Christopher Thornberg, principal of Beacon Economics, delivered the Beacon Economics 2010 Orange County Forecast. I attended, and I report to you today.
It was lonely being right about the Housing Bubble. Surrounded by a world gone mad, solitary voices of reason like Christopher Thornberg, principal of Beacon Economics and formerly with UCLA Anderson Forecast, were ridiculed. He watched as his opinions were disdainfully set aside as the ravings of one of those “bears.”
I recently attended Beacon Economics 2010 Orange County Forecast hosted by the Building Industry Association. Christopher Thornberg gave the keynote address, and he was fantastic. When you compare his presentation with the awful UCLA Anderson Forecast Orange County, you fully appreciate what UCLA lost when he moved on.
One slide that caught my attention was the one below that shows the inflation adjusted house price change since 1997, the last bottom. I covered this issue in the post called 1997 where I demonstrated that house prices are still well above where they should be if market conditions that existed in 1997 are extrapolated to today. Chris Thornberg’s chart matches my observation — Orange County is still vastly overpriced by historic standards, and so is most of California.
Another slide that caught my eye is the delinquency and foreclosure chart. See those two little bumps on the left side? Those where the catastrophic market-crushing foreclosure crises of the 80s and 90s — our current mess is four-times as bad, and we have not hit anything that looks like an identifiable peak. Yikes!
Beacon Economics is predicting a “W” shaped recession as shown on the slide below. Basically, if you were to take the 3 huge downspikes and imagine a big “U” that ties back in to the 3rd quarter of 2011, you see what would have happened if the Government would have done nothing. All GDP growth between now and 3rd quarter 2011 is a direct result of Government intervention. Like a surfer riding out a wave, our economy and our housing market is trying to drift to shore where we can step off in the surf without going underwater. Do you think the Government’s efforts will be successful? Homeowners sure hope so.
The big questions he raises generally pertain to Government policy. In the oral presentation, Mr. Thornberg lamented the difficulty of predicting where the economy is going when it isn’t economics he is trying to forecast, it is Government policy. As was discussed in Who Will Fix the System? our housing market is more dependent upon decisions in Washington than any other factor.
Notice from the summary that Christopher Thornberg is not calling a bottom in housing; in fact, since he is calling for a double-dip, he isn’t calling the bottom of the recession either.
On the subject of financial regulation, Christopher Thornberg was adamant that the problem is one of incentives; investment bankers and other Wall Street players pocket copious cash on manipulated market moves. As long as the system rewards volatility and malinvestment, we will have booms and busts where the winnings are privatized and the losses collectivised.
One thing he said that caught me by surprise was his characterization of Ron Paul as either a lunatic or a moron. Ouch! I know where he is coming from, Ron Paul’s ideas are loopy; shutting down the FED, eliminating the IRS, and so on; however, Ron Paul’s loopy ideas now making sense (and perhaps they never were loopy to begin with).
I don’t envy Christopher Thornberg’s task; he is making a living telling people what they don’t want to hear. It must be costing him money. He would certainly be more popular if he shilled like the UCLA Anderson Forecast Orange County, but his personal ethics get in the way.
Beds 4 Baths 1 full 2 part baths Home Size 2,516 sq ft ($358 / sq ft) Lot Size 6,783 sq ft Year Built 1971 Days on Market 1 Listing Updated 1/14/2010 MLS Number P717571 Property Type Single Family, Residential Community Turtle Rock Tract Bm
Turtle Rock Broadmoor Model G. Secruity gate & double door entry; 3-car garage. Fresh 2-toned painting, scraped ceilings. New floorings-upgraded carpet and laminated wood. New vertical blinds. Above-ground spa w/new cover. Downstairs master BR w/remodeled master bath. New grainte kitchen countertops, stainless stell sink w/GE range & dishwasher. Bonus/game room has a pool table and antique light fixture. Brand new water heater w/earthquake straps in garage. Overlooking community park and pool. Many upgrades unmentioned. Priced below market value for quick sale, please hurry!!
Secruity? grainte?
Many upgrades unmentioned. If they are worth mentioning, shouldn’t you mention them? It isn’t like people are worried that you might run over on your description word quota.
This is the first really desirable property I have seen where I did not recoil with revulsion at the price. Does that make it reasonable? Based on my calculations, this property would cost about $3,600 per month to own. I imagine it would rent for that much (I didn’t pull comps), and I can see where someone at an income level to afford $3,600 a month might want to own a property like this long term. This is a debtor’s prison I might be willing to sign up for… if I could afford it. There are worse places to spend the next decade.
This seller is going to really annoy the neighbor at 6232 SIERRA SIENA Rd Irvine, CA 92603 who I profiled in Doubling Time by offering this comparable property for $370,000 less. Perhaps it will be a dose of reality, but most likely it will prompt further denial.
Why are house prices what they are, and where are house prices going? Today’s posts answers those questions by providing a conceptual understanding of house prices and housing markets.
