With all of the soon-to-be-former homeowners who spent their houses, you have to wonder if the good times they had while walking the path to foreclosure was worth it.
Years ago there were occasions when I would party and drink myself into a stupor just for the fun of it. In fact, I have listened to today’s featured song inebriated far more often than not. I can’t do that anymore because the hangovers are too severe, but even in my carefree youth, the hangovers were not pleasant. I would party and have a good time knowing that I would have to pay a heavy price the next day.
Most people who spent their house had a great time, and most did not realize that house prices could fall and the party might end (that ignorance is astonishing, but very real). There were some that suspected the music would stop and didn’t care because they were having such a good time. Some people are still in denial about the end of the party, but soon enough it will become apparent to all.
Once the reality of the market is widely accepted, do you think those people who spent their homes will regret what they did? Or do you think they will think the spending and good times were worth the price they paid later?
Excellent private location, all living space on one level-three full
enclosed bedrooms, nicely upgraded w/neutral carpet, decorator paint,
crown molding, built-in media center, grand rotundra entrance to great
room, open kitchen w/breakfast counter, G.E. appliance package, four
burner cook-top, walk-in pantry, recessed lighting, living room
w/fireplace/tile surround/custom mantel, dining room leads to view
balcony large enogh to entertain, lovely master suite
w/retreat/built-in display case extends to luxurious bath w/separate
shower, deep oval soaking tub, dual sinks, cedar-lined walk-in closet
w/organizer, interior laundry, two car side/side garage
w/overhead/vertical storage cabintry, resort lifestyle amenities:
pools, parks, spas, meandering greenbelts, gazebos w/fountains,
clubhouse, tennis/sports courts, close to Irvine/Tustin entertainment
complex.
That description has a few too many items in the list for each sentence, but the property is described well with few flowery adjectives and no realtorspeak (unless I missed it). Not bad.
There are a few misspelled words though: enogh, cabintry, and my personal favorite, rotundra
This property was purchased on 8/27/2003 for $475,000. The owners used a $380,000 first mortgage and a $90,000 downpayment.
On 12/30/2005 they took out an Option ARM with a 1.5% teaser rate for $552,000.
On 7/18/2007 they opened a HELOC for $50,000.
Total property debt is $602,000.
Total mortgage equity withdrawal is $222,000 including their $90,000 downpayment.
All that money is gone. If this sells for its current asking price, the total loss to the lender will be $118,080.
So what do you think? If these people had not HELOCed themselves out of their homes, they would never have had the $222,000 to spend. Of course, they would probably be in a better financial position and possibly capable of keeping their home. Which is better: To spend the money and live for today? Or to be cautious and keep your home?
{book3}
Shook me all night long, Yeah you, shook me all night long, Knocked me out, I said you Shook me all night long, Had me shaking and you, Shook me all night long, Well you shook me, Well you shook me…
The traditional definition of predatory lending has the lender making a loan to a borrower the lender knows will default in order to acquire the property in foreclosure and profit from the sale. In fact, the main reason a foreclosure auction is public is to limit a lender’s ability to acquire properties for below market rates to remove the incentive for predatory lending. Despite this systems in place, much of the lending during the Great Housing Bubble was predatory because the lender was still going to profit from making the loan through origination fees at the expense of the borrower who was sure to end up in foreclosure.
When lenders have incentive to produce large quantities of loans without regard to quality, lending standards are eliminated in order to increase volume. Ultimately, this system collapses once people start defaulting and lenders do not get their money back. This is exactly what caused the credit crunch, and it is why our market continues to spiral downward.
Predatory lending is strongly condemned because the lenders are supposed to be the adults in the transaction. Borrowers are not the sophisticated parties involved. There are many ways lenders can rip off the unknowing, so regulations are in place to ensure we don’t end up with a system of “borrower beware.”
But what about predatory borrowing? We have read case after case of borrowers who HELOCed and refinanced themselves up to maximum value at the peak of the bubble and walked away from the debts. This behavior is clearly predatory as none of these borrowers had any intention of paying this money back unless their house sold for more than the loan amount. This behavior is not as strongly condemned because the lenders should have known better than to give away all that free money.
Today’s property is rather different. It was purchased in 1975, and it is still owned by the original purchaser. There are no refinances in the property records, so the original loan–which would have been around $40,000–would have been paid off in 2005. To live 30 years in a property means this owner must be near retirement age. On 11/29/2004 the owner takes out a mortgage for $290,000, and on 2/5/2007 he takes out a refinance for $385,000.
