Applying Case-Shiller Data to Price Predictions

[renterclint]

Lurkor,

You are right about the “second approach” being the easier method. It would be great to just simplify all of the recent developments and say “we will revert to the mean”. When the dust finally settles, that could very well be the end result.

But what if all of the reasons we have sited for a major decline: ARM resets, RE industry job loss, HEW funds drying up, evil 80/20 & exotic loans… etc – what if the true proportion of the SD population effected (or is it affected?) by these factors is mostly insignificant? What if most of the homeowners here bought at the right time and are not in over their heads? Maybe the larger influx of wealthy foreigners moving in has caused SD to become the new San Francisco, and our underlying characteristics of our hometown are under a major transformation. Could it be that we will revert back to the mean, but “the mean” is now a redefined, less affordable mean?

I would love to see someone attempt to quantify the factors sited so often on this site. I for one am dying to know how many people who live on my hoity-toity La Costa Valley street are really under-water and at the verge of ruin. Maybe 50% or maybe only 1%. It would be interesting to know. I think I saw somewhere that 80% of purchases in the last 3 years where made w/ ARMs. And a large % (can’t remember the exact portion) were zero down. Could we apply this to the number of homes sold from ’04 to ’06 and come up w/ # of homes in trouble? That is probably simplifying things a bit. But it would be cool to see the results.

LA renter, you’re right about the impact of troubled borrowers who can find a way to survive – their disposable income is squeezed & there goes our local economy. But again how many people are we talking about?

[LA_Renter]

“Maybe 50% or maybe only 1%. It would be interesting to know.”

Here is also something to consider. Say it is 1% that are in trouble in that neighborhood, if they are in trouble than potential buyers of the same means will not be able to buy that property assuming tighter lending standards. For every person in trouble there is a corresponding decrease in demand. Lets say you have 10% of people that are in trouble that paid near peak prices, then you have also reduced the pool of potential buyers by 10% giving a net of 20% decrease in demand (people leaving Foreclosed properties that they shoud have never bought + decreased pool of buyers that would have been able to purchase that property in previous years) and you have added 10% of those properties back into inventory. Point being the numbers really don’t have to be that big to have significant impacts on local markets.

[sdrealtor]

Renterclint,
Wonder no more! Give me the name of the street and i will let you know. I believe LCV will fare well because the vast majority of homes are still under original ownership there at pre-2001 purchase prices. La Costa Oaks (nice homes, worse location and inferior community feel) on the other hand which was all sold at bubblicious prices wont fare so well IMHO. It seem like the same homes sell over and over again there as exec types transfer in and out for work while the core residents are dug in for the long haul. It would be an interesting test of my hypotheses.
SDR

[SD Realtor]

RO –

Good post. I think your analysis had good points to it. In my opinion I think we will see greater declines because of the points brought up by others. While this is purely based on only my opinion, there are hard data points that already support price decreases of up to 20% in some areas for certain types of housing. This is not theory but fact. Places like attached homes in UC, downtown, even detached homes in lower income areas have hit 2004 pricing already. Again, I believe this downturn will be interesting because I think there will be a larger variance in types of housing and locales. I would definitely agree with the post that sdr just added regarding LCV. I think we will see many people forced out of thier homes, (these people should have never bought to begin with) but we will also see just as many equity rich homeowners sit tight.

If you have to ride out a storm San Diego is not a bad place to hunker down.

SD Realtor

[Bugs]

If the slope of the curve going up this time had been the same as the slope of the late ’80s I’d agree that this downslope would resemble the pace of that downslope. For the first half of this upleg the slope was similar, but the second half of the slope was much more steep.

The upleg of the ’80s lasted less than 5 years; the upleg this time lasted 10 years. The ’80s upleg stretched about 25% above the trendline; the upleg this time stretched 65%+ above the trendline. This indicates to the use of a different slope for this downleg than the one from the 1980s.

First of all there’s the length of time – it’s possible that this downleg could last longer than the one from the early ’90s, which lasted longer than the upleg that preceded it.

Then there’s the slope – if we applied the reverse slope from the upleg to this downleg it woud indicate to relatively sharp decreases during the first half followed by more moderate decreases before the downleg bottoms out and the new cycle starts.

If 2006 demonstrated a 8% decline and the first half of this downleg does turn out to be 4 years, that would indicate to a 32% or so first half and perhaps another 14% – 16% for the second half. And we’d be looking at a recovery after 2015, not 2011.

We’d better hope it is different (better) this time.

