Yes, but how fast will prices drop?

[Diego Mamani]

From today’s USA Today cover story about renting vs owing:

Hessam Nadji, a managing director for Marcus & Millichap, an investment brokerage firm: “rents need to go up, and home prices to come down in some areas, for the balance to be regained. And that may be a painful process that takes between a year to 18 months.”

I find the “18 months” remark above very naive. Rents can’t go up much faster than inflation or personal income, but prices won’t drop that fast either. Also, in another thread here someone said he’s considering selling his house in L.A., and then buying again in 6 months. I think there’s widespread confusion about how fast RE prices will drop.

I think that RE will remain overpriced for several years. Unlike the tulip mania, or the recent dot-com bust, where prices dropped like rocks, RE prices will adjust very slowly. In fact, a substantial part of the adjustment will be in real (inflation-adjusted) terms. We do know, however, that condos will drop faster (overshoot on the way down), compared to SFRs.

We’ve seen these drops in prior downturns in California: they always follow a run-up, and they are always slow, in the sense of taking six or more years of small nominal price reductions.

Some have argued that RE prices this time will drop fast because “this time is different”. That’s like realtors last year saying that RE prices won’t drop “because this boom is different”. For SFRs, we are already seeing the classic symptoms of a RE downturn: the number of transactions dries up, stubborn sellers cling to last year’s prices, and buyers prefer to wait.

SFR prices will drop, but don’t expect 25% drops in the next 18 months, especially not in the nicer, more established neighborhoods.

[Bugs]

If the current rate of decline continues I’m betting that by the end of 2007 we will see a few markets where the decline from peak is 25%. We’re already at yr2004 prices in a lot of areas, and they aren’t just the less desirable neighborhoods, either.

The mortgage resets haven’t really even got going yet and there are already some people getting reset right out of their homes. Gas price increases may hurry that along.

[Daniel]

I agree, but many here won’t. I think it will be slow, slow, slow for a long, long time. The pain will be substantial, though, especially for those overstretched in “affordability” products.

[PerryChase]

I beg to disagree Diego. I believe that all new develpment prices will drop 25% within then 18 months. The resale property will follow a little later.

I don’t have rigorous analysis but that’s exactly what happened in 1990. I expect to see a repeat this time around.

[Daniel]

PerryChase,

Did the builders drop prices that fast in the early 90s? I didn’t know that. I too expect the builders to be the first to slash prices (can you say “motivated seller”?), but I have no clue as to how agressive they may get. Anybody else with memories of the 90s downturn?

[PerryChase]

Yes they did. I remember, in 1990, the Pardee development in Sorrento Valley sold starting at $175k for a single story at the low. That area sold, in 1989, in the upper $200k – $350k originally. In Carmel Valley (then called North City West), several developments went bankrupt taking along with them some S&Ls. HomeFed and Imperial Savings were 2 San Diego casualties — along with S&Ls accross the country.

[Bugs]

I remember the 90s vividly. I had a front row seat for it, albeit I was working in the OC at the time. I watched the prices peak in late ’89, watched it plateau for 3 months and then start to decline in early-mid 1990. The media finally figured it out in late 1990, about 6 months after it had already been in motion. Does that lag ring a bell with anyone?

From mid-1990 on it dropped at a pace that was only slightly slower than the run-up that had preceded it.

If we extend the same reverse slope to this run-up the decline would be faster and farther because the run-up was both (much) faster and farther than the run-up in the late ’80s.

I don’t know if the past will repeat this time, but so far it sure looks that way. As far as I can see, 2006 is playing out exactly like 1990.

[HereWeGo]

Perry/Bugs-
Were the conditions the same wrt/ ARM loans, massive speculation, was the glut as great as it appears to be now?

How is 2006 similar to 1990? How is it different?

[PerryChase]

I was one of the fools who bought a house in 1989 so I should know. You live and learn. 🙂

At that time, there were ARMs but I had not heard of interest-only loans and all the other exotics we have today.