What do you make of this borrowing? If this owner wanted his money, couldn’t he just sell the property and claim his retirement savings? Why borrow this much money after paying off a 30-year mortgage? Why would a lender give him a loan like this?
Charming townhome located in the popular Deerfield Community. 3
bedrooms/2.5 baths, upgraded kitchen with stainless steel appliances,
wood laminate flooring, Hunter Douglas window treatments. This
executive style townhome is an end location with an oversized backyard
patio and overlooks a greenbelt. No Mello Roos, low HOA dues. Close
proximity and walking distance to schools and shopping.
Wow! a well-written description. Nice.
This property has $385,000 on it. After 34 years of ownership, it is going to be a short sale. Amazing.
If this property sells for its current asking price, and if a 6% commission is paid, the lender will lose $32,500.
I hope this guy made good use of the money because his retirement is now gone…
Negotiating to purchase residential real estate can be intimidating, but if you understand the rules of the game, it is not that complex, and you can save yourself a great deal of money.
If you know the enemy and know yourself, you need not fear the
result of a hundred battles. If you know yourself but not the enemy,
for every victory gained you will also suffer a defeat. If you know
neither the enemy nor yourself, you will succumb in every battle.
I stand alone and gaze upon the battlefield Wasteland is all that’s left after the fight And now I’m searching a new way to defeat my enemy
Negotiating the sale of residential real estate is no more difficult that negotiating for any other product of service that does not have a fixed price; however, due to the colossal cost of houses, the process is more important financially than negotiating for other big-ticket items like automobiles. A mistake made while buying or selling a house could cost as much as a new car; sometimes such mistakes could pay for many cars. Skilled negotiators can obtain favorable pricing and terms without the assistance of a broker, but the novice who is inexperienced at this process often will not. Novice negotiators can benefit from using a professional real estate agent.
Perceptions and Motivations of the Negotiators
When two parties enter into a negotiation, they hope to reach agreement and close the deal because negotiations without a deal are a complete waste of time for all parties involved. The one goal both parties have in common is that they both want to close a deal.
Understanding what makes deals happen requires an understanding of the perceptions of the parties, and the motivations for action these perceptions create. Each party entering into a negotiation has (1) perceptions of the value of the property, (2) a belief about the direction of market pricing and (3) a sense of the motivation of the other party in the negotiation. Depending on what buyers and sellers believe about these three issues, they will adjust their bids and asking prices to try to make a deal happen. The greater the degree of alignment between the perceptions and beliefs of the two parties, the more likely a transaction is to occur.
Perception is reality for each individual, but that does not mean that each party to the negotiation shares the same reality or that either parties perceptions match objective Reality. This was nowhere more apparent than with the perceptions of value both buyers and sellers had during the Great Housing Bubble. The parties to transactions during that rally were aligned with their perception of value and both parties where totally incorrect. When prices started to fall, the perception of buyers changed before the perception of sellers did. When these parties began living in alternate realities, deals could not be reached, and transaction volume declined dramatically.
Comparable Sales and the Perception of Value
Sellers almost universally believe the value of their homes is greater than its actual fair-market value. Buyers generally have to be convinced that home values are greater than what they are willing to offer. Once the parties begin to negotiate, the seller usually must lower their asking price and a buyer must raise their bids for a transaction to take place. The actual fair-market value for any property is the price the parties to the transaction agree upon.
Listing brokers will often pander to the fantasies of sellers to obtain the listing. The broker knows the property has little or no chance of selling at a ridiculous asking price, but they take the listing to provide the seller with a wait-and-see opportunity to prove that the asking price is too high. After some period of time, the broker will go back to the seller and prompt them for a price reduction to meet the market.
Buyers will generally offer less than they believe a property to be worth to give themselves room to increase their bids without overpaying. Savvy buyers will establish a maximum bid before they enter the negotiation. If they can get the property for less, they consider it a bonus, if they bid up to their maximum offer without getting the property, they stop bidding and move on to their next-best alternative.
Buyers and sellers do not perform this negotiation in a vacuum. The final sales price the parties agree upon will generally be close to the sales prices of similar properties in the market area. These similar properties are what is known as comparable sales, or “comps” for short. Comps serve as the basis for negotiation for two main reasons: (1) financing is limited based on comparable sales, and (2) if buyers bid too little, or if sellers ask too much, each party has better alternatives to closing the deal; sellers can wait for a better offer, and buyers can find a similar property with a more reasonable seller. Each party to the transaction must be aware of their best alternative to a negotiated agreement because they may need to pursue other prospects.
