the bubble rally when everyone was in love with real estate? Turns out it was an infatuation. The fickle homeowners who sought to possess real estate at any price are now dumping their lovelorn properties en masse. Of course, it is easy to become infatuated when something or someone is making your dreams come true. All people had to do was buy a property and begin extracting and spending all the free money it provided. Now that the market has reversed, and people are saddled with crushing debts, and the property is no longer providing free money, it is easy to see why the object of their infatuation has lost its luster.
Today's featured property is another casualty of the low end of the market. There is much less denial at the low end, and much more carnage -- for now. The married woman who bought this as her sole and separate property has some of her own money in the game, so she showed more resilience than those who bought with 100% financing. You see, with any market price collapse, it starts with the weakest hands -- those that paid way too much and have little incentive to hold on. When these people sell, it drives prices lower and distresses a whole new group of market participants -- people like today's owner that have some money in the game, but not very much. The people who put 5%-10% down who are currently underwater will be the next group to give up. Of course, this will distress those who put more money down or purchased even earlier. Eventually, all of those who are overextended or deeply underwater will give up and capitulate to market forces.
