A look at the various paths the market may take as it wends its way back to fundamental valuations. Will it fall quickly in a ball of fire? or will it hold steady, frozen in time?
The featured property is a tiny 1/1 condo in The Lakes selling for 35% off the peak. This may be the least desirable property in Irvine, and its least expensive.
Asking Price: $197,900
Address: 144 Streamwood, Irvine, CA 92620
{book2}
As you may have noticed, we are experimenting with a new way of organizing posts. When we first converted to the split post format, I struggled for a
place to divide the posts. After about a month of experimenting, it
seemed logical to divide them at the property information breakpoint.
At first, when people would come to the IHB, they would see a few
pictures and the data on each property. We looked like a real estate
blog.
Over time, I started writing more and more in front of the property
description. This made the opening summary much longer, and it began
shifiting the emphasis away from the properties toward my writing about
the market or whatever. Then I added the youtube videos and other
stuff until finally we had 70% of the post above the dividing line. The
dividing line no longer makes sense, and it no longer functions as a
summary. Hence the new format.
Now the summary be a true summary by moving 98%
of the post below the break. This has several advantages: 1. It makes
it easier to scroll down and see several post headlines and brief
descriptions. 2. It gives me something to copy and paste to produce a
newsletter (more on that later). 3. The page should load faster because
there will be no graphics above the line. The big disadvantage is that
it may start to look like a news aggregator site. I would like to try
this for a while and see how it looks and feels. If you don’t like it, let me know, we may try something else.
Fire and Ice — Pat Benatar
Fire and Ice
Some say the world will end in fire,
Some say in ice.
From what I’ve tasted of desire
I hold with those who favor fire.
But if it had to perish twice,
I think I know enough of hate
To say that for destruction ice
Is also great
And would suffice.
Robert Frost
Desire, greed, avarice: house prices rose at unprecedented rates
because people motivated by greed were enabled by lenders (who were
also motivated by greed) to bid prices higher and higher. There is a
certain Karmic justice to the idea of the market perishing in fire.
Those who were motivated from desire should suffer in direct proportion
to the greed to which they succumbed. In fact, all moral hazard
problems emanate from this relationship. If people are not punished by
this behavior, it is magnified in the next generation as more and more
people choose to behave unwisely. In short, each bubble grows bigger
than the last because the survivors tell their tales. If you don’t
believe this is true, take a look at the series of bubbles in
California since the 1970s, and you will see a series of higher peaks
and deeper corrections. It is Karma in action.
Some say our market will crash and burn in a dramatic firestorm;
some say prices will experience a long deep freeze at current levels.
Today we will look at these two possibilities and try to determine
which outcome we will see.
So you think you got it all figured out
You’re an expert in the field, without a doubt
But I know your methods inside and out
And I won’t be takin’ in by Fire and Ice
First, let’s take off the table any ideas of a return of sustained
or rapid appreciation before prices return to fundamental valuations.
The only people who suggest such ideas are self-serving liars and those who chose to believe them. Anything is possible, but this outcome
is so unlikely that I will not waste any print discussing it.
Above is a look at the Fire and Ice scenarios for Irvine median home
prices. There is a tendency when looking at charts like this one to
assume that one scenario is aggressive and the other conservative, so
the truth must be in the middle. Don’t make that assumption. Prices
could easily crash below fundamental valuations as I described in How Bad Could Bad Get. If you think this is not possible, I suggest you check out Christopher Thornberg’s predictions (PDF) he just delivered to the BIA of Orange County. He is predicting a 32+% decline from today’s prices, that is over 50% off the peak. He is more bearish than I am; he may be right.
Take a look at the grey line in the graph above. That is the fundamental value. It is calculated based on income growth (which has now stopped), 6% interest rates, and a 30-year conventionally-amortized, fixed-rate mortgage with a 20% downpayment and a 28% DTI. That is where house prices would be if we would not have had a real estate bubble. The Federal Reserve is working to raise this line by lowering interest rates, but even a drop to 4.5% will not raise it enough to intersect those falling lines at a significantly higher price point. Prices will fall to this line before they find support.