The Problem of Cherry Picking
Picking comparable sales to establish a basis of comparison is as much art as science. Each party could select comparables they believe best serves their perception of value by “cherry picking” either the highest or the lowest sales to exaggerate the base value. If one party can convince the other that the basis for negotiation is 5% higher or lower than what it really is, then the successful cherry picker will make 5% more on the deal. The incentive to cherry pick is strong.
One approach to solving the cherry picking problem is to obtain an appraisal from a neutral third party; however, appraisals are not free, and the buyer is generally the one responsible for paying for it. Appraisals are rarely ordered during the initial stages of a negotiation, so they seldom work to overcome cherry picking.
Another approach is to obtain a Broker’s Opinion of Value to establish a base value. Unfortunately, brokers being agents of either the buyer or the seller are not neutral third parties. Brokers have a strong incentive to cherry pick to serve their clients.
Broker Duplicity and Failed Transactions
Brokers are primarily motivated to make a transaction occur because they generally do not get paid otherwise. Secondarily, they are motivated to obtain the best possible price for the party they represent; they have a fiduciary duty to serve one party to the transaction (although they can serve both in a dual agency situation). Many sales agents believe deceiving the other party in a negotiation is an appropriate tactic justified by their fiduciary duty. Realtor duplicity contributes to the impression in the general public that real estate agents cannot be trusted. Many cannot be.
The reason for the manipulation and deceit among unethical realtors is that the techniques they use alter the perceptions and motivations of the other party in a negotiation. When these techniques are successful, buyers raise their bids or sellers reduce their asking prices. When these techniques fail—which often occurs—the use of these techniques so offends the other party that a deal that might have otherwise occurred does not go through; that result serves neither party, and it can be argued it is a violation of an agent’s fiduciary duty.
Honest Brokerage Establishes a Value Range
The best solution to the problem of establishing a base value for negotiation is for the broker to provide an honest and neutral opinion of value similar to an appraisal. If a broker prepares the opinion of value in such a way that it could serve the buyer or the seller, both parties to the negotiation can agree on a range of pricing within which the negotiation can take place.
For example, if a particular property has a range of comparable values from $450,000 to $550,000 with an average of $500,000, this information can be presented to both parties. Both can agree that the current comparable value is somewhere in this range as each one could make arguments for one extreme of the other.
The range of comparable sales values does not necessarily dictate a range for negotiating the deal—the initial bid and asking price do that—but it does serve to anchor the negotiations to a range of values that reflect the realities of the current market.
Trend of the Market
Sales prices for properties change over time. In most real estate markets, these prices go up with increases in wages among those who live in the market area. In California, we are prone to bouts with irrational exuberance and price volatility. Instead of slowly climbing prices like stable markets in the Midwest, Californians must cope with markets that can quickly move both up and down. The current trend of the market—if widely understood and accepted—distorts the perception of value and motivates buyers and sellers to stay ahead of the trend. In a rising market buyers are motivated to raise their bids and sellers are motivated to ask over comparable sales values. In declining markets, sellers (who accept reality) are motivated to lower their asking prices and buyers offer bids lower than recent comparable sales.
Motivation of the Other Party
Professional poker players spend hours studying people’s reactions to try to elucidate the cards their opponents are holding. In poker if players can determine what their opponents believe about the strength of their hands, they gain a significant advantage over the other players. If you know the motivations of the other party in a negotiation, you can respond by concealing your own motivation in hopes that the other party will either raise or lower their pricing to come to you. This is not deceitful; it is sound negotiating practice.
The risk of divining the other party’s motivations is that the perception could be incorrect and this may result in failing to complete a deal that otherwise might have gone forward. If parties to a negotiation are strongly motivated but pretend not to be, failure to complete a deal can be very frustrating. For anyone who has ever fallen in love with a property, not raising their bid to close the deal and then losing the property can be very disheartening. For any seller who desperately wants to get out of a property but fails to lower their price to meet the market, watching a buyer walk away is disappointing.
To try to gain advantage in this part of the negotiation, people often ask why the other party wants to buy or sell. Listing agents will almost universally tell buyers some story that makes the seller look less motivated than they really are. Buyer’s agents will tell the seller that the buyer is interested, but not too interested or “in love” with the property. Each side looks to gain advantage over the other by disguising their motivation. Sometimes this practice kills the deal, but sometimes it results in a significant monetary benefit to one party.
Comparable sales and the Negotiating Range
Comparable sales represent an anchor point in the negotiation, and the trend of the market tends to push future transactions in the direction of the current market trend. Understanding this dynamic provides a framework for buyers to present their bids and sellers to quote asking prices. Once an asking price is in the market and an offer is made on a property, the two prices establish a negotiating range. If the seller and buyer move to a common point within this negotiating range, a transaction will take place. If the buyer fails to raise their bid, or if the seller fails to lower their asking price, and the two parties do not find common ground, a deal will not take place.
