With the dramatic changes we have been witnessing in the lending arena, it was suggested in the forums that I link to an old analysis post which discussed the implications of what we are seeing in great detail. If you are new to this site, or if you need a refresher on what this change in loan terms is going to do to the housing market, I suggest you follow the links below.
2007-05-07 — Your Buyer’s Loan Terms – The precursor to The Anatomy of a Credit Bubble. It discusses house prices from the perspective of the future buyer of your home. It demonstrates the impact changes in loan terms will have on future buyers and how this will impact the amount your future buyer can bid for your home.
“CNBC just reported that 30 year fixed jumbos are at 8%; they were less than 6% a few days ago.”
can u post the link.
If that’s the case. higher end homes (>750K) will be severely affected, resulting in steeper decline of reported median price.
There’s something FUNDAMENTALLY wrong with using median INCOME vs. median home prices to calculate home affordability.
Think… median incomes take into account EVERYONE… including those who might have bought their homes a long time ago and who might be retired. Or those who could not afford to buy their homes at today’s prices….
I think in order to really look at home affordability correctly you have to look at the median HOUSEHOLD WEALTH vs. median home prices. In this way you will see that retired folks with paid off mortgages, or long term owners with low mortages and lots of equity can easily afford a home because of the huge down payment they’d bring on the table.
Another way to look at home affordability is too examine the median INCOME OF ACTIVE BUYERS vs. median income prices. I believe this is the most valid way to measure the correctness of home prices.
is there a way to determine active buyer median income?
I work for a major lender (won’t say) and all day we’ve been getting e-mails about the lenders who are dropping Alt-A loan programs “until further notice.”
I have very mixed views about the Fed cutting rates. As someone in the loan industry, I naturally want to see loan business pick up. However, we may just be prolonging the inevitable and making the hangover that much worse when all is said and done. Moreover, in some sectors of the economy there are inflationary pressures building…lower interest rates will just contribute to them.
Strictly in terms of interest rates, this reminds me of the tech stock meltdown about six years ago. Then the Fed dropped interest rates to stimulate the economy…which just led to this overheated housing market…which led to a lot of people borrowing money they could not pay back. Who knows what would happen now if the Fed dropped interest rates to “stimulate the economy” again?
Why wasn’t Cramer screaming like this when lenders were handing out $500,000 loans to people with no jobs?
I dunno about you guys, but if the fed overstimulates the RE market again then I’ll sell my home for 5MIL.
Aloha Irvine. Aloha Mainland.
Then move to Kauilua Kona, lease a coffee bean plantation at the 2500 foot level and eventually buy it during the next RE crash.
I’ll sell handpicked, ultra premium bean Kona Coffee from our “W&P Coffee Ranch”. (WP = da Wahine and da Paniolo)
Aloha.
When you examine the projections I used in Your Buyers Loan Terms, I used a comparable market rent value of $2,250 rather than either the median rent, or the median income at 28% DTI. So the basis for pricing is apples to apples. This takes out most distortions.
As for the issue or retirees, this is a component of every real estate market in the United States, so if there were a distorting effect based on that variable, it would show up everywhere. It doesn’t.
I know of no way to calculate the median income of active buyers because I don’t know how to accurately identify this group. When credit loosened, this was anyone with a pulse. In the future it will be those with 20% down and good credit. Plus, this doesn’t factor in the impact of exotic loan terms and the like.
Comparing median income to median home prices is an imperfect measure — one which I compensated for in the analysis. However, there is a relationship between the two measures which is consistent over time in more real estate markets. California, as usual, is the oddball.
I’m beginning to wonder if indeed this time the bubble was different.
Look at the prices in the urban East. Homes and flats are high. SoCal had a lot of land until recently, and now we’re beginning to mature.
When you look at truly mature markets: Western Europe, Japan, etc… the cost of a flat or a house is truly astronomic. Much higher than it is in the US. Indeed, the only place in the US where the cost matches would be Manhattan.
I wonder if as our market matures, the housing availability for a single family home will simply vanish. Just as buying a home in London, Barcelona or similar land shy locales is astronomical.
