San Diego Housing Bubble News and Analysis

Patience, patience. The FBs are doubling down their bets with borrowed money. Comment #43 from this post over on SoCalMtgGuy's website reports that many people carrying I/O loans refinanced last year and took cash out. They probably believe they can use that money to ride out the storm. $200K can float a big spender a loooooooong time, especially if they still have some other income coming in.

http://housingbubblecasualty.com/too-lit...

This is going to take a long time, and the declines may only be in the single digit percentages each year. Speaking of which, cawireman posted this great excel template that lets you compare renting vs. buying. Plug in some negative appreciation numbers (even 1-2% is enough) to get a real feel for just how screwed these people are.

http://office.microsoft.com/en-us/templa...

This has been discussed in previous posts. As we have seen previous real estate cycles tend to take approximately 6 years. There already have been certain housing types in various regions that have had major price depreciation already, like in the 20% range. (See UTC condos)

Again, what we have not seen are drastic price reductions by sellers, as well as lenders who have foreclosed and are offering the property for sale. They just are not pricing aggressively yet. Similarly inventory has dropped off by close to 30% from the summer highs. This has been due to sellers giving up, and seasonal adjustments typical for this time of the year.

Finally I think most people who have posted here only forecast single digit drops for the next year as well. We really need a major catalyst to get the bump down you are hoping for. With the 10 year treasury being so low, our or my biggest fear is that distressed homeowners will simply refinance out of whatever mess they are in.

As I am a future buyer, this is not what I want to happen but it is what I think will happen. We just have to be patient. This spring will be a very interesting time. Cross your fingers for high inventory and slow sales.

SD Realtor

I agree, it's going to take a looong time. A lot of FBs refinanced and cashed out, or took out HELOCs for emergencies. We have just entered the "emergency" period of negative cash flows on "investment" properties and people are still hoping that the market will shoot right back up to save them.

I don't expect a real estate panic until 3 years from now, when the FBs have no more emergency funds to carry them over. At that time, debts would have skyrocketed leaving borrowers no way to service those debts.

Here's a scenario I envisage. BF his bought house in 2004 for $600k. Refinanced at $800k and cashed out $200k in 2006. He can't really afford the $800k note (much less the original $600k loan) so he's using part of his $200k cash horde out to service the debt. He still thinks that in a few years his out will be worth $1.2M, so of course he went out and bought a big SUV.

A few years go by and his cash is running low... but houses in his neighborhood are now only worth $400k. His debt is still $800k and he can't make the monthly payments. His wife and kids are used to having everything. He's now worried about paying for the college education of his oldest son who is also clamoring for a new car, preferably a BMW. What is he to do? He's an FB out options.

Some people might be able to pull themselves out of this quandary. But throw in a few real family emergencies such as medical expenses, unemployment, divorce (ie, the vagaries of life) and you have a nasty mess.

I think Perry is right, there are probably a lot of these people out there. That negative appreciation is the real killer -- if homes are only going down 2% a year, you're losing $10K/year on your $500K home. Even if we had rent/payment parity for the same property (which we don't), that small negative appreciation throws the renter's side of the equation waaaaaay ahead. I have been dinged before on this forum for saying that you shouldn't buy unless it's cheaper than renting (using 20% down, fixed 30 year loan), but I believe that those days will return. It may be 2010 or even later, but we'll get there eventually.

Yes, I remember a few months back, someone here wrote that he was thinking of selling his house in L.A., then come back and buy again in six months to take advantage of the expected price drops! Make that six years, I'd say.

As we know, house prices are notoriously sticky on the way down, and a big chunk of the needed correction will be in inflation-adjusted dollars (this means that in some years house prices will be flat, while wages, consumer goods, even the Euro become more expensive).

Prices will drop, that we know for sure, but it'll be a long and painful process. Houses will remain overpriced for many years, although prices will be gradually less and less "excessive" until we slowly reach a point such as that of 1996.