The final sales price will generally be within a tight range around the price of recent comparable sales, regardless of what fundamental values may be. It is extremely rare for a property to sell for more than 15% below comparable sales prices. There is usually enough buyer competition that sellers will simply hold out for a better offer. It is also rare for a property to sell for more than 15% above comparable sales prices because lenders will not finance the additional sums. To overpay for real estate, buyers must close the deal with their own money. Most buyers either cannot do this, or they chose not to and go bid on other properties. Few properties sell for prices on the extremes, and most sell for near comparable sales prices. In bull markets, these sales are above recent comps, and in bear markets they are below.
Understanding the range of potential transactions is important because it goes to the core of two behaviors that waste time and effort for everyone involved: lowball bidding and ridiculous asking prices. There are many buyers out there looking for a real bargain. Bidding 30% under comparable sales is not going to result in a transaction. Some do this to try to establish a negotiating range and split the difference hoping to get the property for 15% under comparable sales. It does not work. During the deflation of the housing bubble, many bid 30% under comparable sales because they speculated that prices were going to drop 30% from current comparable values. Correct as this assessment was, it did not mean that sellers were going to sell for those values. If a buyer believes prices will fall more than 15% from current comparable sales, they are better off not bidding on properties and waiting for prices to drop.
On the other extreme is the seller asking for a ridiculous price more than 30% over comparable sales. A property priced that high will sit on the market forever and be an embarrassment for the seller and the listing agent. If the seller believes the market is going up and that they may obtain this price in the future, they are better off waiting for that future to come because a property will not sell for 30% over comps in any market.
Seller Urgency and Response
Why do sellers lower their price? The most obvious reason is that they know if they do not, they will not sell their property, but a more nuanced explanation is required to really understand what is going on. Once a seller has established an asking price, greed motivates them to keep it as high as possible. Once a buyer has made an offer, fear motivates a seller to lower the price to close the deal. The battle between greed and fear is the essence of a seller’s struggle.
If the seller perceives their asking price to be “fair” they are not strongly motivated to lower it because they believe any buyer who will not agree to their asking price will be replaced with a buyer who will. This is particularly true in a rising market. To the seller with a “fair” price, it is only a matter of time before a buyer shows up willing to pay their price. It doesn’t matter if the price is fair; it only matters if the seller believes it is. If the price is not fair and the seller is delusional, no buyer will show up to pay how much the seller wants, and no transaction will take place. Denial and delusion distort perception and prevent sellers from doing what is necessary to sell their property.
If the seller perceives their asking price to be fair, but they also recognize the trend of the market is down, they will be much more motivated to lower their price quickly to find a buyer. This is a rational fear because the longer they wait to find a buyer, the more money they lose to declining prices. Of course, this presupposes that sellers recognize the market downtrend and do not believe the market is currently at the bottom.
Buyer Urgency and Response
Why do buyers raise their bids? Again, the most obvious reason is that they know if they do not, they will not get the property because they will either be outbid, or the seller will not lower the asking price to meet their bid. There are a number of motivations buyers have for increasing their bids, and these motivations emanate from their perceptions of (1) scarcity, (2) market trend, (3) bidding competition, (4) property value, and (5) property desirability. Manipulative real estate agents use techniques to generate fear in buyers and alter the buyer’s perceptions and motivate them to increase their bids.
If buyers perceive another property will be available if the current deal falls through, they feel no sense of urgency to raise their bid to close the deal. In order to provide that motivation—through perfidy—realtors taunt buyers with the idea that they should “buy now or be priced out forever.” If buyers believe this fallacious nonsense realtors peddle, they will believe properties are scarce, another deal will not come along, and they should raise their bids to close the deal. It doesn’t matter whether or not this perception is reality, if buyers believe properties are scarce, they will be more motivated to raise their bids and close the transaction.
If buyers perceive the market trend is moving higher, they may believe they will be priced out, but they may also have the more rational belief that if they do not bid higher, someone else may out bid them. If the bidders they are competing with are strongly motivated—for whatever reason—a higher bid may be the only way to secure the property. In the grander scheme, it may be in a buyer’s interest not to buy under these circumstances because such market conditions are indicative of a real estate bubble.
