Excellent treatment of the issue. 

One note, in the conclusions, might want to add:

1.  Inefficient/Increased Transaction Costs.  Short-sales and foreclosures are horrible inefficiency transactions.  They disrupt and consume tremendous amounts of seller labor that would be better spent on productive work activities.  Property maintenance suffers and the deferred maintenance reduces asset value.  Credit hounds and lawyers are administrative overhead—not productive labor—and their business is booming.  All are market inefficiencies avoided by ‘normal’ sale transactions. 

2.  Animal Spirits/Reduced Quality of Life.  There is tremendous emotional toll that extends to those even living “comfortably in their homes.“  Expectations are called “animal spirits” (AKA bear/bull) in macroeconomics.  While animal spirits change slowly, as a macro phenomenon the impact is far beyond the foreclosed seller.  Basically, everyone’s quality of life is worse off, though obviously the folks with the most immediate and painful ulcers are those losing their houses or those whose jobs are directly tied to home sales.

Mike S.
——-

This is a nice summary of the options for repayment of home loans. Excellent work. What is described are the only options whether or not the loan is above water or not: either you repay it, sell the house or you default.

These options came to me when signing my (full doc) loan papers - this is a lot of money and I get to repay every cent though my hard work as long as I want to live here with most of it going straight to the bank (or CDO holder

I guess some people don’t get these feelings. Maybe these are the same people that buy cars based on monthly payment and not how much money the car actually costs. I guess someone has to keep the profit engine of consumer finance going!

The long and winding road…..

or for the Kool Aid crowd

We all live in a yellow submarine.

Great summary and a must read for all who want to know current state of real estate market.

I wonder if the addition of specific time line that it actually takes to do short sale, foreclosure etc. may add further understanding of the topic.

If so, anyone who is familiar with it please chime in.

Irvinerenter wrote, “Residential real estate markets generally move very slowly and trend in a single direction for long periods of time.“

From what I have seen in California, I have to wonder how true this statement is.  In general, I think other parts of the country are like this, but certainly, CA, in the last 20+ years, has demonstrated a very different trend.  It seems that the kool-aid here merely gets put back in the fridge until it cools off and then comes right back out again.  I keep getting the feeling that this state has a very sizeable population of dumb, aggressive, real estate hungry people that once things get down to a certain point, will jump right back in.  This will leave a short window at the bottom before we shoot off into another bubble. 

This place seems to operate in bubble growth and deflation modes only.

“This will leave a short window at the bottom before we shoot off into another bubble.“

I know it seems that way, but this isn’t likely. The market psychology has not changed yet, and the kool aid intoxication is still strong. After the market has dropped for 3 or 4 successive years, then people start to realize real estate does not always go up, and a declining real estate market does not represent a bargain. When the current crop of kool aid bargain hunters get their heads handed to them, the market will start to get the message.

BTW, this kind of thinking makes you a candidate for knife catching…

Very informative.  Thanks IR.

During the last decline, I estimated that my property value fell 24% from my purchase price in 91 to the bottom in 94-95.  I had planned to keep it and my mortgage was still affordable and not changing so I keep paying but put off some upgrades I wanted to make and was a little depressed.

This time is different, price declines will be double or more on a percentage basis what they were in the 90’s and people put much little down while postponing paying the fully amortizing loan amount which wasn’t in their budget.

This blog is really the best, it has kept my wife and I from purchasing a house a year ago and I feel so good that we waited.

that said, we have been renting for 2 years and need to buy a home to get settled.

We would love to spend under 600k, but most new detached homes in OC are all around 700 - 900k, more importantly around 275-300 / SF. Smaller homes have higher sf. pricing, bigger homes have lower sf. pricing.

We found a 3 year old home that sold for 1.3 million in 2005 (insane!) that is on the market for 900k. It is 3500 sf, so 257 / sf.

My question is - with a 400k decline (30%) on this one, how much lower do you think homes will fall in 2 years.

Can you guys really see $200/sf. for ex. 700k for this house.

I would love to see that, but is it really possible. I have not been drinking the OC Koolaid, but lived in OC my whole life and it has always been an expensive place to live. We just have to face that.

Also, with 2 years rent cost of 72,000 (3k a month) Is it better to wait or go for it.

Thanks for the input. really appreciate it.

Wanted to add -

The house needs no work. Every possible upgrade is there. So just move in.

Homes with better deals need work. I looked at every home with what it will cost after fixing it up, even if we waited 2 or 3 years after buying it.

Is it better to rent another year or two or go for it on this house.

Thanks.

