Financial markets can be brutal, particularly for those who speculate. Today’s property was purchased for nearly double its cashflow value as were all the other properties in Northwood II. These properties were all built in 2004 and 2005 near the peak of the housing bubble. Most of them were purchased by speculators, and the featured property today was one of these. So what did the market do? It crushed him…
Gated community, best location next to green belt on the end of the Cul De Sac, bright light open floor plan. Tumbled stone flooring, granite kitchen counter’s, maple cabinets w/ cognac finish. Northwood school district.
Cognac finish? I would rather drink the stuff than finish my cabinets with it.
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If this seller gets their asking price and pays a 6% commission, they will have lost $114,300 in a little over 1 year. Since this price is only 10% off the peak, and we have seen many properties going for 20% or more off peak, this property’s asking price may be $75,000 over market. This speculator may lose over $200,000 in their little foray into the housing market. It is a good thing they are getting out now, properties in this neighborhood could easily drop to near $500,000 in the next couple of years.
That 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.
From the land of kool-aid, pretense, and noveau-riche nonsense, Turtle Ridge, we have a new race to the bottom, and they are going like a bat out of hell. This neighborhood first began to implode back in August when the credit crunch hit. We documented the troubles in the post Crimson and Clover. The property at 30 Crimson Rose went to auction at $1,400,000. Apparently the neighbors did not believe that was where the market stood for their houses. In their race to the bottom, they are almost there, and they still are not selling.
Dazzling ultra-luxury masterpiece perched on oversized lot in exclusive gated community of highly sought after Turtle Ridge. Dramatic curb appeal thanks to sharp contemporary styling. Remarkable entertainers floorplan complete w/ formal dining room, great room & guest house/casita. Magnificent European style gourmet kitchen w/ enormous granite island, slab countertops, full backsplash & breakfast nook. Huge master suite w/ retreat & lavish bath. Massive entertainers’ yard w/ fireplace. WOW!
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This property has already been sold to the lender, they just don’t know it yet. On 2/28/2007, this owner refinanced for $1,425,000, and three months later, they opened a HELOC for $284,990. For the lender’s sake, let’s hope they haven’t taken all this money out and spent it. Assuming this seller gets their asking price and pays a 6% commission, they will need to come out-of-pocket $15,000 to avoid a short sale. Of course, if they spent the HELOC money, then they have a different problem…
One of the LARGEST LOTS in Ledges * * * * * * * * * 7800 feet * * * * * * PRIVACY PLUS * * * * with huge wrap around yards. This home has it all with hundreds of upgrades. Rod iron stair case, front door with iron, travertine floors, upgraded cabinets thru-out, Wolf range and upgraded thru builder master retreat!!Total turn-key home. CORNER LOT LOCATION. You will not be disappointed !!!!!!!!!!!!!
What is the deal with all the ALL CAPS, asterisks and exclamation points? I count 13 exclamation points to end the description.
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These people have fallen $200,000 behind in the race to the bottom. At 258 days on the market, they don’t seem particularly motivated sellers. Perhaps the fact that any lowering of the price would make them lose money has something to do with their reluctance to lower it. I have news for them — they are more than $250,000 over market, and they are losing more every day !!!!!!!!!!!!!
Remember the property from the post Desperation? It appears that giving away the free Mercedes was not successful, and now they have reduced their price $200,000. Unfortunately, they are losing their race to the bottom, and they are already a rollback.
FORMER MODEL HOME with PANORAMIC CITY LIGHTS/OCEAN VIEWS!One of the BEST and highest view lots in The Summit at Turtle Ridge; Over $500K in designer upgrades; Provencial Style Home; Casita with Bath, custom hardwood flooring/wainscoating walls, faux paint, stone walls and stone flooring, spa-like master bath; covered loggia with outdoor fireplace.
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This property is already underwater. If they get their asking price and pay a 6% commission, they stand to lose $169,440, and the same house across the street asking $300,000 less, so I think this asking price is a bit too high. OK, it is a WTF, and these sellers are probably going to lose $500K.
Turtle Ridge — a little HELOC abuse, a stubborn seller praying for breakeven, and a desperate seller who is both overpriced and underwater. Another day in hell for those who want to leave…
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BTW, if you didn’t see this great post at South OC Real Estate Tracker, go check it out. Let’s play…Match Game.