If buyers perceive the market trend is down, they know they can either get a better deal on the property they are bidding on or they will get a better deal on another property if the current negotiation fails. This is perhaps the most difficult problem for a realtor to overcome. When it really is in a buyer’s best interest to wait or make cautiously low offers, the motivation to increase bids is practically non-existent. The answer to this problem for realtors is to publicly call the market bottom every few months even when they know it is not going to happen. Bidders must be convinced that prices are going to rise again soon or there is limited motivation to bid on properties and even less urgency to raise bids.
If buyers perceive they are the only one interested in a property, they are far less motivated to increase their bids because there is no competition, and the negotiation is purely between the bidder and the seller. Realtors have a tactic for this problem; they lie and tell bidders that there are other offers on the property. This is perhaps the most commonly told lie in the real estate industry. If buyers believe it, it renews the sense of urgency for buyers to increase their bids.
If buyers perceive their bid is “fair” relative to the value of the property, they are not motivated to increase their bid. Nobody wants to overpay for real estate. This is where cherry picking comps and arguments about the investment value of real estate are used to convince a bidder that their perception of value is too low and that their bid is not “fair.” The National Association of Realtors spends huge amounts of money to tout the financial benefits of home ownership to convince people homes are more valuable than they really are.
If buyers perceive that a property is uniquely suited to their needs, if they “fall in love” with the property, they are highly motivated to increase their bids to obtain the property. This is the ultimate fantasy of every seller. Once a buyer is in love with a property, they will raise their bids until they either have the property or they reach the limit of their resources. The obvious advice to buyers is not to fall in love with any property you want to get for a “fair” price. For most buyers, this is easier said than done. Many buyers will not even bid on a property unless they are “in love” with it. This behavior almost guarantees overpaying for a house.
The Dynamics of a Transaction
Once a property is offered for sale, and once a bidder presents an offer in a realistic range to complete a transaction, the negotiation for real estate begins. The prospective buyer and the seller generally communicate through intermediary agents through informal messages and formal written offers and counteroffers. The informal messages take two main forms: (1) attempts to solicit information on the motivation of the other party, and (2) attempts to increase the motivation of the other party to either raise their bid or lower their asking price. The informal communications are an integral part of the art of the deal. The formal communications through offers and counteroffers are presented in the context of the narrative provided through the informal communication.
It is the exchange of information through the informal lines of communication that often determines if a transaction will occur. If both parties are not motivated, and the spread between the bid and the ask is wide, no sale will occur. In these circumstances, the motivations of the parties must be increased to meet somewhere in the middle. That is the purpose of the informal communication. If both parties are motivated, then a deal is likely to occur. The price point where they meet is determined by the skill of the negotiators. In these circumstances, concealing motivation results in a transaction with a favorable financial result for the concealing party. It is like the poker player who learns to hide their emotions in order to prevent the other party from reading the strength of their cards.
In reality, the only meaningful communication between the bidders and sellers is the written offers and counteroffers because it is the only actionable communication. Most people do not realize that asking prices are meaningless. A seller is under no obligation to sell a house if a buyer agrees to pay an asking price. In contrast, a written offer is actionable. If a seller agrees to a written offer, a valid contract is formed, and the buyer is obligated to buy the property (subject to contingencies). Once written offers and counteroffers begin going back and forth, acceptance of the written offer by the other party forms a contract, and the deal moves into the escrow process.
Summary
The process of negotiation is a study in human psychology. It can be readily understood, and the process can be mastered. It requires emotional control and an evaluation of reasonable alternatives to completing the deal. The parties to the transaction establish a range of valuations and then negotiate a price somewhere within this range depending on the relative motivations of each party. If the parties are motivated enough, a transaction takes place; if they are not motivated enough, no sale occurs. Seeing the process as one of perception and motivation provides a deeper understanding of dynamics of the process, and it may provide the edge needed to gain financial advantage. To quote Sun Tzu from the Art of War: “If you know the enemy and know yourself, you need not fear the result of a hundred battles. If you know yourself but not the enemy, for every victory gained you will also suffer a defeat. If you know neither the enemy nor yourself, you will succumb in every battle.”
Gorgeous Home on a Large Corner Lot! Truly Stunning! Shows like a Model
Home – Lush Tropical Landscaping Front and Back Including Extensive
Hardscape – Beautiful Stonework ~ Very Light And Bright! The Kitchen
and Family Room area is massive and leads out to the Courtyard Area ~
Downstairs bedroom that is being used as an office can be converted to
4th bedroom ~ Enjoy living in the Prestigious Gated Community of
Northpark which offers Resort Style Living with Community
Clubhouse,Five Pools, Spas, Barbeque Areas, Parks and Trails, Tennis
and Basketball Courts ~ Walk to Elemtary School and Large Shopping
Center just outside Northpark.
