[davelj]

From the article:

“Buyers needed to earn $82,200 to afford financing $411,170, the price the trade association estimated for an entry-level home during the quarter.”

OK, I realize that southern California is “different” from the mid-sized east coast city that I grew up in, but this seems ridiculous. I don’t even have to run the numbers.

Where I grew up, someone making $82K wouldn’t even dream of paying more than $225K (and I’m being aggressive) for a home. It shows you just how screwed up things are out here. What can I do but laugh?

[davelj]

From the article:

“Buyers needed to earn $82,200 to afford financing $411,170, the price the trade association estimated for an entry-level home during the quarter.”

OK, I realize that southern California is “different” from the mid-sized east coast city that I grew up in, but this seems ridiculous. I don’t even have to run the numbers.

Where I grew up, someone making $82K wouldn’t even dream of paying more than $225K (and I’m being aggressive) for a home. It shows you just how screwed up things are out here. What can I do but laugh?

[davelj]

From the article:

“Buyers needed to earn $82,200 to afford financing $411,170, the price the trade association estimated for an entry-level home during the quarter.”

OK, I realize that southern California is “different” from the mid-sized east coast city that I grew up in, but this seems ridiculous. I don’t even have to run the numbers.

Where I grew up, someone making $82K wouldn’t even dream of paying more than $225K (and I’m being aggressive) for a home. It shows you just how screwed up things are out here. What can I do but laugh?

[davelj]

From the article:

“Buyers needed to earn $82,200 to afford financing $411,170, the price the trade association estimated for an entry-level home during the quarter.”

OK, I realize that southern California is “different” from the mid-sized east coast city that I grew up in, but this seems ridiculous. I don’t even have to run the numbers.

Where I grew up, someone making $82K wouldn’t even dream of paying more than $225K (and I’m being aggressive) for a home. It shows you just how screwed up things are out here. What can I do but laugh?

[davelj]

The 10-year treasury has historically mean reverted to 250 bps real return and about a 300 bps inflation premium. (So, it’s averaged about 5.5% over the last 80 years.) The current on-the-run 10-year TIPS are yielding about 1.50% while the current 10-year nominal yield is about 3.80%. So, the market is pricing in that 10-year treasury buyers will be perfectly happy for the next 10 years with (1) a 1.50% real return, and assuming that (2) inflation will average 2.30% annually over the period. Neither of these seem like particularly good bets. But it could be a while before the prices mean revert.

[davelj]

The 10-year treasury has historically mean reverted to 250 bps real return and about a 300 bps inflation premium. (So, it’s averaged about 5.5% over the last 80 years.) The current on-the-run 10-year TIPS are yielding about 1.50% while the current 10-year nominal yield is about 3.80%. So, the market is pricing in that 10-year treasury buyers will be perfectly happy for the next 10 years with (1) a 1.50% real return, and assuming that (2) inflation will average 2.30% annually over the period. Neither of these seem like particularly good bets. But it could be a while before the prices mean revert.

[davelj]

The 10-year treasury has historically mean reverted to 250 bps real return and about a 300 bps inflation premium. (So, it’s averaged about 5.5% over the last 80 years.) The current on-the-run 10-year TIPS are yielding about 1.50% while the current 10-year nominal yield is about 3.80%. So, the market is pricing in that 10-year treasury buyers will be perfectly happy for the next 10 years with (1) a 1.50% real return, and assuming that (2) inflation will average 2.30% annually over the period. Neither of these seem like particularly good bets. But it could be a while before the prices mean revert.

[davelj]

The 10-year treasury has historically mean reverted to 250 bps real return and about a 300 bps inflation premium. (So, it’s averaged about 5.5% over the last 80 years.) The current on-the-run 10-year TIPS are yielding about 1.50% while the current 10-year nominal yield is about 3.80%. So, the market is pricing in that 10-year treasury buyers will be perfectly happy for the next 10 years with (1) a 1.50% real return, and assuming that (2) inflation will average 2.30% annually over the period. Neither of these seem like particularly good bets. But it could be a while before the prices mean revert.

