Is a property market crash truly imminent ?

[lewman]

It is perhaps not a wise thing to buy now if you haven’t. But for exisitng homeowners who think that they could sell the house, rent for a few years, then return to the market to bottom fish in a few years and save a bundle it gets more complicated. Once agent commission, closing costs, loss in tax deductions, capital gains taxes, likely higher mortgage rates in the future, potential reduction in personal income etc. are taken into account, I’m afraid the strategy would work only if the differential is sizable enough.

According to OFHEO data, San Diego property prices more than doubled in the short space of 4 years from 1976 to 79. Then rather than dropping, it continued to edge up with low single digit increases until 1986 / 87, then double digit annual increases resumed until 1990.

Are there any student of history out there who can help point out what is different this time that make us think there is a slim chance that going forward property prices (I am talking about nominal prices) could not just be range bound for the next few years ? And what were the factors that caused prices to stay relatively strong during the early 80s ? Could those factors exist today and in the next few years that could lend support to the market ? I was given “rampant inflation” as the reason and if so, history could repeat itself if you believe the recent run in commodity prices is a prelude for the return of the 1970-style inflation.

Note from peak of 1990 to the trough around 95/96, the average price decline in SD was only in the teens. If history were to repeat itself, unless the timing is immaculate, homeowners may be better off sitting through it.

[powayseller]

I took the strategy of selling, renting, and will bottom fish. Agent commission of 4% plus $2K moving costs each way is minor compared to the money I took off the table. Earning 5% interest on the profits vs. losing 15% annually on the $800K house! As far as tax deduction, this has been covered before: you’re basically deducting part of the interest. Well, I DON’T pay interest now. No capital gains taxes on the first $500K profit (eliminated in late 90s). I also don’t have property taxes, no home improvement/repair/maintenance. My financial situation has greatly appreciated since I sold my house.

It’s questionable whether commodity prices will stay high. I read Steven Roach’s report today, and he makes good points about the parabolic rise in commodities showing another asset bubble. People are buying on specualation of further increases. Prices have risen much faster than actual demand for the commodities. There’s always a “it’s different this time” story. The commodity different this time story is China. China will not create enough demand to make today’s commodity prices stick. Despite high inflation, wages have been flat for at least 5 years, and will continue to be flat due to the global low wage market in which we compete.

As far as why this time the drop will be greater: the imbalance is much greater between incomes and housing prices, 80% of San Diegans who purchased in the last 2 years will face foreclosure bec. they got ARMs, most SD job growth is RE dependent and we will see huge job losses as RE unravels, banks will fail as foreclosures rise, and if you need to quickly move because you lost your job in the RE bust you’ve got more flexibility if you’re not tied down to a house. MEW was 90% of GDP. Without it, GDP would be less than 1%, and that’s what you’ll see next year when MEW stops.

Rich is not recommending that people sell their homes. He never has. But I’ve said it all along. I highly recommend that everyone sell their home and rent until they can bottom fish. Check with your accountant first to make sure there aren’t any unusual circumstances for you. For most people, this is a prudent financial move. Let the landlord carry the loss for you.

We are hoping to afford a house near the coast when this is all said and done. We’ll pay $800K for today’s $1.5 – $2.0 million house. And we’ll do it with a 15 yr fixed mortgage.

In investing, patience and discipline are key.

[Steve Beebo]

Powayseller – Selling and renting may turn out to work for you, but I’ve got to question some of the statements you made:

“80% of San Diegans who purchased in the last 2 years will face foreclosure bec. they got ARMs” Just because someone got an ARM in the last two years doesn’t mean they’re facing foreclosure. A lot of wealthy or well-qualified borrowers used ARMS in the last several years. My current loan is a 10 year fixed, interest-only. I qualified for a 30 year fixed, but I prefer this loan. I can pay a larger amount every month if I want to, and my next months’ payment goes down.

“banks will fail as foreclosures rise” Foreclosures are definitely on the rise, but there have been basically no foreclosures in San Diego from 2002 to 2004, so banks which hold portfolio loans, (which are not that many), can handle a huge increase in foreclosures without failing.