There are several reasons I believe the fire scenario is far more likely:
- Price momentum
- Return to stable financing terms
- Increase foreclosure due to ARM resets
Look at the time it takes fundamental valuations to catch up. Does it seem likely to you that prices would hover in a tight range for 12-15 years? Would it be better to drop quickly then resume its ascent? or it is better to have a slow deflation as Japan did?
The year-over-year price declines have been breathtaking in most markets, although Irvine has held up better than others. The momentum of prices is downward. This will not change until buying makes sense again, and that does not occur until prices are aligned with rents.
The credit crunch has seen the purging of the worst of the “financial innovations” of the housing bubble. We are on our way back to conservative financing terms. Since people will not be able to borrow more, prices will fall to levels consistent with the new loan terms. That is lower than today’s pricing.
I have flogged the deceased equine over ARM resets, but I still see astute observers who believe that low interest rates will stop this bomb from going off. Until that craziness is gone, I will keep mentioning the ARM reset problem. It will create massive numbers of foreclosures. In fact, last Wednesday, I went to a BIA function and I was talking with a representative of Wells Fargo. He told me the foreclosure problem is far worse than most people realize. As he started telling me about the growing problems with Alt-A and Option ARMs, I felt like he was reading from the IHB. He did not know I am Irvine Renter.
The fire and ice scenarios are also playing themselves out in different neighborhoods and different market strata. I lifted the chart above from Piggington.com. As you can see, all market segments are dropping, so the aggregate is dropping steeply. However, different market strata are dropping at different rates. The high end is not dropping as fast as the low end. This doesn’t mean the high end is not going to catch up. In all likelihood, the low end will bottom before the high end, and the lines will all intersect just after the market bottoms.
You can see this same phenomenon if you look at cities or neighborhoods. Santa Ana has experienced Armageddon, and its resale value chart looks like the orange line above. Tustin would be the blue line, and Irvine would be the green one. If you wanted to break down Irvine’s neighborhoods, you would see the same pattern going from the least desirable (like El Camino Real) to the most desirable (like Turtle Rock).
It is important to note that this does not mean that premium neighborhoods will retain a premium on their premium. This is another common misperception. For instance, Turtle Ridge commands an approximate 10% premium over Quail Hill on rentals for identical floorplans. Since the rents are 10% higher, the resale prices will be 10% higher as well. The GRMs in both neighborhoods would be the same. It is not that Quail Hill will bottom with a GRM of 160 while Turtle Ridge bottoms with a GRM of 200. The premium is already factored into rents. There will be no premium on premiums at the bottom. GRMs will be very similar across the entire market (although individual properties will see variations as some drop to investor cashflow levels).
Today’s featured property is a tiny 1/1 condo in The Lakes selling for 35% off
the peak. This may be the least desirable property in Irvine, and one of its
least expensive.
Asking Price: $197,900
Income Requirement: $49,475
Downpayment Needed: $39,580
Monthly Equity Burn: $1,649
Purchase Price: $300,000
Purchase Date: 9/22/2006
Address: 144 Streamwood, Irvine, CA 92620
| Beds: | 1 |
| Baths: | 1 |
| Sq. Ft.: | 639 |
| $/Sq. Ft.: | $310 |
| Lot Size: | – |
| Property Type: | Condominium |
| Style: | Contemporary |
| Year Built: | 1977 |
| Stories: | 1 |
| Floor: | 2 |
| View: | River, Rocks, Trees/Woods |
| Area: | Northwood |
| County: | Orange |
| MLS#: | S561621 |
| Source: | SoCalMLS |
| Status: | Active |
| On Redfin: | 4 days |
cathedral ceilings in living room and hard wood flooring.Extra windows
in this unit make it nice and bright. Private balcony patio off living
room with river/rock view. Beautiful springs complex with two swimming
pools, tennis courts,jacuzzi and club house.
That entry photo has a wonderful artsy quality to it. You can really feel the depression growing with each step into the black hole. The bleak, featureless walls, the interesting composition, and the unique play on perspective are all great — if you were trying to convey the emotions of despair. I question whether or not this technique will help them sell real estate though.
Perfect starter home! LOL! If you are a family of hobbits.
This property was purchased at the peak for $300,000. The borrower used a $239,900 first mortgage, a $60,000 second mortgage, and a $100 downpayment. She must be really upset over losing that much money.
