A Free-Market Solution to Prevent Housing Bubbles

Help — The Beatles

Our new President will need help to address the problems in the residential real estate financing system that resulted in The Great Housing Bubble. My full proposal is here: Preventing the Next Housing Bubble.pdf. The following is an exerpt from this proposal:

The secondary mortgage market was created in the 1970s by the government sponsored entities, Freddie Mac, Fannie Mae, and Ginnie Mae. This market was expanded by the creation of asset-backed securities where mortgage loans are packed together into collateralized debt obligations (CDOs). This flow of capital into the mortgage market is a necessary and efficient tool for delivering money to borrowers for home mortgages. This market must remain viable for the continued health of residential real estate markets. The problem during the Great Housing Bubble was that the buyers of CDOs did not properly evaluate the risk of loss through default on the underlying mortgage notes that were pooled. The reason these risks were not evaluated properly is due to the appraisal methods used to value real estate serving as collateral backing up these loans.

There is one potential market-based solution that would require no government regulation or intervention that would prevent future bubbles from being created with borrowed capital: change the method of appraisal for residential real estate from valuations based exclusively on the comparative-sales approach to a valuation derived from the lesser of the income approach and the comparative-sales approach. Both approaches are already part of a standard appraisal, so little additional work is necessary – other than appraisers will have to focus on doing the income approach properly. In the current lending system, the income approach is widely ignored. This change of emphasis in valuation methods could come from the investors in CDOs themselves. When the fallout from the Great Housing Bubble is evaluated, it is clear that the comparative-sales approach simply enables irrational exuberance because the past foolish behavior of buyers becomes the basis for future valuations allowing other buyers to continue bidding up prices with lender and investor money. Prices collapsed in the Great Housing Bubble because prices became greatly detached from their fundamental valuation of income and rent. This occurred because the comparative-sales approach enables prices to rise based on the irrational exuberance of buyers. If lenders would have limited their lending based on the income approach, and if they would not have loaned money beyond what the rental cashflow from the property could have produced, any price bubble would have to have been built with buyer equity, and lender and investor funds would not have been put at risk. There is no way to prevent future bubbles, and the commensurate imperilment of our financial system, as long as the comparative-sales approach is the exclusive basis of appraisals for residential real estate.

Investor confidence in the market for CDOs and all mortgages was shaken
during the decline of the Great Housing Bubble – and rightly so.
Investors were losing huge sums, and nobody clearly understood why.
There was a widespread belief these losses were caused by some outside
factor rather than a systemic problem enabled by the lenders and
investors themselves. For investor confidence to return to this
market, investors must first ascertain a more accurate evaluation of
potential losses due to mortgage default. This requires an accurate
appraisal of the fundamental value of the residential real estate
serving as colla-teral for the mortgage loans that comprise the CDOs.
Since the fundamental value of residential real estate, the value to
which prices ultimately fall during a price decline, is determined by
the potential for rental income from the property, revaluing properties
using the income approach would provide a more accurate measure the
value of the mortgage note and thereby the CDO.

The ratings agencies who rate the various tranches of
CDOs must adopt the method of valuation utilizing the lesser value of
the income approach and the comparative-sales approach. The ratings
agency’s recommendations and ratings carry significant weight with
investors, and the ratings agencies clearly made a tragic error in
their ratings of CDOs during the Great Housing Bubble. If the ratings
agencies properly evaluate the underlying collateral backing up the
mortgages that are pooled together in a CDO, investors will regain
confidence in the ratings, and money will return to the secondary
market. If investors in CDOs recognize the chain of valuation as
described, they would be unwilling to purchase CDOs valued by other
methods. If investors are unwilling to purchase CDOs where the
underlying collateral value is measured using the comparative-sales
approach and instead demand a valuation based on the income approach,
the syndicators of CDOs will be forced to respond to investor demands
or they will not be able to sell their syndications. Investors and the
ratings agencies can mandate a new valuation method for residential
home mortgages.

In September of 2008, the Federal Government
took “conservatorship” of the GSEs responsible for maintaining the
secondary mortgage market. With the collapse of the asset-backed
securities markets and CDOs, the GSE swaps were the only viable market
for mortgage paper. This provides a unique opportunity for changing the
market dynamics with limited government intervention. If the government
in its role as conservator were to decide to mandate a change in
appraisal methods, the secondary market would be forced to accept this
change. Like any sweeping change in methodology, it could be phased in
over time to properly train appraisers and work out the details of
implementation. If the GSEs lead, the rest of the market will follow.

main objection with the income approach is the difficulty of evaluating
market rents, particularly in markets where there may not be many (or
any) comparative properties for rent in the market. This is an old
problem, one that has been studied in great detail by the Department of
Labor Bureau of Labor Statistics. Comparative rents have been
collected by the DOL since the early 1980s as part of their calculation
of the Consumer Price Index. The problem of irrational exuberance in
the late 1970s in coastal markets, particularly California, caused the
consumer price index to rise rapidly. Since the CPI is widely used as
an index for cost-of-living adjustments, volatility in this measure
caused by the resale housing market needed to be urgently addressed.
After over a decade of study, the DOL decided to value the change in
housing costs by a comparative rental approach rather than a change in
sales price approach used previously. This smoothed the index and
reduced volatility because the consumptive aspect of housing services
were tethered to rents and incomes rather than being subject to the
volatility caused by irrational exuberance in the housing market.