In effect, I think the future for affordable housing in the Coastal OC and LA counties will become mid to low/high rise. Buildiings between 4 to 9 stories high.
Of course, I’m not talking about those fancy digs by the freeway with their “luxo” costs… I’m talking about nice flats, 2400 sq feet, 4b/2ba, for around 300/400 sq foot.
I got a feeling that as we become more and more congested, the cost of land will simply skyrocket and you’ll see a more European urban city design.
And before you start noticing the “empty space” in Irvine. Remember that much of it is already earmarked for open space. Besides, European cities match high density, mid rise buildings with lots of parks -and big Churches and Futbol Stadiums.
The transition you describe will undoubtedly happen over time. However, the parts of Europe with astronomical prices like Manhattan are only in the small section of urban cores. I guarantee you could find a very affordable home in rural Poland.
You do touch on the issue of “running out of land.” It is true that we are running out of “raw land,” but there will always be opportunities for redevelopment and increasing densities on land already in some land use. Note the 5000+ units added on the Jamboree corridor just recently.
Even in highly developed urban areas, there is always a balance between incomes, rents and housing prices. It is possible to be “priced out” on a temporary basis, but the system will reestablish an equilibrium. Even the Japanese, who created a huge bubble and ran out of raw land centuries ago, watched their prices decline back to an equilibrium value.
It isn’t different this time, and it won’t be next time either.
They are dropping Alt-A in part because when sub-prime imploded many sub-prime applications were simply recast as Alt-A. But changing the name doesn’t change the underlying risk.
Tony,
Take a look at this OCBC report on housing http://www.ocbc.org/documents/HousingScorecard2007Final.pdf
They cite that there are 9000 acres of infill space that could be developed in OC that could amount to 77,000 units.
A couple of points that they miss is they cite the median income in 91 was $46k and in 05 it was $68k. What they don’t mention is that adjusted for inflation it didn’t change and if you use the SoCal CPI data it shrank.
The other data point they miss is they cite that the housing stock grew by 158k units between 91-05 and jobs increased by 346k in the same time frame. What they missed is that the amount of people living in the inland empire and commuting to OC for work increased by 200K in that time. There for the 158k units was more than enough for the 146k who live and work in OC.
Also note how the younger population is dropping. Ages 25-29 by -13.2% and ages 30-34 by -10.7%. This really is not good at all.
Because he was (and probably still is) long CFC and WM.
Not sure I understand the “prolonging the inevitable” argument. Prices are a function of rates. If rates are cut, liquidity increases, people can borrow money more cheaply, prices go up. There is no imbalance unless rates are changed and prices do not move in response. Since real estate is illiquid, there will always be some lag. That’s how we got into the current situation — rates slashed to near nothing, 2 and 3 year mortgages doled out like candy, rates raised, 2 and 3 year mortgages come due and poof you have a meltdown.
But cutting or raising rates in and of itself doesn’t really “prolong” anything; rather, it changes things. The permanence of that change is dependent upon the next change in rates. If the Fed wanted to, they could cut rates by 100 basis points and engineer a softer landing in the credit markets. But Big Ben is, as Cramer would put it, an academic, whose first and foremost concern is inflation. It looks like the 17 consecutive rate increases are having an effect on inflation — house prices are coming down, gas prices are coming down, etc. (I know these are not part of the “core” measure of inflation). Unlike Greenspan, however, Big Ben is not as reactionary, so he will likely sit and watch things unravel for much longer before giving the market any relief. That will likely kill credit, M&A, and equities, and that’s why Cramer is so hopping mad.
Well, for one I would not compare The Grande Metropolis of Irvine with Southern Silesia. 😉
If you look at the size of the OC you get pretty much Barcelona. And if you go and add LA proper then you got your Paris/London size.
If you go to those places, you will see that people don’t want (can’t) live too far from the central cores and so they buy flats in the city proper. Yep, you can get a house in the boonies (not in Barcelona though) and have a hellish commute into town for those 30/40 kilometers that would make your typical Riverside to El Segundo commuter blanch with fear and terror.