There are always bargains in the rental market. Something has to define value, and as has been discussed in numerous posts on this blog, rents are where it is at. Today I want to look at the rental market for 3 bedroom units. I am excluding pseudo-apartments and looking at both attached and detached properties to see where the leading edge of rents (and thereby house values) can be found.
This property is the least expensive 3/2 with an attached two-car garage I could find. It does not appear to be updated or particularly well kept. It is located in University Park in a quiet, interior location with an easy walk to 2 community pools.
This looks like a particularly good deal. It is relatively inexpensive, fully detached, it doesn’t look to bad from the one interior picture shown, and it has a very spacious yard by Irvine standards. An address is not given, but the Walnut/Yale intersection would put it in El Camino Real.
This unit is in Northwood just behind the small shopping center on Yale and Trabuco Canyon. It is a short walk to a tot lot and community swimming pool. I have seen units in this neighborhood, and I would guess there is a small, concrete-patio back yard. Very good price though.
This property is also in Northwood near the Potomac property. These are attached condos that feel like an apartment complex. The unit itself is newly updated with granite tops in the kitchen.
I put this one in just for fun. I have seen lower priced rentals in Turtle Ridge. I guess you just need some kool aid…
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Based on the above comps, we can establish the leading edge of rental values for non-updated, small 3/2s with attached garages are going for $2,300 in the market. This puts their fundamental value at $368,000 assuming the rents remain stable. This time last year, I was looking for rentals, and I do not remember so many 3/2s being offered for under $2,500. One of the reasons I wanted to do this series of posts on rentals is to document the rise and fall of rental rates over time. We will check back again later.
If properties of this description are worth $368,000, how much are they currently asking in the for-sale market?
BEAUTIFUL IMMACULATE HOME!!! REMODELED WITH HARDWOOD FLOORING, TILED BATHROOMS, AND CUSTOM TOUCHES THROUGHOUT. STAINLESS STEEL APPLIANCES. CATHEDRAL VAULTED CEILINGS. FIREPLACE IN LIVING ROOM AND MASTER BEDROOM, BRIGHT AND OPEN KITCHEN. LARGE PATIO.
Gorgeous townhome in highly sought-after tract. Premium interior location + one of the largest models available! Inviting floorplan enhanced by soaring vaulted ceilings + custom upgrades. Expansive living room features recessed lighting, custom slate-wall fireplace & a myriad of well placed windows. Charming chef’s kitchen boasts raised ceilings + eating area & attached patio. Huge master suite w/ lavish bath & private balcony. Easy access to shopping, entertainment & freeways. WOW!
Northpark community. Great corner unit, very private. Balcony with view of the pool and green belt. Spacious living room with fireplace, bright kitchen with view of the green belt. ceramic tiles in all the bathrooms, kitchen, laundry room and berber carpert. Lowest price for a 3 bedroom unit. Submit all reasonable offers. Lender owned sold “as is” no warranty. All information believed to be correct please verify for your client.
STUNNING SHOWCASE HOME! Very PRIVATE END UNIT w/ Larger PATIO than most. Lots of High Quality Upgrades featuring; Corian Kitchen Counters w/ full backsplash & Maple Cabinetry, High-end GE Profile Appliances, Designer Italian Porcelain Tiles, Custom-Designed Entertainment Center w/ Surround Sound, Security System, Ceiling Fans & Recessed Lighting throughout home. Elegant French Doors leading to Flagstone Patio. Functional Loft/Tech Area & Upstairs’ Laundry Room. VERY LOW ASSOCATION FEES.
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As you can see, GRMs for this product are hovering between 200 and 220. This is real progress from the 250-280 units like this were going for at the peak. These products are the least desirable of the 3/2s in the market, so there is the very real possibility they may drop below parity with rents because not everyone will want to be an owner-occupant. The bottom for these will probably be closer to 140 which translates to a bottom price of about $325,000. We still have a way to go.
Real estate is viewed by many people as a good investment. Realtors often use this idea as part of their sales pitch. As was described in detail in the post What is a Bubble?, this view is fallacious and it is one of the beliefs responsible for creating an asset price bubble. To understand why houses are not a good investment, one needs to understand the difference between investment and speculation.