Department of Labor Bureau of Labor Statistics measures the market
rental rate in markets across the United States. It breaks down the
market into subcategories based on the number of bedrooms, and it does
a good job of estimating market rents in the various subcategories.
These numbers are updated each year. The figures from the DOL would
serve as a basis for evaluation of market rents, and it may be the only
basis in areas where there are few rentals. In submarkets where there
is sufficient rental activity, the income approach can use real
comparables to make a more accurate evaluation. Appraisers will decry
the lack of available data on rentals as many rentals, particularly for
single-family detached homes are done by private landlords who do not
report these transactions; however, if this method of appraisal were
the standard, private companies would spring up to track these
transactions and maintain an up-to-date database. Valuing properties
based on the income approach may be more difficult than the
comparative-sales approach, but when the latter method is fundamentally
flawed, ease-of-use is not a compelling reason to continue to rely on


There is also the objection that the income approach
method of valuing residential real estate has the same problems as the
comparative-sales approach because both approaches rely on finding
similar properties and making an estimation of market value by
adjusting the values of comparative properties. In both approaches the
appraiser must explain their reasons for the adjustments to justify the
appraised value of the subject property, and this is a potential source
of abuse of the system. No system is perfect, but the potential to
inflate prices though manipulating appraisals based on the income
approach is far less than the potential problems emanating from the
comparative-sales approach because the basis of adjustment in the
income approach is a properties fundamental value whereas the basis of
adjustment in the comparative-sales approach is the prices paid by
buyers subject to bouts with irrational exuberance. If lenders start
accepting appraisals where the income approach contains adjustments to
value that increase the appraised amount 100% – something that would
have been required to justify pricing seen during the Great Housing
bubble – then the system is hopelessly broken. The main argument for
using the income approach is that its basis is the fundamental value
whereas the basis for the comparative-sales approach is whatever price
the market will currently bear. Prices are not likely to decline below
a properties fundamental value where as a property may decline
significantly from a point-in-time estimate of market value. Using the
income approach lessens the risk to lenders and investors and ensures
the smooth operation of the secondary mortgage market. Using the
comparative-sales approach exclusively results in the turmoil witnessed
during the price decline of the Great Housing Bubble.

28 Salt Bush Pool

Asking Price: $5,000,000IrvineRenter

Income Requirement: $1,250,000

Downpayment Needed: $1,000,000

Monthly Equity Burn: $41,666

Purchase Price: $5,500,000

Purchase Date: 11/22/2006

Address: 28 Salt Bush, Irvine, CA 92603

Beds: 5
Baths: 6
Sq. Ft.: 6,000
$/Sq. Ft.: $833
Lot Size: 0.54


Property Type: Single Family Residence
Style: Tuscan
Year Built: 2006
Stories: 2
View: Canyon
Area: Turtle Rock
County: Orange
MLS#: R805382
Source: SoCalMLS
Status: Active
On Redfin: 164 days

Unsold in 90+ days

Inspired by the rolling hillsides of the Tuscany region, this
exceptional custom estate is located in the premier and exclusive golf
community of Shady Canyon. With 5 bedrooms and 5.5 bathrooms, exposed
beam ceilings, a library / office, courtyard with outdoor fireplace,
pool, spa, built-in barbeque center, an additional fireplace near the
pool and private serene views of Shady Canyon, this high quality home
was built by renowned builder, Pinnacle Custom Homes, Inc.

When this beautiful property was purchased on 11/22/2006, the owner used a $4,175,000 first mortgage, a $500,000 HELOC, and a $825,000 downpayment. I suspect some of you may have laughed to yourself when I put the income and downpayment requirements for such an expensive home. When homes start getting over $2,000,000 they tend to be cash purchases with much smaller loans. Part of the reason for this is because anyone rich enough to afford a house like that doesn’t need credit, and since you can only deduct the first $1,000,000 it doesn’t pay to have such a large mortgage. However, the owner of today’s featured property did take out a massive mortgage. Can you imagine those payments? Yikes!

The high end is showing signs of stress. This one is almost 10% off. That doesn’t sound like a lot, but when you are talking about such an expensive property, 10% is $500,000. With two years of payments on combined mortgage of $4,675,000 and a $500,000 loss just on the asking price, this owner can’t be too happy.


Help, I need somebody,
Help, not just anybody,
Help, you know I need someone, help.