As I remember, the population of Kahleefohnya is suppose to almost double in the next thirty of forty years. You can imagine what that will do to the LA Basin. We can not keep building SFHs out in the desert so at some point LA and OC will become urbanized and at that point the cost of land will make it prohibitive except for the real wealthy to own land of any kind.
In the meantime, I think that in the next 10 to 15 years the lands West of the 405 will start to get more and more urbanized and the 405 will become a double decker with rail thrown in.
So…. although we have just had one humongous RE bubble, please note that the underlaying trend is an upward net cost (after inflation) of the land driven by population growth. So, when you calculate the “true cost” of land you must allow for this trend. After all, this is not Iowa where you all a developer needs to do is buy out a square mile just out of town and put in some 200 homes on huuuge lots. The land is just about free over there because there’s an incredible amount of it.
There is some truth to the old adage “there not making any more land”. It does not justify the latest bubble, for long term it is quite true.
It would be “prolonging the inevitable” because the housing market has not reached a point of equilibrium. The runnup in prices was started because of the lowing of interest rates, but that was only the catalyst. The real cause was the dramatic changes in loan terms: allowing DTI’s of 60%, 1% teaser rates on neg am loans, 100% financing, etc.
Current market prices are well above the equilibrium state created by lower interest rates. If you go through the post entitled Your Buyers Loan Terms, you will see I have broken down the various scenarios. You can see what the equilibrium state would be at various interest rate levels based on other available loan terms.
Think about it: would banks let serial refinancing go on forever? At some point, won’t investors want to get repaid? Is it a realistic lending strategy to bet on continual asset price appreciation to serve as collateral for an ever increasing loan balance? The assumption behind every exotic loan option is the idea that some day the borrower will convert over to a 30-year fixed loan. Well, now is the time of conversion. The credit crunch is here.
A few thoughts.
I believe Tonye is correct. The market price is defined by demand (# active buyers and what they can afford) and supply (# home sellers and what they will accept). The median/average income of the local population is not a very good indicator. It may not matter at all if most of the active buyers are coming from out of the area.
That said, the # of active buyers, and what they can afford are affected by interest rates, loan terms, expectation of future appreciation etc.
On the other side, sellers are highly influenced by their expectation of future appreciation. If they expect continued appreciation they will keep (or acquire) more house than they need, stay put when they retire etc. If they expect little, none or negative appreciation they may downsize or leave the area when they retire.
I think prices have most to do with the cost of money (interest rates etc), job creation (loss) and expectations of future appreciation. I think the average/median income of the existing population is important but not a dominate indicator in many markets.
I lived in CA (bay area) for 21yrs (1985-2006). I have seen periods of strong year to year appreciation and periods of flat to down appreciation. Right now I’m feeling pretty good about selling last year, downsizing and “retiring” to a far less expensive area. I figured that the dotcom boom/bust (boom for silicon valley, bust for investors outside silicon valley) and recent low interest rates had worked together to push bay area liquidity to highs not likely to be matched in the near future. Thus a good time to sell.
I would not buy in Irvine now unless I believed there was going to be a huge increase of very high paying jobs for a very long time or (as some were talking about) all the rich people in the world had decided they had to live in Irvine.
If one could characterize the buyers of the last 5yrs that would be very useful info for judging the future. How many of the buyers were locals moving up? Investors (flippers) from around the country? Rich people moving in from around the world?
I enjoy reading your blog. Keep up the good work.
One more thought.
I do think rent levels are important if you find out most the the active buyers are investors who plan to rent a property for some period of time.
Bottom line.
Who have been the active buyers? Who are they now? Who will they be in the future? How many and what will they pay? What is the trend?
Who are the sellers? How many and how motivated? What is the trend?
I think rent levels will become very important to investors once they realize they cannot rent the place to cover their expenses. Most investors don’t want to own a depreciating asset if it is simultaneously running a negative cashflow — which all properties are at these price levels.
There are too many questions to try to pick through them all, but I would say for the most part the buyers in the rally were anyone with a pulse and an insatiable greed — which precludes very few people. Once the music stopped, the only buyers were crazy flippers and a few knife-catchers who saw the dip as a buying opportunity.