CONCHO, I agree with you. One day, it will be cheaper to buy a house than rent an apartment. That's what happened at the bottom of the last crash. I know someone who bought a 3 bed/2bath house in Mira Mesa and their mortgage was just $100/month more than the cost of renting a 2 bed/2 bath apartment in Mira Mesa. But at that time, only people w/ good credit and down payment can buy houses.

I have a hard time seeing that happen. I bought my house in late 1998 and put 20% down. With excellent credit my rate was around 8%. My monthly PITI + HOA was significantly more than rent Pre-tax I spent about $10,000 more per year. After tax assuming a 37% marginal tax bracket I was slightly ahead.

That was definitely pre-bubble times and some would even say housing was undervalued. At the time we bought our house was 3 to 3.5 times our gross annual income.

sdrealtor wrote: I have a hard time seeing that happen. I bought my house in late 1998 and put 20% down. With excellent credit my rate was around 8%. My monthly PITI + HOA was significantly more than rent Pre-tax I spent about $10,000 more per year. After tax assuming a 37% marginal tax bracket I was slightly ahead.

Why do you have a hard time seeing that happen when that was exactly what happened in your case? Of course you'll take the tax benefit into account when comparing the costs of rent vs. buy. You bought when it was cheaper (or at least almost the same) as renting, all things considered, using reasonable financing with 20% down. Those days will return, but we're going to have to wait until all of the big spenders have exhausted their HELOC money. Also, was 1998 the bottom? I thought it was more like 1995.

A mid 1970s 3bed/2bath 1500sq-ft house with 5000+sq-ft lot in Mira Mesa around 96-97 go for about $170k. The mortgage rate around that time was around 9%. That would mean monthly P+I = $1100/month. A 2bedroom/2bath apartment in Summerset Apartment, about 5-10 blocks away from this house was renting for $1000/month. If you subtract tax deduction and add in Tax+Insurance, it would come out to something very similar as well. That's comparing buying a house vs rent an apartment. So, sdrealtor, this case plus yours shows that between 1996-1998, it cost the same to buy a house compare to rent an apartment. If you compare it to renting a similar house, I'm sure you'll come out much more ahead.

AN,
My case was based upon renting a similar house.

Concho,
The marginal tax bracket I used is probably a bit high, I used a 5/1 ARM interest rate and I didnt factor in maintenance. For the record, I didn't buy when it was cheaper or the same as renting, at least that wasnt part of my decision. I bought what I wanted, where I wanted and what I felt comfortable paying. While 1998 was not the bottom it wasnt much different than the bottom which was around 1996 by me.

If it happens as you expect...GREAT...I'll buy 2 or 3 more houses in my neighborhood like I should have last time around. I know a couple people that did exactly that.

"distressed homeowners will simply refinance out of whatever mess they are in."

I think this is a strategy also...I wonder if the banks know this --or the gov't or both...even newer exotic loans to cushion foreclosures.

However, in a scenario like this -- banks still want a profit. Refinancing to someone who cannot afford the house in the first place, does not guarantee the bank will make their $ in the long run. Is it that easy to refinance out of a mess --ie, a $500K house that you cannot afford in the first place? It seems to me it could only work if the banks reduce the payments, keep interest rates very low and wait 100 years for the home to be payed for.

If the banks are giving out interest only loans, then the principal will just keep on being carried forward with never a prospect of principal repayment. Eventually, when the borrowers default the banks will collapse.

Bubbles can take a long time to unwind and can go on for longer than anyone would reasonably expect. All one needs to do is look at the stock market bubble that popped in 2000. There were several people calling it a bubble in 1997, 1998, 1999, and early 2000. Take a look at this chart of the Nasdaq 100 ETF. If you shorted this tracking index in 1999, just a year before the bubble popped, you had to withstand a near 50% price increase before the top in April 2000. Don't think that calling tops and bottoms are easy and that they will always be obvious. If it were easy, we would all be rich.

To get some perspective on how long these things can take, read this story about poster "Rimpy" from the Motley Fool message boards. He believed that the stock market was in a bubble back in 1997. I was on the Motely Fool boards back in those days and Rimpy had to endure tons of ridicule. He was one of the few bears amongst a herd of bulls who were making money hand over fist. Internet stocks would double and triple in a matter of months and then, amazingly, double again in a few more months. People thought stocks would go up forever back in those days. Of course, stocks eventually came down, but now before an amazing run that virtually no one predicted.