The lender bought this at auction for $263,418 on 12/8/2008. If this sells for its asking price, the lender stands to lose $113,974 after a 6% commission. Not a big loss by Irvine standards, but considering the entire loan was only $300,000, it is pretty substantial.
{book}
Ooo, you’re givin’ me the fever tonight
I don’t wanna give in
I’d be playin’ with fire
You forget, I’ve seen you work before
Take `em straight to the top
Leave `em cryin’ for more
I’ve seen you burn `em before
Chorus:
Fire and Ice
You come on like a flame
Then you turn a cold shoulder
Fire and Ice
I wanna give you my love
But you’ll just take a little piece of my heart
You’ll just tear it apart
Movin’ in for the kill tonight
You got every advantage when they put out the lights
It’s not so pretty when it fades away
Cause it’s just an illusion in this passion play
I’ve seen you burn `em before
(Chorus)
So you think you got it all figured out
You’re an expert in the field, without a doubt
But I know your methods inside and out
And I won’t be takin’ in by Fire and Ice
(Chorus)
You come on like a flame
Then you turn a cold shoulder
Fire and Ice
I wanna give you my love
But you’ll just take a little piece of my heart
You come on like a flame
Then you turn a cold shoulder
Fire and Ice
You come on like a flame
Then you turn a cold shoulder
Fire and Ice
Fire and Ice — Pat Benatar
“deceased equine over ARM resets”? You mean they don’t get a pony?
“He told me the foreclosure problem is far worse than most people realize. As he started telling me about the growing problems with Alt-A and Option ARMs, I felt like he was reading from the IHB.”
IHB has always felt like reading news from the future to me. The general media is like reading news from the past. If you follow fundamentals, you have an idea where things are going. If you wait for the data to turn up, you are reporting on the past. Even Case Shiller, which is pretty good housing data, arrives almost three months after the close of the month the index summarizes. Deals closed in Nov 2008 were made in Sep & Oct. It is 4-5 months behind current market conditions. Taking that into account, we are reading info on IHB which won’t be in CS until July.
I think the baseline income numbers in this chart are too optimistic. Because of both the recession and deflation, there is a dip starting in 2008 that will continue at least through year end 2009. That means that the housing price drops will be faster, and a little further. On my last round of calculations, I got 58% off peak for LA/OC at the bottom in 2010/11.
Still over $300.00 per square foot.
Just what I was thinking. Another 35% to go.
$/sqft should be whatever the premium on earthquake insurance is to wipe this dump off the face of OC land. Hit the bricks, Dump.
Yup, there is a long way to go. The unemployment crisis is certainly not going to help real estate prices. Salaries are not going up anytime soon.
On the Alt-A issue, here is some data from a representative Alt-A securitization that was undertaken in late 2006 of a pool of loans originated by (what was then) Countrywide. I don’t have the data by state but can assume this is largely from markets where there is a high portion of Alt A product like california/Florida. The number after the month-end date is the % of all loans that are 60+days delinquent or more, including bankruptcies/in foreclosure/REO. When i dug a bit deeper the fastest growing category over the past few months is 90+ day delinquencies, so this implies to me there will be a big pick up in notice of defaults in the near term….
Feb-08 18.5343469
Mar-08 20.68500772
Apr-08 22.56469905
May-08 23.82063312
Jun-08 25.92819204
Jul-08 26.72187037
Aug-08 27.59461065
Sep-08 30.13973902
Oct-08 30.93601927
Nov-08 31.9318828
Dec-08 36.22155617
Jan-09 39.42174623
“It is important to note that this does not mean that premium neighborhoods will retain a premium on their premium. This is another common misperception. For instance, Turtle Ridge commands an approximate 10% premium over Quail Hill on rentals for identical floorplans. Since the rents are 10% higher, the resale prices will be 10% higher as well. The GRMs in both neighborhoods would be the same. It is not that Quail Hill will bottom with a GRM of 160 while Turtle Ridge bottoms with a GRM of 200.”
Irvine Renter, I’ve grown tired of this stale debate. I will leave you with this: I have lived in multiple neighborhoods both in Southern California and outside SoCal during previous down turns where GRMs of 160 were never met.