Californian’s believe house prices go up by magic. Real estate appreciation is religion in California as people blindly accept the Truth of never-ending price increases. Few question current prices or wonder why current pricesgo up as most fool themselves with wishful thinking, cockeyed optimism, and kool aid intoxication. Most people do not understand real estate prices — they think they do — every Californian is an expert on real estate, after all, we have about half a million realtors, but few people really understand markets. Motivated by greed, blinded by ignorance and enabled by lenders, borrowers inflated The Great Housing Bubble.
{book4}
A foundational understanding of house prices and housing markets is critical. From 2003 onward, with exception of those who purchased houses with conservative financing, which was rare, most buyers bought in ignorance. Some were undeniably stupid and irresponsible, but most were simply ignorant going with the herd believing everyone couldn’t be wrong. Well, they were wrong, and the errors they made are easily identifiable and correctable with a better conceptual understanding of house prices and housing markets.
My understanding of housing markets permeates my posts, but the foundational work upon which I base my posts comes from my education and experience — something unique to me and heretofore undocumented; consequently, this post lays down foundational concepts of house prices and housing markets for future reference.
Three primary variables determine house prices
House prices are set by supply and demand in the market, but demand is arguably more important because house prices cannot rise higher than buyers’ abilities to pay. Therefore, this discussion will focus first on demand, then on how supply impacts prices set by market demand.
The three variables directly responsible for determining house prices are (1) savings, (2) interest rates and (3) allowable debt-to-income ratios. A buyer’s ability to bid for real estate is limited by their savings (and their willingness to put savings toward housing) and their borrowing. Amounts borrowed depend on interest rates and underwriting standards. Of the various loan underwriting standards, the most important is the allowable debt-to-income ratio because it is the direct link between income and the loan amount.
Notice that borrower income did not make the list, at least not directly, because borrower income is only important to the degree it is applied toward making debt service payments. The allowable monthly payment when amortized over 30 years at current interest rates yields the borrower loan balance. The current price-to-income ratio distortion is caused by the combination of very low interest rates and very high allowable DTIs. As I noted in, House Prices Will Decline in 2010, prices can fall even when interest rates are low if lenders simultaneously reduce allowable DTIs. In fact, the credit crunch which began in August of 2007 is crushing the housing market due primarily to declining allowable DTIs. The credit crunch is not over, and IMO, aggregate DTIs have not bottomed for this cycle.
Borrower income is important because it serves as a measurable base for market demand. Aggregate incomes rise with economic growth and inflation, and since income plugs in to the house price equation through the allowable debt-to-income ratio, house prices rise in concert with local incomes. Over the long term house price appreciation and income growth must move together; trees cannot grow to the sky.
A Buyer’s budget
Each prospective buyer investigates current financing terms as part of their process. Lenders apply current underwriting standards and determine the loan balance they will approve and downpayment required before they will fund. Since loan plus downpayment equals maximum bid amount, prospective buyers house-shop with the budget established for them by their lender. As is human nature, most people spend their full budget.
Every buyer goes through this basic process, and since financed purchases dominate the resale market, price levels of individual properties become tethered to the incomes of individuals who desire that property. For instance, today’s featured property is at the bottom of Irvine’s property ladder. If high wage earners suddenly became enamoured with living in condos like this, prices would rise substantially. The substitution effect to similar resale and rental properties keeps income, price and quality in balance.
Irvine has a large number of high wage earners, and its income distribution is not as “downward tilting” as other cities. As a result, wage earners at the mid to high end tend to settle for less in Irvine than they could obtain in other markets because the product in Irvine is not McMansion dominated. The opposite exists in cities like Palmdale where a sea of McMansions trickles down to the maids and field hands at the bottom of the income distribution.
High wage earners can both borrow more and save more of their disposable income. Also, high wage earners are generally long-time wage earners who probably already own a home, so in addition to their formidable saving power, many high wage earners also transfer stored equity from one property to the next, assuming they did not spend it.
A distribution of prices based on income
If you take the income distribution for Irvine, apply conservative underwriting standards of four-times income, a reasonable downpayment and an allowance for stored equity, the resulting distribution of housing prices looks like the chart below.
So why doesn’t our market look like that? Well, to a large degree, it does, although low interest rates and residual bubble inflation has increased the above numbers to an unsustainable level. In addition, the current market is mismatched between the number of people capable of supporting house prices and the number of houses for sale at various price points.
For instance, according to the data, about 22,000 of our 69,000 households can support prices over $750,000. That is 32% of the market. When more than half of Irvine properties have comparable values sustainable by less than a third of the population, something has to give. If you look at what is for sale, over 40% of listings are over $750,000, and as we
know, much of this market is tied up in Shadow Inventory.
As inventory is released at the mid- to high- end, prices of individual properties will decline, but the median will not. People will still spend the same amount on housing, but they will get more for their money. That plus the changing mix from low to high will make the median less reliable. Just as the median has overstated the decline to date in most markets, it will show strength later where only weakness exists. If mortgage interest rates do not rise, the story of 2010 may be a rising median with continually falling prices on individual houses.
