IR:

What an excellent read it is on the mighty important DTI ratios.

Thanks,

George8

Excellent post.

When those pretty curves go up and down there is huge wealth transfer.  I think this has a long term impact on price to rent ratios of premium areas.  Irvine is not SF or NYC, but you can see this effect in SF and NYC. (where rental parity will never exist baring a Mad Max scenario)  For a local example you can see this effect on Balboa Island where you will never see rental parity again.  My opinion might be unpopular on this blog, but I do not think you will see rental parity in premium areas of Irvine due to it’s comparative advantage to surrounding areas.  I know down payments are very large in Irvine.  Is this down payment trend the same for nice surrounding areas with lesser schools and a different target market?

Irvine is headed down from here, without question.  This is excellent data on a macro level.  The trend will be down for quite some time.  Dissecting this data on a more micro level is dangerous.  It’s the equivalent of saying all stocks should trade at the same P/E ratio.  Even in a down market, future projections and time horizons have an impact on economic ratios when comparing apples to oranges.

Rental parity will not require the Mad Max scenario, although it will feel like it to those who have lost so much phantom equity. Time and continued lender tightening is all that is required.

Not all properties will bottom exactly at rental parity. Condos will fall below, median properties will match, and prime properties will retain a small premium. This is the nature of pricing in a normal market absent the effect of irrational exuberance.

Two major things have to occur for prices to remain high: banks need to continue to loan money at default-prone DTI levels, and buyers need to continue demanding it. The lenders are tightening their standards, and they will continue to do so. Our economy is suffering because of lender reluctance to make loans, and they are reluctant because previous loan standards caused them to lose so much money. Buyer psychology is always the last to change.

Nice Post.

Excelent post IR.

I have attempted to make this argument several times over the last three years.  Bank policy takes months or years to change, but they will continue to tighten.  No way around it.

31% is the front-end DTI that covers payment, taxes and insurance. 41% is the back-end DTI covering total indebtedness including car payments, credit cards, etc.

The median income/median price relationship breaks down in areas like Beverly Hills where those in the top 50% make much, much more money than the bottom 50%, and the bottom 50% is relegated to rental housing. Irvine was designed with a many small condos in order to create a balance of ownership products. From 1995-1998 in Irvine, the aggregate DTI was less than 30%, and the median home price to median income relationship was at 4 times.

I agree with you on a more macro level.

Cash down paments impact price fundaments as they are added on top of loan DTI requirements….. but the caveat is that cash down payments are not necessarily seperate from DTI requirements and lending standards. 

Keep in mind when I say “premium” it doesn’t mean prices are going up.  The willingness for cash to flow into certain markets impacts how far asset prices will fall.  The premium can go up while asset prices crash.  Wealth disparity continues to be one of Americas greatest challenges, and I don’t see it changing any time soon.  The knife catching data in Irvine is proof positive of this, we’ll see how long it can last.

The recent buyer pool has been dominated by buyers with large cash downpayments. There is a very limited supply of these people, but they are exactly what the lenders are looking for. Someone needs to step up and absorb the next 20% decline, and the lenders do not want to be the bagholders, so they find those few buyers with cash and give them the bag.

Realtors have no shame and no credibility:

Realtor eyes O.C. housing bottom by summer

http://lansner.freedomblogging.com/2009/01/04/realtor-eyes-oc-housing-bottom-by-summer/10848/

“Condos will fall below, median properties will match, and prime properties will retain a small premium.”

If you run the analysis on an aftertax basis, I’ll bet the numbers line up better across the different types of properties.  People with mortgages just under $1 million are the ones with the highest portion of their income as a deduction for mortgage interest.

“so they find those few buyers with cash and give them the bag.”

I disagree.  The banks are not finding these people.  These people with large cash savings are lining up to pay the banks.  The stupidity of bubble buyers is undeniable. The stupidity of people with piles of cash is another story.

“There is a very limited supply of these people”

This is why I read your blog, to find out if this is true.  The massive wealth transfer that occured during the global bubble is an important side show to asset deflation.  I would like to see an analysis that some how catpured the “limited supply of these people”.

“The FHA currently allows a 31% DTI for housing debt. Years of experience has shown that DTIs in excess of this amount have high default rates.”

In your example above, 31% DTI using the median income results in a $2,353 monthly housing debt payment.

“Someone using a DTI of 31% is really spending almost 50% of their take-home pay on housing and related expenses.”