“but lived in OC my whole life and it has always been an expensive place to live. ”

Expensive relative to what? House prices and incomes must come back into alignment in order for a bottom to form. Without the exotic financing, people are only going to be allowed to borrow what they can actually afford to pay back. House prices have been elevated from incomes for much of the last 20 years because of irrational exuberance, but after the inevitable crash, rents, incomes and house prices become aligned again.

It is difficult to predict a $ / SF price at the bottom because the bottom is going to be formed by the relationship between rent, income and financing terms. If wages and rents go up with our newly created inflation, then the $ / SF will not be as low. My guess would be that $200 / SF is likely in most neighborhoods. Some of the better ones may hold up at $250 / SF.

One thing I am confident about is that prices will be lower 2 years from now.

wait.

Try the California Homes, Willows and College Park sections of Irvine.  California Homes and Willows are best because of their close proximity to Heritage Park, the library and Irvine High School. 

These are small homes (1,200 - 1,500 sf) and very nice lots.  You can easily build forward, back or up.  Or for cheap you can add a great front courtyard and pick up 500sf or so of outside space.  No association so you can pretty much do what you want.

Recent sales are in the mid $500,000.  Work them hard or find one that needs some TLC and you can probably get into the high $400,000

Can anyone tell me what happens if a person defaults on their heloc. Can the bank go after them or do they just get foreclosed on? Also is there any tax consequences to this?

Nice summary, but I wanted to point out that Tanta at Calculated Risk is rather skeptical that there are substantial numbers of borrowers who are walking away from mortgage payments they could afford to pay.  She says that banks are talking about such folks, but she hasn’t seen any actual data that it is happening.  And how would the banks know anyway?  They don’t know what the borrowers’ actual income is, because many of the loans were stated income.

“...people start to realize real estate does not always go up, and a declining real estate market does not represent a bargain.“

This statement by IR is key to me. Judging by what I’ve encountered, the common thinking is slowly shifting away from the “real estate always goes up” method of thinking, but there is still plenty of “property values have dropped (to any extent), so they must be great bargains!“

It doesn’t seem like people have fully begun to make the connection that real estate was widely overvalued, and is still overvalued compared to any rational market. They are still basing their expectations on a bubble market.

It looks like that much higher inflation is being seeded by the politicians and Fed policy today…

http://www.321gold.com/editorials/schiff/schiff021508.html

Upping the Inflation Dosage
Peter Schiff
Feb 15, 2008

In perhaps one of biggest ironies to ever to come out of Washington, this week Congress simultaneously pilloried major league baseball players for using artificial stimulants to pump up their performance while passing legislation to do just that to the national economy. Am I the only one laughing?

In reality, the current slump in the U.S. economy is simply the come down from years of financial doping in the form of skyrocketing home values and easy credit. Rather than reaching for yet another syringe, Congress should ask Americans to do what it demands of ballplayers: play within their natural means. Unfortunately in the case of the economy, the patient is already so juiced up that further doses may not only fail to stimulate but may result in a trip to the emergency room.

As the widely-praised “economic stimulus” bill was signed into law, the only dissent heard was from those saying the plan did not go far enough. Speaking for those unheard voices who disagree with the strategy entirely, I believe the most significant aspect of the plan is that it creates a new and improved method for delivering inflation.

Previously, the government has largely relied on interest rate stimulus to keep the economy humming. In this method, money supply growth, also known as inflation, is channeled through the banking system. The Fed makes cheap credit available to banks, which then lend out the new funds or use them to acquire higher-yielding assets. As a result, asset prices, such as stocks, bonds and real estate, have been bid up to bubble levels. However, the inflationary impact on consumer prices occurs with a considerable lag.

Now that rate cuts alone are proving insufficient, mainly because banks are now so over-loaded with questionable collateral and shaky loans that few can consider acquiring more assets or extending additional credit (no matter how cheap such activities can be funded), the Government is opting for a more direct approach. By printing money and mailing it directly to the citizenry, the “stimulus plan” cuts out all of the financial middle men and administers the inflation drug directly to consumers.

If simply printing money could solve financial problems, the Fed could send $10 million to every citizen and we could all retire en masse to Barbados. However, more money chasing a given supply of goods simply pushes up prices and does nothing to improve underlying economics. Since this new money will go directly into consumer spending, without first being filtered thought asset markets, the effects on consumer prices will be far more immediate.

This politically -inspired placebo will do nothing to cure what ails our economy. The additional consumer spending will merely exacerbate our imbalances, allow the underlying problems to worsen, and put additional upward pressure on both consumer prices and eventually long-term interest rates as well. The failure of the stimulus plan to cure the economy will cause the Government, and the Wall Street brain trust, to conclude that it was simply too small. Their next solution will be to administer an even stronger dose.

