The Tipping Point
Falling Down -- Oasis
Time to kiss the world goodbye
Falling down on all that I've ever known
Malcom Gladwell wrote a book called The Tipping Point. In it he traces how social phenomenon including financial manias can spread like a disease epidemic. In many real estate markets, we are witnessing a new epidemic: walkaways. Statistics have shown that the rate of foreclosure rises dramatically when homeowners fall underwater. Some estimates are that as many as 12,000,000 homeowners are currently underwater, and as many as 20,000,000 will be before prices stabilize. These are alarming statistics for a banking industry already rendered insolvent by losses on their mortgage portfolios.
The tipping point with respect to walkaways is not difficult to understand. Many people bought at inflated prices because they thought prices would continue to rise. When prices went down, they examined their alternatives (something they should have done in advance) and realized it was much cheaper to rent than to continue making payments on the depreciating asset. Anecdotally, there also seems to be a correlation between how much money people put into the transaction and how far underwater they must fall before they give up. Several months ago, most of the properties I profiled were 100% financing deals gone bad. Some of these owners were not far underwater, but they were giving up anyway because there was no point in continuing to make payments and actually losing some of their money. However, lately I have been seeing more and more properties where the owners had put 10% down. Many of these properties, like today's featured property, were 10% or more below their loan amount before they gave up.
There has been much conjecture on the fate of Option ARM holders and whether or not these borrowers have given up already and sold into the declining market. Certainly many of the properties I have profiled have been Option ARMs. However, it doesn't seem likely that these people have given up and already sold. Why would they? For them, their current house payment on the teaser rate is actually less than renting. Plus, they can stay in the house for 7-12 months free-of-charge after stopping payments. Their incentive is to stay in the property until their recast, then quit making payments and ride it out. Most of these people have already given up, and their plan is to do just what I describe. They make up an enormous shadow inventory of unlisted properties that will be hitting the market as foreclosures. Some of these people might list at a breakeven price and hope, but with market prices putting them far underwater in many circumstances, most of these people do not bother.
The subprime implosion set the stage for the collapse of the more desirable markets like Irvine. The implosion of subprime lowered prices in all markets and made financing much more difficult to obtain. The lower prices has put all the Option ARM, Alt-A and Prime ARM holders in a precarious financing situation. Many will be unable to refinance because they are either underwater or they do not meet the more stringent standards. If they cannot afford the payment when their ARMs reset -- something that will be a particular problem for Option ARM holders -- they will go into foreclosure. It is only a matter of time.
I am still anticipating price declines this fall and winter. The economy is heading into a tailspin, unemployment is increasing, and credit is still tightening. These are not rally conditions. However, we will not see the full brunt of the foreclosure problem in Irvine until 2009 through 2011, and it will be a year or two beyond that before all these reseting ARMs become foreclosures and work their way through the system.
In Santa Ana, parts of Riverside County, and other subprime dominated markets, the worst is over. Prices there are down 50% or more in many of these areas. They may not see appreciation any time soon, but they are already seeing a recovery in sales volumes, and many properties are at or near the bottom in pricing. The same is not true for Irvine. The brunt of our problems are ahead of us, not behind us...
Asking Price: $309,000
Income Requirement: $77,250
Downpayment Needed: $61,800
Monthly Equity Burn: $2,575
Purchase Price: $450,000
Purchase Date: 9/26/2005
Address: 30 Fairside #24, Irvine, CA 92614
| Beds: | 2 |
| Baths: | 2 |
| Sq. Ft.: | 1,125 |
| $/Sq. Ft.: | $275 |
| Lot Size: | - |
| Property Type: | Condominium |
| Style: | Colonial |
| Year Built: | 1983 |
| Stories: | 2 Levels |
| Floor: | 1 |
| View: | Park or Green Belt |
| Area: | Woodbridge |
| County: | Orange |
| MLS#: | S538953 |
| Source: | SoCalMLS |
| Status: | Active |
| On Redfin: | 116 days |
 Unsold in 90+ days |
|
leminate flr? kitchenwith? Ownersship incls? mell roos?
