House of Fire — Alice Cooper

The Village of Woodbridge is a desirable Irvine Village. It is an interesting study in the collapse of the market. Woodbridge is laid out with a large loop road framed with large duplexes giving the impression of driving through a series of manor homes. Behind this pleasant veneer is a great deal of high density housing. Outside the loop has the highest concentration of attached product while inside the loop has many large, single family detached homes. As the market decline has progressed, the low end has been deteriorating more quickly than the high end, and this has created a great disparity between the prices on the outside of the loop as compared to prices on the inside of the loop. This large disparity cannot persist forever. Either prices outside the loop will rise (which isn’t very likely) or prices inside the loop will fall. People who might want to live inside the loop will find the price differential so great, that many will purchase outside the loop as a next-best substitute. It is this substitution effect that pulls down the prices in the most desirable neighborhoods. It can be seen in small scale within Woodbridge, or it can be seen in large scale between Riverside County and Orange County. As prices drop in adjacent markets, sales volumes will continue to dwindle in the higher priced neighborhoods until the price curve flattens to its natural balance. This is why the big increase in sales volumes being touted by the bulls is only happening in the most downtrodden communities. The high-end properties still suffer from anemic sales volumes and significant price pressures.

Today’s featured property is a nice 3/2 outside the loop in Woodbridge. It is a typical starter home that will likely bottom in the $375,000 to $400,000 range. A household making $90,000 to $100,000 a year should be able to comfortably afford a property like this. Right now, they can’t.

Asking Price: $515,000

Income Requirement: $128,750

Downpayment Needed: $103,000

Monthly Equity Burn: $4,291

Purchase Price: $645,000

Purchase Date: 6/30/2005

Address: 15 Woodland, Irvine, CA 92604

I am too lazy to get up off my a$$, you go ahead and show it, just leave me the commission.

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20% off and falling. This was purchased a full year before the peak, to it is priced closer to 25%-30% off the peak resale value. Of course, it was purchased with 100% financing. If this property sells for its asking price, the Alternative Financing Corporation stands to lose $160,900.

Another day, another lender getting stiffed for over $100K. I wonder if any of these lenders are wishing one of our California wildfires would burn Irvine to the ground. At least then, they could collect the losses from their insurance company.

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House of fire

We ain’t gotta pay rent now, baby
No landlord to throw us out

Take me higher

Building a house of fire, baby

We are building a house of fire every time we touch

House of Fire — Alice Cooper

Shooting Star — Bad Company

Sometimes when you see an egregious case of HELOC abuse, you have to ask, “On what did you spend the money?” On many of the properties we profile, the owners at least put some of the money into the property and outfitted it with pergraniteel. Apologists offer the possibility of health issues or investment, but it seem pretty obvious that most of these people just blew the money. It is living like a shooting star, you burn brightly, but it can’t go on forever, and when your equity has burned up, you just fade away. Today’s featured property took over $400,000 out of their home, and it is being offered for sale as a fixer upper. So I ask again, “On what did you spend the money?

Asking Price: $499,000

Income Requirement: $124,750

Downpayment Needed: $99,800

Monthly Equity Burn: $4,158

Purchase Price: $210,000

Purchase Date: 7/11/1997

Address: 5 Star Thistle, Irvine, CA 92604

Beds:	3
Baths:	2
Sq. Ft.:	1,600
$/Sq. Ft.:	$312
Lot Size:	4,365 Sq. Ft.
Property Type:	Single Family Residence
Style:	Garden Home
Year Built:	1975
Stories:	1 Level
Area:	El Camino Real
County:	Orange
MLS#:	S532383
Source:	SoCalMLS
Status:	Active
On Redfin:	7 days
Fixer-upper

Great opportunity to overpay for a moneypit.