[hipmatt]

I still feel confident that price declines around 50% are very likely. This event is completely different from previous cycles. This ere, has lending products, that weren’t around before. Literally anyone who wanted a home, could go buy one. This lead to RAMPANT speculation. Homeowners were getting rich, lenders, RE agents, construction, etc. So many people were behind this and supported it and devoted a lot of time and effort into promoting this boom.

It became common knowledge, that the easiest way to get rich was to buy a home, regardless of your financial condition or the price of the home. Homes have never been looked at this way in our history. In the 90s, a home was barely an investment, but after y2k, a home was considered FREE money. Emotions ran high, as did the peer pressure to go buy a home, cause everyone else is, and everyone else is getting rich. The psychological impact that this current housing boom experienced is also a first for RE.

There is no argument that easy credit, speculation, and a whole new market psychology all have played a crucial role into creating a housing boom that is beyond compare to anything we have previously seen. This correlates the fact that interest rates have been at or near historical lows now for over 4 years.

Some have assumed, that buyers in a tight spot will magically “figure out a budget” to allow them to afford ballooning payments. While if this was possible in theory, which it is not, it would still spell disaster for housing prices. If households facing rate increases, all of a sudden, drastically reduced non mortgage spending, in order to make their payments, these impacts would be felt in the rest of the economy. This trickle down effect has already been felt in the financial markets, and this is just the beginning. The people that try to live life w/ the ridiculous mortgages that they recently have signed up for, will not be buying as many Hummers, Dinner and a Movie Dates, Starbucks lattes, and stamped concrete patios, like they have been in recent years. You will and have already seen corporate downsizing, layoffs, and unemployment. Once again, we are at the beginning. Just as the boom builds momentum slowly on its way up, the same effects will happen on the way back down.

Unfortunately, the only thing that can fix things is a huge market correction. It has begun, but it will take years to reach bottom. My humble advice…be patient sell your home if you have one. Rent for about three years. Save the difference between rent, and what a toxic mortgage would cost you. And after everyone has learned their lesson on cheap excess credit, buy aging. Save yourself 50%

[Cow_tipping]

By 2011 we’d start seeing serious numbers of baby boomers try to unload their built in the 70’s crapboxes complete with lead paint and asbestos in the walls to “fund their retirement”.
If we dont crash and recover by 2011 … we’d not see anything recover for 30 more years … of course if we crash now and recover by 2011, we’d crash again in 2011 and stay down for 30 years.
Fast Crash now and start recovering in 08-09 and crash again in 2011 or slow crash to 2011 and then continue to crash for 30 more years.
Cool.
Cow_tipping.

[PerryChase]

I just read an interesting article by Calculated Risk on the changes in the mortgage industry. Underwriting is a big difference between this downturn and the last.

There was a rush to finance everyone so risk management went out the window. Well, it turns out that FICO scores and computer models weren’t any good at managing risk.

But I don’t think that we’ll return to the days of manual underwriting (a very costly process) for the lenders. The lender will have to charge higher interest rates to make up for the losses and higher rates will dampen housing.

http://calculatedrisk.blogspot.com/2007/04/walk-down-subprime-memory-lane.html

[PerryChase]

I don’t think that households can tighten enough to make their increasing housing payments.

Considering how people spend at 7-Eleven, Starbucks and other “affordable” luxuries, they won’t have the discipline to make the adjustment. They’ll say f— it and walk. That is the American way.

[RottedOak]

I’m not going to reply directly to the majority of the latest responses, because most of them are exactly the sort of thing I dismissed earlier: claims of “it’s different this time” (sometimes even using that phrase) with nothing more than generalities in support. I give these claims about the same credence I give to “we’ve hit bottom” and “subprime problems won’t spread” statements from real estate bulls.

Bugs,

The history suggests that the downslope isn’t exactly a mirror of the upslope. The price drops are generally slower than the rise — this is the commonly-cited “stickiness” of prices in a downturn. However, the price drops are stronger in the first few years than they are later in the bust. I will try in a subsequent post to make some more specific comparisons between the last bust and what has happened so far in this one.

SD Realtor,

I want to emphasize that the Case-Shiller data are not the same as the MLS data, and it is risky to mix statistics between the two. The Case-Shiller index shows a 5.3% decline from peak as of January 2007. I believe the 8% drop cited by Bugs is reflective of the MLS data. I assume your comments about drops in specific areas are also based on MLS data, or perhaps just on anecdotal instances. The Case-Shiller data is collected for all of San Diego county. I don’t believe they provide any breakouts for zip codes or other limited areas.

