One of the forum participants, a long-time San Diego appraiser, has posted a really good summary of how things played out during the last down cycle in the local real estate market. I think it’s very instructive for those of us who weren’t punched in to the housing scene back then—so much so that it deserves to be its own post. Without further ado, quoting "Bugs":
I think all cycles play out a little differently. But I also think that past predicts the future.
I remember in 01/1990 seeing a real softening in most of the residential markets. For about 3 months it was real spotty and inconclusive. By about 03/1990 most of the appraisers had figured out that the market was in decline. It took the newspapers about 6 months before they picked up on that and by then it was way too late for some of the "last fools".
The residential markets here started to decline and the foreclosures started to rack up. As the lenders’ reserves got quickly eaten up by foreclosing, then selling the foreclosed properties under quick sale conditions, the feds would close them in order to stem the losses. That only made it worse. More lenders went down, more properties came on the market as "bank-owned foreclosures". Believe me, when potential buyers see that sign on a property they know they can lowball the offer even more because the lender is under pressure to sell and they have to liquidate. It sets the market because at the same time the prices are declining that decline is contributing to the rate of foreclosures which in turn swell the inventory and cause further declines. This is the flip side of the "real estate never goes down in value" line that has been so popular these last few years.
As the declines picked up speed, it affected almost every price bracket, but especially the middle ranges. The bottom end lost a bit, but the middle and top price ranges collapsed like an accordion. At one point there wasn’t a whole lot of price differential between what would have previously passed for a $350k home and a $150k home.
The subdivision developers had to finish their projects and get out, no matter what, so they had to cut their pricing. That made selling their homes even harder, and on top of that it spurred some lawsuits from previous buyers. The developer had basically undercut their purchase prices leaving them upside down. People were suing because a $50k loss was enough to ruin them. There were a whole lot of people who were basically trapped in their homes for a good 6 or 7 years, until prices caught up in the 1996-1997 time frame. Those who could hang made it through and those that didn’t added to the inventory.
All that happened in a market where the peak had topped out about 25% – 30% above the long term trendline. Now that we’re 60% above the trendline I don’t think I am capable of overestimating how bad it can get. We only wish we were looking at $50k losses. Heck, that one model in Bressi Ranch has basically lost $70k and things haven’t even started going south yet.
The thread in which this post appeared can be found here.
My continued thanks go out to all the folks who post insightful comments on this site. I have gotten a lot out of the commentary and I suspect that many readers have as well.
April 3, 2006 @ 3:11 PM
Add this from
Add this from Sandiegobanker1, a commercial lending officer, from forum topic New Bankruptcy Laws and Foreclosure, 2/26/05:
This HAS happened before. I worked as an REO Marketing Analyst for the RTC when they took down Home Fed Bank around 1991. It was the largest bank ever taken down with hundreds of millions in REO. I personally sold bank REO for 20%-30% of what it appraised for just two and three years earlier. Banking regulators don’t give lenders alot of leeway to play the market so to speak, or hold on to get a better price. They HAVE to get those non-performing assets OFF their books. I have lots of stories about those days and I’m convinced this time it will be far worse because back then we didn’t have any of the Geo-Political crises we have now, and because the advent of the internet now facilitates the free flow of information much much faster. Look at all the housing bubble blogs there are with all the reliable data they are providing. It’s almost an avalanch.
I remember telling people in 1989-1990 that the writing was on the wall and nobody listened because there was no publicly available data, and the media, especially newspapers, weren’t going to report it because their largest source of advertising comes from brokers.
With the internet and the info that is available on it, you’ll soon see the amount of time it takes for real estate to crash significantly compacted. In fact when homeowners increasingly start putting their homes up for sale in the next few weeks to get an early start on the spring home buying season, and they realize how inventories on their local MLS’s have tripled and quadrupled and worse, you’ll see panic set in, especially now that you can monitor home inventories in any metropolitan area on ZipRealty.com and other sites. This will feed the panic. In 1991-1994 (the last time there was a real estate crash), only real estate brokers with access to the MLS were able to see the early signs. Now everyone sees the signs and is blogging about it.
The one thing I’m always amazed to find out is how many borrowers think that when their home goes back to the bank, that’s the end of their problems. What they don’t realize is that if the lender writes off or forgives any debt to them (i.e., short sale, etc.) the former borrower will get a 1099 for the amount of that forgiven debt as though they had received it as income. If they sold their home through a short sale at the begining of the year and they got a 1099 by January 30th of the following year, they not only have to pay taxes on that forgiven debt, but penalties and interest too, because it was due (unless you pay estimated quarterly taxes) at the time the debt was forgiven.