Loan officers were affiliated with builders but they did not sit in the sales offices running buyers through various iterations to see what maximum monthly payments they could afford. There were no 1%, 2%, or 3% buydown loans. At that time my loan was 9.5% fixed.

Most people would put down 20% or had to pay PMI. Buyers generally did not do 100% loans nor the 80/20 loans we see today.

Loan equity loans were available. But HELOCs were rare.

Today, the marketing machine is much more effective and buyers are not really aware of what they are getting into. They still think that so long as they can afford the monthly payments, they are “investing” in their future (not throwing money away in rent).

I believe that the exotic loans and payment resets will have the effects today that the mass lay-offs had in 1990.

If we have a recession in 2007 then unemployment and loan resets will be double whammys on the real estate market.

[Bugs]

There were a number of differences in 1989. For one thing, those buyers were’t engaged in what I’d call speculation. There was no real flipping, at least not in the way we saw it this time around. People were mostly paying extra out of fear. I called it “fear-buying” at the time. These buyers were genuinely concerned that if they didn’t buy then they would never get in.

I haven’t seen much comment about this, but one of the factors driving the fear back then was that there was some political acticity on the so-called “slow-growth” initiatives. Rent controls in various cities and counties were being enacted and pressure was being applied to the cities to curtail growth by downzoning densities, increasing fees and the like. People were literally sold on the idea that we were out of buildable land.

We didn’t have people quitting their jobs to dabble in RE flipping, they werent’ exporting their equity to other states, and there was no “property ladder” train of thought. People simply wanted a place to live and were afraid their time was running out. Property investment was mostly about generating positive cash flow through rental income, not about holding for a year and expecting a 30% return from price appreciation.

At least, that’s how I remember it.

[VCJIM]

Bugs, it’s interesting! Your memory and mine exactly coincide! What happened to PMI anyway? Are all these people that didn’t put down 20% paying it? I put down 20% on my first house in 1994, specifically to avoid PMI.

[powayseller]

I also wondered what happened to PMI. We bought in 2000, with 3% down, no PMI. I was surprised we could put so little down, and no PMI. We had a 30 year fixed loan. I was also surprised my in-laws bought their home with a piggback loan, an 80/20 to avoid PMI. I had never heard of such a thing before.

The first time I realized the extent of exotic financing is when I read AnotherF*ckedBorrower.com, now called HousingBubbleCasualty.com, in late fall. Before that, I thought everybody made 3x as much money as we did. Now I know it was due to MEW.

[equalizer]

ps

what kind of loan did you have with no PMI? You had no 2nd mortgage 3/17?

[powayseller]

30 year fixed in 2000. no second, just one loan. I don’t recall why we didn’t have to pay PMI. After rates dropped and we built a new house after the fire, we got another 30 year fixed, but by then we had enough equity that we didn’t need PMI anyway.

[Diego Mamani]

Bugs and Perry, thank you for sharing. I was a college graduate in my early 20s when I moved to the USA (and Calif.) in 1989. In the next few years I met a couple of people who told me how they had made money during the late 80s boom. It was essentially buy (preferably new construction), have the landscaping done, then sell at a profit and use the proceeds to buy an even bigger house. The formula worked well, up to a point of course, when they run out of GFs.

I suspect this time, price drops will be more severe in Midwest areas where job losses are severe. Next, price drops will be relatively fast in certain neighborhoods (in bubbly states) where lots of investors and lots of marginally creditworthy buyers purchased a lot of properties.

For instance, now I’m renting a house in an upscale neighborhood in Westlake Village (on the 101 fwy, right on the Ventura-L.A. county line). Most of my neighbors are owners who purchased brand new back in the late 70s/early 80s, most are retired, and they are not at all concerned with what happens to their property values (they’ve been through many ups and downs over the years, and probably carry very small, if any, mortgages).

It’s areas more like Riverside or San Bernardino, where I expect faster price drops, due to the larger number of marginal borrowers and investors.

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