Today's featured property was purchased on 9/26/2005 for $450,000. The owner used a $359,650 first mortgage, a $45,300 second mortgage, and a $45,050 downpayment. If the property sells for its current asking price, and if a 6% commission is paid, the total loss on the property will be $159,540. The lender is losing quite a bit considering how small the mortgage amounts were. The owner is going to lose their $45,050 downpayment.
This property is being offered for 31.3% off its 2005 purchase price.
The summer sun
It blows my mind
It's falling down on all that I've ever known
Time to kiss the world goodbye
Falling down on all that I've ever known
Is all that I've ever known
A dying scream
It makes no sound
Calling out to all that I've ever known
Here am I, lost and found
Calling out to all
We live a dying dream
If you know what I mean
All that I've ever known
It's all that I've ever known
Catch the wind that breaks the butterfly
I cried the rain that fills the ocean wide
I tried to talk with God to no avail
Calling my name from out of nowhere
I said "If you won't save me, please don't waste my time"
Falling Down -- Oasi
Nice pergraniteel. Textbook.
Looks like there was a lot of ‘Flip This House’ Kool-Aid floating around in the water over on this side of town.
300.00 monthly HOA fees. What a bargain!
It is also relatively inexpensive to put in pergraniteel when the property is so tiny. How much can 40SF of counter space and 1000SF of flooring cost?
With all the clutter on that counter top, there is no room to prepare food.
The best part is that 40SQ of granite couners and a new refrigerator magically adds 171K to the value of the condo. It’s true, I saw it on ‘Flip This House’, the appraisor walks in and waves his magic wand and an inflated number pops out of his mouth.
Sale History
09/26/2005: $450,000
03/26/2003: $279,000
11/27/2002: $241,000
Today’s bagholder sure did make the previous owner very happy back in 2003. The ‘02 seller left the casino way too early. Should have stuck around a little longer.
It shouldn’t be a surprise that the current market is finding knife catchers out there when there is all this phoney bubble wealth out there when even the small-game condos were earning 6 figure incomes during the mania.
Better to exit a trade two years too early than one day too late.
Irvine Renter,
I’ve been a long time reader of your blog. Thanks again for all of your market insight. I wanted to get your opinion on the goverment’s 500B plan announced today to aid lenders modify default homeowner’s mortgage to 3% fixed rate for 5 years to avoid foreclosure. Like many others, I’ve been patiently waiting to buy. How do you think that will effect the prices in Irvine?
It won’t. This is just another program to lessen the impact of the foreclosure crisis. It will help a few marginal borrowers, but it will not do anything for the hopelessly overextended. Like all government efforts, this merely panders to the denial demanded by homeowners. Prices will continue to fall.
What happens to these people in 5 years? Fundamentals will still not justify prices. If it has any impact at all, it will just delay the inevitable. Prices will still fall to levels of affordability because that is what buyers will be able to bid.
JB007,
It’s smart that your waiting. While you wait, try to save as much as you can for a down payment. You work, make money, and pay your taxes. Once you have these after tax dollars saved up, the more you can put down, and the less you’ll have to borrow from the bank. The less you borrow the less interest you’ll have to pay. That way you’ll have a smaller monthly payment and/or less years of payments. I bought my house in 2000 ($425K) and was able to pay it off in 7 years. Good luck.
So—does that mean that the government is now giving out Adjustable Rate Mortgages?
Wow, I hadn’t thought of that!
Someone correct me if my understanding is wrong:
Prices will continue to come down for the sheer fact that they’re too high/unaffordable for the area.
Foreclosures are merely the gas pedal - the more of them, the faster the correction happens. If we slow foreclosures, it’ll just take more time to work our way out of these too-high prices.
Does that sound about right?
Yes, foreclosures determine the speed of the drop. If there are huge numbers of foreclosures, there might be an overshoot at the bottom due to short-term supply and demand imbalances, but foreclosures do not determine the bottom near as much as financing terms do.
Which is why Santa Ana and Riverside prices will continue to slide. McJobs are vanishing. Down payments have evaporated. Financing terms have tightened. If a lucky buyer does have a down payment and a reasonable job, expect banks to ask for a second appraisal plus an automated valuation model run which will end up souring the deal in most cases.
