Lenders are completely in control of the pricing in many markets around California and the rest of the Country, and they control the lowest tier of the market here in Irvine. What will they do with their power?

Asking Price: $263,500

Address: 244 Lemon Grove, Irvine, CA 92618

{book7}

Bonus question: Would you buy on a freeway?

I Wanna Rule the World — 10CC

I wanna be a boss
I wanna be a big boss
I wanna boss the world around
I wanna be the biggest boss
that ever bossed the world around

Lenders will be the bosses of the Irvine market because they will control the majority of for-sale property in the market. They already control many markets where REOs make up more than 50% of all sales. They completely control the bottom market strata here in Irvine, and as foreclosures work their way up the property ladder, they will end up controlling our entire real estate market.

A couple of weeks ago, I wrote about Irvine’s Future REO Inventory. In that post, I noted the following:

Foreclosure is a four step process: (1) the borrower quits making
payments, (2) the lender issues of Notice of Default, (3) the lender
issues a notice of Trustee Sale, and (4) the foreclosure auction occurs
on the courthouse steps. Steps 1, 2 and 3 are separated by 90 days
each. At any time during this period, either the borrower can get
current with their payments, or the borrower and lender can agree to a
loan modification. If either contingency occurs, the foreclosure
process is aborted.

California passed SB1137 to force lenders to try harder to reach
borrowers in default and work out a loan modification plan. Also, the
GSEs and many large banks were on voluntary or mandated foreclosure
moratoria. This caused a dramatic decline in Notices of Default (step
2). Unfortunately, as I noted Moritorium on Defaults Announced,
stopping lenders from issuing notices does nothing to prevent borrowers
from actually defaulting (step 1). Borrowers everywhere stopped making
payments, and lenders merely stopped issuing notices about it.

I borrowed the chart below from Mish’s blog showing the delinquency rate since January of 2006 (#1 above — people who quit making payments). As you can see, there has been a steady increase in the delinquency rate. This is the first step in the foreclosure process. Unless a borrower who goes delinquent cures this delinquency, the property will work its way through the system and ultimately become REO.

In the past, people cured their delinquencies either by selling the property or borrowing the payments from another source. In today’s market, they cannot sell because they are underwater, and creditors have cut off other lines of credit; therefore, the two primary methods of curing default have been removed. Of course, this assumes that people want to cure their delinquency. When their is no equity in the property, and when the cost of ownership exceeds the cost of rental, there is little incentive to cure delinquency. In short, people walk.

Since the primary methods of curing delinquencies have been curtailed, and since the desire to cure is also diminished, the cure rate has dropped to near zero. Since the cure rate is near zero and likely to stay that way, new delinquencies will end up as foreclosures. The current delinquency rate is 9.12%. That means that over 9% of all homes with a mortgage are entering the foreclosure pipeline right now. The rate of delinquency is still getting worse.

In the astute observations last week, Dafox posted a link to Orange County foreclosure data. One of the charts created from this data is shows the number of NODs and foreclosures with the foreclosure numbers shifted by one year to account for the duration of the foreclosure process. I have taken the delinquency chart based on national data and guestimated the loan delinquency rate in Orange County based on national trends. I combined the two data sources into the chart below.

The purpose of the chart is to illustrate the pipelines of inventory currently working its way through the system. Remember just because a lender hasn’t filed a NOD does not mean people are not going delinquent on their payments; these properties make up the “Delinquency Inventory.” The foreclosure tsunami will continue to build until delinquencies stop rising and actual foreclosures catch up. There are no “green shoots” here.

Another kind of inventory known as “pipeline inventory” is the number of properties moving from NOD through to foreclosure. These properties will become REO unless the loans are cured.

The chart demonstrates that lenders were processing their foreclosures as they were obtaining them through mid 2007; there was little delinquency or pipeline inventory. In late 2007 as the various foreclosure moratoria began, lenders began falling behind on their filing of NODs and their foreclosure processes.

The foreclosure moratoria were supposed to workout
several million loans and stop people from entering the foreclosure
process. As we all know, this process has been a fiasco. The number of
loan modifications completed is a very small percentage of the number
of delinquencies, and 70% of those loan modifications default in 6
months. Other than buying the banks a little time, the foreclosure
moratoria were a failure.

The delays in foreclosure caused a buildup of properties in the system in the form of delinquency inventory and pipeline inventory. Unless the delinquencies and defaults are cured during the process–which seems unlikely–these properties will become REO.

As we all know becoming REO is only part of the story. Once a property becomes REO, it must be disposed of by the bank. The inventory owned by the bank but not being sold in the open market is known as “shadow inventory,” and estimates of this number vary widely. I cannot find a data source to verify the number, but the rumor is that there are 50,000+ bank owned properties in the five-county area of Southern California.

Add together loan delinquencies, pipeline inventory and shadow inventory, and you have a huge number of homes that will emerge from the system as must-sell inventory.

It will take years for the lenders to catch up on all the loan delinquencies they are facing because they are falling further behind every day. The result of all this inventory in the hands of lenders is a complete domination of the market by REO.