When I was younger, so much younger than today,
I never needed anybody’s help in any way.
But now these days are gone, I’m not so self assured,
Now I find I’ve changed my mind and opened up the doors.

Help me if you can, I’m feeling down
And I do appreciate you being round.
Help me, get my feet back on the ground,
Won’t you please, please help me?

And now my life has changed in oh so many ways,
My independence seems to vanish in the haze.
But every now and then I feel so insecure,
I know that I just need you like I’ve never done before.

Help me if you can, I’m feeling down
And I do appreciate you being round.
Help me, get my feet back on the ground,
Won’t you please, please help me.

When I was younger, so much younger than today,
I never needed anybody’s help in any way.
But now these days are gone, I’m not so self assured,
Now I find I’ve changed my mind and opened up the doors.

Help me if you can, I’m feeling down
And I do appreciate you being round.
Help me, get my feet back on the ground,
Won’t you please, please help me, help me, help me, oh.

Help — The Beatle

60 thoughts on “A Free-Market Solution to Prevent Housing Bubbles

  1. granite

    You can bet common sense solutions like this will be fought tooth and nail by realtor groups. John Lansner proposed doubling the deduction yesterday.

    Question, what is the “income value” of the detached house (1540 s.f.) I’m renting for $2260 in Northwood? In case I decide to buy it in 2-4 years. The current market price is near $600K.

    1. alan

      Good question…

      The income value assumes you are getting a return on your investment better than what you would get by leaving your money in the bank. In real estate investing, typical returns are 10%(since you can get 4% at no risk in a CD)

      In your case, you have to subtract taxes, association fees and upkeep to find your income stream. Lets say these total $500/month. Then the actual income stream to the owner is $1760/month. Multiple this by 12 months and 10 (10% return) gives an income value of $211,000.

      Now you see how far properties really have to fall.

        1. Dave

          Landmark: it’s economic reality. If the numbers don’t work, it doesn’t matter what anyone feels about it. Why people cannot understand this I find extremely disturbing.

          1. biscuitninja

            I own a few properties and during the peak we were as much as 100%+ out of income values. I just shook my head and saved. Its alot better now, but still nowhere near what it should be. I’m sure it will always be on the expensive side, but not 2x what it should be….

            As a side thought, we can’t sustain this economy when California taxes the daylights out of businesses. They just won’t stay.

          2. Landmark

            Is a 10% return really necessary for the numbers to work? Please ellaborate. The only way we will get to 10% is if interest rates rise to 10% or greater. Possible, with the type of inflation that’s possible as result current policy.

            Could one get 10% return on a single family home in Irvine in ’96? If yes— I would like to see an example and I will concede. Unless this is truely the next great depression or you can show me historical data of areas like Irvine with 10% cap rate I have to say I think you are wrong. Areas with great schools, good jobs, and limited land tend to have lower cap rates because there is less risk. When was the last time that rents dropped in Irvine? Anyone waiting for a 10% cap rate in Irvine will be waiting a long time. That being said, a reasonable income approach should be used. As long as interest rates stay low, Irvine has jobs, and people want to live here we will never see a 10% cap rate, that’s market reality.

            That being said, I agree with the idea of income approach. I have rented in Irvine since 2004. During this time I purchased homes out of state that would break even or cash flow with 20% down or less. Thus leveraging historically low interest rates. While the home I rent would have cost $650,000- $700,000, I could lease it for $2100. With the same $700,000 I could gross crica $7,000/month. OC/ Irvine did not make sense, Irvine still doesn’t, however if you are looking at 10% cap rates you will need to focus on Santa Ana, Texas, or Michigan.

            Although I could get 10% caps all day in areas like that I would buy in OC with a 7 or 8 cap all day before a 10 cap in those areas.

          3. IrvineRenter

            Real estate cap rates for true income properties are generally 3%-4% higher than prevailing mortgage interest rates. It is only during the bubble when people were betting on appreciation that cap rates got so low, and the spread between the cap rate and the interest rate got so small.

          4. Landmark

            IrvineRenter- Do you think that if rates stay at circa 6% we will see cap rates at 10% in Irvine for single family homes?

    2. Landmark

      As a realtor I agree with IrvineRenter 100%— if people want to pay more than they can loan they still can. I’m sure some still will. Let them use their own money. Nevertheless, Granit is probably right regarding NAR.

  2. cara

    No interior pictures?

    What, too much priceless artwork to trust a photographer to be allowed inside??

    Or just a “must see to believe it” vibe? Or given 171 days on the market so far, were their tastes in interior finishings too garrish or too spartan for the other buyers of their ilk?

    1. SnowKat

      Maybe the owners are pissed off they have to sell their dream home in Turtle Rock & won’t let anyone inside for photos…

    2. Walter

      That or they have run out of money for a pro snapper. I have helped setup some interior shots. Lighting the interior can be very time consuming = $$$.

    3. Mike7

      The price they are asking for this house is a joke. Plus the resolution of the photos are so low, you can take them with a camera phone and post them online. If I was going to sell a condo, I’ll have more that 4 pics.