I maintain that the neighborhoods with the highest GRMs will be those with high income households and loan values just below $1 million. That group has the highest home mortgage interest deduction and the highest marginal tax rates.
This also helps explain why GRMs tend to be lower in poor neighborhoods than in rich ones.
I would add that not everyone wants to own a rental in the hood. We own a number of donut shops and Chinese fast food places. The locations in Compton throw off much more cash than the locations in nicer neighborhoods because there is less competition in the rough places.
So, I would expect GRMs to be somewhat higher in places where you don’t fear for your life. Newport Beach for example seems to have high GRMs in all markets.
Some area have higher expenses, so net rents should be used for investment analysis. Extra cost such as HOA, repairs (a times excessive), vacancy rates and insurance should be factored into the calculations. I would estimate that if rates rose 0.5% from 5.0%, house price should drop about 7%, and if rates decline 0.5% then price should increase 7%. Possible the effect of the Republican proposal for a bailout to reduce interest rates for a 30 year fix to 4.5%. (That might cancel out the current decline, at least for the moment.) Or stick someone else with the bill.
Are you talking about typical GRMs for individual properties, or are you talking about the GRM of typical rents in a city to typical home prices in a city? Two very different things, obviously, since in most cities the average rental home is much lower in desirability than the average owned home. If you are talking about the latter I wholeheartedly agree, but if you are talking about the former I find your statement hard to swallow. Do you have any specific examples to help us out?
“Irvine Renter, I’ve grown tired of this stale debate.”
I was not singling out you for this comment. I did not realize we were debating about it.
There will be a range of GRMs among different properties with the most desirable hovering around 180 and the least desirable falling down to near 100. In as much as entire neighborhoods are composed of large numbers of desirable or undesirable properties, you could see variability in these neighborhoods. My point is that if you look at two neighborhoods with similar property composition, such as Quail Hill and Turtle Ridge, the aggregate GRMs of these neighborhoods will bottom together at similar values.
Is there a graph of historical GRM for Irvine or OC? If so, please direct me to it. If not, could you do one?
I’d like to see the average GRM for the last 25 years. If Irvine Renter is right, then the average GRM for the last 25 years should be 160 for Irvine.
For some reason I believe the historical data will show 180 to 200 GRM for Irvine.
The historical data is messed up because of the bubbles. What is more pertinent is the values at the market bottom. This is where the fundamentals lie. I have graphs for price-to-income, price-to-rent, and debt-to-income for Irvine. You will find those in a number of analysis posts. The GRM is basically the price-to-rent ratio presented with a different “Y” axis.
https://www.irvinehousingblog.com/images/uploads/2008sept2/Projected%20Orange%20County,%20CA%20Price-to-Rent%20Ratio%201983-2020.jpg
the historical “national” grm is 181…
https://www.irvinehousingblog.com/blog/comments/wot-3-22-2008/
graph here… http://tinyurl.com/d7asnj
Again, is this a graph of typical GRMs for individual properties, or is it the GRM of typical rents in a city to typical home prices in a city? Two very, very different things.
IrvineRenter-
Check out the Business section of today’s LA Times. There is an article about how housing in West LA is dropping. This is somewhat surprising because this market was SO strong for so long…it never experienced a lot of new development (due to strong slow growth pressure and scarcity of land) and people who live there have A LOT of dough.
There was quite a bit of new construction near the area, especially Malibu, Marina del Rey, Baldwin Hills, Bel Air etc.
IR,
In Thornberg’s report cited, he is calling just recession, but not depression. I understand 2 quarters of negative GDP is defined as recession. I however do not understand how depression is defined.
So, how is depression defined?
I was not too convinced by Thornberg’s conclusion since he did not provide his supporting arguments why depression would not occur?
A Depression is just a REALLY REALLY long Recession. 😉
There is no official definition of depression, but most set the bar at an economic cataclysm approaching that of the Great Depression. This recession will probably be the worst since then, but it will probably not show the same grim statistics of that era (hopefully).
One fairly accepted definition of a depression is a decline in GDP of 10%. A “great depression” is sometimes defined as a contraction of 20%
From wikipedia: “Between 1929 and 1933, U.S. GDP fell around 30%”
What is it called the last twenty years of Japan’s economics?