Demand, supply and football
Demand is measured by a borrower’s ability to put money toward real estate, and contrary to popular belief, desire is not demand. Excess supply lowers base market prices established by demand. To better illustrate this concept, consider the following football analogy:
Sellers (supply) are blitzing linebackers and buyers are offensive linemen. If more linebackers blitz than offensive linemen block, then the offense gets thrown for a loss. If more sellers want to sell than buyers want buy, then prices decline; buyers have to be enticed from the sidelines. However, if enough offensive linemen pick up the blitzing linebackers and push the scrum forward, the offense advances the ball. If buyer demand exceeds seller offerings, prices go up as sellers have to be enticed from the sidelines.
In football, the offense generally advances the ball just as buyers generally advance prices with their rising incomes. However, in football, each team is limited in the number of players. In housing markets, no limit exists which can create enormous supply and demand imbalances. When subprime lending took off, we sent hundreds of offensive linemen on the field, and they pushed prices across the goal line. Now, we have a much smaller and leaner offensive unit facing a defense composed of the zombie debt holders who previously were celebrating in the end zone.
Lenders are ordering linebackers not to blitz to prevent further losses, but the number of linebackers building on the defensive side of the ball ensures the offense will not be advancing the appreciation ball very far (imagine being the running back buried in the picture). Such is the nature of overhead supply — banks may hold on to properties to prevent a loss, but they will sell swiftly if they can get out at breakeven, and realistically, being an unruly group of zombies — cartels are inherently unstable — a few linebackers are going to blitz anyway.
BTW, I am still mourning the Packer’s loss in the playoffs….
It starts at the bottom
The entry level buyer utilizing only their savings plus a loan is the foundation of the housing market. If you follow the chain of move ups backward, it eventually leads to the entry level buyer, and as a result, nobody in the real estate market gains move-up equity until the entry level buyer does. If owners of entry level properties do not gain equity over time due to price declines or stagnation, they do not have the equity necessary to move up, and neither will any other seller in the move-up equity chain.
I want to be careful here because the equity move-up market does not function like most people think it does; buying a home is not the first stop on the equity train leading straight to a Laguna Beach mansion. Each step up also requires an increase in income to support a larger mortgage. With each step homeowners transport their equity — at least those who did not spend it through HELOC abuse — and bid up prices on the next property rung. Over time this produces significant stored equity in neighborhoods most desired.
During the rally of the Great Housing Bubble, subprime financing doubled or tripled the borrowing power of the entry level buyers.Rich Toscano pointed out (sorry, I can’t find the link) housing prices in San Diego rose $250,000 across all property classes in 2004. If you add $250,000 to the average loan balance of your move up buyer, the owner selling that entry level property just received a $250,000 windfall they can use to bid up prices at the next level. This reverberates through the entire system and inflates housing bubbles.
Move-ups must come down
If you examine the three main sources of buyer funding; loan, savings and equity; all three have been under pressure since 2007, and this trend will continue.
Loan balances have been getting smaller because lenders had to go back to rational underwriting standards. Incomes only supported about 50% of the average loan balance in 2006, and the greatest single cause of lower house prices, by far, has been smaller borrower loan balances. The Federal Reserve temporarily helped by lowering interest rates, but mortgage interest rates will almost certainly rise making future loan balances even smaller.
Personal savings rates went negative during the bubble, and much of the reason for our current economic contraction is that people stopped spending and started saving again. With the long term erosion in savings rates experienced during the bubble, fewer borrowers have sufficient savings to buy a home, and those that do have savings have less of it. The result is smaller downpayments — at least outside of Irvine.
Equity has been declining because during the bubble, everyone spent it, and after the bubble, everyone lost it. I have documented on numerous occasions the perils of mortgage equity withdrawal and HELOC abuse. Equity has been crushed by falling prices since 2006 with exception the delusional high end where move ups terminate. The foundation of the housing market is crumbling from below, and only the lack of transaction volume sustains high-end bubble equity. With equity disappearing at the bottom of the market, the high end has nobody to sell to but each other. There is a limit to how many properties even Nicolas Cage can own.
What is required for a healthy real estate market?
The low end of the market is resetting. Based on payment affordability, it is inexpensive to own a low-end Irvine condo like today’s featured property. Prices may go down further as interest rates rise, but payment affordability on these low-end condos is at a bottom. That is a good thing because until these condos find a pricing bottom, the housing market is doomed. There is no chain of moves ups when there is no equity.
Before there will be a sustainable market recovery, we need (1) entry-level units like these to find a pricing bottom, (2) unemployment to go down, (3) wages to go up, and (4) people to start saving. We may be finding a bottom at the low end (I still have doubts), and savings rates are improving, but the savings baseline is zero, unemployment is still rising, and wages are still stagnant. We do not have the building blocks of a sustained housing market price recovery. When the stars and the moon align, loan balances expand, downpayments enlarge, and move-up equity accumulates; those are the three essential elements of an appreciating market.
