With the deflation of the housing bubble, home equity hit its lowest level in seventy years. It will fall further.
Irvine Home Address … 165 ROCKWOOD Irvine, CA 92614
Resale Home Price …… $315,000
My heart is aching, I'm a fool
To let it go on breaking
Maybe I'll awake and find that I'm mistaken
Louis Armstrong — I Wonder
The process of market capitulation requires the individual participants to realize their folly. Their pocketbooks are aching, and they ask themselves how long they should let it go on breaking, and finally they realize they were the fool.
As prices fall in the wake of the housing bubble, whatever equity wasn't spent through rampant HELOC abuse is being washed away by falling prices.
One data series that shocked me when I first saw it was the graph of home equity during the housing bubble. Everyone assumed home equity went orbital when house prices rose so far so fast. It would have except for one inconvenient truth: people were extracting that equity and spending it the moment it appeared. As a result, the expected huge increase in aggregate home equity from 2003 to 2006 never happened. Loan owners spent it all.
June 9, 2011 — The Associated Press, Bloomberg News
Falling home prices have shrunk the equity Americans have in their homes to nearly the lowest percentage since World War II.
Average home equity plunged from more than 61% at the start of 2001 to 38% in the January-March quarter this year, the Federal Reserve said in a report Thursday. That drop comes as home prices in big metro areas have reached their lowest level since 2002.
Prices fell 33% in 20 cities through March from their 2006 peak, reaching their lowest level since 2003, according to the Standard & Poor's/Case-Shiller index of U.S. home prices on May 31. The decline signaled a “double dip” as the index fell below its previous post-housing-bubble low set in April 2009. Prices more than doubled from 2000 to July 2006.
Further declines in home prices are likely.
Robert Shiller, the economist who co-founded the S&P/Case-Shiller index, said a further decline in property values of 10% to 25% in the next five years “wouldn't surprise me at all.”
“There's no precedent for this statistically, so no way to predict,” Shiller said Thursday at a Standard & Poor's conference in New York.
It's called overshooting to the downside, and it is very difficult to predict because the reasons it occurs is part mechanical and part psychological.
Mechanically, downside overshoot is caused by excess supply. With the millions of foreclosures lenders have already absorbed, and the millions more waiting in shadow inventory, housing markets everywhere have a huge supply problem. It has been masked over the last 3 years by withholding this inventory, but the problem didn't disappear, it's merely being held in abeyance to prevent a catastrophic price decline.
Psychologically, downside overshoot is caused by a change in buyer psychology. Since capturing appreciation was the primary reason people were buying during the bubble, and since prices are now depreciating, buyers who once were enthusiastic about real estate are shunning it like the plague. And they should.
Buyers need a new reason to buy, and and realtors calling the bottom is not sufficient. Only when prices are less expensive than competing rentals will buyers find a new motivation to buy real estate. And since rental parity is well below current pricing in markets like Irvine, buyers sit and wait, and sales volumes are anemic.
A backlog of foreclosures poised to hit the market means prices may stay depressed, dissuading builders from starting new construction.
The main reason for our ongoing economic doldrums is the lack of new residential construction. Housing is the economy. Nearly every recession since WWII has ended when residential investment picked up. Residential investment will not increase until the housing market has found a natural, sustainable bottom. The reason is simple: unemployed construction workers don't buy goods and services and stimulate the economy.
When the government tried to stimulate the housing market with tax credits and the federal reserve bought mortgage debt, their goal was to stimulate housing and jump start the economy. It failed.
The stimulants all failed because prices had not fallen to the point of affordability where real demand could sustain the momentum. It's like drinking coffee to stay up studying for an exam. You might get a temporary boost, but if the body is tired, it needs sleep, not stimulants. Similarly, if prices are inflated, temporary stimulants may cause prices to rise temporarily, but if what the market needs is a deeper price adjustment, that is what is eventually going to occur. And in fact, that is what's happening now.
How could someone tell if the market needed a deeper correction? On a macro level, measures of price-to-rent or price-to-income provide a clue. Plus, simply looking at long-term trendlines reveals prices are still too high.
On a micro level, rental parity is the best indicator. If prices are not affordable as measured by the cost of ownership compared to comparable rents, then prices need to come down. By both macro and micro measures prices are still too high in many markets.
Unemployment, which rose to 9.1% in May, and stricter lending conditions are signs that any recovery in housing may take years.
Shiller's comments paint a more pessimistic possibility for home prices than other forecasts. Additional declines will be “incremental,” Bank of America CEO Brian Moynihan said last week..
The CEO of Bank of America is telling people prices will go down. He is a good person to listen to because he will be one of the primary agents of the decline. Other than the GSEs, B of A has more REO than any other lender, and they are planning to liquidate. They won't dump the properties all at once, but they will liquidate, and their activity will push prices lower.
While it would be a surprise to see prices fall steeply, it's possible for homes to lose more value if inflation picks up, Karl Case, co-founder of the index, said Thursday.
“You could have flat nominal prices but still have it go down 20%,” Case said during an interview at the conference.
“If house prices stabilize, they could still go down in real terms. If we had inflation, it'd be great, because it'd mask a 25% decline.“
Did Karl Case just say inflation would be great because it would mask a 25% decline? A professional economist really said that? WTF? Does he really think it's a good thing for prices of everything else in our economy to rise significantly relative to housing is good because it keeps housing prices up? I'm starting to wonder who the real brains behind the Case-Shiller Indices is.
The Fed report showed that household debt fell in the January-March period at an annual rate of 2% from the previous quarter.
That drop was due entirely to a decline in mortgages.
Auto loans, student loans and other consumer credit rose 2.4% — the second-straight gain after nine consecutive declines.