  3. Texas Triffid Ranch

    What’s going to be really interesting over the next few years is what’s going to happen to the high-end real estate market. On one side, IrvineRenter’s absolutely correct: the sort of people who buy houses like these usually do it in cash. The problem I’ve seen is that during the bubble, a lot of developers decided to bypass the midrange and go directly for the stinking rich. That’s fine so long as you have more and more stinking rich willing to buy what my wife calls “American Godawfuls”, but if the economy goes south and the only people with that kind of income are dope dealers and executives who cashed out their retention bonuses “to spend more time with their families,” who’s going to buy these houses?

    The 171 days on the market for this place is also, sadly, appropriate. I live not far away from a rather old-money portion of Dallas, where a lot of the Fifties-era ranch houses were bought out when the owners died and replaced with American Godawfuls. Quite seriously, one of these things was obviously inspired by the Magic Kingdom at Disneyland, complete with guard tower and cute little banners on the parapets. In almost every case, the developer built the place on the assumption that it’d be snapped up in a matter of hours, or because a potential customer offered a 10 percent payment to have it done His Way. Well, the portfolio takes a major hit, the buyer realizes that it’s cheaper to take a $200k hit on the deposit than to pay the whole $2 million for a place that’s already worth $1.5 mil, and the developer is stuck with another zero-lotline monstrosity that can’t even be converted into apartments. Expect a lot of this in the next few months, especially when the developers finally decide it’s better to sell at a dead loss than to be trapped under the tax liability for the properties.

    1. IrvineRenter

      Historically, the problem with creating subdivisions and communities for the rich has been absorption. Only the investors and developers with the deepest pockets could make it selling just a few homes a year. Most want to be in and out in a few years. Some of these communities take 20 years or more to build out because of the low absorption rates. These high-end neighborhoods saw a boom during the bubble because banks were willing to give out $4,675,000 loans, and borrowers were willing to take them out. That is going to stop. The Mega McMansion market is going to go back to all-cash, and there simply are not that many people who have it. Most of these properties were built for over-leveraged pretenders.

      1. MalibuRenter

        There is a large group of people who can afford such homes: the people who already own one somewhere else. If they have to relocate for work, they trade a massively expensive house near SF for one in LA.

        However, that doesn’t lead to absorption overall. It only helps the destination market. I have the funny feeling the outmigration is typically from the more expensive markets.

  4. Joseph

    Excellent post. However, I have to say that when I read the words “free-market solution” I get a little nervous, especially since it makes me think of this guy:


    I don’t purport to understand all of the underlying reasons for the Great Housing Bubble and resulting crash, although wonderful blogs like this one have helped me get a better sense for what happened. Still, while I realize there were guilty parties galore, I can’t help but believe that rabid supporters of deregulation and the “free market” (or at least Phil Gramm’s version of such) have been some of the biggest.

    Any thoughts on this?

    1. IrvineRenter

      “But looser regulation played virtually no role, he argued, saying that is simply an emerging myth.” — Phil Gramm

      In other words, he does not want to be blamed.

      The free market is going to play a role in what is to come. My proposal establishes a methodology to be used by the free market to prevent another bubble. It sets a boundary to lending; a boundary lenders should desire because it would prevent disasters like we are currently experiencing.

      Regulators need to set boundaries so that the playing field is fair to everyone. The deregulation Phil Gramm supported (along with many others) was an elimination of the boundaries. Partially deregulated free-market capitalism created a series of incentives that resulted in the housing bubble. Some might argue that deregulation didn’t go far enough. Most might argue that more regulation is necessary.

      1. Matt

        The capacity people have to deny reality when it goes against their ideology is amazing. Essentially, a LOT of these Ayn Rand conservatives are experiencing a TON of cognitive dissonance these days.

        I’m an American liberal. In the grand scheme of ideologies around the world, that makes me a relatively big fan of the market. Markets are freakin’ awesome. However, it takes a special kind of idiot to think that ANYTHING is perfect. The market is no different. Left unregulated, our market developed incentives for middle-men that eliminated the fundamental market forces of risk and profit. It’s not that the underlying theory of human motivation is incorrect; it’s that the system that got set up no longer connected those motivations to positive outcomes. This is a kind of market failure. The very term itself demonstrates pragmatism. Markets don’t do everything perfectly. There are a number of ways in which markets don’t work. They increase societal wealth very well, but tend to concentrate wealth, for example. The question becomes: once you accept reality (that markets aren’t perfect), the question becomes: for what failures is the cure better than the disease? A heck of a lot of these Ayn Rand disciples are, essentially, like Christian Science applied to economics–no cure is acceptable. Once you step back and realize the sheer hubris that this takes (the belief that your ideology is absolutely flawless), you can see that an ideological approach like these guys take is simply being willfully stupid.