What is with the tildes? Which is more annoying: tildes to separate sentences? or multiple asterisks? ~~~~~ ******
Why the Title Case? Or is it intermittent Capitalization?
Today’s featured property was purchased on 5/17/2002 for $487,500. The original loan amounts do not appear in my property record database.
On 5/22/2003 the first mortgage was refinanced for $450,000.
On 1/24/2005 they refinanced again for $567,600.
On 5/1/2006 they opened a HELOC for $106,000.
On 3/12/2007 they refinanced with a $750,000 first mortgage.
On 8/9/2007 they opened a HELOC for $70,850.
Total property debt is $820,850.
Total mortgage equity withdrawal is $341,000 plus their downpayment. One of the things we forget about when we see these HELOC abuse cases is that these people are also losing their downpayments that may have come from savings from their incomes. If the bad credit doesn’t keep them out of the housing market, the lack of a downpayment will.
If this property sells for its current asking price, the property will show a signficant profit; however, the sellers will end up with nothing, and the bank will lose tens of thousands of dollars.
{book1}
If you know the enemy and know yourself, you need not fear the result of a hundred battles. If you know yourself but not the enemy, for every victory gained you will also suffer a defeat. If you know neither the enemy nor yourself, you will succumb in every battle.
I stand alone and gaze upon the battlefield Wasteland is all that’s left after the fight And now I’m searching a new way to defeat my enemy Bloodshed I’ve seen enough of death and pain
I will run, they will hunt me in vain I will hide, they’ll be searching I’ll regroup, feign retreat they’ll pursue Coup de grace I will win but never fight
Since last Saturday's post on HELOC Abuse Hollywood Style was so popular, I thought I would explore some other high-end cities and see what I could find. After looking through several $1M to $2M HELOC abusers, I decided on one typical $1.6M abuser and a beachfront property where the owners took out $5M in just a few years. I want one of those houses…
What happened near the water? An enormous amount of HELOC abuse is what happened. HELOC abuse knows no socioeconomic boundaries. The lowliest condo in Irvine managed to extract $100,000, and the poshest beachfront home in Laguna managed to extract $5,000,000.
Let that sink in a moment…
$5,000,000
That is five million dollars.
(cue the sharks with FRICKIN LASER BEAMS attached to the heads.)
This isn't one of those deals where the owner put a huge amount down and might have taken the money out for other reasons. This was a highly leveraged transaction, and the HELOC abuse paralleled the increase in phantom equity. My brief search turned this up all over Laguna Beach. The high end is going to get flattened.
Markets like Laguna Beach where cash buyers are common show how a few cash buyers can create a windfall for an entire neighborhood. Let's look at a simplified hypothetical example:
Assume you have a neighborhood of 10 homes each valued at $100,000. The total real estate value of the entire neighborhood is $1,000,000. Imagine some truly wealthy buyer falls in love with a property there and pays $1,000,000 for one of them (the truly rich can do that because they are not subject to financing limitations). The $1,000,000 sale becomes a new comp, and the entire neighborhood can justify $1,000,000 valuations on the properties, the entire neighborhood just became "worth" $10,000,000.
Since lenders lost their minds during the bubble, they would agree that the houses in the neighborhood are now worth $1,000,000 each, so they would offer each of the other homeowners HELOCs up to $1,000,000 based on the new value of their properties. Many of these people will borrow this money and do what they wish with it. Some will go out and buy other properties (who wouldn't after such a huge windfall). This buying will drive up prices in other neighborhoods which provides this same HELOC money to others, and property values go crazy. (Does this sound like fractional reserve lending?) The resulting economic stimulus would create an economic boom as everyone became more wealthy, and everyone was given access to a huge supply of new spending money (see Our HELOC Economy and California Personal Finance: Ponzi Style).
This process doesn't happen overnight with a single new comp, but the cumulative impact of many transactions with increasing values fueled by loose lending certainly does have this effect over time–and it happens relatively quickly. As you will see from the examples today, this is exactly what was going on in our real estate market.
There is only one problem with this little arrangement: IT IS A PONZI SCHEME! It cannot be sustained. The illusion of wealth created by aggressive lending disappears the moment people start to default and the crazy lending stops. Prices must fall back to equilibrium levels sustainable by the new lending standards. In these high-end neighborhoods, I believe we will see 65%-70% declines across the board. Stable price levels are going to be determined by people's real incomes applied to conventional mortgage financing; people only make enough money to support prices 1/3 as high as they currently are. Prices in these neighborhoods quadrupled or more since the late 90s–incomes have not.