My prediction is that over the course of the next few years, successive doses of even larger stimulus packages will fail to revive the economy. As the recession worsens and the dollar drops through the floor and consumer prices and long-term interest rates shoot thought the roof, politicians and economists will look for scapegoats. Few, if any, will properly attribute the problems to the toxic effects of the stimulus itself.

However, like all drugs, the biggest danger is an overdose. In monetary terms an overdose is hyperinflation, which will surely kill our economy. It is my sincere hope that before we reach that “point of no return,“ a correct diagnosis is finally made. When that occurs, the stimulants will be cut off, and the free market will finally be allowed to administer the only cure that works: recession. If that means we lose some speed on our fastball, so be it

Maybe we could use a few months in the minor leagues to get back to basics. While we may not like the economic side effects of stopping cold turkey, it sure beats carrying our money around in wheelbarrows!

Renting for two years is not a sign of failure.

“Settled” is relative. My wife and I rented for 13 years, nine of them in one place. You can still move even if you own something. It’s easier to move if you’re renting, though. So if you’re young, change jobs often, like to try living in different places, renting is probably preferable.

As for regretting the $3000/month in rent lost every year, you’re going to spend quite a bit in interest payments and “opportunity cost” (lost investment income) from your down payment.

Also, it’s a fools errand to try to time the market. No one can predict the market: If everyone knew the price will be X tomorrow, it would be X today. The only thing you can do is decide that you can afford something at the price at which you can buy it, and you will be OK with owning for the next few years whether or not the price comes up from there. You’re likely to break even after a few years, and believe you me: Irvine is not Detroit, the economy is not collapsing.

Another thing. Budget for how much you will spend when you own a home, and set aside that much each month. That will prepare you for when you do own, and also help you build up your savings (and good savings habits) in the meantime.

I think real estate is subject to the same fear/greed cycle as any other asset in a capitalist system. “Always goes up”, “is different”, “new support level” arguments have also been made in stocks and pretty much any other bubble. Everyone wants to get in on a rising market, no one wants to get in on a declining one. So people make arguments using these phrases to rationalize paying for something that should be obviously overvalued. ...Or to manipulate others into buying the overvalued thing.

Experienced investors (“A learning experience is one of those things that say, ‘You know that thing you just did? Don’t do that.‘ “ - Douglas Adams) recognize these phrases as GIGANTIC FLASHING RED WARNING SIGNS.

I recommend Burton Malkiel’s book “A Random Walk Down Wall Street” to anyone who is thinking about putting their savings into the stock market or houses or any other investment.

If nothing else, it will teach you to hold at arms’ length any charlatan who comes at you with the above phrases.

“After the market has dropped for 3 or 4 successive years, then people start to realize real estate does not always go up, and a declining real estate market does not represent a bargain.“

Kind of like watching an impressive run of black on the roulette table.  After you watch black come up 8 or 9 times in a row, you think, “okay, it will be black again.  Watch.“  Sure enough, it is black again.  The next time you (finally) put your money down on black, but the ball lands on red!  Darn!  Surely must be a fluke, so you put some more money down on black.  Red again!  Darn.  You put your money down again on black because you know the table favors black and it is long overdue.  Red again!  Now you stop gambling because it has finally sunk in that the table doesn’t favor black.  It took a while to realize, but you certainly know it now!

“With so many people with so little in the transaction, it did not take much of a price decline to cause people to give up…“

The present or future tense may be more appropriate for the paragraph beginning with this sentence.

How ironic—-  you said you would love to spend under $600K for a home—yet you are looking at a $900K home and think it is a deal?

Best advice-  sit down and figure out how much you can “comfortably afford”-  this blog has great resources for just that.  Then go shopping…..

You have time-  as IR said, prices will continue to fall.  Great deals will abound.  But if you can’t comfortably afford your new home-  the “deal” will turn into a “nightmare”

Wow, IrvineRenter. This is a stunning piece of writing. The most understandable and complete explanation I’ve read anywhere. Your book deal should be a slam-dunk with writing like this. Go for it now, everyone will buy it. Looking forward to your and Mrs. IR’s housewarming party in Shady Canyon soon!

Your observation is correct. The most difficult challenge in writing a book on this subject has been finding the appropriate tense. By the time it is published, this will be past tense, so I have been writing as such.

My husband and I are in our 50s, rented for 25 out of 28 years of marriage. Those 25 years as renters were definitely happier times for us than the 3 years of ownership. And we owned a beautiful new house in a great neighborhood! Much happier now that we are back to renting.

As renters, we didn’t move often; we usually stayed in one place longer than most of the owners in our neighborhoods. Every place we rented truly felt like home, and we’ve always been able to rent a much nicer place in a better neighborhood than we could afford to own.