        Honestly, I wish the American conservative movement would recognize the difference between socialism and regulation. Sadly, too many of them don’t.

        1. autolykos

          The “Ann Rand disciples” are the consummate strawmen. The idea that there is a large body politic out there agitating for no regulation of the US economy is ridiculous.

          Just because a person favors less regulation over more regulation doesn’t make them irrational. And just because people aren’t rushing to blame the housing bubble on the boogieman of deregulation and point fingers at guys like Phil Gramm, doesn’t make them ideologues.

          1. Matt

            Reasonable people can (and likely will) disagree over the ideal level of regulation, particularly once you get into the precise details of what and how to regulate.

            And, yes, calling them “Ayn Rand disciples” does make my argument against strawmen. However, I would argue that a lot of people make arguments that are, at root, appealing to 2 concepts: that regulation is fundamentally harmful; and equating regulation with socialism, which is an entirely different economic structure. Whether they truly believe these things or not is impossible for me to know. But, I would submit that there are a lot of people using duck noises to make the case for more bread in ponds. (I hope I completely and totally abused that analogy….I think I have)

            Of course, there is a natural human desire to find “a cause” for all this. Ascribing cause to one factor makes life a lot simpler. Blaming Phil Gramm or Alan Greenspan falls into this tendency. Life is more usually more complex than this, of course. However, I would argue that deregulation of the whole financial side of this, as was done in the 1990s, is a contributing factor. Had Alan Greenspan used the regulatory power given him by Congress after they deregulated, I think that the Great Housing Bubble might have been less extreme. Take IR’s proposal. It doesn’t solve the problem of Housing Bubbles happening. But, I would argue it would likely lead to a little less air in that bubble. I don’t think Alan Greenspan caused the Housing Bubble (and I have even more of a problem with assigning causation to Phil Gramm). But, it seems like they contributed to it. Not saying they were irrational. I’m just saying they aren’t perfect, and, as Greenspan himself has “admitted” in a roundabout way, he made a mistake.

          2. autolykos

            Fair enough, though I don’t think socialism is an entirely different economic system. The failed experiment with socialism in Great Britain, for example, was marked by state control of a number of industries/companies. I don’t see a substantive difference between regulation that allows the government to exercise practical control and socialization. That obviously doesn’t make all regulation bad, but it should merit our attention.

            As for Greenspan, you can throw as many stones at him as you’d like and it won’t offend me. While reasonable people can disagree about what effect his policies had on the extent of the housing bubble, I feel that he, more than anyone else, was in the best position to recognize the existence of the housing bubble and work to mitigate its effects (which he failed to do).

      2. Dan

        I believe irresponsible lending is here to stay–if things get bad again, the banks that are left (which are “too big to fail”), will simply ask for a shipload of taxpayer money to pay for capital improvements and start the cycle all over again. Please, someone tell me that I’m wrong.

        1. Walter

          I am afraid you are right, up to the point that the government runs short on money. At some point the market will force the situation. If this happens, it will not be pretty. Lets hope our leaders are not this reckless.

    2. Walter

      I think IR is right on this one. But I will add my idea:

      If you want 80%-90% LTVs, use income approach.

      If you want to use market approach (or greater fool approach as I know it), limit LTVs to whatever the current margin requirements are for stocks. Stocks are priced on comparable (market) prices. Because of the bubbles inherent in market priced markets, there are limits to the amount of borrowed money that can be used. Real estate is an exception to this general rule. Should it be?

  5. Kelja

    IrvineRenter, your proposal is brilliant but fatally flawed. And that’s because it makes too much sense.

    Also, remember, Obama is anything but a minimalist when it comes to government. He’s already said he’ll do what it takes to solve the crisis.

    Watch for the trillions coming out of Washington!

  6. Soylent Green Is People

    So if we’re really going down the legislative path towards an unfree market, here’s my suggestion.

    1) Declare any interest charged over Fed Funds rate (1%) plus 3% margin as usury, subject 110% recapture by the Federal Goverment.

    2) Modify all loans – commercial and residential – to Fed Funds plus 3%.

    3) Don’t have a mortgage, but you own property that you “foolishly” paid off? How’s a 10% of appraised value tax credit, paid over 5 years?

    4) Now that the Government has resolved the mortgage issue, now what about sales prices? Sales prices will be limited to original paid price, plus inflation indexing from purchase date. If you sell over that price, 50% of the gain is recaptured by the Government, of which 1/2 of that is paid back to the banks who lost money on all those modified loans.

    5) You pay cash for the home – there isn’t a recapture tax on any gain.

    6) You pay cash for the home? Sorry, cash out refi’s are limited to 50% LTV.

    7) Commission based employment for Realtors and lenders is replaced by a 1.5% maximum fee on the sales price and the loan paid. Sure, fee income and commission motivation will be taken out of the mix, but isn’t that a good thing?

    Rough to say the least, but to settle things once and hopefully for all, you’re going to have to take very tough action.