Catalina Island, Coastline, Ocean, Panoramic, Has View, Water, White Water
Year Built:
1983
Community:
Laguna Village
County:
Orange
MLS#:
S564400
Source:
SoCalMLS
Status:
Active
On Redfin:
68 days
AN INCREDIBLE OPPORTUNITY FOR A LAGUNA BEACH, 'OCEAN FRONT' RESIDENCE! ON THE SAND, LOCATED IN PRESTIGIOUS LAGUNITA! CUSTOM HOME WITH 5 BEDROOMS AND 5.5 BATHS! PANORAMIC OCEAN VIEWS FROM NEARLY EVERY ROOM! ELEGANT MASTER SUITE ON TOP LEVEL WITH FIREPLACE, RETREAT & LUXURIOUS BATH! ENTERTAINMENT ROOM WITH WAT BAR! GOURMET KITCHEN WITH CUSTOM CABINETS, GRANITE COUNTERS AND CENTER ISLAND! LIGHT AND BRIGHT WITH VAULTED CEILINGS AND LARGE VIEWING WINDOWS! ADDITIONAL AMENITIES AND UPGRADES INCLUDE…CUSTOM LIGHTING, 2000 SQ FT MASTER SUITE, INFINITY EDGED SPA, BEACH FRONT TERRACES, 4 QUEST SUITES WITH LIMESTONE BATHROOMS, WALKING DISTANCE TO THE MONTAGE RESORT AND SPA, 24 HR GATED COMMUNITY, AND MORE!! TROPICAL LANDSCAPING AND CUSTOM HARDSCAPE! MUST SEE!
What is a WAT BAR?
A listing for a $9,000,000 property in ALL CAPS. Amazing.
The property records on this house are bit confusing, but I will try to sort through it. It was purchased on 8/31/2000 for $5,500,000. That buyer took out a $2,000,000 loan and put $3,500,000 down. On 6/30/2004 this property was resold to a different couple for $6,000,000. The new owners used a $5,500,000 first mortgage and a $500,000 seller financed second mortgage-100% financing. It seems like an unusual transaction as one would think the property would have been worth more in 2004, but that is what the records show. This is where it gets interesting.
The new owners too out a new second for $1,250,000 on 1/26/2006.
On 9/1/2006, they refinanced the second again for $3,000,000.
On 7/11/2006 there is another loan for $1,850,000.
On 8/8/2007 there was a refinance for $10,000,000.
On 9/18/2007 they took out a stand-alone second for $1,000,000
Total property debt is $11,000,000.
Total mortgage equity withdrawal is $5,000,000.
I have no idea what this money went into. Perhaps these people are so rich that these sums are insignificant. Of course, if they were, this wouldn't be a short sale as the borrowers could simply pay off any shortfall.
The facts are that these owners pulled out $5,000,000 in 3 years. That is $1,666,666 per year if you want to think of it in terms of income…
*APPROVED SHORT SALE* Over 5300 square feet on 1.2 acres priced at $380 a square foot is the best deal on the coast.This custom 3 story swiss chalet estate is the BEST DEAL in LAGUNA BEACH. 6 bedrooms, 5 1/2 baths, 3 fire places, over 5300 square feet with OCEAN VIEW priced at $380 per square foot.
Shouldn't "swiss" be capitalized?
This property is more typical of a HELOC-dependent Ponzi-financing master. Read on and learn.
This property was purchased on 10/19/2004 for $1,500,000. The owners used a $1,000,000 first mortgage, a $200,000 second mortgage, and a $300,000 downpayment.
On 12/21/2004 the first mortgage was refinanced for $1,500,000 which got the owners their downpayment back. The two-month waiting period is typical of refinances. They knew how to game the system.
On 2/4/2004 they opened a HELOC for $500,000. At that point, they had owned the house for just over 3 months, and they had extracted their downpayment plus $500,000.
On 7/15/2005 they refinanced their first mortgage with a $2,337,500 Option ARM. It must have seemed like an eternity waiting to get that extra $337,500. It took 5 whole months!
On 12/8/2005 they opened a HELOC for $500,000.
One 12/23/2008 they got another loan for $20,500.
Total property debt is $2,858,000
Total mortgage equity withdrawal is $1,658,000 including their downpayment.
These people milked this property for every dime just as quickly as they could. They did have to come up with $300,000 for two months to get access to this money, but it seems a small price to pay for that kind of income.
With the free money these properties were generating for their owners, is it any wonder the kool aid intoxication is so strong in California?