IR,
Why do you think that the worst has hit the Inland counties like Riverside? Just because they have fallen 50% and sales have been increasing? Sales in Riverside have risen 106% YOY, however, the sales volume is only 4,551 and median sales price has slipped 36%.
IMO, with the economy going down the toilet and easy financing gone, I can’t see how housing prices even in Riverside can prevent further collapse. Fewer jobs, inflation, and stagnant wage growth isn’t going to prevent the median price from slipping. What will?
Sales volume in Riverside county sales since ‘03:
Notice how the average summer sales volume was about 6,000.
And how many of the home sales were foreclosures?
“And how many of the home sales were foreclosures?”
70% of sales in Riverside are foreclosures.
Riverside RACED down the hill. For a whole year now, list price and sold price have been virtually identical. Corona is down to $167/sq ft; Riverside is down to $145.
With a median income of 78K in Corona, and median list price of 300, that’s at 3.8x income. Granted, it’s going to go for less because of location, but 3.8x ain’t all that bad for SoCal.
My guess is that the IE still has a way to go down (because it’s simply overbuilt for the population and the population might choose to move closer to work), but I think that most of Riverside’s fall has occurred….at least, until interest rates go up. Then, game on!
Yes, that is why I believe Riverside County is much closer to the bottom than to the top. Prices in many areas are down to rental parity.
Who says rental prices in the IE will hold up?
Here is my two cents. City of Riverside, western edge, a 4bd/2ba sold for 197k in 2001 and it just sold for 255k in Aug. Aug sale was as a forclosure and the property needs lots work compared to 2001. Good neighborhood so the vacant homes were sold easly, but I think those buyers will be surprised. These homes were 150k in the mid 90’s.
The foreclosures tend to get priced-to-sell by the banks which will has the effect of bringing the other neighborhood sellers’ expectations down to reality. It will speed up the process, but it doesn’t change the fundamentals.
Prices are only going to go up to what banks will allow people to borrow.
When the interest rates start going up again and the creative 0 down, NINJA financing voodoo is not available to the average homebuyer - then it means the average buyer will be able to afford less and less house. The sellers will have to bring their prices down to what the banks are handing out to borrowers unless they don’t mind the house not selling. This scenario is going to be playing itself out throughout 2011-2012 and onward as many of the knife catchers in the current market go underwater and start looking for the exit.
It is going to happen. It’s only a matter of time.
Just received your book yesterday. Don’t know if I will every buy again (sold last year thanks to your blog). Interesting article on Market Ticker ...
http://market-ticker.denninger.net/
I like the term “leaving rm”. It seems like a literal translation of some other culture’s term for “entryway”.
Or maybe they just don’t know how to spell “living room”.
That was property description by Lewis Carroll.
“Twas leminate and the ownersship
Did flr and kitchenwith in the mell…”
FTW!
Wait, I can’t read that without a mirror…
I like to watch TV in the leaving room!
I know this has been discussed before, but how on earth do real estate agents get away with such horrible spelling and grammar? Don’t you think the seller would read the description of their house (especially if they are paying a 6% commission) and chew out the agent for such a massacre of the English language? Don’t you think someone in the office at Keller Williams would tell the agent (Anup Dhar) about these mistakes, or require listings to get reviewed by someone before posting to the MLS? Wouldn’t this be embarrassing to the agent? Shouldn’t the manager of the Keller Williams office tell his agents how to use a spell checker? Amazing! It just goes to show how unprofessional this industry has become – no one could get away with this in any other industry……
I agree…if that was my listing I would be pissed. Although, I wouldn’t hire an agent named Anup in the first place. Just kidding.
Maybe they really aren’t paying the 6% commission…you get what you pay for I guess.
Didn’t waynoway or someone used to “invite” realtards like this to look at the IHB postings that were on their properties?
Does anybody remember any of them actually posting to defend themselves????
Spellcheck outsourced to India.