    My .02

    Soylent Green Is People.

  7. Hormiguero

    Nice writing! But – flawed premise, and a somewhat surreal take on the nature of real estate as an asset.

    “This market must remain viable for the continued health of residential real estate markets. ”

    Obviously true, insofar as without borrowing, present values, sales volumes, etc, would absolutely fall off a cliff. But inherently true? Not at all. The idea that there is some kind of a God-given right to be able to leverage a fractional down payment and income into a residential mortgage is absurd.

    I know that my stockbroker won’t allow more than 50% leverage in terms of margin debt. Why should a residential bank? Why should any kind of leverage be encouraged at all? Isn’t the homeowner with 100% equity from the very beginning the most stable homeowner and citizen? And isn’t the lack of air in pricing which would result the best outcome in terms of lessening the social pressures which come with high housing costs?

    As for valuing real estate based on income – that’s really putting the cart before the horse. When I retire, I hope to have (and need) a minimum of income, and really don’t see the relationship between someone’s “income” and the place which I hopefully live in. Why should an investor?

    1. MalibuRenter

      Whatever you might think about the exact value, homes are assets. Loans are made against all kinds of assets, from pawned jewelry to industrial equipment.

      1. Hormiguero

        Did I state something to the contrary? And what exactly are the income-producing properties of pawned jewelry and industrial equipment, anyways?

    2. IrvineRenter

      I don’t disagree with your point, but the catastrophic decline in real estate prices associated with the elimination of leverage would be very painful. Home ownership rates used to be much lower, particularly prior to WWII because all mortgage lending was interest-only with very high LTV requirements (50% being most common).

      The 30-year fixed-rate conventionally amortized mortgage was a method of getting people into homes while keeping default rates very low. This loan program has a track record of stability, even at LTVs of 80%.

      The relationship between income and the cost of their home can be maintained after retirement, assuming the debt is retired at the same time the worker is. That is why people work to pay off mortgages. It allows them to enjoy the same standard of living in retirement even though they no longer have the same income.

      Investors (not speculators) value assets based on their cashflow. This is how finance works. Assets yielding high risk-adjusted returns attract more capital which in turn increases production of the asset. In this way the market properly allocates capital to those uses which are most productive. It is only when speculative betting create asset bubbles that we have an inefficient allocation of capital resulting in McMansions in San Jacinto.

      1. Hormiguero

        True, it would be painful (and would never happen, for political reasons). It also could be argued that it would minimize mobility in many senses of the word.

        But I worry that so many of these assumptions are based on a world that just doesn’t exist – the paradigm of constant economic growth that we’ve generally seen in the past 60 years is one that may have changed. So much of that paradigm was based upon American hegemony, exponentially increasing productivity baby boomer demographics, general fiscal stability, and near-full employment.

        As for your distinction between investors and speculators – no offense, but that isn’t intellectually dishonest, it is just stupid. How many value traps have ‘investors’ fallen into this summer?

        Here’s a nice example of a professionally-picked, very well diversified portfolio, with an emphasis on consistent earnings and yield, held with extremely low turnover:


        It has lost more than half of its value in the past half year. Is that “speculation”? It certainly strikes me as “speculation” to assume that the average american worker’s income is more quantifiable and predictable over the long term than a large international company which has had steady dividends for decades (which describes most of that list).

        1. IrvineRenter

          If the purchase was truly a cashflow valued purchase, the resale value of the asset would not be important. A cashflow investor would be receiving the rate of return they desired, assuming the cashflow generator performed as projected.

          Stocks are a different animal. It is very, very rare that stocks are valued in the open market at their cashflow value. 99% of the time or more, stock “investment” is really speculation. If you want true investment, you need to look at bonds held to maturity, other forms of debt, or rental real estate to name a few.

          Even though Warren Buffet is considered a legendary investor in stocks, most of his stock purchases were not bought at an exchange. He most often bought companies in private offerings and added them to his portfolio. It is only through initial or private offerings that you can get stock at cashflow value. Once it gets on to the exchanges, it generally trades at a multiple to cashflow value.

          1. Hormiguero

            “If you want true investment, you need to look at bonds held to maturity, other forms of debt, or rental real estate to name a few.”

            I’m glad you consider the REITs which have stunk up my 401k to be true investments, and not just speculation. The poor souls holding on to emerging market and automaker bonds should also feel flattered by your classification. And those holding freshly-minted Bernanke treasuries for the duration… Personally, I think the season win over on the Falcons and/or Titans would have been much better places for my money in the past month.

    1. autolykos

      My favorite line from the article:

      “Buyers who gave false information to mortgage lenders are technically guilty of fraud themselves. Yet authorities are mostly targeting schemes such as the one allegedly perpetrated by Mazzarella and Grimm.”

      They’re just “technically” guilty of fraud, it’s not real fraud. The ability of people to continue thinking they did nothing wrong (and of society to look the other way) is amazing.

