Monthly Archives: June 2008

Will the Market Panic?

Prices are sinking like stones, and we are all done for. It it time to panic?

People will not panic this year. This will be the last year of denial. Only the weakest of speculators have been flooded from the market at this point, and there are many, many more who will be hopelessly underwater and drowning in debt as time goes on. Most of the buying this year has been by foolish knife-catchers who still believe in the fallacies of kool aid intoxication and bought now that they are no longer “priced out.” (Of course, now they are “priced in” forever…) There is still the widespread belief among the general public that house prices will return to the peak in a couple of years and everything will be like it was during the bubble rally. That is not going to happen. This fall and winter, prices will make another big drop just as they did last fall and winter. That drop will put fear in the hearts of everyone who owns speculative real estate (which means almost everyone who bought since 2002.) By next year, we will see real fear and possibly some capitulatory selling. Remember, the speculators we have profiled to date have only been the trickle of water that breaks the dam. This problem is much larger than what we have seen to date.

There is a funny mathematical truth few understand: drawdowns are asymmetrical. If prices fall 50%, it takes more than a 50% increase to get them back up to the peak. In fact, after a 50% drop, prices must go up 100% to get back to where they started. Even now, with prices down 20%, prices have to go up 25% to get back to the peak. The deeper the price drop gets, the harder it will be for prices to recover. This is also why timing the market is important. (I will post on this concept in more detail at a future date.)

Today’s featured property was purchased in 2004, and now it is selling for significantly less than its purchase price as REO.

14921 Yucca Ave Kitchen

Asking Price: $649,900

Income Requirement: $162,475

Downpayment Needed: $129,980

Monthly Equity Burn: $5,415

FB Purchase Price: $730,000

FB Purchase Date: 12/22/2004

WAMU Purchase Price: $610,000

WAMU Purchase Date: 4/2/2008

Address: 14921 Yucca Ave, Irvine, 92606

REO

Beds:	4
Baths:	3
Sq. Ft.:	2,650
$/Sq. Ft.:	$245
Lot Size:	5,000 Sq. Ft.
Property Type:	Single Family Residence
Style:	Other
Year Built:	1972
Stories:	2 Levels
Area:	Walnut
County:	Orange
MLS#:	U8002616
Source:	SoCalMLS
Status:	Active
On Redfin:	2 days
Fixer-upper

Large two story pool home in a great interior tract location in the
College Park neighborhood.4 bedroom plus big bonus room upstairs.Lots
of area downstairs with living/dining rooms and family off the kitchen.
Custom oak stair railing, crown mouldings and nice wood cabinets in the
kitchen. Upgrades thru out but will need a little TLC.Low HOA dues and
no MELLO ROOS.

nice wood cabinets in the
kitchen? I have had better in apartments. Did you notice how they were cropped out of the picture?

When this house was purchased, the buyers put 10% down. I don’t know if they abused their HELOCs after that. The data service we have been using has been scrubbing their records after a property goes REO. We are looking for a new one. In any case, if this property sells for its asking price, the total loss on the property after a 6% commission will be $119,094. It is interesting to see how WAMU prices their REO. They have marked up their auction price by 6% to cover the cost of the commission. If this sells for asking, and assuming they bought it for the outstanding balance on the first mortgage, they will recover their cost. Of course, the second mortgage is a total loss, and if they were any HELOCs or other debt, that is gone too. It may be that our 2004 buyer is losing $73,000, but I doubt it…

Oh, we’re sinking like stones,
All that we fought for,
All those places we’ve gone,
All of us are done for.

We live in a beautiful world,
Yeah we do, yeah we do,
We live in a beautiful world,
Oh, we’re sinking like stones,
All that we fought for,
All those places we’ve gone,
All of us are done for.

We live in a beautiful world,
Yeah we do, yeah we do,
We live in a beautiful world.

Oh, all that I know,
There’s nothing here to run from,
And there, everybody here’s got somebody to lean on.

