How Bad Could Bad Get?

Many people when they first discover bubble blogs think housing bears are tinfoil-hat-wearing crackpots with extremely pessimistic outlooks on life. There are perma-bears (Roubini, Shiller, Fleckstein) as well as perma-bulls (Watts, NAR, Kudlow). The truth is generally somewhere in between. I learned long ago that extremists are never happy people because they seldom get their way. As the Buddha noted, it is the "middle path" that leads to happiness. I have spent my voting life as a independent/Libertarian voting for whoever I believed to be the best candidate, most generally a moderate. However, there are times when what is perceived as an extreme is actually the correct view. As Barry Goldwater noted, "…extremism in the defense of liberty is no vice! … moderation in the pursuit of justice is no virtue." Many who read my post "Predictions for the Irvine Housing Market" thought the scenario I described as extreme. It only looks extreme because the psychology of the bubble as skewed the collective perspective of the market. That Predictions post was moderate; this one is extreme.

We have been witnessing a great deal of bad news lately, the impact of which cannot be good. If the perfect storm continues to form over our local housing market, things could become much worse, much faster than even the most bearish among us think possible. Have any of you noticed the carnage in Sacramento? For the doomsday scenario to take place, we would need the following: Foreclosures, unemployment, rising interest rates and tightening credit, and a decrease in home ownership. The combination of these forces could make the price collapse a catastrophe.

Foreclosures

We all know the wave of foreclosures is coming.

Foreclosures

And it should continue unabated for 5 more years.

Loan Reset Calendar

There isn't much more to say. It is not bad yet, but it will be very bad, and it will go on for a long time.

Unemployment

We know layoffs are coming to Irvine/Orange County. New Century went bankrupt along with numerous other sub-prime lenders based in Orange county. People are already losing jobs. I think it is save to speculate this will have ripple effects through the local economy. Even if unemployment remains low, how much will incomes decline? Mortgage brokers, realtors and others in the REIC have been living on the transactions created by the borrowing of those about to go bankrupt. They may find other work, but the $250,000 a year days are over. The only mystery is how bad the unemployment problem will become. Right now, things don't look good.

Rising Interest Rates and Tightening Credit

We know mortgage interest rates are near historic lows.

Mortage Rates 1963-2006

The large number of foreclosures will make lenders more cautious (either that or the losses will put them out of business). Increased lender caution will result in a tightening of credit and an increase in interest rates to compensate them for the increased risk. An increase to 8%, which is near the historic norm, would seem to be likely. If lenders become very cautious, an overshoot to 10% or more could easily take place. Interest rates have not begun to rise yet, and many are holding out hope that the FED will save them. It won't. Due to the increasing risk premiums, the best one can hope for is a lowering of the FED funds rate to compensate for the increased risk premium. We will have to wait and see.

Credit is already tightening. This cannot be denied. The increased cost and decreased availability of credit will have a severe impact on demand.

Impact of Tightening Lending Standards

Credit Suisse estimates the most recent credit tightening just eliminated 21% of the borrowers in the market. This is assuming further problems in Alt-A or prime loans do not force credit to tighten even further (in other words, credit will tighten further.) This will crush demand and it will also put an end to serial refinancing. The inability to refinance is what will cause all the resets shown in the previous chart to go into foreclosure. Which leaves us with the most important question: Who is going to buy all of these houses in foreclosure?

Decrease in Home Ownership Rates

Ownership rates in Orange County have risen 2.8% between 1994 and 2005. This is actually behind the rest of the country where homeownership rates have increased nearly 5%. This is a direct result of lending money to those borrowers previously excluded from the housing market either because the borrower did not have the downpayment, or they lacked good credit.

Homeownership Rates

Home ownership rates will decline as homeowners lose their homes in foreclosure. With foreclosure comes bad credit; those with bad credit just got eliminated from the buyer pool. Therefore, people who lose their house to foreclosure will move into a rental, and the previously owner-occupied home will likely enter the rental pool. (A popular misconception is that rents will go up. The number of rentals will increase along with the number of renters.)Mr. Housing Bubble

There will be some new buyers (like many on this board) who have cash and good credit; however, this group is small in number, far smaller than the number of foreclosures about to hit the market (if you don't believe me, ask yourself how many potential buyers you know with cash and good credit.) This means a significant number, perhaps a majority, of the houses due to hit the market due to foreclosure will be purchased as rentals.

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If the bulk of the houses going through foreclosure are going to be purchased as rentals, prices will have to decline to the point where a rental generates a positive cashflow. Prices are double that today! Home prices will have to decline at least 50% for properties to make financial sense as rentals, so if this is the fate of the bulk of the upcoming foreclosure inventory, prices will decline at least 50% before buyers will enter the market and adsorb this inventory.