An investment is an asset purchased to obtain a predictable and consistent cashflow. This would include things such as bonds and rental properties or even cash in a savings account. The value of the asset is based on the cashflow, and this value can be determined in a number of ways. For a “point in time” analysis simple division will yield the rate of return (return = income / investment.) Risk is evaluated by comparing the rate of return of the investment to the safe return one can obtain in a savings account or government bonds. For more complex financial structures the value can be determined by a process known as discounted cashflow analysis. The sales price at the time of disposition is often not a major factor in the investment decision, particularly if the eventual disposition is many years in the future. In fact, true investments need never be sold to be profitable. As Warren Buffet noted “I buy on the assumption that they could close the market the next day and not reopen it for five years.” In contrast to investment, speculation is the purchase of an asset to sell at a later date at a higher price (Actually, you can also speculate by selling first and buying later in a process known as “selling short.”) Speculative assets are not valued based on cashflow but instead are valued based on the perceived probability of selling later for a profit. Houses can be purchased as an investment at the right price, but most often when people purchase a property they are engaging in speculation based on the belief they will be able to sell the house for a profit at a later date.
A study by Robert Shiller has shown that historically houses have appreciated at 0.7% over the general rate of inflation since 1890. Over the long term house values are tied to incomes because people buy houses with mortgages for which they must qualify based on their income. Inflation keeps pace with wage growth because people will bid up the prices of all goods and services with their available income. Therefore, long term house prices, wages and inflation all move in tandem. There are short term fluctuations in this relationship due to variations in financing terms and irrational exuberance, but any such deviations from the mean will be corrected over time by market forces. As an investment, houses serve as a hedge against the corrosive effect of inflation, but over the long term appreciation in excess of the general rate of inflation is not possible. In this regard, houses are little better than savings accounts as an asset class, and they are inferior to stocks or bonds in the long term.
Leverage and Debt
As a speculative investment, residential real estate has the potential to make or lose vast sums of money due to the impact of financial leverage (debt.) Houses are typically leveraged at 80% of their value. During the Great Housing Bubble, this leverage was often provided at 100% by various lenders. Leverage is a powerful ally when prices increase, but leverage works just as strongly against the speculator when prices decrease. For example, if a house is leveraged 80% and it increases in value 5% in one year, the return to the investor is actually 25% due to the 5 times multiplier created by leverage. With the effect of leverage, returns generated by speculation on housing can far exceed any competing investment strategy. However, the inverse is also true. If a house is leveraged 80% and it decreases in value 5% in one year, the loss to the investor is 25% of their downpayment not just the 5% the house declined in value. Leverage magnifies both the return and the risk of any speculative venture.
One of the worst mistakes lenders made during the Great Housing Bubble was to allow 100% financing and negative amortization loans. This was a boon for speculators because it allowed them to participate in the market without any of their own capital, and it allowed them to hold the speculative assets with a minimal debt service expense. Plus, there was the implicit idea that they would simply default if the deal did not go in their favor (which of course many did.) Combine these facts with the near elimination of loan underwriting standards allowing anyone to participate, and the conditions are perfect for rampant speculation and a wild increase in prices.
Why Speculators Fail
Despite the huge price spike in the final two years of the bubble caused by wild speculation, most speculators will lose a great deal of money. The causes are rooted in basic human emotions that work against making the proper decisions to profit in a speculative market. The moment a speculative asset is purchased and the speculator has taken a position in the market, emotions are immediately in play. If the potential resale price in the market is rising, the natural reaction is to want more. Greed takes over and the asset is strongly coveted by the speculator. If possible, the speculator will go out and purchase more of the asset in question. This was common in the bubble when people would take the equity from one property and purchase even more residential real estate. The problem with this natural emotional reaction is that it prevents the speculator from selling the asset and taking profits when they are available. People who make a living participating in speculative markets have learned to override this natural instinct and sell when their emotions are telling them to buy more. The average residential real estate speculator does not have this discipline or awareness. They will hold the asset through the good times.
When prices begin to fall in a speculative market, most speculators immediately lapse into denial. They were so emotionally rewarded by purchasing and holding the asset, they see no reason to believe the first signs of a declining market are anything other than a temporary aberration. As prices continue to fall, the emotions change: fear begins to creep in, and the battle between denial and fear goes on well past the breakeven point where the speculator could have closed the position without losing any money. As prices fall further, the fear begins to take an emotional toll and the speculator starts to feel pain. The further prices drop, the more pain is inflicted on the speculator. What is the natural reaction to pain? Push it away. As a speculative investment becomes painful, the natural reaction is to want to get rid of it. This prompts the speculator to sell the asset – only after they have lost money. A speculator’s emotions always work against them. When the asset is rising in price they want more of it, and when it is falling in price they want less. This is a natural reaction, and it is the cause of all losses in speculative markets. This is why most speculators fail.