What will lenders do?

The fantasy of fence sitters everywhere is that lenders will either by choice or by force will dump large numbers of properties on the market all at one time and create so much must-sell inventory that prices roll back to the stone ages. I rather doubt 1970s prices are on the horizon. There will be regulatory pressure on the lenders to dispose of their assets, but an extreme rollback in prices would be so disruptive, that regulators will likely give the lenders some room to work off their inventories without causing a catastrophic collapse of asset values. So the question is, “How low will they go?”

Lenders are not completely stupid (kool aid insane perhaps, but not utterly clueless). Most understand cashflow valuations, and they can recognize price levels where it is cheaper for people to own than it is to rent. Once they cross that threshold, they know they can entice a renter to purchase a property from them because it really is a good deal. Depending on the desirability for long-term owner occupancy, they may have to increase their discounts in order to find a buyer, but it isn’t very likely that lenders will allow asset values to drop far below rental parity because even they recognize the value there.

IMO, once lenders gain total control of housing markets with the inventory they have, they will push prices down to rental parity and attempt to hold them there. There will be some pressure from regulators to dispose of assets, but there will be a pushback from lenders who recognize the floor of values rental parity creates. This tension will keep prices at these levels until the inventory of REO is flushed through the system.

It is hard to estimate how long this flushing process will take without hard numbers. Based on the current state of our economy, the huge number of bad loans yet to reset, and the general trend illustrated in the charts above, I would estimate we will not see a peak in foreclosures until 2012, and it will be three to five years after that before the inventory is purged from the system. It will take a decade to work off the excesses of The Great Housing Bubble.

{book3}

Asking Price: $263,500

Income Requirement: $65,875

Downpayment Needed: $52,700

Purchase Price: $350,358

Purchase Date: 5/8/2009

Address: 244 Lemon Grove, Irvine, CA 92618

Mirroed?

Aurora Loan Services did not mess around with this property:

They bought it at auction on 5/8/2009 for $350,358.

Foreclosure Record
Recording Date: 04/10/2009
Document Type: Notice of Sale (aka Notice of Trustee’s Sale)
Document #: 2009000174390

Foreclosure Record
Recording Date: 01/02/2009
Document Type: Notice of Default
Document #: 2009000000595

This property is tracking right on the statutory limits. Relative to what we have been seeing, this one is on the fast track. Given the rapid deteioration of low end pricing, it is wise to get this done as quickly as possible.

Pricing of these low end properties are still above cashflow investor levels, so quick foreclosure and sale provides opportunity for the lender to bequeath future depreciation to a knife catcher.

Asking Price: $130,000

Income Requirement: $32,500

Downpayment Needed: $26,000

Purchase Price: $62,500

Purchase Date: 10/29/1997

Address: 228 Orange Blossom #34, Irvine, CA 92618

IMO, this is a well executed price drop. They started high enough to get some of their money back, after an initial look, they began methodically lowering the price, and they did so at an unpredictable interval so potential buyers could not just wait a certain number of days expecting further declines. Of course, it can be argued that such a large price drop reflects too high a starting asking price. This is probably an accurate criticism, but with as fast as the low end collapsed, it is hard to say for sure.

This property was a classic “put” to the bank. The owner paid $62,500 on 10/29/1997 using a $35,000 first mortgage and a $27,500 downpayment. She only borrowed against the property once during the bubble taking out a $20,000 loan in late 2003–that is until 7/23/2007 when she took out a $212,000 first mortgage. Her timing was great because two weeks later the credit crunch hit, and financing these properties became significantly more difficult.

Why even look for a buyer when the bank will give you 100% of peak value?

Asking Price: $179,900

Income Requirement: $44,975

Downpayment Needed: $35,980

Purchase Price: $315,500

Purchase Date: 2/29/2007

Address: 426 Orange Blossom #202, Irvine, CA 92618

The property was purchased at auction for $268,814 on 2/20/2009. The owners lost their $50,000 downpayment.

Foreclosure Record
Recording Date: 01/05/2009
Document Type: Notice of Sale (aka Notice of Trustee’s Sale)
Document #: 2009000002015

Foreclosure Record
Recording Date: 08/22/2008
Document Type: Notice of Default
Document #: 2008000402030

The discount on this property is remarkable: 43%. The sad part is that it is still overpriced. It is probably near rental parity, but this isn’t a property an owner-occupant wants. This must fall to cashflow investor levels, and it isn’t there yet.

{book4}

Will the Cartel Collapse?

Implicit in my belief that prices will hold at prices between rental parity and cashflow investor levels is the belief that a variety of lenders holding properties will behave as an informal cartel and hold prices at levels above where supply and demand would find its own equilibrium. Cartels are inherently unstable because each member has an incentive to cheat. There is the possibility that the collapse of cartel pricing may push prices even lower. I doubt this will happen, not because the cartel will be stable, but because I believe cashflow investors will provide sufficient demand to mop up any supply. I might be wrong.

What do you think the lenders will do?