Conclusions

Foreclosures, unemployment, rising interest rates and tightening credit, and a decrease in home ownership are all required in some measure to create the doomsday scenario. Do I think this will happen? Probably not, but it could. Did anyone think the NASDAQ could drop from 5200 to 1200 from 2000-2003? Did anyone think housing prices in California would drop from $200K to $177K from 1991-1996 in our last "correction?" Did anyone think real estate prices in Japan would drop 64% between 1991 and 2005? When bubbles collapse, they often drop lower and last longer than anyone thinks.

Today we do not have any of these conditions to an impactful degree. Maybe these conditions will not develop further; however, all indications are that these problems will develop and get worse. So how bad could bad get? Ask them in Sacramento, their party is just getting started.

Irvine Market Decline Extreme

Market Decline Extreme Spreadsheet

Get this party started on a Saturday night

Everbody's waiting for me to arrive

Sending out the message to all of my friends

We'll be looking flashy in my Mercedes Benz

GET THE PARTY STARTED by: Pink

Land of the Rising Sun

Rising Sun Kitchen

Asking Price: $918,000

Purchase Price: $678,000

Purchase Date: 6/9/2005

Address: 43 Rising Sun, Irvine, CA 92620

Beds: 3IrvineRenter

Baths: 2.5

Sq. Ft.*: 1,708

Year Built: 2005

Stories: 2

Type: Single Family Residence

View: Mountain

Neighborhood: Woodbury

$/Sq. Ft.*: $537

MLS: S479901

Status: Active on market

On Redfin: 11 days

Craigslist, Redfin, Zillow

$918000 SELLER NEEDS TO GET OUT !!!

This according to the ad on Craigslist. I call BS on this one. This flipper is so desperate, they only want to make $184,920 in profit (after 6% commission) in less than 2 years? If this flipper is successful, their house will have made them more than the median income in Irvine over the last two years ($83,891 * 2 = $167,782). That is one hard working house!

This seller is not the only one cracking the whip on their house. The neighbors at 32 Rising Sun want $1,139,000 for the Former Woodbury Model Home they bought for $940,500 on 6/29/2006. They are working their house even harder. After a 6% commission, they stand to make a profit of $130,160 after only 9 months.

.

Devo rising sun

When a prop’ty comes along

You must flip it

Before the home sits out too long

You must flip it

When somethings going wrong

You must flip it

.

Now flip it

Into shape

Shape it up

Get straight

Go forward

Move ahead

Try to detect it

Its not too late

To flip it

Flip it good

Bamboozled

39 Bamboo Kitchen

Asking Price: $879,500

Purchase Price: $869,000

Purchase Date: unknown

Address: 39 Bamboo, Irvine, CA 92620IrvineRenter

Beds: 4

Baths: 4

Sq. Ft.*: 2,492

Year Built: 2004

Stories: 2

Type: Condominium

Neighborhood: Northwood

$/Sq. Ft.*: $353

MLS: S477978

Status: Active on market

On Redfin: 23 days

Redfin, Zillow

Do you get the feeling flippers are getting nervous? There are 46 addresses on Bamboo Street in the Northwood neighborhood adjacent to Woodbury; 7 of them are for sale. 41 Bamboo just sold on 2/13/2007 for $820,000, so there is activity in the area. There are 7 other homedebtors looking for the greater fool to save them. The owners at 39 Bamboo just got nervous and decided to sell even if it is at a loss. Zillow thinks the property is worth over a million dollars. Apparently the market does not agree.

Bamboo Spreadsheet

Real estate always goes up, or so buyers are bamboozled into believing by realtors. It only takes a few nervous neighbors to drive down property values in an entire neighborhood. Comps are set at the fringes where the transactions take place. I’m sure the owner at 57 Bamboo would like to make his $211,106, but it is more likely that 39 Bamboo is going to lose his $42,740 first.

Canyon's Edge – Is it worth more than it was in May 2005? – UPDATE #1

Originally posted November 17, 2006

Address: 29 Shade Tree, Irvine, CA 92603 (Turtle Ridge)
Plan: 1993 sq ft – 3/2.5
MLS: U6603755 DOM: 4
Sale History: 5/13/2005: $1,010,000
06/02/2003 — $701,500
Current Price: $1,150,000

Here we have a detached condo in the Canyon’s Edge tract built by Standard Pacific in Turtle Ridge. This home was purchased in May 2005 with 5% down.

I don’t have much to say on this one yet. If they get their asking price, they stand to make about $71k after 6% in selling costs. Pretty nice return on their $50,500 investment in 18 months.