“We’ll pay $800K for today’s $1.5 – $2.0 million house” Very few experts are predicting that prices will drop 50-60%. I’ve been an appraiser for nearly 20 years, and if I thought prices were going to drop 50%, I would sell and rent, too, but I don’t think it will happen. My guess, (just a guess), is that prices will drop 15-25% over the next four years, and then stay relatively flat for another four years.

[4plexowner]

Don’t overlook that Mr. Roach excluded the precious metals from his “bubble” comments.

The precious metals are rising because of the commodities bull market AND monetary concerns.

Even if the commodities bull dies today (which would be about 7 years too early based on the last 5 commodity bull markets), the precious metals will continue to rise because of monetary issues.

[powayseller]

You’re right, PM are in a different category, and have to do with the falling dollar, not demand from China. I should have clarified. Thanks for doing so.

[powayseller]

Prices already dropped 5% in many SD areas, and we’re just coming off the top. We have to agree to disagree on the depth of the price drop. I put my money on my beliefs, you put your money on yours. Only time will tell… Steve, were you an appraiser in the 90’s? Privatebanker posted that he worked in an REO department for a major bank in SD, and they were selling homes for 20% of previous prices. Some homes got that cheap.

As far as listening to the experts, that hasn’t got me very far. As I posted earlier today, Dean Baker wrote to me about the poor track record of economists. In 2/01, the 50 top economists wrote their predictions in the Blue Chip report. Although the stock market was already unraveling, not one of them predicted a recession. The lowest GDP projected for 2001 was 2.4%. Neither economists nor Wall Street financial advisors recommended that I flip RE or buy PMs. So now I get my financial ideas from reading piggington, Calculated Risk, GlobalEconomicAnalysis, TheMessThatGreenspanMade, OfTwoMinds, iTulip, and IAmAFuturesTrader. I subscribe to Zeal and Yamamoto Forecast, and may join Iacono and Chris J’s services. I am sorely disappointed in the quality of economic forecasts!

S&L: I remember the S&L bailout, and the LTCM hedge fund bailout. More to come! What you saw before will be peanuts compared to what we’ll see in 2010 and 2011. Banks have failed before. Now, with lending standards lowered to the point that we have increased homeownership rates from a stable historical rate of 65% to 69%, and the credit quality has gone way down as investors chased the higher yields of the most risky products, the foreclosure risk has intensified. Main culprit: staggering of risky products: no doc, stated income, 0% down, adjustable rate, negative amortization. The main problem is the layering of these products. 100% financing is risky, no documentation of income is risky, but giving someone a no doc 100% loan is more than 2x as risky. I’ve written about this before.

Re: quality of SD loans. You have a IO loan. I don’t want to pick on you, but let’s examine the typical reason that you, or anyone got a loan like that. The buyer qualifies for a 30 yr loan on a $800K house, but wants the $1.5mil house. He opts for the IO loan to get a house more expensive than he could get with a 15 yr or 30 yr fixed loan.

Further, he gets the house based on the highest payment for which he qualifies, typically a 35%-40% DTI. So now you’ve got a 40% DTI IO loan. The buyer is not paying down any principal, so basically he’s renting the house from the bank, and getting equity only if the house keeps appreciating. Today this homeowner is losing equity on a house he’s renting from the bank.

So we’ve got a borrower who stretched to get a house he couldn’t afford with a fixed rate product. When the market cools, he’s underwater on the mortgage. If his job is RE related, his risk of job loss is high, and he can be foreclosed on. When his IO period ends, or his interest rate adjusts, how will he make his payment. Steve, you said your loan is IO for 10 years. I am guessing that the higher interest is being tacked onto the principal. The most popular product was the 1/1, 2/1, 3/1, or 5/1 ARM. $2 trillion of ARMs are adjusting nationwide next year. The adjustment will be 10%-50% higher! Since people are already maxed on the payment, how will they handle the higher payment? Add rising gas cost, doubled credit card minimums….Perhaps you are safe for 10 years, but most people are not. Every day, newspapers across the country report on people losing their homes to foreclosure because their ARM did what its name tells you it’s going to do: adjust.