IT WILL GET VERY UGLY “/
I can’t recall the number of Banks that went belly-up, but it was a shocking number and they were all over the USA. The funny thing I remember was that RTC’s Sr. Mgmt., at Home Fed, the RTC Credit Review Committee, was comprised of CEO’s and EVP’s from failed banks in Arizona and elsewhere in Calif. that the RTC had taken down. I also remember there were no S&L’s left in Phoenix at that time because when I was trying to sell houses there for a client in San Diego we were told there were no S&L’s left in Phoenix and the banks just weren’t lending. The mortgage companies had minimum loan amounts that were much higher than the $15,000 & $20,000 my client was selling his Phoenix homes for in 1991 (they were in crappy areas if that’s any consolation). In fact the only people willing to buy the homes were the tenants and my client had to “creatively” manufacture the down payment. He just wanted out at any cost and would have given them away to a charity if the tenants hadn’t bought them
At the time, there was alot of talk at the begining of the crash that the government would step in, but it was all wishful thinking and it won’t happen for many reasons:
The government is too far in the red already
Things have to play out to their “natural” conclusion. It’s all part of the economic cycle of life. The crash has already long been anticipated in numerous other ways. It has to play out normally.
Allowing Uncle Sam to step in and cure or mitigate the crash would create a consumer mindset that would be far more dangerous for our economy. There has to be consequences. Even though bankruptcy allows you to wipe out all your debts, you pay a big price not being able to obtain credit for years, other than maybe credit at more onerous terms.
Your question, why have people forgotten what happened just over a decade ago is one I’d really like to address because the answer says more than you’d think. The only people who “really” understand that period were those “right in the middle of it” like those working at the RTC who sold that REO at firesale prices and those who got financially burned badly. That’s a smaller group than those not part of this group, and even then, many of those never understood what caused the crash in 1989-1995, so what you have is a very small number of people out there who really understand, although I’m extremely impressed about how knowledgable Rich at Piggington and other housing bubble blogs are, and their very public discussion of the facts/data will compact the cycle this time.
The only thing I remind people is that if you don’t have to sell in a bad market, competing with the sale of bank REO, massive inventories on the MLS, etc., you can say your property is worth anything you want based on any amenity of dubious merit, because you’ll only be called on it when you actually have to compete with the market by trying to sell in competition with it. I have vivid memories of many real estate owners during the 1989-1995 period who would argue in the face of actual sale comps all day long. The point I’m making is look at the data only, not statements of subjectivity.
Regarding all the new investors seeking to scoop up deals which will hold up the market…that ocurred last time too, UNTIL the new market psychology kicked in. The emotions of optimism and greed that drove this market through the roof will invert into pessimism and frugality which over time will drive prices through the floor. There is a new emotional mindset already taking place. You can see it in many postings, not just housing bubble blogs, but real estate listings on the classified section of SDREADER.com and others where people who probably don’t consider themselves religious are actually praying for a buyer, yes they used the word praying in their ad. I saw another ad for a Hillcrest property that basically said they were sick of real estate investing. This mood will permeate the market as the market increasingly begins to grind down even slower.
As far as live auctions, they are a strange thing in my opinion and are driven more by emotion than anything else. I’ve been to many of these and am always amazed at how often investors will bid the properties up to market with less assurance than they would get if they had bought in the traditional way through a broker. People just get caught up in the emotion. Some people think “auction” and “good deal” are synonomous. I’ve heard many people brag about the deals they got at auction, but when you comp them out, they simply bought at market, with fewer assurances, which to me makes it a worse deal.
April 3, 2006 @ 7:29 PM
I bought a Sabre Springs
I bought a Sabre Springs condo in Jan 1990 as a 29 year old. Saved my ass off to get the 16k needed for a 10% down payment and closing costs. The original loan was at 9.75% through Great American. Refied into an amortized ARM 93-94 timeframe at a great rate. Still have this loan today.
Anyway, I paid $111,000 for the 900 sq ft 2 BR condo. The unit upstairs sold for $114,000 a couple months later and that was the peak. The price decreased steadily until comps were about $85,000 in 1996. I got a job in Arizona and there was no way I was going to write a check to get out of this property. So we rented the unit, initially cash flow negative but now it’s about $400/mo. cash flow positive plus whatever goes to principal on the loan.
Interestingly at the time I met with “financial advisors” otherwise known as insurance salesmen and told them I wanted to invest in SoCal real estate mutual funds REITS or the like. They told me I was crazy and I didn’t get into this (the stock market was gangbusters in the time frame so we did well in growth mutual funds until April 00 at least). We were also told to sell by real estate agents because it didn’t make sense to have a cash flow negative unit. Geniuses there.
There was a mentality in the complex that “Gee, these keep on going down so we have to sell.” The unit is probably now worth $320k albeit down from maybe $350k about a year ago. And yes, there were a lot of people upside down in their houses. Luckily for most the job market was better in the mid 90’s than it is today.