IR, why do you think option ARM failures are going to affect Irvine and other more-upscale locations? Don’t you think the gov’t is going to just step in and make things ‘right’ instead of letting the market take its course? Too much bloodletting is very politically unpopular, you know.
And could you or someone else please explain what ‘Recast Schedule based on current Negative’ means?
Option ARMS have a provision that is the loan to value surpasses a certain threshold then the loan turns into a fully amortizing loan - thus resetting the interest rate well ahead of schedule.
There is not enough money in Wash to bail out all of the people who will not be able to afford their resets. These defaults will impact Irvine directly (Option ARMs loan in Irvine) and indirectly (impact on bank’s ability to lend). If a certain percentage stay in their home under one of the ‘rescue’ plans on the table this will only minimally mitigate the overall impact.
And could you or someone else please explain what ‘Recast Schedule based on current Negative’ means?
I believe that refers to the payment recasting based on current negative amortization. That is, when the loan principal hits X% of the original principal, you have to start paying down the principal so your payment goes up by a few hundred bucks depending on what you borrowed.
I am not clear on whether the ‘teaser rate’ recasts separately from a recast based on negative amortization… I stayed away from voodoo home financing, thank FSM.
I ran the numbers a couple months ago, on a hypothetical Option-ARM recasting to a conventionally amortizing loan. I don’t recall the exact numbers I used but I think they were based upon borrowing $400,000 on a teaser rate 2% which recasts to 6% after 2 years when the principal hits 115% of the original loan amount.
These were all rather conservative assumptions, too. Many people borrowed substantially more than $400K, and I think that many teaser rates were lower than 2%, plus the recast interest rates are usually substantially higher than 6%.
The payment for that hypothetical loan escalated about $500 a month, if I recall correctly. And I’ve heard of folks whose payment jumped up $700, $800, $900 or more.
So if you think about all the calculations involved, you begin to understand how truly toxic these mortgages were. Everything worked against the borrower except for that ‘low, low’ introductory rate. You borrow an amount you can barely afford to carry, on a very inflated asset, you’re not even paying down the principal, and in a couple or so years your payment is going to increase substantially (as well as the interest rate on the loan) while the underlying asset is worth substantially less than what you paid for it.
It’s no wonder people are walking away from these loans. It’s a shame more people didn’t run the numbers before signing for these mortgages, but very few people kept their heads about them during the bubble. All everyone was hearing was how you had to act now or be priced out forever.
Thank god for blogs like this and listening to my gut…glad we didn’t “trade-up” a couple of years ago…
Speaking of recasting loans, we know that many of the Option-ARM, Alt-A, and Prime loans are due to reset the next few years but not all of them are going into foreclosure. I wonder how many actually will? For instance, my adjustable loan resets next year but we are financially comfortable enough to handle the increased payments…I wonder how many homeowners out of that lot are in my situation.
not very many, I’d wager. If you can barely afford the low, low teaser rate, you’re gonna be screwed, blued and tattooed when it jumps up several hundred bucks a month
The carnage for interest-only ARMs will be substantial, but it will not be as severe as it will be for Option ARMs. If interest rates are low over the next 4 years (which doesn’t seem likely) then many of the interest-only ARM holders will be able to buy themselves more time. This would be a bad thing for the market because unless they refinance into a fixed-rate mortgage (which most won’t) then we just drag out the foreclosure problem several more years.
“if interest rates are low over the next 4 years”
beg to differ, but I think this is becoming increasing likely as the threat of deflation is now greater the the threat of inflation. At least according to Roubini.
Just my 2 cents.
There are a few. A couple guys in my office took out exotic mtgs in 2005. Both were 5 year fixed below 5% interest only loans that are scheduled to adjust in 2010. Absent the typical setback that causes foreclosure (prolonged income interruption, divorce, etc.) they will be prepared to refinance into a fixed mtg before then.
I don’t know anyone who received an option ARM (or anyone who’d admit it). IMO, there are two types of option ARM borrowers:
1) Reckless, uninformed speculators who purchased additional homes and fancied themselves Trump-like landlords; and
2) Reckless, uninformed borrowers aspiring for homes well beyond their means.