It’s nice to not have any stress sourcing from the home that you live in. You want your home to be a comfort when you come home from work each day. Renting allows you that luxury.

There’s no law that dictates that you need a mortgage to put down roots in a community. You can put down roots as a renter. It’s all about quality of life here, not chasing someone else’s idea of “The American Dream.“

If you like youtube better than reading, then watch this. Don’t know if it was linked on this blog or not.

http://www.youtube.com/watch?v=4XhvG_fD0HA

A well written and informative article.  Nicely done.

I think these homes will actually do well after the bottom when people are interested in “value”.  No Mello Roos, little to no HOA fees, big lots, well-made lathe and plaster, safe, well established neighborhoods.

E
Right now, everyone wants new and shiny.  Give this thing a few years and all the value plays will be taken out, dusted off and attract buyers is my guess.

It makes no sense to pay more than 150-160 price to monthly rent ratio in _any_ circumstance.
So, if you are not paying 3k/mo, for the same thing you shouldn’t pay more than 450-480k in _any_ circumstance.
But of course, you can buy a better house than the one you’re renting now
My recommendation: just wait a few more years.

It took five or six years to get to the bottom of the last cycle and then a few more of hanging around not far off the bottom before real estate started moving again.

Many would-be sellers failed to sell their homes at inflated bubble prices…

Paper gain…. paper gain.

Besides, even with a 50% drop I can walk away paying off my mortgage and have a nice, big downpayment to put on the house up the hill.

In fact, it would make more sense for me to see the market crater to 50%.  Then the “upgrade” path would be a lot cheaper.

It’s a question of who’s to blame - if the problem is predatory borrowers (lack of creditworthiness) then the banks have the excuse that they can really only infer creditworthiness from past actions (credit reports).  If the banks admit that the problem is ability to pay (capacity), they do not look good, because capacity is (or should have been) much easier to quantify.

In other words, the banks’ admission that widespread stated income fraud lead to many of these walkaways would be eo ipso a confession that they were wrong to allow stated income loans in the first place.

djd, I think the lesson that lenders (who aren’t subsidized by taxpayer guarantees) will eventually learn from this bubble is that the size of downpayment is the most important determinant of future losses on a home loan.  Credit quality and income will be seen to be of secondary importance. 

In a declining market such as California’s, downpayments of less than, say, 30% right now are strong evidence of government intent to use taxpayer funds to cover future losses.  If the FHA and FNMA and Freddie and FHLB all the other govt schemes to support banks that continue to lend more than 70% of home prices were taken away tomorrow, then prices in CA would drop by maybe 50%, plus or minus 10%.  So I would argue that anyone lending more than 50% is doing so only by assuming that any big losses will be covered by the taxpayers, and they wouldn’t do it if they were told they were not going to be bailed out.  Can you imagine if 50% were the new minimum downpayment requirement, until house prices went back to their long-term trendline?  This whole market correction would only take 2 years or so, instead of the 5-7 more years it is likely to take now.

Great post, as usual. 

Two items of note to hopefully add some value: 

1) When viewing listing information, it is important for potential buyers to be informed that a property offered “subject to short sale” should not be given the same weight as a bank-owned (REO) in regards to advertised price.  The former is merely a hypothetical price that is fished out to the public to entice bids, with no guarantee that either the current owner will accept the writedown on any deficiency, or that the bank will accept a full-priced offer, either.  The unfortunate policy of the banks, due to the abundance of short- properties is that they will not publish an acceptable price until a qualified offer comes in.  They actually refuse to begin working until they have an active buyer who has made the first significant step of writing a prequalified offer. The latter REO cases, however, are much further developed.  The property is already on the banks’ books, they have compared (possibly) several BPOs (Broker’s Professional Opinions) and have set a price that they WILL settle at.  Something to watch for as more of this downturn plays out.

2) Lawmakers are currently considering a “forgiveness” package for short-sales where the properties are a primary residence, wherein the tax consequences would be negligible for owners who have suffered a loss in the current down market.  I am admittedly a fairly charitable citizen but think it is irresponsible to see the gamblings of some being born by the interest rate of the many.  It is akin to sending 50 people to MORON-GO (the most apropos of all casino names, in my estimation), giving each $1000 to gamble with, and then refunding any losses. Does this sound like a sound fiscal plan to anyone, or just more pandering during an election year?  If we are going to let people keep the gains, we have to hold them accountable for the losses, plain and simple.

P.S. With your permission, I’m going to steal “Price is the ultimate amenity.“  It will be used frequently in my near future listing appointments.

“..the lender will bid on the property up to the value of the loan”

I want that job. To sit there and bid up the price at these auctions for the bank. I guess somebody has to do it.

Nice theme for a Hollywood movie.