April 3, 2006 @ 3:45 PM
There were a whole lot of
There were a whole lot of people who were basically trapped in their homes for a good 6 or 7 years, until prices caught up in the 1996-1997 time frame. Those who could hang made it through and those that didn’t added to the inventory.
One big difference this time around that will force more homes onto the market is all the adjustable rate mortgages in effect now. Many recent buyers will not have the option of remaining “trapped” in their homes, as their monthly payments will rise and become unaffordable. That’s when it catches up with San Diego that only 14% of its residents can afford a median price home.
April 3, 2006 @ 5:53 PM
They way “Bugs” describes it
They way “Bugs” describes it is pretty much the way it was. I have owned my home for almost 20 years and watched my home go down from 300K in 1990 to 200K by 1993. This is based on appraisals that were performed for a HELOC (1990) and a Refi. (1993). My home would probably fit into the “middle range” that Bug’s mentions. That’s a 33.33% loss on paper. It was pretty eye-opening and in my view a pretty big hit.
Question out of curiosity, the Bressi Range models referred to in the thread regarding price reductions, I noticed was dated April fools day, or April 1. Bottom line, are these price reductions for real or an April fools joke?
April 3, 2006 @ 10:40 PM
After much discussion in
After much discussion in another forum, it appears that they are ONLY selling for 13% less than last year. Only an April Fool’s Day joke if you were the builder who sold that guy, that house for $875,500 last February which you could buy today for roughly $762,000. That was very funny as the builder must have laughed all the way to the bank.
April 3, 2006 @ 6:04 PM
Bugs, how do you value a
Bugs, how do you value a house in a declining market? Do you look at the comp and deduct 5%?
April 3, 2006 @ 8:30 PM
The biggest weakness in an
The biggest weakness in an appraisal is the fact that we are relying primarily on closed sales, which by definition are dated with respect to what’s happening right this minute. Sometimes the lag is a few days and sometimes it can be a few months or longer. Putting a current value on a property in a rapidly changing market – whether the direction is up or down – can be quite the challenge.
There are a couple ways of doing it. One way is to apply adjustments to the sales prices of the comps to account for the different market conditions that were applicable when they sold vs. the current date. When developed properly, that is, when there’s enough data analyzed to actually find out what this rate of change is for the subject’s market segment, time adjustments are very effective. Your “deduct 5%” would be an example of that. As long as the 5% was demonstrable in the data it would be okay to do that. What’s not okay for an appraiser is to assume the 5% is applicable because sometimes it might be 10% and sometimes 0%. The different markets are imperfect and they move at different paces.
Another way of doing it is to bracket the subject with the most recent closed sales, the pendings that are currently in motion and the active listings. We generally consider an active listing to be useful in establishing an upper limit of value. The exception to that is in an ultra-hot market when there is overbidding going on. If that’s the case, the trend for overbidding can be demonstrated in the closed sales, as those will close above the list price.
I usually avoid the time adjustments and just use the extra listings and pendings, giving greater weight to the sales contracts that are the most recent, which are the pendings. For a declining market, the pendings will still be more timely than the closed sales. The thing is, when following the trend, we have to weight for the direction of that trend. If we go to the top of the range in an increasing market because we don’t know how high it will go, we should go to the bottom of the range in a declining market because we don’t know how low it will go.
In an appraisal, I usually array my sales data chrconologically, the most recent sale being listed first. All other things being equalized, if there is a trend among the data in terms of increase or decrease that trend will demonstrate itself. If the data is inconclusive or has too much noise for such a trend to stand out that will demonstrate itself, too.
In my opinion it’s a lot easier to expand the dataset to include the actives and pendings and then pick a value out of that range than it is to limit my sales to only the closeds and have to adjust those for changing market conditions. It’s not the only way to do it but it is the easiest (for me) to support.
That’s probably a lot more about the application of the Sales Comparison Approach in an appraisal than you ever wanted to know, but there it is.
April 3, 2006 @ 9:30 PM
Wow – there’s so much to
Wow – there’s so much to consider.
I presume the banks remember the housing bust of the ’90s. Do the managers see/expect this to happen again? If so, are they concerned about foreclosures?
Some banks keep their mortgages inhouse, rather than selling them to investors. Those banks should be very concerned about not only the appraisal, but also the direction of the housing market. An appraisal is accurate only for that particular transaction. In a rising market, a lender wouldn’t care if a house appreciates. In a declining market, what would keep me from caring?
Since you as the appraiser have figured out the rate of decrease, say 5%, doesn’t the lender have to consider this as well. Wouldn’t she have to think that this 5% decline between periods x and y, can continue, until in a year, the borrower is equity-negative. Have you ever heard a banker talk about this, admit this, even consider it?