      I still have absolutely no idea why so many people thought liar loans weren’t a problem. Why weren’t people at least required to deliver a copy of their tax return?

  8. John S.

    Hi IR or fellow readers,
    Can you please share how we can obtain the public records such as the mortgage details etc. that you routinely use in your analysis? is there easier way of getting it online, other than visiting the public records office? Thanks

  9. Carl

    I am a particular fan of the ultra high end (1,500,000.00 +) in Irvine posts. I think it is because with rare exception there is no intrinsic market for these homes. They were all built and sold with the idea of speculation in mind. As someone mentioned, it is hard to justify more than $300/sq.ft. if you can’t walk to the beach or see the white caps (I paraphrase and oversimplify).

    Shady Canyon is a particularly telling ‘vale’ of tears. It is only 1/3 built out. There are no natural conditions that justify the astronomical asking prices. Further, the bottom of Shady Canyon is collapseing-take a look at Prairie Grass-close to 20% of the homes on that street are for sale-diminishing its aura of exclusivity.

    If you had 3 million to spend on a house and wanted a million dollar mortgage, would you buy in Turtle Ridge, Shady Canyon or Newport Beach-where you could walk to the ocean and see the white caps? More importantly, it would cost you 50% less to rent than to buy so why buy? As an example, this Turtle Ridge home http://www.redfin.com/CA/Irvine/51-Cezanne-92603/home/5900749 is for rent at $6,500.00 a month. If you borrow $1,000,000.00 your monthly payment will be about $6,500.00. Therefore, you get the house for about 60% off if you simply rent it. (More, if you consider the not inconsiderable HOA dues and taxes and Mello Roos). What you arguably give up is appreciation over 2.2+ million. Hmmm,would you really have to flip the coin on that decision?

    One last point. Quail Hill. I think it is the canary in the coal mine for expensive Irvine tract homes. It once had several sales over $2 million. I don’t think there are even asking prices over that now (I haven’t checked lately). It also lacks any natural feature to justify its prices. I assume that potential buyers here take a look at Shady Canyon and decide they’d rather live (rent) on Prairie Grass(?) Dunno.

  10. Perspective


    Anyone see this proposal in the Register to double the mortgage deduction? I was wondering when we’d see this proposed. It certainly makes owning more attractive for the higher taxed/higher mortgage folk.

    I’m guessing we’ll see this proposed by some Congress-person soon. Although it’ll probably be capped at $500k of mortgage debt and maybe for just the next 5-10 years or so.

  11. IrvineRealtor


    One point of criticism that I have in your proposal is the uncertainty of tying fair market purchase value to a formula of fair market rental value.

    For example, a property in say, Oak Creek, could fetch a rental price that varies widely. Looking at this year’s numbers for just one street, neighbors at 6 and 8 Madagascar – rents vary from $2450/month through $4000/month within one door of each other. I could pick several others which mark the same rental disparity.

    When this variability gets compounded by the uncertainty of multiplier rates (120x through 180x?) this could lead an appraiser to come up with values from $294,000 (low x low) all the way through $720,000 (max x max) for essentially the same home.

    How would you propose to mitigate discrepancies like these (other than, of course, eliminating people who would rent at $4K/month here from the pool.)? Even with small input variances, the net effects are significant on the outputs.


    1. IrvineRenter

      These are exactly the same problems an appraiser faces when using the comparative sales approach. There are procedures for adjusting the raw numbers by saying this one add $X for this feature and subtracts $Y for that one. The income approach could be treated the same. In theory, appraisers already know how to do the income approach as it is part of a standard appraisal. In practice, they would probably need to be reeducated.

  12. Austin Real Estate

    Great post. As a real estate agent, I do wonder how accurate/feasible the income approach would be for primary residences. I mean that $20k in exotic wood for the floor and $10k in kitchen granite isn’t going to add all that much in income, but it’s surely a choice many would make on their private home. Also, in apartments/offices, etc where the income approach is more common, there is a lot of data and offices are for the most part offices. Same goes for a 2bed/1bath apt. Would you use class for primary residences in a similar way that class is used for commercial space in order to get comps or take into account the wide variances in single family residential property?


  13. darms

    I thought I saw here a few weeks back (but couldn’t later find) a proposal that new appraised values for refi’s & HELOCS be immediately used to update the appraisal value for RE taxes. Sounds like a good idea to me in that it might put a damping factor on excessive valuations, especially in CA where the Prop 13 caps already create a very distorted view of property valuations for taxing purposes seeing as a property’s taxable value only changes at a sale. Shouldn’t a refi or HELOC for an inflated appraisal also count as a kind of sale?

  14. ignorantoutsider.

    If its a little off topic and the source is lower than the usual intellectual level of this blog did anyone catch the California “homeowner” Dawn on the Suze Orman show this week. The poster babe for the crash. $200,000 on credit cards, $900,000 house, 2 outdoor plasma TVs, $200,000 in landscaping, $19,000 a month expenses balanced by $9000 income. paying monthly expenses out of the 401k and thinks she can save the house. Oh I forgot… “she loves diamonds”. Seemed to explain a lot of the thinking that goes on. Sorry I dont know any links.