Once we return to sanity after a few more years of decline and clean up, lenders will be responsible (which worries me) to ensure the growth of loan balances never again exceeds our collective ability to pay. Everyone enjoys the ride up, but once we cross the threshold of insolvency, the market collapse is truly devastating. Let’s not do it again.
Beds 1 Baths 1 bath Home Size 512 sq ft ($264 / sq ft) Lot Size n/a Year Built 1977 Days on Market 5 Listing Updated 1/14/2010 MLS Number P717447 Property Type Condominium, Residential Community Orangetree Tract Cm
According to the listing agent, this listing may be a pre-foreclosure or short sale.
LOWER UNIT. Great, cozy one-bedroom condo with its own deck off LR slider to lovely stream w/bubbling water, rocks, plants, view of little bridge over stream. Eating area-counter in kitchen, master bedroom suite with dressing area, separate commode and shower over tub, walk-in closet. Own covered parking space, plenty of guest parting space–easy for your guests to find your home! REAL ONE-BEDROOM-NOT A STUDIO. HAS OWN INSIDE WASHER & DRYER. Lake Condos have two community pools, spa, gym, basketball court, tennis court, playground and clubhouse. There is a golf course across Irvine Center Drive. Excellent location next door to Irvine Valley College, UCI down the road (think bike to school). Near 5 and 405 Freeways, Irvine Spectrum Entertainment Center, Business District, Shopping. Located in Building #23. GREAT INVESTMENT OPPORTUNITY. BEST BUY/LEAST EXPENSIVE 1-bedroom CONDO in all of Irvine-the safest city in the USA!
There is a golf course across Irvine Center Drive. This is true, but I doubt anyone living on less than $1,000 a month housing costs is playing much $100+ per round golf on a world-class Tom Fazio golf course… unless you live to golf perhaps.
Personally, I like when the agents upload the floorplan. I wish more listings did this.
Notice the less-than-stellar 2% annual appreciation since 1990. If it were for a drop in interest rates from 10% to 5%, this property would be priced below its 1990 purchase price (1990 was the peak of the last bubble). Twenty years, and the only appreciation on this property is due to a change in financing terms.
Look at the financing requirements for this home: Income Requirement $28,529, Downpayment Needed $4,725, 3.5% Down FHA Financing. If that isn’t affordable, I don’t know what is. Of course, people making $30,000 a year may not have $5,000 saved up for a downpayment, but that is the reward prudent renters are supposed to receive — less competition when bidding on property.
What they are saying about The Great Housing Bubble
“The author does an excellent job in showing how various commercial
and investment banks sought to create a speculative market for home
loans by the process of securitization. The main tool was
collateralized debt obligations (CDO’S).The idea is purely speculative
since real estate is a nonliquid durable asset. The bundling and
selling of trillions of dollars worth of the subprime backed bonds that
were not only highly risky, but of uncertain value, created the bubble
that deflated just as every other banker financed, speculative bubble
has deflated in world history.
The author does a good job in demonstrating that low interest rates
were not the cause of the problem. The main cause of the problem was
the loan practices of various financial institutions that threw
overboard their own clearly specified creditworthiness criteria and
standards for borrowers seeking loans.”
Michael Emmett Brady – PhD Economics
Stated Income Loans
One unique phenomenon of the Great Housing Bubble was the
utilization of stated-income loans, also known as “liar loans” because
most people were not truthful when stating their income. Loan
documentation is usually a routine part of obtaining financing. Lenders
ordinarily require a borrower to provide documentation proving income,
assets and debt. However, during the final stages of the Great Housing
Bubble, loan documentation was seen as an unnecessary barrier to
completing more transactions, and loan programs which circumvented
normal documentation procedures flourished. The fact that these
programs existed at all is remarkable proof of the risk lenders were
taking through the relaxing or outright elimination of lending
standards. Eighty-one percent of Alt-A purchase originations in 2006
were stated-income, and 50% of subprime originations in 2005 and 2006
were stated income (Credit Suisse, 2007).
Stated income loans increased from 18% of originations in 2001 to 49%
in 2006 according to Loan Performance. In a related study by the
Mortgage Asset Research Institute, 60% of stated-income borrowers had
exaggerated their incomes by more than 50%.[1],[ii] Obviously, lying about one’s income to obtain a loan is not a conservative method of financing a property purchase.
The stated-income loan was originally provided to borrowers such as
the self-employed who most often do not have W-2s to verify income.
When these loan programs were first started, they were not made
available to borrowers with W-2s as the transparency of the lie would
have been obvious to all parties. During the bubble rally, this loan
was made available to anyone, and lying was not only encouraged,
borrowers were often assisted in fabricating paperwork by aggressive
loan officers and mortgage brokers. [iii] Since the loan could be
packaged and sold to investors who had no idea what they were buying,
there was a complete lack of concern for whether or not the borrower
actually made the money stated in the loan application and thereby
could actually make the payments on the loan. Everyone involved was
raking in large fees, the borrower was obtaining the real estate they
desired, and for a time, the investor was receiving payments from the
borrower. [iv] As long as prices were rising, everyone benefited from
the arrangement. Of course, once prices started to fall, borrowers did
not want to continue making payments they could not afford, and the
whole system collapsed in a massive credit crunch.