This trend will really pick up in SD this year, and grow as a problem in 2007, 2008, and peak in 2009. This puts distressed property on the market.

Please let me know if you would like links to these stories. I can dig up data for everything I have written. For example, Christopher Cagan of First American Real Estate Solutions said 29% of people who got a mortgage in 2005 have 0% or negative equity in their homes. Douglas Duncan, chief economist with Mortgage Bankers Association said 35% of loans since 003 are not a traditional 30 yr fixed, and the March delinquency rate was 4.7%. ABC News reports foreclosure rates are up because people stretched into homes with ARMs and IOs, relaxed lending standards, 0 or no equity, and people’s reliance on equity buildup through price appreciation rather than through paying down principal. You fit into this last category. Reliance on price appreciation as a way to cover debt loans cannot continue, per ABC News. In Denver, thousands of ARMS were obtained 3 years ago, and will cause tens of millions of dollars in extra mortgage payments and drive up foreclosures. In 2005, there were 14,000 foreclosures in Denver, and this is not due to any recent job loss. Foreclosures are rising in Columbus and Georgia due to these loans. It’s really a nationwide problem.

American Real Estate Solutions estimates that 1/8 of pepole who took out ARMs, 1 million people, are expected to default on their loans.

An LA/Bloomberg poll found that in March, 26% of ARM holders were worried about making mortgage payments if interest rates go up.

Anyone with an ARM needs to make sure they can handle their mortgage payment when the interest rate to to which their loan is pegged rises to 6%. That would be probably a 9% interest rate. If they can’t, they should get a fixed rate loan or sell their house. The only other option is foreclosure, and that’s the path most will take, bec. they cannot afford their current home with a 30 yr fixed. If they could, that’s the product they would have obtained.

And to prove my point, ask yourself how many times in the life of your IO loan, you made more than that minimum interest payment. Ask yourself if you’re banking on appreciation to pay off your house, if you can make the payments if you had to switch to a 30 yr fixed….Most people cannot. And that’s the problem.

[4plexowner]

In a falling market, powayseller and I are better off expecting a 40-60% decline EVEN IF IT DOESN’T HAPPEN.

With our expectations, we won’t be ‘catching a falling knife’ at the 15-20% correction level if the market continues down.

If we are wrong and the market only corrects 15-20%, the signs of a bottom will become obvious over the 6 – 18 months following that bottom.

So we miss 6 – 18 months of appreciation before buying. How much appreciation are we going to miss in the first 6 to 18 months coming off a significant correction? (not much – look at previous downturns – they aren’t ‘V’ shaped bottoms)

And, as powayseller points out, this correction has barely started and prices are down 5% (quoting powayseller) and 8.8% (quoting Will Careless) already. I think the bottom is a long way down from here – not just another 7-10%.

Summary of current market: record number (or close to) of listings available, rising interest rates, LOTS of media attention given to real estate market softness / decline, out of spring and into slow season for sales, hugely over-build condo market with additional units still be built, etc.

Not my idea of a market that is within 7-10% of a bottom but I’ve been wrong before.

[Steve Beebo]

Powayseller –

I agree with a lot you have said, I just don’t think prices will drop 50-60% from the top of the market. I have been appraising in San Diego County since 1987. In the early to mid 90’s I literally did hundreds of appraisals on REO properties, right after banks took possession of them. So I don’t know exactly what they ended up selling for, but I doubt if many sold at 20 cents on the dollar. I know that some sold at huge discounts in bulk sales by lenders.

I agree with you that 100% financing combined with Neg. Am. loans are a recipe for disaster. I’m anticipating a large number of foreclosures in the next several years also. My point was that not a large numbers of borrowers with ARMs will have their properties foreclosed on. A 12% foreclosure rate, or 1 out of 8 seems quite high to me. My wife and I sold a home this past winter, and downsized quite a bit on a new home. We could have paid cash, but got a 10 year IO loan. We qualified for a 30 year loan on a 800k house, but we still bought just the 800k house.