Don’t Panic — Coldplay

A Brief History of Kool Aid

What a Fool Believes — The Doobie Brothers

Kool Aid intoxication is synonymous with irrational exuberance as I outlined in the post What is a Bubble.
It has not always been part of the culture here in California as people have not always believed such foolish ideas. Kool Aid
intoxication is a pathology that infected the populace of California in
the 1970s. Up until the mid 1970s, California had a median home sales
price of approximately three-times income just like the rest of the real
estate markets in the country. (Data: Median Income of Households by State: 1984 to 2006, Median Family Income by State: 1959, 1969, 1979, 1989, and 1999, California median home price since 1968.)

Median Home Prices 1968-2006

Median Home Prices 1986-2006

In the late 1970s, the country was in the grips of a wage/price inflationary spiral.
Under those conditions, people began to bid up the value of real estate
partly as a hedge against inflation, and partly because rising wages
made fixed payments more affordable. If you expect your wages to go up
10% every year, even a debt-to-income ratio over 50% becomes affordable
after just a few years. During the late 1970s, prices were bid up very
high, very fast, and many people made fortunes in real estate. It was
during this time that residents of California learned they could bid up
the price of real estate, and they could make money from it. This
realization spread like a virus throughout the state. The bust of the
early 80s did impact specific properties in various markets, but the
median only leveled out and did not fall. As Robert Shiller noted in
his paper in 1988 (Warning, big PDF file,) this taught people that after a big boom, prices do not fall.

Inflation Adjusted Median Home Prices 1968-2006

Median Home Prices 1968-2006 Inflation Adjusted

By 1985, incomes had risen to where house prices were at four-times
income. This became the new floor beneath prices, and it was the
beginning of the “sun tax” here in California. The combination of lower
interest rates and strong employment started people buying again. By
this time it had been over 10 years since prices were at three-times
income, and it looked as if they would never get down there again. Thus
the fear of being “priced out forever” was born. At this point, people
believed in rapid appreciation, they did not fear a decline in prices,
and now they had the fear of being priced out. Kool aid intoxication
had gripped the society, and people began buying real estate and created the first real bubble in California real estate. Prices rose dramatically, but when the limit of affordability was reached with the loan products of the time, prices stopped rising, and it looked like there was going to be another leveling off period like there was in the early 80s. However, this time, prices were bid up much higher than incomes could support, and the median actually fell across the state by almost 20%. Just as in the first crash, prices of individual properties fell more than the median, and in fringe markets the decline was spectacular.

Affordability as Measured in Debt-To-Income Ratios 1986-2006

Debt-To-Income Ratio 1986-2006

The long decline of the early 90s might have been the end of kool aid intoxication. Prices of individual properties dropped below four-times income, and a relative level of affordability had returned. After 6 consecutive years of falling prices, some of the core beliefs of kool aid intoxication had fallen out of favor and a degree of sanity had returned to the California real estate market. Prices began rising in 1997, and there was solid appreciation for 3 straight years as the market recovered from its slightly oversold condition. However by 2000, prices were high relative to incomes, and it looked as if the market might be at a top. Of course, prices did not top in 2000, and with a dramatic drop in interest rates engineered by the Federal Reserve, the conditions were created for another housing bubble. The beliefs of kool aid intoxication crept back in to the California psyche, and the rest of the story is The Great Housing Bubble (Warning, big PDF file.)

It is my greatest hope that people see that there is nothing special about California real estate. Prices here go up and down because we make them do so. The fallacious beliefs of Kool Aid intoxication makes people behave foolishly and buy properties not because they are a good value but because prices are going up. This price crash is going to be very, very painful to a great many people, and Kool Aid intoxication may fall from favor again. However, As long as this behavior is not seen for what it is, people will continue to repeat the mistakes of the past, and we will have another painful housing bubble crash.

Doobie Brothers He came from somewhere back in her long ago
The sentimental fool dont see
Tryin hard to recreate
What had yet to be created once in her life

She musters a smile
For his nostalgic tale
Never coming near what he wanted to say
Only to realize
It never really was

She had a place in his life
He never made her think twice
As he rises to her apology
Anybody else would surely know
Hes watching her go

But what a fool believes he sees
No wise man has the power to reason away
What seems to be
Is always better than nothing
And nothing at all keeps sending him…

Somewhere back in her long ago
Where he can still believe theres a place in her life
Someday, somewhere, she will return

What a Fool Believes — The Doobie Brother

WOT 6-7-2008

You can see where the subprime blew up…

Making a Small Fortune in Real Estate

Mack the Knife – Frank Sinatra

The people who bought properties as flips in 2007 had to put their own money into the transaction. All of these people made a small fortune by starting out with a larger one.