No matter how strong or weak the downturn, there will undoubtedly be some areas that perform better than others. A given area may have experienced gentrification, infrastructure improvements, etc. that help shore up prices, while another area may have the opposite pulling prices down. I assume this was true during previous busts as well, so I don’t see it as something distinct this time. As I imagine you realize, individual buyers and sellers should be looking at the specifics for the property that interests them, not just broad economic numbers. Even in a strong downturn, a specific property may be worth more if it has been thoughtfully renovated. And a property might be worth a lot less even during a strong upturn, if the previous residents used it as a meth lab, or if a canyon wall collapsed taking the back yard with it. So I don’t make any pretense of trying to predict what will happen in highly localized areas. Making county-wide predictions is sketchy enough!

[sdrealtor]

Renterclint,
I just checked the most hoity toity of streets in LCV. Out of 89 homes, 2/3rds are under original ownership. Of the 1/3rd that have resold, many have very low LTV’s. I also know of several resales that were purchased by individuals with deep 8 figure net worths as well as a bunch with very substantial incomes that will have no problem sleeping. I live relatively close to that community and know it very well. I would guess that 10% would be the upper limit there and the real number is more likely about 5% potential REO’s.

I have several good and very fiscally prudent friends living there that wont move because they have such a low tax basis. If prices fell, they would be more likely to move than if prices rose as strange as it might seem. However, here’s the problem. If prices fell another 30%, they would buy the bigger home they wanted and could easily afford but they would keep their current home as an investment because it would still be cash flow positive by at least $500/month with lots of upside on value.

I dont know if you want to own a home there if it makes sense financially for you at some point in time, but if prices ever reach $700K for a nice 4BR/3ba home there I wouldnt expect to see it go any lower. At that point, the monthly PITI+HOA would be around $4200 and aftertax it would be roughly equal the $3000 homes like that rent out easily there.

SDR

[Chris Scoreboard Johnston]

Chris Johnston

I agree with this post, the original almost in it’s entirety, and it isolates several of the reasons that I have called for a 20% drop and not much more. I do not believe in the “it’s different this time” arguments. If it is I will be wrong.

[sdrealtor]

BTW, I agree with RO’s post as well. The drop over the last 18 months has been fairly significant in my area of town. Any drop from here will be painfully slow IMHO.

Welcome to the neighborhood Chris. It looks like a great home.

[equalizer]

RO asks the right questions, but casually throws out what he doesn’t like. For example, RO states that ” A given area may have experienced gentrification, infrastructure improvements, etc. that help shore up prices, while another area may have the opposite pulling prices down. I assume this was true during previous busts as well, so I don’t see it as something distinct this time.”
Well that wasn’t true. I don’t think the 0% down, zero closing costs were around back in the 90’s. Just check the latest NOD, foreclosure for SD county and you will see that the low income areas have been hit hardest. Condo conversions were not a big item in the 90’s as they are now.
Here’s some more questions:
How many homes were sold since Jan 2004?
How many of them were financed with 2-3 yr ARMs?
How many of them were refinanced since first loan?
For a certain zip code/sub-zipcode, can we check how many of the homes in that sector were sold since 2004? (Ignore new areas, and check % of new sold compared to all in the sector. I’ll bet that “better” homes had less turnover and hence will experience less depreciation)
Can we pick a street in a few different zip codes and track 10 homes to get a sample?

[capeman]

There is a lot being forgotten when it comes to fundamentals involved in real estate. What it comes down to is that there is one very basic element to predicting how much prices will correct over time. The leading indicator being: What can the people of a given area afford based on average income and the current interest rate on a standardized loan (30 year amort. has been the gold standard)? Since most all other non-standard and risky forms of mortgages are quickly being worked out of the system, it will very soon come back to this basic fundamental level of affordability.

For example, a life-time SD resident such as myself, with a professional degree, earning upwards of 30% over median “family income” (without including my significant other’s income) cannot afford an average home in an average neighborhood via standardized loan with 10-20% down. Until prices come to a point where I can afford a home given these conditions and making no more of a payment than ~30-35% of my income then prices are not fundamentally sound and I can expect further declines. Otherwise I can expect overall incomes to increase by >30%, interest rates to skyrocket to >1980’s highs or the area to turn purely into a luxury haven where only the richest 10% of people can afford a home. Based on these predictions and aside from mortgage rate changes that I cannot predict (likely to go up greatly though!), I expect single family homes in a somewhat desirable neighborhood to drop 30-60%. It is that simple. The only thing one cannot predict are economical pressures or MANIPULATIONS that would alter the timeline for reversion to equilibrium.

[Author]

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