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These people bought right at the bottom of the last bubble. The caught their shooting star and burned through about $400,000 in the 10 years that followed. The bullet-point recap is as follows:

• The property was purchased on 7/11/1997 for $210,000. There was a $189,000 first mortgage, and the owners put $21,000 down (10%).
• On 9/23/1997 they took out a stand-alone second for $25,000 taking out all their equity plus $4,000. At this point, they have no money in the property.
• On 12/1/1999 they refinanced with a $240,000 first mortgage bringing their MEW to $45,000.
• On 12/29/1999 they opened a HELOC for $45,300.
• On 3/19/2002 they refinanced with a $284,000 first mortgage.
• On 4/19/2002 they took out a stand-alone second for $50,000. Total MEW of $145,000.
• On 12/26/2003 they refinanced for $378,750. Merry Christmas.
• On 7/27/2004 they refinanced for $500,000. Total MEW of $311,000
• On 11/22/2005 they refinanced for $511,000 with an Option ARM with a 1% payment rate.
• On 1/13/2006 the opened a HELOC for $100,000 bringing their total debt to $611,000 and their total MEW to $422,000.

If this house transacts at its asking price and a 6% commission is paid, the total gain on the property will be $259,060; however, the total loss to the lenders on this property will be $141,940. Countrywide will lose $41,940, and Washington Mutual will lose the amount withdrawn on the HELOC, presumably $100,000.

I hope everyone realizes that this house should not be on the market. Distressed sales brought about by HELOC abuse leading to a short sale or foreclosure are properties that would not be for sale right now if the lenders and borrowers had not gotten into this mess. Any fantasies of a bottom or appreciation going forward is going to be crushed by the onslaught of these distressed properties. A normal market characterized by modest appreciation requires relatively affordable prices, widely available financing, and a minimum of distressed properties. We have none of those conditions. The reservoir of distressed properties is not drying up; in fact, it is being replenished faster than the market can absorb them. Defaults and foreclosures continue to set new records, and properties like this one have become our daily fare. All signs are that the number of short sales and foreclosures is going to increase as the Alt-A and prime borrowers face their resets over the next few years. Many, if not most, are not going to qualify for refinancing due to tightening standards, in particularly they will not meet the new combined-loan-to-value requirements because they are underwater or close to it. Until the homedebtors who utilized toxic mortgages and HELOC abusers are flushed from the system, they will continue to poison the market through a steady supply of REOs. This debacle is just beginning.

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Johnny was a schoolboy
When he heard his first Beatles song
Love Me Do I think it was
And from there it didn’t take him long

Don’t you know

Don’t you know
That you are a shooting star,..(don’t you know, don’t you know)
Don’t you know that you are
A Shooting Star
And all the world will love you
Just as long..as long as you are?

Don’t you know,…

Shooting Star — Bad Company

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Have you ever wondered what they do with in outer space when they have to go?

We Will Rock You — Queen

As far as HELOC abusers go, today’s sellers are just like boys playing in the street. They made a big noise, tried to take on the world, and ended up a big disgrace. The market put them back in their place.

HELOC abuse crosses all socioeconomic lines. We have profiled high end, middle class, and now small-time condo owners freebasing the kool aid and spending themselves out of house and home. Everyone has ambitions to better themselves and their station in life. However, some people hatch plans to accomplish this goal that are not completely successful. Sometimes it is just fate or bad luck that causes some people to win or lose in life. Sometimes it is bad execution, and sometimes it is just bad planning. HELOC abuse would fall in the “bad planning” category.

How was this supposed to work? Even if the kool aid dreams were true and you could perpetually borrow against your house as it increased in value. What is the end game? Is there no limit to the amount of debt you can support? What happens when you sell and the house is no longer providing income? Does the house ever retire? Or does it provide endless free money forever? In reality, there was not plan. Everyone just took the free money and spent it without regard to future consequences, and now that there are consequences, everyone is avoiding responsibility and letting the lenders deal with the fallout.

The owners of today’s featured property managed to find a lender who thought their sub $200K condo was worth over $580K and loaned them money accordingly. These owners may set the record for the greatest return on their initial investment. They put down $5,500 in 1999 and took out more than $400,000 over the 8 years that followed.

Asking Price: $450,000

Income Requirement: $112,500

Downpayment Needed: $90,000

Monthly Equity Burn: $3,750

Purchase Price: $182,000

Purchase Date: 7/29/1999

Address: 18 Queens Wreath Way, Irvine, CA 92612

What is the “3rd room currently set up as a
3rd bedroom?” Is this an illegal conversion, or just realtor BS trying to make a 2/2 sound like a 3/2?

At least some of the HELOC money went toward pergraniteel.

Excellent
location? If you like being about 100 feet from the 405. This place has to be very noisy.