You can also see from the Nasdaq 100 chart that the value of that index went from 120 in 2000 to 20 in 2003. I don't think even the most ardent bear on this board is looking for an 83% decrease in housing prices, so that bubble was much more pronounced than the current housing bubble. The collapse of that bubble didn't lead to a collapse in our economy, so I doubt that the popping of the housing bubble will destroy our economy either.

Another thing that is going to temper the drop in prices is the lack of liquidity in the housing market. Stock markets are much more subject to emotion than housing markets due to the liquidity. It's easy for most anyone to buy and sell a stock -- not so easy to do with a house. Plus, houses have value above and beyond their economic return. Many people will pay more to buy a house than they would pay in rent just so they can have the stability of ownership and can fix up their place the way they want.

Additionally, you would be amazed at the number of people that have no idea how to value a house. I was talking to a colleague the other day and she told me that even if she decided to move out of her condo, that it would provide good rental income. Equivalent condos near her are renting for about half of her ownership costs. It's so obvious that this would make a terrible rental property given her carrying costs, but she has been brainwashed to think that owning is always better than buying.

Finally, there are several owners that will do whatever they can to hold onto their houses. Their dream is to be a home owner, so they will get a second job or cut back on other expenses in order to afford their mortgages. The extra work and cutbacks will go towards salvaging a terrible investment, but they won't care. They are just desperate to be home owners.

Husing busts are worse than stock market busts. First, almost 70% of Americans own a home, whereas mainly the middle class and rich own stocks. So the effect of a housing bust is spread among more people.

Second,the outsized impact and multiplier effect on wealth that housing has, is much bigger than the stock market. "According to the study authors (Christopher Carroll, Misuzu Otsuka and Jirka Slacalek), an increase in housing wealth of $100 will boost spending by $9. A similar increase in stock market wealth "only" creates $4 more spending." Reverse that for the way down.

Third, the impact of MEW is HUGE. Since rates hit their lows in 2003, MEW has been responsible for more than 75% of GDP growth.

Fourth, housing start downturns lead to recessions. Every time housing starts decline more than 25%, a recession follows. Can the same be said of the stock market? I don't know.

Fifth, 25% of all mortgages are resetting to higher interest rates next year and millions of people will lose their homes in foreclosure and become renters (or tenants with Mom and Dad).

I disagree that homeowners can cut back on expenses to avoid a 50% jump in payments. At 35% or higher debt ratios, how can you cut back enough to afford a 50% payment increase? And forget that 2nd job - it's recession time.

I do think that people are desperate to be homeowners, so they try hard to keep their home, but they won't be able to.

"Husing busts are worse than stock market busts."

Do you have any statistics to back up this assertion? The Great Depression was preceded by a stock market bust. Has there been a housing bust that led to something worse than the Great Depression?

"Fifth, 25% of all mortgages are resetting to higher interest rates next year and millions of people will lose their homes in foreclosure and become renters (or tenants with Mom and Dad)."

You got a cite for this, poway? This statistic is hard for me to believe.

I admire your use of statistics and would note that poster "Rimpy" from the Motely Fool message boards had tons and tons of statistics to back up his stock-market bubble prediction beginning with his first post in 1997. Today, his "Bubble Port" is 4% higher than it was when he first started it in 1998. A very bad return on investment, but not a disaster by any means.

I agree that home prices are very likley to decrease, but counting on total economic destruction as a result of the housing bubble is unreasonable in my opinion.

TB, I think that we'll have 'total economic destruction,' due to our past overconsumption. I lay out my logic here:

http://piggington.com/depression?page=1

The housing bubble is merely a symptom of the easy credit/overconsumption environment that we've had for some time. Now, the bills are coming due: consumer debt to disposable income is at 130%, which is exactly the level at which the Japanese consumer quit spending back in the late '80s. Result: retail sales have clearly slowed, as have purchases of autos.

