How will the collapse unfold?

[Jim Brubaker]

Everyone is alluding to the bubble popping. I think that it will happen, but the way it happens will be different than you think.

Lets say that owners can’t pay the mortgage starting as of January 1, 2006. After 8 months they will be foreclosed. Then after 3 months of legality, they will be put up for sale by the bank (owner of the trust deed).

Second you will have sellers that “counted” their rise in net worth wanting to sell. They still want some of the pie and will probably hold out and end up selling at the bottom.

Third, you have builders, their cost of construction is $39 per sq ft for condo’s and about $90 per sq ft for homes. Now factor in the value for land.

Of the three, the builder is the most flexible. He can drop the price $100,000 and still break even. Plus he can continue to build at a new lower price, to be determined by the price of the land he is purchasing.

The other issue, what will happen to the banks and interest rates? What will happen to the retirement plans that invested in real estate? These are the questions that don’t yet have answers

[RightSide]

What can you build for $90 a square foot in California? A mobile home? I’ve looked into builiding a house, nothing fancy, but nothing cheap either, and it was going to cost me between $250 to $300 sq foot. Just the permits alone were a ridiculous amount. Thats NOT including land or an architect.

[Bugs]

Oh, there are answers, all right. They just are too unpleasant for most people to entertain. Banks and retirement funds and insurance companies have gone BK over bad investments before. The only difference this time will be the scale of it – there are so many more dollars in play.

I’m wondering if the Alternative Minimum Tax “changes” that are coming up this year will be a significant contributor to some of the defaults. That little gem could end up being the straw that broke the camel’s back.

[Jim Brubaker]

What I was talking about were construction costs figuring the land cost 0. This is what a builder uses to figure what its going to cost him to construct the unit. The cost of a house in California and the cost of a house in Louisiana is the same, its the land that people pay extra for. $300,000 for a 1,000 sq ft house is a little outrageous unless you live where I do in San Marcos. If you were a builder, it would be one hell of a return.

[powayseller]

Use Weiss ratings to check the stability of your bank. Subprime lenders who hold their mortgages inhouse, will go under. I’m taking my money out of World Savings Bank when my 4 month CD expires, because they have a B rating now, but very low liquidity and too many RE loans. There’s a reason they pay the highest CD rate in the country. They desperately need the money, and not only to fund more loans. I am suspicious of their ability to keep up with their payments. I took the bait for 4 months, but then I’m out.

Remember the S&L crisis? This will be much worse. It’s interesting, the CEO of Fannie Mae keeps talking about the oncoming glut of foreclosures, as people won’t be able to make payments when their ARMs adjust. Why is he so honest? What is his motive?

Anyway, pension funds, insurance companies, mutual funds, hedge funds, etc. are going to be in big trouble and I think they could go under. Make sure your money market doesn’t hold any GSE bonds. I sold my Fannie Mae stock in spring 04, when I started reading about their accounting scandals. At that time it was $75. I don’t understand why it wasn’t dumped by everyone. It’s now around $55, and probably overpriced.

Jim, I wish I understood this MBS stuff better. It’s a fascinating topic, but way over my head. But the risk of defaulting mortgage borrowers has been spread all over the world, and with the biggest housing bubble in history, and about 45% of all loans in the US last year with no downpayment, even I can tell the fallout will be huge.

By the way, we built our house very cheap, between October 2004 and September 2006, and it cost $140/sq ft, which included $50K paid to the builder, and excludes land costs. We paid the invoices ourselves, to the subs. We used small companies too small to have much overhead, i.e. without marketing and HR departments, and some illegals, and that kept the cost down a lot. My custom stained alder cabinets were $20K, half the price of Home Depot’s. The only way to build cheaper is to do it yourself. How can you build for $90/sq ft?

[Anonymous]

One of the most interesting topics, actually is how the “bubble popping” scenario will unfold. Will it end with a “bang” or a “whimper?” Reality, always intervenes.

Let me preface to say I am NOT a realtor. I have personally owned and leased both residential and commercial property, however. My professional livelihood does not depend on the real estate market. Of course, if you live and work in San Diego, you can make the case that EVERYONE indirectly is affected by thr local real estate market.