50% of take-home pay is a lot of money to spend on housing. If prices fall to valuations supported by fundamentals as cited in the charts above, that’s still a big expense for housing.

Regarding rental parity, does that mean someone making the median income should be paying almost $2400 for rent? I can’t speak for everyone, but I consider that to be entirely too much money to be paying in rent or any housing expense for that matter.

Don’t forget that on a macro level all these assumptions and predictions don’t factor in job losses or extended economic pain.

If 3 bedrooms crammed into under 1600 sq ft is what the median family in Irvine making nearly $100K/yr should expect to be able to afford, then that is very sad indeed.

This small condo should not be considered a “median” property.  This was simply developer’s greed, during the bubble, maximize the number of properties per lot and maximize profits.  When people realize this, they will flee to places where they can get more space and Irvine will crash down to earth and will be considered no better than Costa Mesa.

I wish I knew of a way to quantify this number, but I do not. Asset price deflation has certainly reduced the aggregate wealth of society, and the savings rate decline during the bubble, so there wasn’t much sitting around in savings accounts that missed the asset price crash. Residential real estate markets have functioned for the last 60 years based on the availability of credit. The bubble was clearly inflated on credit. Perhaps there are enough buyers with 30% down to keep prices inflated indefinitely, but I doubt it.

Right now, inventories are relatively low because there are no discretionary sellers, and the influx of distressed sellers will not come until the ARM resets and recasts occur. As long as inventories are low and sales volumes are low, the few cash buyers can support the market. Do you think this situation can go on long enough for incomes and rents to catch up to current pricing? That will take years, and the market must absorb the must-sell inventory from the ARM problem before this occurs. Anything is possible, but it doesn’t seem very likely that buyers with large downpayments can absorb the coming must-sell inventory at current prices.

You always have to remember that ‘ole boogeyman, the AMT. If you have a million dollar mortgage, and the income to support it, then there’s very little chance the AMT isn’t chipping away at the “tax benefit” of home ownership.

This is just another extremely complicated calculation a prospective homeowner must make.

where’s the DTI data for 2007 and since? I would love to see it after the peek

In my generation, the colloquial way of talking about pushing the DTI was “house poor”—so much of your income going into showy housing, or to get into a good school district, that you had to take all kinds of lifestyle tucks—no travel, no eating out, discount-store clothes and furniture, old cars, doing all your own home repairs, etc. We felt sorry for people who had to do that. In places like SoCal, the housing bubble made “house poor” obsolete because you could compensate with HELOC money from your appreciating asset.  Of course in my parent’s generation (the Depression Generation) everybody lived the no travel, no eating out, etc. life style just by instinct regardless of DTI, but I don’t think folks today are as ready for that. So it’s time to put the useful concept “house poor” back into popular usage.

I love the user comments at that link, especially this one:

Bogey Says:
January 4th, 2009 at 12:30 pm

“All of the ingredients for a market recovery are there”

http://www.urbandictionary.com/define.php?term=captain assclown

The elimination of the problems of being house poor by HELOCs and refinancing is exactly what is keeping the market psychology from changing. People who believe they can have the big house, put 50% of their gross toward it, and not be house poor are the ones buying right now. People really believe those habits that have proven so disastrous to lenders are going to be enabled again soon.

People who bought because prices were going up became house poor out of ignorance to the market. People who are buying now that prices are going down are becoming house poor out of ignorance to the credit cycle. Both cases of buyer ignorance are sad, and they will have lasting financial impact on the lives of buyers.

I believe that down payments in Irvine will continue to be higher than all areas of the OC with the exception of premium coastal areas.  Beause of this I believe there will always be a premium for Irvine that exceeds any rental premium that might exist.  Prices will continue to drop, the premium might end up being small.  If prices drop too much there will be mass economic devestation (the Mad Max scenario).  Few here are willing to recognize just how leveraged these assets were and how their jobs and the entire economy are connected to the value of these assets.  This is an unfortunate fact.  Those who keep their jobs close to asset bubble incomes will benefit greatly.

“If prices drop too much there will be mass economic devestation (the Mad Max scenario).  Few here are willing to recognize just how leveraged these assets were and how their jobs and the entire economy are connected to the value of these assets.”