One of the myths of the real estate bulls is the rich-foreigners-will-save-us fallacy. This myth has a hint of racism to it: foreigners must be culturally superior to have the money to come to the rescue of us poor Americans. Whenever I see this argument raised, I always link to a post done by Rich Toscano at Piggington.com called The Dumb Money. As stated in the article, “Far from being a positive fundamental, a sudden excess of foreign
participation in an asset market is indicative of ill-informed
speculative money at work. When the foreigners really start piling on,
it’s always a good sign that the end of the bubble is nigh.” As you might have surmised, today’s featured property was a flip attempt by someone with a non-Westernized name (as was yesterday’s.) The stupidity of this particular flip is breathtaking to me. It was purchased as REO for well over what the lender paid, and now it is being offered for much less. The entire loss is going to be the flipper’s money.

If the property looks familiar, it is because we have featured it before: Brookside Comp Killer.

Asking Price: $660,000

Income Requirement: $165,000

Downpayment Needed: $132,000

Monthly Equity Burn: $5,500

Purchase Price: $740,000

Purchase Date: 12/19/2007

Address: 4342 Brookside Street, Irvine, CA 92604

Beds:	4
Baths:	1
Sq. Ft.:	2,200
$/Sq. Ft.:	$300
Lot Size:	5,623 Sq. Ft.
Property Type:	Single Family Residence
Style:	Contemporary
Year Built:	1971
Stories:	1 Level
Area:	Portola Springs
County:	Orange
MLS#:	Y803965
Source:	SoCalMLS
Status:	Active
On Redfin:	3 days

REO! REPO HOME AT A GREAT PRICE. 4 BEDROOMS IN A GREAT AREA OF IRVINE.
SELLERS MOTIVATED SUBMITT TODAY. CALL LISTING AGENT FOR SHOWING

That description is a lie (and annoying for several reasons.) This is not REO. Do you think the seller is so embarrassed that they are losing so much money on the deal so quickly that they are pretending it is still bank owned?

This property was REO when the bank purchased it on 12/17/2007 for $678,340. It was sold to a woman “as her sole and separate property” on 12/19/2007 for $740,000. Perhaps the husband knew it was a dumb idea? The lender had to be thankful someone was foolish enough to purchase a house for over $60,000 more than they paid at auction, particularly given the sorry state of the market last December. A lender was willing to loan 80% of the $740,000 purchase price, but the owner had to put $148,000 down. If this property sells for its asking price, the owner stands to lose $119,600 after a 6% commission. Basically, they lost $120K in 6 months. That knife was quite sharp.

I doubt a regular reader of the IHB would have made that deal. I must admit, I feel a bit of schadenfreude on that one 😉

Thus concludes another week at the Irvine Housing Blog. Come back next week as we continue chronicling ‘the seventh circle of real estate hell.’ Have a great weekend.

🙂

Oh, the shark has pretty teeth, dear
And he shows ’em, pearly white
Just a jack knife has Macheath, dear
And he keeps it, keeps it way out of sight

When that shark bites with his teeth, dear
Scarlet billows, they begin to spread
Fancy white gloves though has Macheath, dear
So there’s rarely, never one trace of red

On the sidewalk, one Sunday mornin’
Lies a body oozin’ life
Someone’s sneaking ’round the corner
Could that someone, perhaps, perchance, be Mack the Knife?

From a tugboat on the river goin’ slow
A cement bag, it is dropping down
Yeah, the cement is just for the weight, dear
You can make a large bet Macheath is back in town

My man Louie Miller, he split the scene, babe
After drawin’ out all the bread from his stash
Now Macheath spends just like a pimp, babe
Do you suppose that our boy, he did something rash?