Why would a bank want to continue making loans in a market that has taken a turn, that they know will take a dive. Keep taking profits until the collapse is unavoidable? Is that the idea?
April 3, 2006 @ 11:39 PM
That’s a really good
That’s a really good question. First of all, we should all keep in mind that the business of banking involves some stiff competition. Most of these companies are publically traded and they’re judged in the market by their quarterly profits. More than one lender has told me that while they’re nervous about price stability they can’t just let their competition make all the money and win all that market share.
As far as what they do when prices decline, we should also remember that only the smart lenders make it through these types of down cycles anyway. These are the lenders who never let themselves get that far out in the first place.
One of the things lenders do during a down market is tighten up their credit standards. A lot. Not only are the Loan-to-value ratios lowered – look for 80% LTVs to become common – but every aspect of the credit and employment are verified. No 100% LTVs, no stated income qualifying, no piggyback second TDs. It’s fairly difficult for the self-employed to get a loan at all and even then they have to pay extra. The lenders don’t do much in terms of forecasting further declines but then again they don’t rely solely on the property to provide their payment.
Obviously, a much tighter credit environment will contribute to the price declines. It shifts the risks of speculating from the lenders to the buyers, which is how I think it should always be. People tend to be more thoughtful and careful about their investments when their own cash is in the deal.
One interesting thing – during the last bust we were all anticipating it would turn around sooner than it did. Myself included. The market psychology was really bad and it took an extra couple years to turn around. That lag was repeated, only in reverse, during this upcycle. It just goes to show how hard it is to time these swings.
Anyhow, the smart lenders know how to underwrite a loan without exposing themselves to a loss. Not many loans made during our last bust ever went bad. Believe it or not, the bankers have a saying about this – “bad loans are made during good times”. Deja Vu, man.
April 4, 2006 @ 2:41 PM
I observed past
I observed past crashes.
Sometimes I feel like I’m one of the few who witnessed the last crash. I remember the crash in the 80’s when a guy I know lost a whole block of prime commercial real estate on Prospect, and his house in La Jolla because he was mortgaged so heavily during that crash.
Then after the 1989 Oakland earthquake home prices started falling again. No one would pay huge money for CA property because of the earthquakes. Many people told me they were selling and leaving CA. Homes flooded the market in the following years. I noticed homes including condos at the coast in north county were not selling. The sellers told me they paid $250,000 for them.
By 1995, I saw the for sale signs in the windows asking $129,000 and I know a guy who bought 1 for $90,000 and another for $100,000 in 1997, on a waterfront location. The banks were selling them all over the place. Foreclosures were really lowering prices. I saw neighbors walk away and give their keys to the bank, adding to the foreclosures. They were so upset over their homes being worth less than half of what they paid, that they walked away from them.
I know it sounds strange, but I saw it happen. It was mentally hard for some people to make payments on a 250,000 loan, when the place next door was for sale for $100,000.
Prices started back up in about 1998. In about 2001, I had many people telling me that they actually did not lose money when they sold their homes, as they had lost money before. They were happy just for that. Some told me they were still under water in homes they bought in Temecula years earlier.
Incredibly, some buyers paid $650,000 to $700,000 last year for the same condos near the coast, that I saw sell for $100,000 just 10 years ago.
After seeing those homes sell for $100,000 it is just mind boggling that buyers paid $700,000 for them last year. They have no Idea how bad the last crash was, and they have no Idea how much value they are going to lose this time. And that’s without another earthquake. If we have a catastrophe of some sort, you can imagine how much more that will affect the current slide we are in now.
So many people just don’t learn from history.
April 4, 2006 @ 3:23 PM
Are you a homeowner, or a
Are you a homeowner, or a renter?
Since you’ve seen such extreme valuation differences, you’ve probably wondered what happened to these assets to justify such a higher valuation.
April 6, 2006 @ 5:51 PM
Someone posted that few
Someone posted that few people learn from history and remember what happened during past housing downturns. Part of that is human nature, I guess. It’s always “different this time.”
But certainly the torrent of flexible loans now available have mightily contributed to the current boom. It’s funny how easy money is when prices are skyrocketing. But in a downturn or crash, credit dries up. Who wants to lend money on a deflating asset?
That’s why it’s so critical to have cash available to bottom-fish, if that’s what you hope to do. Because when the prices are finally worth paying, no one will want to lend you the money to buy…or at least not with a decent down payment.
I’ve been renting my primary home in NorCal for 3 years awaiting the final curtain on the housing bubble. We sold off 2 of our 4 income properties in NorCal in late 2004. So we’re debt-free and have plenty of financial firepower in case the market wishes to come back to reality in the next few years.