Folks have big bills from past overconsumption, and now interest rates are at risk of going up given the attractive investment opportunities in Europe and elsewhere and the cold feet that foreigners are having about purchasing ever more U.S. Treasury debt.

We've over 'invested' in real estate, and now construction is slowing markedly. Example: it's going to take years to absorb the condos already built and now being finished in downtown San Diego.

Big bills, rising interest rates, and slowing employment makes it difficult for folks to pay their bills, as evidenced by higher notices of default and foreclosures.

If holders of MBSs go after issuers of MBSs because of poor performance (payments) on the portfolio, and the issuers go after their 'insurers,' we'll have a financial meltdown given how many times the risk has been sold/resold (and given that 'insurers' did not sufficiently reserve to cover their exposure, to wit, Fannie Mae's miniscule equity: $39B against a $2.0T mortgage portfolio, as of 12/31/04).

I think we'll have a disaster, but falling home values are only one, and only a symptomatic, element.

Just my 2 cents regarding the question "whats taking so long?"

a 10% drop in the price of median homes and a 30% drop in sales, year over year, is a huge and fast drop in a market that is perceived to be so stable. Housing market busts historically take place over years rather than months. Personally, I'm amazed at how fast market sentiment is changing.

Just my 2 cents regarding the question "whats taking so long?"

a 10% drop in the price of median homes and a 30% drop in sales, year over year, is a huge and fast drop in a market that is perceived to be so stable. Housing market busts historically take place over years rather than months. Personally, I'm amazed at how fast market sentiment is changing.

Well said pencilneck.

Housing busts are worse because more people are affected. That is the point I made above, including the data on recessions and the amount of higher consumer spending due to housing price increases vs stock price increases.

US residential mortgages total $ 10 trillion. 20% of that is adjusting next year, according to moody's.com. I quoted 25%, because the percentage is much higher in San Diego, probably on the order of 40% or higher.
" The Saturday WSJ reports that "More than $2 trillion of U.S. mortgage debt, or about a quarter of all mortgage loans outstanding, comes up for interest-rate resets in 2006 and 2007, estimates Moody's Economy.com, a research firm in West Chester, Pa. Let's repeat that number: Over the next 20 months, more than two trillion dollars worth of adjustable rate mortgages will reset at higher interest rates. "
March 2006, The Big Picture
http://bigpicture.typepad.com/comments/2...

Thanks for the link, poway. I had no idea that 20% of mortgages have\would reset over a 20-month period beginning in March 2006. I was thinking that 5% resetting every year would be a lot. 20% over 20 months is a huuuuge number. This should certainly hasten housing price declines.

Of the mortgages that reset in 2006, is there any way to know how many resets led to a default?

Pencilneck -

"a 10% drop in the price of median homes and a 30% drop in sales, year over year, is a huge and fast drop in a market that is perceived to be so stable."

If we ever get a 10% y.o.y. drop in median resale prices, that would be huge. That hasn't happened yet, though. To this point prices are off 5% from 12 months ago. The 30% drop in sales is huge, but that appears to be almost completely the lack of investor buyers in the market.

jg -

Home building has slowed to a crawl, but that's actually healthy for the market. The more new homes that are built right now, the more downward pressure there will be on prices, since there isn't a lot of market demand for new houses in SD now.

If builders keep building new condos Downtown, that market will take a long time to recover, though. I don't know what bank would want to make a construction loan on a new project downtown at this time.

"The 30% drop in sales is huge, but that appears to be almost completely the lack of investor buyers in the market."
/Steve, I think this is an example of why people tend to pull your chain. You're AGREEING with a previous post but you have to qualify it. Who cares WHY there was a 30% drop, it's still HUGE. I think your statement that declines were only 5% is misleading. Why not say the decline was only 2% and quote the figure for the entire continent? If you look at distinct markets I think you can seem some with 10%+ declines.