That’s why I believe the vast majority of option ARMs are heading for default.
How will these guys in your office be able to refi?
after the 20% or whatever decline in values, they still have LTV lower than 80%? so they put 40-50% down?
They’re both sophisticated (in the financial sense) borrowers. One is currently around 70% LTV and the other probably above 80%, but both have savings. They’re both prepared, if necessary, to bring cash to the table in order to refi.
They are the exception rather than the rule.
Okay, who’s the regulatory agency that watches this type of activity?
Now that’s a fun question (my practice area). The regulatory framework is a labyrinth of agencies with competing objectives and mandates (OCC, OTS, FDIC, SEC, state regulatory agencies, etc.).
I don’t have a lot of sympathy for people who take out these loans without figuring out if they can afford them, but I also think there is a lot of potential for fraud here too. Both parties are responsible.
Whatever happened to ethics, personal responsibility and moral obligation? I suppose that’s just old-fashioned crazy talk. I think our society needs a good dose of those attributes instead of more regulation.
I took out a mortgage in Ohio in June and the documentation left little room for fraud. More possible is an emotional fraud where the agents and brokers skillfully fill the borrower’s mind up with the notion that the price bubble would keep getting bigger and there would not only not be any problems but that a large upside was practically guaranteed. But the documents I signed (after reading) were quite complete and unambigous that the contract was I would get $X and pay it back monthly for Y years at Z% rate, without any guarantees of future re-fi being part of the contract. Not familiar with California documentation, but a lot of it was Federal forms, so it should be pretty similar. I’m not sure where “blue skies” BS shades into fraud, but if all you have are your mortgage documents, it is going to be a hard case to prove.
I was starting to feel some sympathy for McCain again then he got on Larry King last night and said “the government needs to buy up these mortgages and then modify them to levels people can afford so they can stay in their homes. The problem with the economy is housing and the government needs to put a floor on the housing prices”
I almost threw up. And he calls himself a conservative. Conservative my arse. Maybe he agrees with the morals of the christian right but his economics are as socialist as they come.
At least McCain wants to lower taxes.
Because Bush showed us what a great idea that was.
In their first term, a number of presidents saw the national debt, as a % of GNP, go up slightly. However, only Reagan, Bush I, and Bush II turned a decreasing debt load into a bigger one (and DRAMATICALLY so).
So, go ahead and push for lower taxes (BTW, Obama will lower more individual’s taxes than will McCain; McCain lowers corporate taxes more than Obama). But, don’t complain when the eventual inflation comes.
I spent most of my adult life thinking that taxes were important. I was wrong. It’s spending. Bush cut taxes. He raised spending. We now owe over 4 trillion dollars more than when he came into office. This year, Bush is not even taxing us enough to pay the interest on it, we are borrowing to pay the interest.
See the parallels with the housing bubble? Taxes are like paying principle on your mortgage. If instead you borrow more principle every year and you aren’t even paying the interest on a negative amortization loan, you don’t feel any pain and live like you’re rich, until the bubble pops.
McCain is promising to continue inflating the federal deficit bubble.
That’s exactly right, its the spending. And the US thinks its got an unlimited credit card.
I remember when Clinton/Gore actually said they would cut govt spending, eliminate inefficiencies, and not have to increase taxes. That was their platform, and it was great to hear someone say that.
They did balance the budget, but didn’t do enough to reel in the spending govt beast.
Then came 43. Spending like a drunken sailor. Except even a drunken sailor has to run out of money and stop spending.
Govt expenditures are insane and unsupportable. There is plenty of waste that could be cut easily.
Hopefully, the next guy will be able to do that. Otherwise, we’ll be foreclosing on our country and our future.
I think the government needs to get off of this kick that our economy runs on housing. The economy needs to run on manufacturing - seems to me to be the only way we earn cold hard cash.
Good point, a company without a product eventually won’t be a company; example Enron.
How will the bailout measures affect this? For many of those on Option ARMS or any type of exotic financing… won’t Big Loan (AKA our tax dollars) help them out before they recast?