As for the sellers, there are a number who are just clinging to wishing prices, but there are ever increasing numbers of underwater homeowners and bank REOs who by their nature are very motivated.
The bottom line is that the demand side of the equation is greatly reduced, and the supply side is greatly increased, and this trend is continuing.
The fed cannot cut rates. cutting rate at this point will cause inflation which means that the nominal rate on a mortage will stay the same.
The reason AG was able to cut rates without inflation was globalization which enable him to export the inflation to china. But now as china and india wages are coming up to western standards he cannot export inflation any more.
Home Myths Meet Reality
Builders Were Supposed
To Handle Downturn;
What Went Wrong?
http://online.wsj.com/article/SB118618271832887837.html?mod=home_we_banner_left
Seems that inventory increases slowed in the last few weeks…
Probably removed homes that were languishing on the market…
Interesting fact from the article:
“The incentives that companies are using to sell homes are so large that they are crippling profits. Take Miami-based Lennar Corp., which said its average incentives were $43,700 on houses worth an average of $342,000. That is up from a year ago, when incentives averaged $24,700. And Lennar has one of the best cash flows in the industry.”
So why doesn’t Lennar just drop the prices to $299K and forget about the nonsense incentives?
Nobody is fooled anymore. I don’t want a $40K car or a plasma TV, I want a place I like in a location I like for a price at parity with the rent for the place and in line with my income.
It is easier to lower pricing when starting a new community than it is on the communities in which they have been building for a while. Homeowners who purchased before the price drops get very angry when you undercut them because you wipe out whatever fantasies of equity they had in their homes. Plus, price reductions in mid-development of a community actually have a negative impact on sales as people simply stop buying and wait for more reductions.
A blast from the past:
http://query.nytimes.com/gst/fullpage.html?res=9D04EEDA153BF934A2575BC0A967948260
Is it any different this time?
Great comedy about the subprime lending fiasco:
http://www.comedycentral.com/motherload/player.jhtml?ml_video=90948&ml_collection=&ml_gateway=&ml_gateway_id=&ml_comedian=&ml_runtime=&ml_context=show&ml_origin_url=/shows/the_daily_show/videos/larry_wilmore/index.jhtml%3FplayVideo%3D90948&ml_playlist=&lnk=&is_large=true
IR-
I love the site–and I love this article. Unless I am mistaken, this is written by THE Ben Stein of Hollywood fame (Win Ben Stein’s Money, Ferris Bueller’s Day Off, and several Visene commercials), as well having been a speechwriter for Presidents Nixon and Ford.
I wonder where Ben Stein’s money has been going lately? I’m guessing he hasn’t been speculating on California real estate…
Here in the Nation’s capitol, prices have been slowly but perceptibly dropping for about the last year. I keep a database of homes in a specific area (zip codes 20002, 20003, and 20024), and of a specific type (3/2 townhomes and condos) and price range (250-600k, median for these zips). As of today, there are 129 active in the MLS. They are averaging 105 days-on-market, and of the ones still active, they are reducing prices at the rate of $267.85/day per listing, which translates to $(8035)/month–PER HOUSE. (Median price for this specified grouping–$449,900, avg–$444,465). The bummer for these folks is that the listings that sell have been reducing about 10% more quickly to make it happen ($285.41/day). I can compile these stats, but apparently their Realtors ™ cannot or will not. I guess candor is hard to come by in some professions.
I track this reduction number every day, and and while it fluctuates, it is only getting steeper over time. I was going to buy this spring, but I just can’t see it yet. If the events of the past few days are any indication, the reduction rate will steepen, and prices not equilibrate until historical norms are reached–about 50% lower than the peak in these neighborhoods. My best guess is the bleeding will continue for 6-10 quarters.
If it would just be one quick painful blast, that would be cool. But like a big bandaid on a hairy chest, this one will just hurt and hurt as it slowly get peeled off.
Thanks again for the site. I’ll try to update on the DC RE stuff from time to time.
-Kurtyboy-
Thank you. I look forward to seeing your updates on the activities near you.