Figure 5: National Home Ownership Rate, 1984-2005
Downpayments
The risk management measure not related to the mortgage terms is the
downpayment. Most people do not think of downpayments as a way of
managing risk, but lenders do. Downpayments reduce risk in two ways:
first, they lower the monthly payment, and second, they provide a
cushion ensuring the borrower can refinance (if necessary) should the
house value decline. The problem with downpayments is obvious: few
people save enough money to have one.
Eliminating downpayments through the use of 80/20 combo loans was
another massive stimulus to the housing market. Subprime loan
originations in 2006 had an average loan-to-value ratio of 94%. That is
an average downpayment of just 6%. Also, 46% of home purchases in 2006
had combined loan-to-value ratios of 95% or higher (Credit Suisse, 2007).
Lenders used to require downpayments because they demonstrated the
borrower’s ability to save. At one time, having the financial
discipline to be able to save for a downpayment was considered a
reliable indicator as to a borrower’s ability to make timely mortgage
payments. Once downpayments became optional, a whole group of potential
buyers who used to be excluded from the market suddenly had access to
money to buy homes. Home ownership rates increased about 5% nationally
due in part to the elimination of the downpayment barrier and the
expansion of subprime lending.
Equity Components
In simple accounting terms, equity is the difference between how
much something is worth and how much money is owed on it (Equity =
Assets–Liabilities). [v] People who purchase real estate use the phrase
“building equity” to describe the overall increase in equity over time.
However, it is important to look at the factors which either create or
destroy equity to see how market conditions and financing terms impact
this all-important feature of real estate.
Figure 6: Types of Equity
For purposes of illustration, equity can be broken down into several
component parts: Initial Equity, Financing Equity, Inflation Equity,
and Speculative Equity. Initial Equity is the amount of money a
purchaser puts down to acquire the property. Financing Equity is the
gain or loss of total equity based on the decrease or increase in loan
balance over time. Inflation Equity is the increase in resale value due
to the effect of inflation. This kind of appreciation is the “inflation
hedge” that provides the primary financial benefit to home ownership.
Finally, there is Speculative Equity. This is the fluctuation in equity
caused by speculative activities in a real estate market. This can
cause wild swings in equity both up and down. If life’s circumstances
or careful analysis and timing cause a sale at the peak of a
speculative mania, the windfall can be dramatic. Of course, it can go
the other way as well. If a house is purchased at its fundamental
valuation where the cost of ownership is equal to the cost of rental
using a conventionally amortized mortgage with a downpayment, the
amount of owner’s equity is the combination of the above factors.
Initial Equity
The initial equity is equal to a purchaser’s downpayment. If a buyer
pays cash for a home, all equity is initial equity. Since most home
purchases are financed, this initial equity is usually a small
percentage of the purchase price, generally 20%. A downpayment is the
borrower’s money acquired through careful financial planning and
saving, gifts from family members, or from the profits gained at the
sale of a previous home. Downpayment money is not “free.” This money
generally is accumulated in a savings account, or if a buyer chooses to
rent instead, downpayment money could be put in a high-yield savings
account or other investments. There is an opportunity cost to taking
this money out of another investment and putting it into a house. This
cost and its impact on home ownership costs are detailed in later
sections.
Financing Equity
Financing equity is determined by the terms of the loan. With a
conventionally amortizing mortgage, a portion of the payment each month
goes toward paying down the loan balance. As this loan balance
decreases, the owner’s equity increases. This is a substantial
long-term benefit of home ownership. With an interest-only mortgage,
the loan balance does not decrease because only the interest is paid
with each payment. With this kind of loan, there is no financing
equity. One of the major drawbacks of using an interest-only loan does
not become apparent until the house is sold and the seller wants to
take the equity to the next home in a move-up. Since no financing
equity has accumulated, the seller obtains less equity in the
transaction. This means the move-up buyer will be able to afford less.
Over the short-term, financing equity is not significant because the
loan balance is not paid down by a large amount, but if the house has
been held for 10 years or more, or if the loan was amortized over a
shorter term, the financing equity can be a large amount. This can make
a real difference when the total equity amount is to be put toward a
larger, more expensive home. Also, financing equity is a great
reservoir for retirement savings. In fact, it is the primary mechanism
for retirement savings of most Americans outside of social security.
[vi]
The worst possible loan is the negative amortization loan because of
its impact on equity. As noted in the figure on the next page, if a
negative amortization loan is utilized, it will consume all equity in
its path. It is a form of cash-out financing that reduces equity. This
loan relies on inflation and speculative equity to have any equity at
all. The negative amortization loan will only begin to build financing
equity after the loan recasts and becomes a fully-amortized loan and
the payments skyrocket–assuming the borrower does not default. Most
people cannot afford the fully-amortized payment, or they probably
would not have used this form of financing initially. Even after the
recast and the dramatic increase in payments, the loan does not get
back to the original balance for many years.