Ah, old Satchmo, Louis Armstrong, Bobby Darrin
They did this song nice, Lady Ella too
They all sang it, with so much feeling
That Old Blue Eyes, he ain’t gonna add nothing new

But with Quincy’s big band, right behind me
Swinging hard, Jack, I know I can’t lose
When I tell you, all about Mack the Knife babe
It’s an offer, you can never refuse

We got George Benson, we got Newman & Foster
We got the Brecker Brothers, and Hampton’s bringing up the rear
All these bad cats, and more, are in the band now
They make the greatest sounds, you ever gonna hear

Hey Sookie Taudry, Jenny Diver, Polly Peachum, Old Miss Lulu Brown
Oh the line forms, on the right dear
Now that Macheath, I mean that man Macheath
Yeah he’s bad, mercy mercy
Yeah he’s badder than old Leroy Brown
You better lock your door, and call the law
Because Macheath’s, that bum,
He’s back in town

Mack the Knife – Frank Sinatra

A Foolish Flip

Sugar Shack — Jimmy Gilmer and The Fireballs

There were people attempting flips in 2007. There were looking for their own Sugar Shack to sweeten their lives. Prices in our area were still at or near the peak, but all the signs were pointing to a downturn which was already underway in many markets. Residential real estate markets are dominated by amateurs because professionals do not bother with the headaches of what is generally a poor investment. Non-professionals by and large have no idea what they are doing, and they only make money when they get lucky because the emotions of speculators always lead them astray (remember Speculation or Investment?) Today’s featured property was purchased after the collapse of subprime was front page news in March of 2007. Our would-be Donald Trump either wasn’t watching the news, or he truly believed the subprime containment BS put out by the media. This guy actually put some of his own money into the deal, so it wasn’t just gambling with the lenders money. You would think if someone was going to put their own money in the deal they might have a clue about what he was doing: apparently not.

36 Gillman Street Outside

Asking Price: $699,000

Income Requirement: $174,750

Downpayment Needed: $139,800

Monthly Equity Burn: $5,825

Purchase Price: $850,000

Purchase Date: 4/4/2007

Address: 36 Gillman Street, Irvine, CA 92612

Short Sale

Beds:	5
Baths:	2.5
Sq. Ft.:	2,294
$/Sq. Ft.:	$305
Lot Size:	5,220 Sq. Ft.
Property Type	Detached, Single Family Residence
Year Built:	1965
Stories:	2 Level
County:	Orange
MLS#:	S08079260
Source:	MRMLS
Status:	Active
On Redfin:	5 days

You would love this beautiful home in this college community. Motivated
Seller needs to sell quickly. Short Sale subject to lender???s
approval. Please contact showing agent for details. Please do not
disturb occupants.

Is this another example of a house being sold or foreclosed with an unwitting renter inside? Anyone think this landlord is skimming the rent?

The property was purchased for $850,000 with a $637,500 first mortgage, a $170,000 second mortgage, and a $42,500 downpayment. The 5% downpayment evaporated even before he closed as he overpaid for the house. When the credit crunch hit in August, the property values really plummeted, and now he is asking $699,000. If this house sells for its asking price, the total loss on the property after a 6% commission will be $192,940. The seller will lose his $42,500, and the second mortgage holder will lose $150,440. The lesson for our speculator will not be as tough as it is for the lender, but losing $42,500 along with trashing your credit cannot be a good time.

Theres a crazy little shack beyond the tracks
And evrybody calls it the sugar shack
Well, its just a coffeehouse and its made out of wood
Expresso coffee tastes mighty good
Thats not the reason why Ive got to get back
To that sugar shack, whoa baby
To that sugar shack.

Theres this cute little girlie, shes aworkin there
A black leotard and her feet are bare
Im gonna drink a lotta coffee, spend a little cash
Make that girl love me when I put on some trash
You can understand why Ive got to get back
To that sugar shack, whoa baby
To that sugar shack, yeah honey
To that sugar shack, whoa yes
To that sugar shack.

Now that sugar shack queen is amarried to me, yeah yeah
We just sit around and dream of those old memories
Ah, but one of these days Im gonna lay down tracks
In the direction of that sugar shack
Just me and her yes were gonna go back
To that sugar shack,
Whoa uh ohT
o that sugar shack, yeah honey
To our sugar shack

Sugar Shack — Jimmy Gilmer and The Fireball