I think what you are describing as the Mad Max scenario is what I have been describing for quite some time. The closest parallel to what we are going through in 2009 would be 1992. What lies ahead will be similar to 1993-1996 except a bit worse. The deflation of a California housing bubble leaves many in the building industry either unemployed or underemployed, and it leaves everyone else in a state of indentured servitude to their houses. With the reduction in aggregate income, and with so much of the income of the states people going toward debt service, little is left over for discretionary spending. This is why the economy suffers. Reinflating the bubble or attempting to support prices will not help. Only time and people buying in at lower prices with lower DTIs will put the economy back on a stronger foundation.

Wow, is this guy David Lereah’s reincarnation?

I believe there were enough people who were smart (and lucky) enough to sell near the top and are waiting with cash to get back in at a lower level. Once their remaining intoxication turns to a hangover then we’ll be closer to the bottom.

I remember in the mid-nineties when real estate was considered a bad investment is when we finally hit bottom. We’re not there yet.

It goes without saying, but I have to say it anyway, an absolutely amazing and educational post.

Did anyone read the article in the Orange County Register this weekend about Citi Bank giving a loan modification to the former owner of Quick Loan Funding - one of the companies who wrote billions of dollars of toxic loans? Daniel Sadek lived the high life and his company was a prime offender in this housing bust and yet he gets his loan modified. What a joke! If I read the story correctly, at least the loan modification didn’t seem to help him - the house is going to default anyway….

http://www.ocregister.com/articles/sadek-citi-loan-2270290-billion-quick

Dano

House Poor and the Money Pit. When the house was a burden and when sinking thousands of dollars in repairs and upgrades was largely money down the drain.

I’m noticing the workers are more helpful at Home Depot, now that they aren’t so crowded.

Debt to income ratio should never be over 40%, that is the breaking point when it comes to deciding whether someone can afford a mortgage or not, in my opinion.

Ryan Philipenko - Real Estate in Edmonton

The Mad Max scenario I am describing is more like the 1930s.  I expect this to be more like 1990s Japan than 1990s Irvine… where mortgage interest rates go lower and stay low for a decade to deal with the ARM problem, a very slow bleeding of the asset bubble.

Great Post IR!

*Great research and data as well

If I’m not mistaken, that’s a plan 2 without Cathedral ceiling.  Plan 3 has the Cathedral ceiling and you could build a loft floor over it for an additional 340 sq ft ($15k-$20k cost).

I like the town-homes here but not the parking situation.  For 3 bed homes they only give you 2 car garage without drive way, and limited street parking spaces.  At night the streets are packed with cars and I had to park all the way by the pool.

I am one of those people who would love to buy but see no property that would interest me. Here in Irvine you get so much less for your money—small lot on top of your neighbors. Most can’t even hold a pool. We are packed in like sardines. I really dislike this area and only reason here is we need the airport. But I think the city did a piss poor job of design. Large parks, large berms wasted so much space. Yet they water all this property while you get a 3k sq. foot yard. Apartments are everywhere. In my neighborhood you can’t even park your car in the driveway (doesn’t fit) and we all have recieved tickets from police. Insane build a drive way that does not fit a normal car. What great city planners here in Irvine—REALLY—great post IR—-

I’ll never forget when in 05’ being transfered here I sat down and did the math—I make this much spend this much—2k a month for college (two kids in at the time) and I can live off of this much for a mortgage. And it sure was not 5k that could put me in the same house I just left.

The HOA, mello roos, homeowners tax was here 26k here in Irvine—What I left behind paying 5k for similar home in the Bay area mind you. Where HOA was $70 per month—no mello roos and taxes were almost 5k—for a somewhat new home. Irvine went tax insane!!!!!

No one would belive me when I said I looked at developments same kind of house and taxes were this high—HOA was over $100 even up to $400 in some areas in Irvine.

Everyone here needs to realize how over taxed you are compared to other places in CA. Along with how over priced these homes are.

In the Bay area at least I had a decent lot!!!

Yes, I came quite close to the AMT in recent years.

This reminds me of a collection of the things realtors don’t mention.  The tax deduction gets lower over time, because there is less interest being paid.  The tax brackets and rates move around.  Congress is always playing with the tax code: you don’t know what your deduction will be in a few years.  Congress could also completely get rid of the deduction.

Alan, couldn’t agree more. I also have a hard time categorizing this place a a median property.

How about the potential of the DTI changing because peoples’ incomes might finally go up now that we have a new administration?  Thoughts on the other end of this equation?