Back to my point. We will most likely have a mixed bag, when it comes to the eventually fall-out. High expectations in any investment always end badly. We know, if you are involved in the business community, and keep you ear to the ground, that the moving companies are having to deal with a plethora of one way rentals OUT of San Diego County. We also know that in the counties in SoCal who report it (Orange County, for one) that property tax delinquencies are increasing. Now, SD real estate bulls can spout all they want about the nice weather and “they aint making any more land,” but the common denominator in any investment trend is “everything has its price.” Realtors, often are terrific qualitatively in critiquing properties, and even comparatively. Some, (ususually commercial prop specialists) are even good quantitatively. However, this is limited to the micro scale. The key items that this site seems to hit on are the strengthenings gale forces that are building up on the MACRO scale.

A billiard ball eventually travels in the direction that is a result of the forces acting upon it. So it is with markets.

Real estate relies heavily on debt financing. Certainly more heavily than any other investment category. Speculators are fools to ignore this important concept. Things like the level and TREND of interest rates, the availability of money, tax concerns, ability to service/retire the financing are key pieces of the puzzle as to what’s gonna happen. It is bordering on malpractice for realtors not to discuss this integral part of the picture to people when opining on the real estate outlook.

So, if you are looking at the “quality” (desireability) San Diego, don’t overlook the “quantity” (of money avialable to afford current prices.) If you are looking at the “quantity” of current buyers still coming into the market, don’t overlook the “quality” of these buyers, in that the “stupid” money is now streaming in. Likely the “smart money” is exiting. We saw this first in the commerical properties. The largest commercial prop families have sold out, unlosding onto the “dumb money” of the pension plans. Now the savvy residential buyers are taking chips off the table (most likely selling to the attendees of the real estate investment seminars. Who really cares that there are still buyers out there if they are the last lemmings sucked into the real estate hype?

We also know that, in a form of Darwinian economics, that they will not be long term investors, as in a downturn, they will be wiped out. We already know, in the last cycle, the largest source of bankruptcies in CA was from real estate. Isn’t it the number of long term investors that can hang in there, that helps mitigate a decline? Not a comforting thought.

We’ve seen this all before, in previous booms.

This isn’t an academic exercise. The reason you need to worry about the “stupid money” is that is is inexperienced and often — LEVERAGED. This, folks, means fire sale, and, as pointed out on this site — high likehood of widespread foreclosure.

Unless real estate appraisal magically departs from the concept of comparative pricing, the foreclosures will drag the prices. Again, a quantitative thing. So, the numbers start to bite you. And unless banks decide to get into the property management business, count on them to liquidate foreclosures as soon as they get them. They will be priced to move.

Ah, but there is a “qualitative” thing that adds insult to injury. That terrific house/condo you painstaking picked and/or remodeled to be so good should surely sell well. Hate to break this news to you. In a post- peak real estate sell-off, many properties that were witheld from the market for years are suddenly put on the market. Did you consider this? How well is your place going to comparatively “show” when several super properties, that were never on the market suddenly come up for sale? It adds insult to injury. But, again, typical in a post bubble world.

“Well, it always comes back.” Oh really? To this, I relate the story of the condo I had a chance to buy in 1998 from a seller who bought it in 1988. After 10 years, he was breaking even. And the prop taxes + HOA expenses swallowed most of his tax benefit over the decade.

Owing to the economic ripple effect, can you afford to say in San Diego in a post bubble economy? Many businesses that prospered in an easy money economy will suffer in a decline; restaurants, retail, services, etc. Will you still be working full time living here? Will your business still want to be located here?

It would be naiive to think that other lovely neighborhood communities are not being built elsewhere, and many so-so ones are not being improved.

The greater the bubble distorts, the longer may have to be the holding period if you want to hold through a downturn. This is part of the risk.

You want to make a lot of money and avoid losing a lot of money, you need to understand the concept of assymetrical risk. Simply put, the downside could be a lot worse than the upside. Since the problems created in the local economy by the real estate boom grow to be more systemic, the downside could particularly bite. This concept is particularly poignant to San Diego. Why? Well, for the simple fact that the biggest industry in San Diego is not tourism, not Defense. Biotech? Guess again. The biggest industry in San Diego is real estate. Pause, sip a cool drink and ponder this for a moment. So if the market tanks we are not only going to have “shock and awe” but we will have considerable “collateral damage” to the local economy. This hinders the qualified buyers who would naturally come in to naturally stabilize a decline.

Case in point, escrow company in my office building is leaving. Are they folding? No — but they are pulling in their horns and consolidating their local offices. So this building loses 33% of its sq ft occupancy. Some employees were shed. I seriously doubt they will be buying homes.

As businesses completely leave SD, there is less wage base to pay the current prices, unless these businesses are replaced by others. Is that happening? Sure. The “creativeness” of the RE financing is the barometer of that. Still not convinced? Chat with U-Haul.