We still have a long way to go to write down all the bad mortgages lenders are holding. Appreciation is not going to bail them out. The moment prices begin to rise, lenders will sell into the rising prices in order to liquidate their inventory. If both prices and volumes rise, lenders will quicken the pace of liquidations to stop the bleeding from their carrying costs. Any increases in lender selling will snuff out appreciation before it gains any momentum.
As long as lenders have copious amounts of houses and droves of delinquent mortgage squatters, house prices will not go up. Excess supply and carrying-cost pressures for liquidation will prevent price appreciation. Affordability will be excellent.
100% financing makes everything affordable
By far the dumbest idea that was fully executed during the housing bubble was embracing 100% financing. When lenders ran out of people with down payments and high credit scores, they took anyone off the street and gave them all the money to buy a house. With absolutely no barriers to entry to the housing market, everyone could afford to buy, and prices went straight up.
Of course, giving out the money is easy for lenders, but getting it back is more problematic, particularly when they loaned money to people under terms that nobody could meet.
What we are left with are properties like today's featured property. The owners paid $245,000 on 7/25/2002, and they obtained a $245,000 first mortgage. They put nothing down.
After a refinance for $225,600 and a stand-alone second for $24,000 on 6/5/2003, the owners went back to the housing ATM on 5/18/2006 and refinanced the second for $165,000.
Basically, they put nothing down and extracted about $130,000 in HELOC booty during their first four years of ownership. Now that prices have dropped more than 30% for small condos like this one, these owners are underwater and bailing out. Why wouldn't they?
They already extracted whatever the lenders was going to give them, and now with the large debt, it costs them far more than a comparable rental. Since they don't have any of their money in the deal, only their emotional attachment to the property or a sense of moral obligation would keep them paying. Since people don't often fall in love with tiny condos, and the moral obligation to repay debt is largely washed away, short sales like this one should not be surprising.
This is the type of inventory that will prevent appreciation until it is cleared from the market.
Irvine House Address … 165 ROCKWOOD Irvine, CA 92614
Resale House Price …… $315,000
House Purchase Price … $245,000
House Purchase Date …. 7/25/2002
Net Gain (Loss) ………. $51,100
Percent Change ………. 20.9%
Annual Appreciation … 2.8%
Cost of House Ownership
$315,000 ………. Asking Price
$11,025 ………. 3.5% Down FHA Financing
4.49% …………… Mortgage Interest Rate
$303,975 ………. 30-Year Mortgage
$65,931 ………. Income Requirement
$1,538 ………. Monthly Mortgage Payment
$273 ………. Property Tax (@1.04%)
$0 ………. Special Taxes and Levies (Mello Roos)
$66 ………. Homeowners Insurance (@ 0.25%)
$350 ………. Private Mortgage Insurance
$337 ………. Homeowners Association Fees
$2,564 ………. Monthly Cash Outlays
-$141 ………. Tax Savings (% of Interest and Property Tax)
-$401 ………. Equity Hidden in Payment (Amortization)
$18 ………. Lost Income to Down Payment (net of taxes)
$59 ………. Maintenance and Replacement Reserves
$2,099 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$3,150 ………. Furnishing and Move In @1%
$3,150 ………. Closing Costs @1%
$3,040 ………… Interest Points @1% of Loan
$11,025 ………. Down Payment
$20,365 ………. Total Cash Costs
$32,100 ………… Emergency Cash Reserves
$52,465 ………. Total Savings Needed
Property Details for 165 ROCKWOOD Irvine, CA 92614
Sq. Ft.: 1125
Property Type: Residential, Condominium
Style: Two Level, Contemporary
Year Built: 1983
Wonderful Woodbridge living at its best. This is a completely remodeled townhome. Nice laminate hardwood floors, beautiful upgraded kitchen w/ granite countertops, new cabinets & appliances. Bathrooms have been remodeled and upgraded. Features scraped ceilings with recessed lighting. Keep cool with energy efficient attic fan and ceiling fans in both bedrooms. Both carports are directly behind patio. Enjoy the Woodbridge Village Association amenities, including the lakes, parks, sport courts, and much more!
RELAY FOR LIFE is THIS WEEKEND
June 11-12 (9:00 am to 9:00 am) CENTRAL PARK in RSM (Behind the Bell Towers, across from the movie theatres) The Relay event is a 24 hour team relay supporting our survivors and in memory of those we have lost and a fundraising effort on behalf of the American Cancer Society. As of this morning we have raised approximately $13,500 with only $1,500 left to raise to meet our goal of $15,000 for St. John's. We have about 30 official team members toward our goal of 50. There is still time to JOIN the official St. John's team on line (avoid filling out waivers on the day of the event) and/or DONATE to the team or a team member — www.relayforlife.com/ranchosantamargaritaca
You are welcome to make cash donations on the date of the event as well. Please note that the despite a possible misunderstanding, there are NO DOGS allowed on the track during the event, sorry. Please note that if you did not get your St. John's black shirts they will be available at the event, and those that pre-registered on line as a team member and raised $100 or more will also be provided with an official RSM Relay for Life T-Shirt as well. As in years past, St. John's will have a booth and will be providing free food and drinks all day to St. John's members as well as providing to the general population on a donation basis (all proceeds will go to the RSM Relay event).
On Sunday morning our own Bob Hayden will be making his “world” famous waffles as a fundraiser to the event as well. Please feel free to stop by and walk a few laps as part of our team and in support of those you have loved and cared about that have survived or fallen to this disease. Help wipe it out…..run, walk, eat, play…. ALSO, there is a silent auction taking place from 11:00 a.m. ending at 6:00 p.m. with over 35 baskets available for bidding (along with our own donated basket from Kathy O'Connor of fabulous Silpada jewelry).
SATURDAY IS THE DAY – RELAY FOR LIFE