  15. QualityPicks

    Pretty good ideas. But I have always thought that avoiding bubbles is really hard, close to impossible. It is just part of the psychology of people. Where there is a will, there is a way, right? And people are greedy and will find a way to inflate bubbles 🙂

    Your suggestions would make it harder to inflate a bubble in housing no doubt about it. But what if incomes are inflated (as in a bubble) for some reason? bubbly incomes could cause bubbles in rents and real estate too. Am I wrong?

    Anyway, speculation itself is not good or bad. I love this country because one can speculate and become rich (or poor) by speculating. But things certainly got out of hand here.

  16. Zulu

    The sellers of the house on Saltbush are going to learn firsthand that their home isn’t worth $5 million. It isn’t worth $4 million. It’s worth somewhere in the high-3’s, because it can easily be replaced for that in this depressed market. Buy a lot for $2 million and slap a home and landscape on it for $1.9 million. $3.9 million tops.

    At the height of the boom, people were paying contractors far too much. A few years of building experience and you were making $100k per year. Those days are gone. Subcontractors are sitting at home watching Gilligans Island reruns. Soon, they’ll be working for whatever you want to pay. Try $15 per hour instead of $75.

    As far as Shady value goes – there are 400 homes on 1,600 acres of land. Excluding the homes on Prairie Grass, the density is quite low. Lots of open space. That’s the draw, and that’s why these home will hold their value (albeit, a lower value than previous) unlike the body pack of Quail Hill and homes near the beach.

  17. frank murphy

    does anybody know whether those semiliterate realtards receive a blast fax or email telling them what to say? i’ve seen in email from a realtor whom i tentatively contacted and NUMEROUS times in the media some variation of ‘there are definitely opportunities out there.’

    those discredited whores seem to all have the same talking points, and that particular one has been done to death even when the universe is cooling in its final entropy around the worthless carcasses of those realtards.

    so clue me in if you’ve heard of them being told to parrot this idiotic phrase.

  18. donotlikehaters

    Lots of haters on the blog tonight. First, Zulu, sounds like your wife slept with your contractor, tough. A solid person with a few years of building experience deserves to make $100k per year. If you’re going to look at people making money that shouldn’t have been look at all the mortgage guys, especially the high school drop outs making 1/2 million. At least a builder is working for his money. I sure hope you are contributing to society because based on your comments it seems you are not too happy with your life.

    Second— of course are realtors are saying the same thing— what else are they going to say? There are not good deals out there all homes are over valued and by the way I’m going on food stamps. There are good realtors out there, that being said there are some really bad realtors out there as well. Just like there are bad contractors, Zulu’s, and Frank Murphy’s. y’all need to keep hiding in the shadows.

  19. Michael

    It’s rather simple IMO. Housing bubble could have been easily prevented if the housing price was included in the CPI. If it were, Fed would have seen the “inflation” and the resulting rate hike(s) would have prevented risky ARMs and kept housing price in check. It boggles my mind why they don’t include the home price (largest expense item for most people) in the CPI.

  20. woody

    Hi, someone please help me with this, the IrvineRenter says that property records are public information, like how much the first and second mortgages are, how much someone put down on a house, HELOCs, and other what nots… I would like to know where I can find this public information for a couple of houses I’m looking at, can anyone point me in the right direction?

    1. Landmark

      Hi Woody:
      I know most don’t like realtors on this site, however, I’m a realtor that agrees with 99% of what IrvineRenter says. In fact, I’m currently a CA renter myself, while I own investments out of state. I can pull up Realist Reports that have most of the info you are looking for. In addition, my title company can pull up detailed information that may help. You can email me at shevy.akason@evergreenrealty.net and I can send you the info.

  21. Austin Real Estate

    Hi Landmark,
    I just joined your blog via rss feed. Cool deal. I’ll have to read it later tonight, but I’ll let you know what I think.

    As for Austin, we’re seeing price drops in most prices and locations. Buyers and sellers are not meeting on price in my experiences for the last few months. I have two clients (buyers) in particular who refuse to come close to market value as they are still expecting large price drops and sellers are not for the most part of the same opinion.

    We are still seeing small appreciation in most areas as the good houses are still selling and having multiple bids at times. I think downtown is getting hammered with the over development of condos. from 2006/2007 they were seeing 30% depreciation according to a local title company statistician. I don’t see that market getting any better any time soon. There is way too much inventory and the prices are way too high for being in downtown Austin imo.

    You can join my blog too at http://www.affinityproperties.com/wordpress/


  22. 25w100k+

    I love it! This is the best thing you’ve posted so far. I agree with a lot of what you say on the bubble, and your analysis on home prices in Irvine is great too, but you hit this one out of the park!

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