The epitaph of this real estate boom will be written thus: “Interest rates were their lowest in four decades, yet nobody questioned why buyers had to resort to all sorts of creative financing and interest-only loans to buy properties at these lofty prices.”

If the U.S. dollar slips, compared to the rest of the world’s currencies, we may get int’l buyers. SD market is a prime one to benefit from this. However, it will only benefit certain kinds of properties. My first impression is downtown. However, for reasons given in parts of this website, the DT inventory overhang will first have to be dealt with.

There is a saying that, in a stiff breeze, even the turkeys can fly. And another, you know the weather is REALLY bad when even the ducks are walking. Well, maybe in San Diego the ducks are the third generation Portuguese. They never sell anything. So whenever they start to sell, watch out. (Not clear if they are selling, yet.)

I may have more to say on this, but time is money, it will have to be continued.

[powayseller]

Yes, San Diego’s economy is based on us selling homes to each other. I checked the hiring data in January, and it was a wake-up call. Manufacturing is down, and hiring is basically in all things RE: construction, realtors, mortgage officers, service sector which caters to homeowners who have taken out home equity lines of credit (furniture, home improvement, clothing stores, car dealers, vacation sellers, restaurants).

I have a concern about local banks. Are they strong enough to weather a portfolio loss when their mortgages aren’t paid, their Fannie Mae bonds don’t pay out, etc. I thought my credit union would be immune, but today I found out they hold their mortgage loans in-house. Great, I want my bank to be holding mortgages on overvalued real estate. I cashed out by selling my overvalued house, but my bank is still busy making loans. I don’t even have a finance degree, but if I were in charge at the credit union, I would put an immediate stop to mortgage lending and sell the portfolio to another sucker. Even the banks are idiots. No one knows when to get out.

This morning I spoke w/ an attorney, who had an auction business in the 1980’s, auctioning houses. He thinks RE is still a good buy because the interest rates are so low. He said in the late 80’s it was the high interest rates (16% prime, I think) that caused foreclosures. So he believes it cannot happen now. I tried briefly to tell him about adjusting ARMs, but he kept cutting me off, so I dropped it. There are too many fools still out there.

I like your ideas, please write more.

[NotARocketScientist]

Powayseller,

Thanks for the hot tip about Weiss. From your research can you give us any hints about what SoCal banks and S&Ls are *more* secure?

I am heavily tied up in Fremont S&L cds right now. Should I be worried? Also curious where IndiMac and Ing stand.

Bottom line: where would you park your money right now? As always, I much appreciation for your great posts!

[NotARocketScientist]

“As always, I much appreciation for your great posts!”

Huh? I wrote that? Sorry, long week been it has!

[powayseller]

Weiss Ratings Inc. charges $14.99 for each report, and I ordered only the World Savings report. They don’t publish free reports, but give a short list of the best and worst banks and thrifts. They don’t rate credit unions.

Perhaps some of the bankers who come here can advise us where to find this information free of charge, or which banks are conservative lenders.

I want a bank which can weather a loss in its mortgage portfolio, so that means a small percentage of assets in mortgages, and that is not heavily invested in the bonds of the government sponsored enterprises, because they are at high systemic risk of default if housing values plummet. However, the money in the banks is FDIC insured, so even if they go under, there is only the inconvenience of having to wait for the government to reimburse you.

I’ve read of others who advise holding most of their assets in gold, either through stocks or in physical possession, but I’ve not been able to persuade myself of how useful that would be. If the economy collapses, can I pay for rent and groceries with gold bullion? And if things get that bad, would people even go to work and make sure we have our utilities, gas, and grocery services? It’s all too bizarre. And how could I be assured that gold won’t sink back to half its value next month (although it could keep going much higher), as it is so speculative and doesn’t seem to be attached to any fundamentals. I’ve not received a single response to any of these questions, so I think the gold bugs are just in love with gold, with its allure and glitter and mystique, but have not thought through what they would actually do with it if their much-awaited economic armageddon came to pass.

Thanks for your kind words. My kids are now really impressed with me.

[NotARocketScientist]

Found an interesting FDIC sponsored site that allows one to generate reports on any FDIC insured institution. You can set a number of the perimeters yourself and call up a staggering amount of information. Problem for me, of course, is parsing out the relevant numbers (assuming they’re there).

http://www2.fdic.gov/idasp/main.asp

If anybody has a knowledge of this sort of stuff and is included to take a look, I’d sure be interested to know if any of the data available are actually useful or just sound and fury signifying nothing.

[Author]

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