Okay - this may be a dumb comment... but if I had a loan that was due to reset to a higher interest rate soon, why couldnt I just refinance? There are ads EVERYWHERE (seen the annoying ones on CNN.com with the dancing idiots?). Why couldnt a large number of these people do that?

Mexico Resident -

I'm not completely agreeing with his statement. It is a fact that median resale homes are off by 5% in the past 12 months in SD County. I was just correcting his 10% figure. And I don't mind if people yank my chain. I just like to sometimes point out that things aren't quite as bad as some believe.

lostkitty - you have a good point. A lot of people will be refinancing into other loans. The problem is, that an incredible number of people have gotten loans of up to 100% of their homes' value in the last couple of years, (either as purchases, or as cash-out refis), and if prices even go down 5%, they may not be able to refinance at all.

Yes, but doesnt that mean that the appraisals have to come in 5% lower? At this point, i am guessing the appraisals arent down much at all. Also, I am sure there are appraisers in the pockets of mortgage companies that will get the 'right" number. It will be in the interest of the mortgage companies to keep this whole thing propped up as long as possible.

Mexico Resident:

I have seen many areas that are off in price by 10%. I've seen individual properties that have lost 20%. But I am also seeing a lot of established areas in SD County that have had very little to no declines in price over the last year. Prices WILL continue to decline, I'm just not sure how much. You may not feel that the median price is an accurate gauge of the market, but the bottom line is that the median resale price is down by 5% in the last year, not 10%.

lostkitty -

Appraisal values generally are lower this year than last year - some areas by a little, and some by a lot. Unless an appraiser is just plain dishonest, you can't argue with market data, both recent sales and active listings. I've done quite a few appraisals in the last 6 months, where the current value is lower than the outstanding loan amount.

Some appraisers will try to push the value up, but most banks will have a private fee appraiser or on-staff review appraiser look at the appraisals they receive. (At least I hope most do.) It's very common for the review appraiser to cut the appraised value.

SB, yes, slowing construction is good for home pricing, as it reduces the rate of buildup of inventory, with its negative impact on pricing.

But, slowing construction is bad for the construction guy losing his job, bad for Home Depot and Macy's that sell fewer appliances and furnishings, bad for the mortgage broker who has fewer homes to finance, etc. Not good at all, for employment/wherewithal to pay. Reduced employment and wherewithal to pay is a major, major factor that will negatively impact the real estate market beginning in '07.

Then, home prices will really come down, despite fewer homes coming online.

Just my read of the future lay of the land.

lostkitty, this is my laywoman's comments on what could prevent a refinance:
1) current value is less than borrower's home value, due to falling home value and too much equity withdrawn
2) borrower has at least one mortgage late payment, so lenders don't want to touch him
3) borrower's income is too low for a loan at today's 6% rate; he could qualify when Fed funds rate was 1%, 2%, 3%, 4%, but not at today's Fed funds rate of 5.25%
4) prepayment penalty of $10K or higher; I know several people who cited this as a reason they are delaying refinance; they hope the Fed will lower interest rates next year and by then their prepayment penalty will be expired
5) no money to pay closing costs. Closing fees are 1% or more of the loan amount, and cash-poor people have to put the closing fees into the loan amount. If the home's value is too low, they cannot fold in the closing costs, so basically, they lack the money to pay for a new loan
6) Once the State of CA follows the other 20 states that have adoped the new lending guidelines, many people will just not qualify for another loan they could afford
7) Borrower lost his job, because he's in construction, real estate, lending. No job, no loan. Thousands of construction workers are already laid off.
8) Borrower has too much debt, so the debt/income ratio is too high for a new loan. Maybe they took out a HELOC, car loan, and now their expenses are too high.

Nonetheless, there are still plenty of people refinancing, as proven by the Mortgage Banker Association Refinance Index.

It's interesting that Fannie Mae (or Freddie Mac) said that 88% of their refis this year are at a higher interest rate, so people are refinancing into more expensive loans just to get cash out. (The CEO did not say it was to transfer from a lower cost adjustable loan into a more expensive fixed rate loan - he specifically said it indicated cashing out. So he may be referring to conforming loans which refinanced, rather than all loans.)