This property was already the low-price leader in Irvine, but it must not have been low enough. The listing prices has been reduced to $114,900.
Yesterday, when I described the ratings of properties and the cashflow levels to which they should fall, I mentioned that the bottom of the Irvine market is defined by condos that only make sense as a cashflow rental. Today’s featured property is one of those.
Nothing here remains No future and no past No one could foresee The end that came so fast Hear the prophet make his guess
Shades of death are all I see Fragments of what used to be
People seem to be recovering from the weekend’s nuclear blast. I knew the announcement would have some shock value, but I did not anticipate the level of heightened emotion it would cause. If I had it to do over again, I would do it differently. I apologize to everyone who was upset and hurt by my foolish decision. I am completely human.
{book6}
Remember our little graphic from yesterday? I have updated for today’s property. A property like this should fall to cashflow investor levels. Who wants to coup themselves up in 475 SF for any period of time? This is a student rental or perhaps a 20-something professional just starting out, and then the only motivation to own would be to save on rent for a couple of years while saving for a nicer property.
Even at $149,900–which is the least expensive unit in Irvine–I doubt this is even at rental parity, particularly after all the discussion we had yesterday about declining rents. Even though this is already a 2003 rollback, it will drop much further, IMO. This property sold for $50,000 in 1998. If you allow for a generous 4% rate of appreciation, this place would be worth $75,000 now. Factor in lower interest rates and perhaps a slightly higher rate of appreciation, and it might justify $100,000, but that is about it. This property could conceivably see a 50% reduction from its 2003 purchase price.
The scary part for Irvine’s market is that these are the investment properties that should bottom first, and they are nowhere close to where they should be. One unique phenomenon of The Great Housing Bubble was the extreme appreciation at the low end. At one point, this property appraised for $270,000. That represents a 540% increase in price in less than 10 years. There is so much air under these prices, that it will take a 70% price cut to bring them back to affordable levels. We have already witnessed price declines of this magnitude on properties in other markets. These are the least desirable properties in Irvine, and it will happen to these too.
FABULOUS VALUE!!! Quiet & Serine Studio Unit. Newer kitchen with
newer applicances, including dishwasher (unique for this complex).
Cherry wood cabinets. Granite countertops accentuated by
state-of-the-art decorative lighting. Nice tile floors. Contempory
kitchen opens to living & dining area for those who like to cook
& entertain. Enclosed patio overlooks running steams & peaceful
trees. Vaulted ceilings for open & bright feel.
Serine? A hydrophilic amino acid which is a constituent of most proteins. Hmmm…
applicances? Contempory?
including dishwasher (unique for this complex). Real nice.
for those who like to cook
& entertain? With 475 SF, you better be entertaining Lilliputians.
ALL CAPS AND THREE EXCLAMATION POINTS!!!
My observation of HELOC abuse is that it crosses all economic classes. I have profiled properties where people spent more than $1,000,000, and then there are properties like today’s where the owner of the tiniest condo in Irvine managed to borrow and spend almost $100,000.
Stop and think about that for a moment. The owner of the least expensive property in Irvine was able to tap the housing ATM for $100,000 in under 3 years. If you want to understand why we have so many knife catchers right now, one of the reasons is because many people think the housing ATM will be turned on again soon. It won’t.
This property was purchased for $171,000 on 12/19/2003 (I wonder if there is room for a Christmas Tree?) The owner used a $162,450 first mortgage and a $8,550 downpayment.
On 9/1/2004 he opened a HELOC for $9,000 to “liberate” his downpayment equity.
On 11/1/2005 he refinanced with a $180,000 first mortgage.
On 9/22/2005 he opened a HELOC for $47,000.
On 10/12/2006 he opened a HELOC for $90,000.
Total property debt is $270,000.
Total mortgage equity withdrawal is $107,550 including his downpayment.
This appears to be a short sale although it does not say so in the description. I doubt the owner cares; he has his $100,000.
{book7}
Minutes seems like days Since the fire ruled the sky The rich became the beggar And the fool became the wise Memories linger in my brain Of burning from the acid rain A pain I never have won
Nothing here remains No future and no past No one could foresee The end that came so fast Hear the prophet make his guess That paradise lies in the west So join his quest for the sun
Shades of death are all I see Fragments of what used to be
Remember our little graphic from yesterday? I have updated for today’s property. A property like this should fall to cashflow investor levels. Who wants to coup themselves up in 475 SF for any period of time? This is a student rental or perhaps a 20-something professional just starting out, and then the only motivation to own would be to save on rent for a couple of years while saving for a nicer property.