I’ve heard stories of banks starting to do some interesting things to prevent defaults (one homeowner would not get any help from a bank until they missed a payment… once they missed, the bank offered ZERO interest on their HELOC as long as they continued to make a minimum payment).
I’m worried that all this government help is going to keep some air in this bubble.
“I’m worried that all this government help is going to keep some air in this bubble.”
I think that’s the general idea, the government needs to stop price deflation. At least that’s what the politicians are saying.
I think the analogy is ALMOST there.
I think that all this bailout does is put air into the bubble. It can’t fix the fundamental reason that the bubble is deflating, though (which is a pressure differential). Putting more air into the bubble will keep it a bubble longer, but, in the end, we don’t call them the gas LAWS for nothing.
“I’m worried that all this government help is going to keep some air in this bubble.”
The government help is designed to perpetuate homeowner denial and keep them in a state of indentured servitude to the lenders. The government’s biggest worry, now that they have liability, is that all real estate markets will hit the tipping point where borrowers default in large numbers.
Quite honestly, the government couldn’t care less about home prices, they care about people making their debt service payments. Unfortunately, statistics show that falling prices dramatically increases default rates, so they must at least give lip service to house prices. The next thing you know, the government will start to sound like the NAR and try to convince people housing is a good investment and that they should hang on and keep making those payments.
We need punishments for walking away. Reinstate the taxes on forgiveness of debt income. Even if there is no money for taxes, the IRS can bruise them up a bit.
Hey AZ…
My brother-in-law, lives in the Bay area, just sent all his family members a prospectus for a condo development in Phoenix, 1 mile from the airport. The deal was you agree to buy with no money down (1bdrm - $160-170k) from this dubious “llc”, then the “llc” leases your unit back for 5 years and rents it out for you, then the llc guarantees that the rental income will not only cover all your costs.. mortgage, taxes, hoa but you are guaranteed $500/month positive cash flow for the first 5 years.
Sounds like a Ponzi scheme to me. I don’t know the Phoenix area so I’d like to forward this to you for your opinion. I’m actually thinking of calling the FBI if it is a ponzi scheme.
Can’t be too careful in this economic market. I bet there are many people doing whatever it takes to keep from going under. Other folks are always trying to game the system, but with the financial stresses in play right now, I’d bet there are more than a few normally on the level folks doing some grey area stuff to get by.
Referring to the ideal that the gov’t will add to the housing bubble. IMO this triage that the gov’t is implementing is literally to stop a global depression. We will still see home prices drastically cut to more affordable levels. In fact we will see a lot of assets lose the high price tag for while. We were living in a fake economy and now we have to face the truth, we have to live within our means. We are indeed living in interesting times, will the future generation become a nation of savers?
The generation that grew up in the Depression did.
“After several years in which Americans were buying stuff on credit they couldn’t afford, a rapidly increasing number are complaining about getting harassed and abused by bill collectors.”
How rude that people who are owed money want it back!
This type of phenomenon never would have occured with the folks who grew up during the Depression.
http://www.cnn.com/2008/US/10/30/debt.collectors.ap/index.html?iref=mpstoryview
“How rude that people who are owed money want it back!”
LOL!
Collector: “When can we expect payment on your loan?
Borrower: “I don’t have the money, I spent it.”
Collector: “Yes, but when are you going to pay it back?”
Borrower: “You mean I have to do that?”
Collector: “Yes, it was a loan, not a gift. When can we expect payment?”
Borrower: “As soon as someone else loans me the money.”
After several years in which Americans were buying stuff on credit they couldn’t afford, a rapidly increasing number are complaining about getting harassed and abused by bill collectors.”
At least then somebody cares whether you live or die, and checks on you. Once you don’t owe money, you might as well be dead. You are what you owe.
“...they shook their heads, and came to the conclusion chat Ichabod had been carried off by the
Galloping Hessian. As he was a bachelor, and in nobody’s debt, nobody troubled his head any more about him; the school was removed to a different quarter of the Hollow, and another pedagogue reigned in his stead.”
The Legend of Sleepy Hollow
http://authorsdirectory.com/b/sleep10.htm
Excellent Halloween tie-in.
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