As Reagan said, a resession is when my neighor is out of work and a depression is when I’m out of work.
and recovery is when Carter is out of work!
Why no sub-Armageddon profile?
I’m having a tough time with that chart, IR. I look at the fundamental increase line of what looks like 7% a year and then I remember a couple weeks back where you said that home prices since the 1900’s have only increased at a mere .7% rate (inflation adjusted). So what gives? Why the difference?
And I really don’t think we have any idea how a deflationary recession is going to play havoc on asset prices. Your numbers right now are sobering but I think there are better than decent odds that the final results will be worse still.
I can answer that. Go to this paper, http://www.imes.boj.or.jp/english/publication/mes/2001/me19-s1-14.pdf
See especially Fig 10, page 404. Japan 1989 = US 2006. Asset prices dropped by more than half.
I also find Fig 19 amazing. It shows in a variety of countries how the ratio of private credit to GDP correlates with asset prices. More credit = higher asset prices.
The rate of appreciation in the chart is 3.6% which is about 0.7% over the general rate of inflation as reported in the CPI.
Not trying to be a huge jerk here but take a look at the inflation rate in each decade from the 1930’s. I don’t think averaging out the inflation rate and projecting the anticipated rise in prices works very well for predicting prices within a particular small era, I think a better analysis would be to look at different types of periods (recessionary, deflationary, high inflation) and get an average for each type of period and then apply it forward, at least as well as possible.
http://inflationdata.com/inflation/Inflation_Rate/HistoricalInflation.aspx?dsInflation_currentPage=6
I would actually expect inflation to be negative for some years to come so trending a rise in home prices due to price inflation wouldn’t be my choice.
(I don’t know how reliable this data is but heck, it’s on the internet so it must be correct, right?) 😉
Why Be a Nation of Mortgage Slaves?
“Finally, loan modification is not only ineffective, it is evil. Coercing borrowers to continue paying a mortgage on a home that is hopelessly overvalued and not informing them of alternatives is predatory lending.”
It all depends on the type of modification, reduction in rate or principle. A reduction in rate is with low moral hazard but leaning towards slavery for the borrower. The reduction of principle is a deep moral hazard with the tax payers as the slave.
I agree with IR than the bottom line in the price of the home should be the price of ownership vs. rent. Less bubble caused by no-money down, special low interest and other rigging of the system.
Correction… this is in the Springs Association, not the Lakes.
$189 in HOA fees monthly, too. It’s still overpriced.
Its actually $214 a month
I walked around there a couple of weeks ago. The pools were closed until safety issues were corrected.
“…Would it be better to drop quickly then resume its ascent? or it is better to have a slow deflation as Japan did?…”
I would prefer the option that disrupts the economy the least. My guess is, that’s the first option – which would also help me (assuming our income remains somewhat stable) because my tax basis would drop very low immediately thereby lowering my housing costs slightly.
In the past, we have always let the crash proceed in order to get back to growth. Japan when the route of the slow bleed, and their economy has been suffering for 20 years.
“Crash” is a relative word. We’re entering unchartered waters. This isn’t 1990 on steroids. Past crashes are nothing like what we face now.
Right now, Japan’s “lost decade” is preferable to a massive economic collapse. Sadly, we’re past that soft landing.
How can we avoid a massive collapse and over correction?
The 1990/91 bubble bust in CA was due to recession/unemployment. So far all the damage, very serious, due to construction slow down and bad loans. We haven’t begun to see the impacts of all these layoffs on home inventory.
BUST.
There are some other options. One of them is to try to reduce the amount of damage done to other sectors, let housing reprice, and make changes in the banking system.
For example, you could take over banks with troubles, provide some capital to the banks which are not troubled, provide money or guarantees to lenders who didn’t do housing (e.g., auto and equipment finance, municipal finance).
While other sectors might be justifiably told they should be prepared for economic cycles, when those changes are very large and had little to do with that company’s business, I have some sympathy.
I like the photo of the stairs…are you going upstairs, or downstairs? Eerie.
It rubs the lotion on its skin or else it gets the hose again.
LOL. 😛
Question about the ugly little condo…isn’t it at rental parity? I haven’t done the math, but seems like it could be. You might get $1,100 rent for it. Ugly properties like this will get to rental parity first!