IR, great 1981 article from Ben Stein. I love the historical perspective. If you happen to find any from even earlier periods, I’d be fascinated to see them. I arrived in CA in 1987, so I didn’t see the market here in the 1970’s and early 1980’s, but it sounds exactly the same as what I’ve seen since I’ve been here.
Lending rates lower than home price appreciation means lenders are paying borrowers to buy and hold houses. With these nutty incentives, a bubble and eventual deflation is inevitable. That was apparently true in the 1970’s, and again in the 1980’s and in 1996-2006.
Even the idea that foreign buyers are driving prices up is in this 1981 article. I thought that was modern. In fact, about all that’s different is that back then a major force driving prices up was:
(a) many women joining the workforce for the first time, and
(b) Paul Volcker driving interest rates well above home price inflation, and making it absolutely clear that there would be no helicopters dropping cheap or easy money to take away the pain.
meant to say “… major forces driving prices up and then down again were:”
Interesting stats that are you tracking.
Usually they are available after the fact, and then everybody asks: why nobody told me about it?, well, as I read somewhere: “information is power, that’s why you don’t get any”.
Is not the lack of candor of the realtors, based on the evidence unearthed by this blog, is the lack of intelligence.
I’m also a fan of Ben Stein’s work and humor, he has a column on the Yahoo Finance section.
Hmm…he didn’t mention at all the US military closing local SoCal bases as the culprit of the past real estate crash, seems to me that that came later, and real estate and mortgage industries re-wrote history for their own convenience.
Oh I remember that time.
My dad had a bunch of CDs at 13 and 14%. I walked into the bank one day and I saw the 18 1/2% yields. I went home, calculated his cost to sell his CDs and realized than within three months he’d be making more money.
Anyhow, that afternoon all of my parents’ CDs were at 18 1/2%. My only mistake was not getting them all af the maximum time. We staggered some at 3 years instead of 4 and 5.
My parents though I was a genius! 😉
The RE market did not recovered until ’87. We drew up the contract on our home in January 87 and by the time we closed in April the home had appreciated $35K! Our seller tried to break the contract, did she ever, but we had the loan money on escrow and we would not let her off the hook unless she came up with LOTS of money.
Anyhow, the rest is history.
BTW, interest rates, even in 87, were really pretty high by today’s standards. And you need 20% down or 10% and PMI. That was that.
Somehow the banks forgot about financial responsibility in the last three years.
No Money Down Disappearing as Mortgage Option
http://www.washingtonpost.com/wp-dyn/content/article/2007/08/04/AR2007080401418_pf.html
Western states went exotic with mortgages
But credit crunch means options are dwindling
http://www.marketwatch.com/news/story/risky-mortgages-were-very-popular/story.aspx?guid=%7BB164A336%2DA000%2D48C5%2DA9D1%2DFEE96F0DFD35%7D&siteid=yhoof
California led the nation in originations of payment-option ARMs, with about 24% of all its refinanced and first mortgages falling into this category last year, according to data firm First American LoanPerformance.
…
One hit with borrowers over the last few years was the interest-only loan, which allowed homebuyers to pay just interest for a fixed period of time. Interest-only mortgages made up about 22% of all U.S. loans last year, says LoanPerformance. Nevada outpaced the average in this category too, with 34% of its mortgages deemed interest-only; California stood at 32% and the District of Columbia 33%.
Lets assume Fed cuts interest rates, what would that do to falling $$? I believe $$ will fall further, falling $$ has already impacted in terms or inflation, everything we touch everyday is made in china or somewhere in Asia, if $$ keeps falling, things will keep getting expensive.
Why would Fed cut rates and on top of all knowing people who are stuck in credit crunch has caused billions of dollars of loss to banks and brokers, why would you as an investor invest in mortgage backed security knowing financial condition of US?
A nice easy to read article that sums up how the house loans work
http://www.nytimes.com/imagepages/2007/08/05/weekinreview/20070805_LOAN_GRAPHIC.html
Thanks a lot, Sue! That should answer a lot of people’s questions. Great link!