Has anyone been inside this tract? It’s part of Turtle Ridge but it is completely separated from the rest of the homes in Turtle Ridge which are all off Summit Park. Strange location…

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UPDATE #1 – March 26, 2007

Thanks to a tip from Owen in the forums, I’ve come to realize that this home has been relisted (MLS U7000708) and the price has now been reduced to $1,099,000. Assuming 6% in selling costs, their expected profit is now about $23k. Where did the other $48k go?

Bitter Buyers say William's Lyin'

Today was a beautiful, blue-sky kind of day, the kind of day that reminds me why I love Irvine so much. My little boy and I played for quite a while at “Bob the Builder Park” (aka, Colonel Bill Barber) as well as a small pocket park in Westpark. But first, on our way over to Bob the Builder park, I couldn’t resist making a short detour. I pulled into Columbus Grove and saw the line-up of protest signs along the main thoroughfare, Sweet Shade. I pulled up to the curb, put on my blinkers, gave my boy his Clifford Reading game on his Leapster, and chatted for a few minutes with homeowner Bob Spillar. He was sitting in a beach chair with, at the time I was there, two other men whom he identified as neighbors. I told Bob I was a blogger, writing for a blog on the local housing bubble, and Bob didn’t quite seem to get what I was referring to. (First clue, right? Too bad Bob hadn’t spent some time here, or over on

Ben’s housing bubble blog or on Rich’s site…) Bob was very eager to share his story with me. Here it is:

This is their second weekend protesting William Lyon Homes, Inc. He and 17 other buyers of Phase I Lantana homes plan on sticking it out for the foreseeable future, until Lyons makes appropriate restitution. They have clearance from the Irvine police to hold this protest; they are on public land and Lyon has no recourse to remove them. Bob said that Lyon has not tried to make them leave.

Mid-2005 Bob decided to buy one of the homes in Phase I. He closed in May 2006. He received lots of assurances from the salespeople that prices would not drop in future phases. He said that he feels “coerced, manipulated.” Bob acknowledges that he should not have signed the contract without reading it in its entirety (no kidding!), however he said the sales team promised him he didn’t have to do so. After the purchase, he and his 17 neighbors read “Addendum G” in their contracts which apparently states the standard legalese stuff about this written contract being the only legal agreement, that any verbal agreements not included in the contract would not be considered valid, etc.

So now, Lyon has dropped asking prices significantly in newer phases, and he and the neighbors are hoppin’ mad. Bob told me that he put 20% down when he purchased this home – he said that it was a requirement and you couldn’t buy the house from Lyon unless you put 20% down. (I don’t quite believe this could be true, however this is what he told me). He further told me that he took out a 100k second mortgage to pay for landscaping, etc., and that its rate is going to adjust in August and he is going to be forced to refinance in order to afford his payments. He believes that most of his neighbors also took out seconds that will be adjusting and they are all in the same boat. The whole “I put 20% down but took out a 100k second” just didn’t quite sit right with me, but I didn’t push it since my boy was itching to get going to the park!

He handed me a copy of the protest letter he and his neighbors wrote, letter to Lyons (new information: here’s the back of the petition)as well as a one-page flyer they are apparently giving to would-be new homebuyers who come to check out the models. Take a look: Experience the Lies

In their letter to Patrick McCabe, Project Manager for Lyon Homes in Newport Beach, the neighbors have this to say, “The undersigned phase I residents in the Lantana neighborhood are writing to you today to ask for your consideration to make things right…During the selling process, given the real estate market uncertainties, we had numerous conversations with the sale staff (Nancy, Jennifer, etc) about prices and we were reassured that the home purchase prices would remain stable throughout the development of our community. We believed in the community and you. We understand fluctuations and economics, but a $75,000-$200,000 price reduction? What does that say to your phase I buyers?…Given all the startup problems we endured through the first phase of development, we are asking for William Lyon to consider some type of compensation to all of us. Afterall, when we think of the sub-contractors and laborers that completed work; the quality was average at best. We trusted in you and now feel like we were misled and betrayed…”

So I asked Bob what exactly he wanted from Lyon. He stated that he does NOT want a “refund.” He wants Lyon to refinance the Phase I owners into lower-rate loans; he wants a “small stipend” and he wants free upgrades, retroactively. He said Lyon had already met with the protestors and informed them that the contracts they signed were completely legal and they had no intention of giving the homeowners anything they were asking for now.

So I thanked him and drove away, not having the heart to tell this poor, sweet guy that the carnage had just begun and his equity evaporation was just going to get worse over the coming several years. Best of luck to you and your Lantana Phase I neighbors, Bob.