Figure 7: Negative Amortization Loan Equity Curve
Inflation Equity
House prices historically have outpaced inflation by 0.7%
nationally. [vii] In a normal market, this is the only
appreciation homeowners obtain. This appreciation is caused by wage
inflation translating into higher housing payments and the ability of
borrowers to obtain larger loan amounts to bid up prices. In areas like
Irvine, California, where wage growth has outpaced the general rate of
inflation, the fundamental valuation of houses has increased faster
than inflation. The related benefit to home ownership obtained through
utilizing a fixed-rate, conventionally-amortizing mortgage is mortgage
payments are frozen and the cost of housing does not increase with
inflation. Renters must contend with ever-increasing rents while
homeowners with the proper financing do not face escalating housing
costs. Over the short term this is not significant, but over the long
term, the monthly savings accruing to owners can be very sizable, and
if the owner owns long enough or downsizes later in life, housing costs
can be nearly eliminated when a mortgage is paid off (except for taxes,
insurance and upkeep). Although this benefit is attractive, it is not
worth paying much of a premium to obtain. The long-term benefit is
quickly negated if there is a short-term additional cost associated
with obtaining it. For instance, if a property can be rented for a
certain amount today, and this amount will increase by 3% over 30
years, the total cost of ownership–even when fixed–cannot exceed this
figure by more than 10% to break even over 30 years. The shorter the
holding time, the less this premium is worth. In short, capturing the
benefit of inflation equity requires a long holding period and a
minimal ownership premium.
Speculative Equity
Speculative Equity is purely a function of irrational exuberance.
[viii] It has become a common element in certain markets, and capturing
it is the dream of every would-be speculator who buys residential real
estate. It is a loser’s game, but it does not stop people from chasing
after it. Will the markets bubble again? Who knows? Human nature being
what it is, the delusive beliefs of irrational exuberance may take root
and the cycle may continue. In the aftermath of the Great Housing
Bubble legislators may pass laws from preventing it from happening
again. Of course, such laws require enforcement, and when greed takes
hold, enforcement may simply not occur. For those that purchased at the
peak of the bubble, they need another bubble or they may not get back
to breakeven in the next 20 to 30 years. [ix] If however, there is
another bubble, those who purchased at rental equivalent value after
the crash will have an opportunity to reap a huge windfall at the
expense of those who purchase at inflated prices in the future. As PT
Barnum is credited with saying, “There is a sucker born every minute.”
[x]
The speculators who purchased at the peak of the Great Housing
Bubble who put no money down (no Initial Equity) and utilized negative
amortization loans–and there were a great many of these people–will
have a painful future. The loan balance will be increasing at a time
when resale home prices are falling. They will be so far underwater;
they will need scuba equipment to survive. Plus, during the worst of
their nightmare, their loan will recast, and they will be asked to make
a huge payment on a property worth roughly half their loan balance.
What default rates will these loans see? Realistically, they will all
default. The only reason they purchased was to capture speculative
profits which did not materialize. Even if some of these people hold
on, and there is another speculative bubble similar to the last one, it
will take 10 years or more for them to get back to breakeven, not
including their carry costs. If there is no ensuing bubble, it will be
20 years. If you factor in their holding costs, they may never get back
to breakeven.
Equity is made up of several component parts: Initial Equity,
Financing Equity, Inflation Equity, and Speculative Equity. Each of
these components has different characteristics and different forces
that govern how they rise and fall. It is important to understand these
components to make wise decisions on when to buy, how much to buy, and
how to finance it. Failing to understand the dynamics involved can lead
to an equity graph like the one for the peak buyer who purchased at the
wrong time and utilized the wrong terms. Nobody wants to suffer that
fate.
Figure 8: Peak Buyer, No Downpayment, Negative Amortization Loan
[1] This data comes from the Credit Suisse Report (Credit Suisse, 2007). The source of their data was Loan Performance.
[ii] This data comes from the Credit Suisse Report (Credit Suisse, 2007). The source of their data was Mortgage Asset Research Institute.
[iii] Anecdotal evidence indicates the practice of fabricating loan
application income was common. There were a few high-profile arrests,
as is always the case with this kind of phenomenon. As of the early
2008, no definitive studies have been undertaken to assess how
widespread was the practice of intentionally fabricating loan
application data by mortgage brokers.
[iv] Payments to investors from collateralized debt obligations were
actually made by the servicer. If the borrower failed to make payments,
the servicer would make them to the investor. When the loan was
discharged through sale, the servicer would then recoup the money, plus
interest, on any payments made on behalf of the borrower.
[v] (Libby, Libby, & Short, 2004)
[vi] Numerous reports have been compiled on the savings adequacy of
Americans. In the report Lifetime Earnings, Social Security Benefits,
and the Adequacy of Retirement Wealth Accumulation by Eric M. Engen,
William G. Gale, Cori E. Uccello (Engen, Gale, & Uccello, 2004), the authors detail the savings patters on various generations preparing for retirement.