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To look at the listing, you would think these people are going to make $268,000, but when you see the short sale notice, you know they got crazy with their HELOCs. Let me give you the bullet point summary:

• The property was purchased for $182,000 in July of 1999. There was a $176,500 first mortgage and a $5,500 downpayment. 3% down was probably an FHA loan.
• On 7/31/2001 the property was refinanced with a $200,000 first and a $50,000 second. They took out their $5,500 plus an additional $62,500.
• On 4/10/2003 they refinanced with a $266,500 first mortgage taking out another $16,500.
• On 2/20/2004 they opened a $100,000 HELOC.
• On 5/23/2005 they refinanced with a first mortgage for $412,000. It was a negative amortization loan with a 1% teaser rate. The HELOC was likely paid off. Total MEW of $230,000.
• On 10/6/2005 they took out a second mortgage for $50,000.
• On 6/30/2006 they took out a $121,500 HELOC. Total MEW of $341,500.
• On 4/13/2007 they refinanced their first mortgage with a $564,000 first mortgage and a $21,150 second mortgage. The total property debt totals $585,150, and total MEW equals $408,650.

If the seller gets their short-sale asking price, JP Morgan Chase stands to lose $162,150 after a 6% commission. Of course, getting this asking price may prove difficult. They are trying to get $341/SF for a 1965 condo located 100′ from the 405. There are other sellers who have consumed even more kool aid.

Do you think this is going to happen again? Will people be able to do what these borrowers did? Will prices bottom out and quickly rebound so we can all borrow and spend ourselves to prosperity at the expense of our lenders? Somehow, I don’t think we will see this again in our generation, but you never know. If the peak of the next bubble would happen to correspond to when I want to retire, that would be great…

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Buddy youre a boy make a big noise
Playin in the street gonna be a big man some day
You got mud on yo face
You big disgrace
Kickin your can all over the place

We will we will rock you
We will we will rock you

We Will Rock You — Queen

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P.S. A special bonus for all Queen fans:

I’ll Walk Away — James Hunter

Calculated Risk recently had a post Freddie Mac on Walking Away. During a recent conference call, the following exchange occurred:

Analysts: What do you see? Is it in line with historical default rates as they get underwater or does it …

Freddie Mac: No, it is different. The rate of increase in defaults in that part of the population is much steeper. For those borrowers that bought a home based on rapid house price appreciation as a way to grow wealth, if they find themselves quickly underwater – you know we’re even seeing it when we try to modify and renegotiate those loans – they are walking away. They’re finding it not constructive.

In short, when people go underwater, they are walking away from the property. We now have some statistical proof this phenomenon is occurring. Statistics are great for discussing macro trends and the like, but we take a microeconomic approach here at the Irvine Housing Blog: we show you the properties the owners are walking away from. Today’s featured property is seriously underwater. It is being offered for sale at 27% under its peak purchase price.

Asking Price: $575,000

Income Requirement: $143,750

Downpayment Needed: $115,000

Monthly Equity Burn: $4,791

Purchase Price: $785,000

Purchase Date: 8/1/2006

Address: 37 Night Bloom, Irvine, CA 92602

Beds:	2
Baths:	2.5
Sq. Ft.:	1,545
$/Sq. Ft.:	$372
Lot Size:	–
Property Type	Detached, Condominium
Year Built:	2006
Stories:	2 Level
County:	Orange
MLS#:	I07181021
Source:	MRMLS
Status:	Backup Offer
On Redfin:	139 days
Unsold in 90+ days

That is a daunting wall of text, isn’t it?

Nice to see that realtors are still using multiple exclamation points.

INVESTOR’S
SPECIAL! I hope no investors are that stupid.

PROFESSIONALLY
INTERIOR DESIGNED TO MATCH YOUR EXQUISITE TASTE. Thank you for kissing my a$$.

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Can you believe someone paid $785,000 for a 2/2? WTF was he thinking? Even at 27% off, it is still overpriced. If this property transacts for its asking price, the total loss on the property will be $244,500. The seller put $78,500 down (which he is losing,) and Bear Sterns Residential (or JP Morgan Chase) is going to lose $166,000.

It is not terribly surprising this owner walked away. He needs scuba gear and an endless supply of money to survive the cashflow drain until this property gets back up above water.