Two Kinds of Real Estate Investors
There are two types of true real estate investors: Rent Savers and Cashflow Investors. These two groups will enter a real estate market without regard to future appreciation because either the cash savings or the positive cashflow warrant the purchase price of the asset. These people are largely immune to the emotional pratfalls of speculators because the value to the investment to them is not dependent upon a profit to be garnered when the asset is sold. They will hold the asset through any price declines because they are not feeling any pain when prices drop. Since these investors will purchase houses even if prices are declining, they are the ones who move in to create a bottom and end the cycle of declining prices.
In a declining market, a market where by definition there is more must-sell inventory than there are buyers to absorb it, it takes an influx of new buyers to restore balance. Since it is foolish to buy with the expectation of appreciation in a declining market, the buyers who were frantically bidding up the values of properties in the rally are notably absent from the market. With the exception of the occasional knife-catcher, these potential buyers simply do not buy. This absence of buyers perpetuates the decline once it starts. Add to that the inevitable foreclosures in a price decline, and the result is unending downward spiral. It takes Rent Savers and Cashflow Investors to enter the market to provide support, break the cycle and create a bottom.
Rent Savers are buyers who enter the market when it is less expensive to own than to rent. It doesn’t matter to these people what houses trade for in the market in the future. They are not buying with fantasies of appreciation. They just know they are saving money over renting, and that is good enough for them. Cashflow Investors have a different agenda; they want to turn a monthly profit from ownership. For them, the cost of ownership must be less than prevailing rent for them to make a return on their equity investment. Cashflow Investors form a durable bottom. If prices drop low enough for this group to get into the market, the influx of investment capital can be extraordinary.
Buyer Support Levels
When do Rent Savers and Cashflow Investors move in to a market and create a bottom? In the post Rent Versus Own there is a detailed analysis of the true cost of ownership. When comparative rents come into alignment with the total cost of ownership, Rent Savers enter the market and begin purchasing real estate. It makes sense for them to do so because ownership becomes a savings over renting (hence the term Rent Saver.) The “return” on the investment is the hedge against inflation the Rent Saver obtains by locking in the cost of housing with a 30-year, fixed-rate, fully-amortized mortgage. As rents in the area continue to increase, these costs are not borne by the Rent Saver. Utilizing the gross rent multiplier concept from that post, the Rent Savers will enter the market when the GRM falls to 160. There will be knife catchers who enter at higher prices, but there will not be enough of them to stabilize the market. It takes a decline in prices to where it is less expensive to own than to rent before enough new buyers enter the market to create a bottom. However, there are some properties that Rent Savers do not want because they really don’t want to live in them. This includes transitory housing like apartments or small apartment-like condominiums. Prices on these properties will generally drop below the 160 GRM breakeven for owner occupants until they reach price levels where Cashflow Investors will purchase them as rental properties. Since these investors do not want to merely break even, the price must be low enough for the rental rate to exceed the cost of ownership by enough to provide a return on the investor’s capital. Historically, GRMs from 100-120 are required to create the conditions necessary to attract Cashflow Investor’s capital.
Conclusion
When it comes time to consider purchasing a house, it is important to know if the motivation is one of an investor or one of a speculator. Investment in real estate requires an accurate assessment of the revenue (or savings) and the costs associated with the property. If the cashflow from the property warrants the purchase of the investment — without regard to future asset value — then it is a true investment, and the risks of ownership are much reduced. If the property’s asset resale value were to decline, the investment value would still be there, and the investor would feel no pain and no pressure to sell. In contrast, speculation is a loser’s game, and if the motivation is to capture a windfall from future appreciation, there is a good chance it may not work out as planned because the emotions of a speculator will cause a sale at the worst possible time. A few can put their emotions aside and properly evaluate the market and trade the asset, but most who profit from speculation simply sold at the right time due to life’s circumstances. In short, they were lucky. The people who bought late in the rally and are now holding on to the asset while they drift further and further underwater: they are not so lucky…
It appears we are having a problem with defaults. The above chart is based on a percentage basis, so it is adjusted for the increase in housing units over time.
Don’t need reason, don’t want names
Unsold in 90+ days