[vii] Robert Shiller constructed a graph of housing prices from 1890-2005 for the book Irrational Exuberance (Shiller, Irrational Exuberance, 2005).
The rate of appreciation during this 115 year time period is 0.7% over
the rate of inflation. The data from the US Census Bureau shows a 2.0%
increase over inflation since 1940, however much of this increase was
during the baby boom right after WWII and it does not reflect the
improvement in house quality during this time. The 0.7% statistic is
referenced a number of times in this work.
[viii] Robert Shiller titled his groundbreaking book Irrational Exuberance (Shiller, Irrational Exuberance, 2005)
after a phrase in a speech given by Alan Greenspan, FED chairman from
1986-2006, in a speech at the Annual Dinner and Francis Boyer Lecture
of The American Enterprise Institute for Public Policy Research,
Washington, D.C., December 5, 1996 (Greenspan, The Challenge of Central Banking in a Democratic Society, 1996).
The term “irrational exuberance” is used synonymously in this writing
to describe the behavior of buyers in creating an asset price bubble.
[ix] Human nature being what it is, another real estate bubble will
form unless measures are taken to prevent one. The projections of how
long it will take markets to recover vary depending on the variables
analyzed. Later chapters explore this question in detail.
[x] Joe Vitale in his book There’s a Customer Born Every Minute: P.T. Barnum’s Secrets to Business Success (Vitale, 1998) disputes the contention that PT Barnum ever uttered the phrase with which he is credited.
I’m dizzy walkin outta Larry’s army wear used With some black leather shoes and desert BDU’s Many boxes of ammo, i got the camo face paint Barricaded the tower doors, safe this place ain’t Up to the top, i can see the whole planet it would seem The sun is beatin on my head as i’m livin my horror dream
Just in case any who walked away from their mortgages in the Marquee at Park Place North Korea Towers missed the notice, they need to go back and pick up their crap before it gets donated to Goodwill.
ABANDONED PROPERTY WILL BE DONATED TO GOOD WILL – JANUARY 31, 2010 – 1/4/2010 New!
Attention all Marquee Park Place Residents: Over the past couple of years Marquee Park Place has acquired vast amounts of abandoned personal property items belonging to
residents. Currently, these items are stored in an Association common
area room.
Please be advised, if you believe that any of these items may belong to
you please contact the Marquee Management Team. A detailed description
of your item(s) must be provided, prior to retrieval, for ownership
verification. Thereafter, effective January 31, 2010, all items will
be donated to Goodwill.
Thank you. The Marquee Management Team
IHB News
The Great Housing Bubble
The printable eBook with the full text of The Great Housing Bubble is available in the sidebar (Get the PDF eBook – FREE). You can now read the full text online in post form, in eBook form, and of course in paperback. This is the first the eBook has been available free.
Back to Class
I have been working on my writing of late. I began a quest to improve early last year, and I did become more comfortable in my own skin, but I did not stretch myself to explore the craft of writing itself sidetracked by setting up a brokerage business.
After reflection, I committed myself to write at a higher level. To that end, I refocused my writing on my strengths, analysis and insight, and I will continue to provide a mixture of my own analysis of properties and market trends together with a critical review of residential real estate news and opinions.
However, I want to improve the reader experience of my writing because reading good prose should be a pleasure. I want my writing to enjoyable for its subtle rhythms and its attention to a reader’s inner ear. I have much work to do. But one change I have made, a change that drives my wife crazy, is that I now read every word aloud (actually, I mutter mostly). It is amazing how many subtle errors you find when you read your own writing aloud.
I have enrolled in a basic writing class at Irvine Valley College to banish the grammar gremlins. The most frustrating limitation I face each time I sit down to write is my own insecurity about punctuating a complex sentence. Given some time and attention, I can craft complex sentences with subordinating clauses providing additional detail, and I have a few sentence structures I feel comfortable with using, but I do not have true freedom of expression to convey my basic thoughts in a way that is both compelling and engaging without running into the fear — did I punctuate that properly? Did I? Rather than take a risk, I simplify my thoughts working them into comfortable sentence structures never seeing if I can write more complex and artful sentences without losing readers in boring, dragged-out monologues to the Narcissistic joy of reading one’s own writing… you get the point.
I will be brief. I still value concise delivery of information, and good writing need not be burdened with words for words sake. If done properly, a more complex grammar delivers more information in fewer words due to better organization. I want all of you to enjoy your daily visits to the IHB, so I remain committed to providing analytical, creative, and entertaining writing focused on Irvine real estate at the highest level of quality I can.
Beds 2 Baths 2 baths Size 1,583 sq ft ($284 / sq ft) Lot Size n/a Year Built 2006 Days on Market 57 Listing Updated 12/19/2009 MLS Number S596135 Property Type Condominium, Residential Community Airport Area Tract Marq
According to the listing agent, this listing may be a pre-foreclosure or short sale.