If you like to be at break even and putting down 20%.
Currently rents are going down so that means this is still over priced.
Views of rocks and trees?
Oh, IMHO the “better” locations always command a premium. They have done so for since the City of Irvine was created, so I see no reason why this should not change.
And even if Armageddon brings us back to 2004 (per your chart) at a “loss” of 50%, that still leaves Irvine on the expensive side of things.
As I noted earlier, anyone who bought after 2003 is screwed. And this means all the new developments (TRidge, Quail Hill, etc…). The degree of screwness will increase the further away from the ocean you are, particularly as in the peak the price per square foot of inland developments was in line with the ocean side.. hence the “inland” developments were “more” overpriced.
Again, IMHO… but I have lived in Irvine since ’87 so I saw this once before in the early 90s.
Define “screwed.” That’s a strong choice of words – could mean a wide range of things. Are you trying to convey that their balance sheet will never recover and they’ll be doomed in poverty in perpetuity? Or, by using “screwed” do you mean, they’ll be fine if they financed conservatively, but 2010 and later buyers will get in at lower prices?
That’s a wide range…
Screwed as in being upside down for a very long time. The curve above shows 2021 before we attain those prices again.
IMHO, being stuck upside down for 16 years is being “screwed”.
Got it, just trying to understand what you mean.
There are so many variables when talking about different families’ finances. Renting currently is preferable to owning and having bought after 2003. How preferable? Well, if we could compare two exactly similar families, the one renting is in a position to build a much stronger balance sheet over the next decade. But will they?
In 2012, when that “2005 million dollar Irvine house” is selling for $600k, will they stretch to reach for it? Will they continue to live the same lifestyle as the underwater family, or will these families’ spending diverge due to their relative circumstances?
I guess, I’d qualify your statement, and say, “Anyone who bought after 2003 is screwed if they’re not in a fixed mortgage and more than 28% of their gross income goes to housing costs.” Otherwise, they’ll manage (barring incurring any number of variables that can destroy a renter’s finances as easily).
Such a timely article since all I keep thinking about is when…
There still is no real “fear” in Irvine and what it will take to instill it into the local mindset. All people hear about are the job losses elsewhere (autos, banks, aircraft, etc). Except for the subprime losses there hasn’t been a shocker locally. Or will we have a national or state economic 9/11 do the trick?
When they shout “Fire!” in a crowded theater what do people do?
Well, Samsung left Park Place very quietly. One week they were there, the next they were history. I’ve no idea where they went, but I bet all that missing asian money will have an affect on Irvine, there are a lot of Koreans here but I can see they are starting to pack up.
I used to live in that complex. This kind of apartment could be rented for $1200 or maybe slightly more last year. Maybe rents have fallen somewhat now. It’s probably going to fall more since these units are bought as investment property so GRM of 120 or so for a final price looks likely. We are not at the bottom yet. Didn’t you have a similar apartment in the same area for 180k a few months back?
The stairs picture looks like something from a recent or future David Lynch film. Something pretty horrible will happen to anyone going up or down those stairs. Is it a really a stairs going up or is it some entrance to a deep pit or well or… worse. Unbelievable that a realtor would post such a photo.
There was just an article in the Irvine Newspaper about terminate issues in that complex. Definitely still seems overpriced for a 650 sq ft condo.
Here’s another interesting 1bed/bath condo in Irvine.
http://www.redfin.com/CA/Irvine/62-Costero-Aisle-92614/unit-308/home/5589181
Its only $2100 more and is in a much nicer community in Westpark.
The other thing of interest here is it was originally bought for $122,500 in 1999 and is a short sale at $200k. So these folks extracted at least $77,500 in “free money” on this unit, Ouch!
Not necessarily on topic, but LA times reports that sales of million dollar homes dropped 43% in 08.
Cities in the OC ranked as follows..
Laguna Beach #17 with 173 total, high $7.5 mil
Huntington Beach #22 with 159 total, high $3 mil
Newport Beach #23 with 158 total, high $8.2 mil
Irvine didn’t have enough million dollar sales to crack the top 25 cities list.
What gives Irvinites, what’s wrong with your fair city?