Equity Curve of peak buyer using a negative amortization loan.

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I have received a few emails asking about the statistics I post ever day on the featured property, so I thought I would take this opportunity to review them.

Income Requirement: $143,750 — I base this on a four-times income standard. Most financial advisors would say a house should only cost 2.5 to 3 times income. I have my doubts prices will drop that low in Irvine. The income requirement is based on historic lending standards similar to what a borrower would encounter if they were to utilize an FHA loan (The FHA didn’t drink much kool aid.) Current FHA requirements only allow a 31% Debt-to-Income ratio for the mortgage and a 43% total DTI. This is only slightly elevated from the 28%/36% of the pre-bubble era. As lenders continue to lose money, credit will tighten until we are somewhere in near historic standards. I would not be surprised if the FHA were to tighten if defaults become a problem for them as well. The DTI ratio has an enormous impact on the total amount borrowed. As DTIs fall, so does the total amount loaned to a particular borrower. If people cannot borrow as much, they cannot bid up the price of real estate. The entire housing bubble was built on borrowed money, and as the quantity of this money decreases, prices fall. If we return to a 28%/36% standard, the four-times income I use in the calculations may not be made available. Current conditions in the market permit borrowers to obtain 5.5 times income due to the combination of low interest rates and very high DTIs being allowed. This is why there is ongoing activity at our still-inflated price levels. As the credit crunch grinds on, these numbers will fall.

The opinion of many bulls in the market right now is that FHA loans will save the market. In practice, first-time buyers utilizing these loans will stabilize the low end — at prices 40%-50% off the peak. People utilizing FHA loans are only going to be qualified to borrow 31% of their income. As you can see from the chart above, that will put us back at fundamental valuations with the same relationship between income and price witnessed during the mid 90s. One more thing to note relative to DTIs is that the debt-to-income ratio is a measure of how far buyers are “stretching” to buy real estate. Buyers have historically committed larger sums to purchase real estate when prices are rising in order to capture the appreciation of rising prices. Conversely, buyers have historically committed smaller and smaller percentages of their income toward buying real estate when prices are declining because there is little incentive to overpay. Some may look at this phenomenon as a passive effect of the rise and fall of prices, but since buying is a choice, the fluctuation in debt-to-income ratios is an active force on prices in the market.

Downpayment Needed: $115,000 — I have been using a 20% downpayment requirement because it was the standard in the past, and I believe it will be again. Think about what Freddie Mac was saying in the conference call at the beginning of this post: the rate of default increases dramatically when borrowers go underwater. Given the evidence of this effect, wouldn’t it be prudent for banks to require larger downpayments to avoid the defaults? Considering the staggering losses banks have already endured, I suspect they will begin being more prudent in the future, either that, or they will go out of business. Many people have speculated that 10% down will become the new norm. Why? Wishful thinking is not going to change the behavior of borrowers or lenders. If people default when they go underwater, lenders will do whatever is necessary to make sure they don’t. The only tool at their disposal is raising downpayment requirements. There is nothing in the behavior of lenders or borrowers to suggest that 20% downpayments will not become the standard again. If someone can present a convincing argument why 10% down will become the norm in the comments, I would love to hear it — and the fact this requirement will destroy the housing market is not an argument for why it will not happen, it is simply an observation of the result of higher downpayments.

Monthly Equity Burn: $4,791 — I have speculated that the housing market will drop 10% a year for the next 2 or 3 years (it has actually been dropping faster than that.) If prices do drop at this rate, buyers will see their equity dissappear at the rate of 10% per year. The monthly equity burn is this yearly decline converted to a monthly figure. Most people think in terms of their monthly payment or their monthly cost of housing, so converting this figure to a monthly figure demonstrates the hidden cost of ownership created by the loss of property value.

I hope these explanations clarify things a bit. If there are any other questions, I will attempt to answer them in our collection of astute observations.

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Darling if ever you refuse me
Like I know you will one day
I won’t let the change confuse me
I’ll know that my cue to walk away

When I feel my chances growing slimmer
Cause there’s nothing left to say
When the lovelight in your eyes grows dimmer
I’ll know that’s my cue to walk away

I’ll Walk Away — James Hunter