[powayseller]

My reason for 50% price drop is the the chart on the piggington Bubble Primer, titled Per Capita Income/Median Price. Where would you pencil in the line from today to 2012?

A 12% foreclosure rate is high. Is it possible? Yes. In recent financial history, except for the Great Depression, we have not had the magnitude of this speculation and excess in lending. The global liquidity bubble and investor demand for high yields created risky loan products. Without the risky loans, prices could not have become so imbalanced. If prices had gone up with people getting 30 yr mortgages, and if wages had kept pace, the current housing prices would be sustainable.

I would like to compliment you on carrying on a debate in a gentlemanly manner. You are setting a good examaple in this regard, and it just goes to show, you can disagree with someone’s ideas, debate their points, and have fun doing it because you are nice about it. I do appreciate your style.

[dukes]

powayseller: Thanks for taking the time to respond to Steve. I must admit that I agree with every single point that you made.

Trends end, manias end, real estate prices have been rising for so long it has become a true crutch for the American public to think that it can never go down. That real estate is a no brainer investment. These are the times to avoid ANY asset class that garners that type of reputation.

P.S. You might want to subscribe to Bill Fleckenstein: http://www.fleckensteincapital.com/index.aspx it is the best $100 a year someone can spend to learn from a guy who has been around the investment block many times. He is rational, smart and honest. I have been reading him for years, have profited greatly and would recommend him to anyone.

[powayseller]

Will do. I’ve enjoyed reading his posts on MSN, and agree with everything he says. Now I’m up to 5 subscriptions – I might get dizzy.

[lewman]

Thanks rich for the info. I definitely didn’t mean to suggest you were trying to persuade people to sell and rent. It was actually my own situation and I ask myself the question by “thinking out loud”.

I guess the keys are wage growth (or the lack of it in the foreseeable future) and exotic mortgage resets (expected rate increases).

Just out of curiosity, property prices skyrocketed in the late 70s while rates also soared until 1982. What were the causes that drove prices that high ? Was it due to true economic growth (i.e. everybody actually got richer in reality) ?

And I wasn’t aware of capital gains law change. Powayseller thanks.

[lendingbubblecontinues]

Please help me to understand why prices won’t drop 50-60% from the top of the market. If I “zillow” most any property in San Diego county, it was worth only HALF of where we are today within the last 5 years. Homes we have been looking at, for instance, in the Poway school district that sold for 900K in 2005 were selling for 450K in 2001.

If you can convince me why a retracement of only 15-25% is in order (effectively rolling back the clocks by only a year or so’s appreciation in this near decade long bull run) instead of a return to at least 2003’s prices, I’d highly appreciate it.

I’m going to be hard to convince, though, because I have lived through enough “it’s different this time” scenarios to know that IT ISN’T DIFFERENT THIS TIME. So sorry to see that you’re on the hook for at least a 320K paper loss (-40%) and more likely 400K to 450K of loss in the coming return to a TRUE “normal” market.

[Anonymous]

Just one comment on the metals, then I will drop this. I reviewed my research on Gold this weekend just to be sure before posting this.

There is not a historical relationship of any significance between gold and the US dollar in terms of causation of price movement. Gold may go up, but if it does it will not be due directly to a dropping US dollar.

For such a relationship to have meaning, it must be consistent over time. This relationship is essentially a flip of a coin with all the testing I have done with it.

What does this mean? Only, do not bet your life’s savings on Gold rising just because you think the US Dollar is going to drop.

[sdrealtor]

PS,
I as well as most others on this board are anxiously awaiting your report on the Anderson Forecast. I know you were very excited about going but you have been rather quiet on the topic. Can you share your secrets and let us in on what they had to say? They seemed to do a 180 turn from what they were saying only a month or two ago. Was this media spin or did they really predict something else?

[Author]

Posts