2 Bedroom,2 bath unit with den overlooking community pool. Spacious living room and separate dining room. Gourmet kitchen with granite countertops and stainless steel GE Monogram appliances. Master suite and secondary bedroom with custom drapes. Master bath and guest bath in marble and travertine. Enjoy Marquee social events, exercise room, pool, spa, billiards, media room, 24 hour concierge and elegant lobby for greeting guests. Close to shopping and airports. Come home to your own private paradise.
Turn on your heartlight Let it shine wherever you go Let it make a happy glow For all the world to see Turn on your heartlight In the middle of a young boy’s dream Don’t wake up too soon Gonna take a ride across the moon You and me He’s lookin’ for a home Cause everyone needs a place A home’s the most excellent place of all
The lyrics to this song appeal to me on many levels. Wishful thinking and kool aid intoxication resonates in the boyhood reverie of days of boundless abundance when prices were shooting to the moon because we are running out of land, because everyone needs a place, and because Orange County is the most excellent place of all….
Don’t wake me up too soon….
If we could only recapture that moment. Have you ever awoke from a fantastic dream and wished you could quickly fall back asleep and pick up where you left off? Isn’t all of Orange County hoping they will wake up one day and realize it was all a bad dream and prices really haven’t gone down?
Irvine’s Auction Market
The failure of the Great Housing Bubble will ultimately be recorded on the auction block. Amend, extend, pretend cannot continue forever; lenders will foreclose and boot out the money renters who occupy the lender’s property. I recently heard Christopher Thornberg quip, “A rolling loan gathers no loss.” Lenders will modify who they can, short sale some for expediency, and foreclose on the rest — the rest being a plethora of properties.
I am focusing more attention on the auction market in preparation for an upcoming in-depth look here on the blog.
Today’s featured property is scheduled for auction February 4, and a number of high end homes clog the pipeline (I am defining high-end as Irvine over $800,000) as you can see from the list below:
Fifty-four properties over $800,000 are scheduled for auction over the next few months and another 39 are in preforeclosure. No catastrophic supply problem, but this does not include the shadow inventory of those who have stopped making payments but the lenders have not served with a Notice of Default. When the NODs begin in earnest, they will show up here in the auction market. The over $800,000 market will become more active because borrowers in these price ranges have few refinance options, and they are not eligible for loan modification programs. Borrowers with debts over the $729,000 conforming limit are basically screwed.
$1,150,000 Approved Short Sale
The bank doesn’t want to buy this property at auction. It was in escrow, but fell out, so the lender is praying someone will pony up $1,150,000 before they have to take their chances at auction. There have only been two auction prices over $1,150,000 in the last 6 months.
Trustee Sale Discount
Cash is king. If the lender does not find a buyer at $1,150,000, this property will probably go to auction on February 4 (At this point, they have given up on the borrower, so why would they postpone it further?)
Often properties go at a significant discount in the auction market as compared to the resale market where financing abounds. Fifteen percent, even twenty percent or more can be saved; however, for what are obvious reasons, desirable properties listed on the MLS with few unknowns like today’s featured properties get discounted the least. I haven’t researched the comps to have an opinion on the auction value of this property, although a cursory glance suggests it may sell between $1,050,000 and $1,100,000, unless the lender bids it up to $1,150,000 and takes the property.
If this sells at auction for $1,050,000 it will represent nearly a 30% drop from the original purchase price of $1,464,500 back in 2006. Is 30% off the bottom for Irvine’s high end? I don’t know, but it is certainly closer to the bottom than to the top.
Beds 5 Baths 4 baths Home Size 3,531 sq ft ($326 / sq ft) Lot Size 5,494 sq ft Year Built 2006 Days on Market 112 Listing Updated 1/14/2010 MLS Number S590545 Property Type Single Family, Residential Community Woodbury Tract Wdmf
According to the listing agent, this listing may be a pre-foreclosure or short sale.
JUST FELL OUT OF ESCROW. NOW APPROVED AT $1,150,000!!! Absolutely gorgeous 5 bedroom, 4 bath home in prestigeous neighborhood in Woodbury at an amazing price! Rare, premium corner lot! Granite counters, huge tumbled stone shower in master bath plus soaking tub, custom outdoor BBQ kitchen, 2 bonus rooms,and lots more upgrades! This home is priced to move fast! Please see private remarks for restricted viewing hours.
prestigeous?
That price is so good it warrants four exclamations points — not three — no, three exclamation points does not convey the incredible excitement that erupts from every buyer’s bones when they see $1,150,000!!!! I need a cold shower….
ET bought a home on here earth, and he has recently been spotted lightening up and enjoying earthly pleasures — his finger is in high demand.
If you want to investigate bidding on today’s featured property or properties like it, contact us at sales@idealhomebrokers.com. It is up for auction on February 4.
I hope you have enjoyed this week, and thank you for reading the Irvine Housing Blog: astutely observing
the Irvine home market and combating California Kool-Aid since
September 2006.
Have a great weekend,
Irvine Renter
Come back again I want you to stay next time Cause sometimes the world ain’t kind When people get lost like you and me I just made a friend