[davelj]

The 10-year treasury has historically mean reverted to 250 bps real return and about a 300 bps inflation premium. (So, it’s averaged about 5.5% over the last 80 years.) The current on-the-run 10-year TIPS are yielding about 1.50% while the current 10-year nominal yield is about 3.80%. So, the market is pricing in that 10-year treasury buyers will be perfectly happy for the next 10 years with (1) a 1.50% real return, and assuming that (2) inflation will average 2.30% annually over the period. Neither of these seem like particularly good bets. But it could be a while before the prices mean revert.

[davelj]

I basically agree with you Bugs. When I use the term “bifurcation” I use it in the sense that “everything will suffer, but to varying degrees.” Perhaps I wasn’t clear on that point.

To use the residential market as an example, if the median peak-to-trough decline in SD County ends up being 40% – just to pick a number – there will be certain areas (think Chula Vista, Imperial Beach, etc.) that will decline by 50% and other areas (think La Jolla and RSF) that will decline by 20%. We have seen similar outcomes in previous downturns. (“Location, location, location” won’t save anyone from a decline, but it may save a lot of folks from the dramatic declines witnessed in other areas.)

I think we will see something similar on the CRE front going forward. All will suffer, but to dramatically varying degrees. But I could be wrong.

[davelj]

I basically agree with you Bugs. When I use the term “bifurcation” I use it in the sense that “everything will suffer, but to varying degrees.” Perhaps I wasn’t clear on that point.

To use the residential market as an example, if the median peak-to-trough decline in SD County ends up being 40% – just to pick a number – there will be certain areas (think Chula Vista, Imperial Beach, etc.) that will decline by 50% and other areas (think La Jolla and RSF) that will decline by 20%. We have seen similar outcomes in previous downturns. (“Location, location, location” won’t save anyone from a decline, but it may save a lot of folks from the dramatic declines witnessed in other areas.)

I think we will see something similar on the CRE front going forward. All will suffer, but to dramatically varying degrees. But I could be wrong.

[davelj]

I basically agree with you Bugs. When I use the term “bifurcation” I use it in the sense that “everything will suffer, but to varying degrees.” Perhaps I wasn’t clear on that point.

To use the residential market as an example, if the median peak-to-trough decline in SD County ends up being 40% – just to pick a number – there will be certain areas (think Chula Vista, Imperial Beach, etc.) that will decline by 50% and other areas (think La Jolla and RSF) that will decline by 20%. We have seen similar outcomes in previous downturns. (“Location, location, location” won’t save anyone from a decline, but it may save a lot of folks from the dramatic declines witnessed in other areas.)

I think we will see something similar on the CRE front going forward. All will suffer, but to dramatically varying degrees. But I could be wrong.

[davelj]

I basically agree with you Bugs. When I use the term “bifurcation” I use it in the sense that “everything will suffer, but to varying degrees.” Perhaps I wasn’t clear on that point.

To use the residential market as an example, if the median peak-to-trough decline in SD County ends up being 40% – just to pick a number – there will be certain areas (think Chula Vista, Imperial Beach, etc.) that will decline by 50% and other areas (think La Jolla and RSF) that will decline by 20%. We have seen similar outcomes in previous downturns. (“Location, location, location” won’t save anyone from a decline, but it may save a lot of folks from the dramatic declines witnessed in other areas.)

I think we will see something similar on the CRE front going forward. All will suffer, but to dramatically varying degrees. But I could be wrong.

[davelj]

I basically agree with you Bugs. When I use the term “bifurcation” I use it in the sense that “everything will suffer, but to varying degrees.” Perhaps I wasn’t clear on that point.

To use the residential market as an example, if the median peak-to-trough decline in SD County ends up being 40% – just to pick a number – there will be certain areas (think Chula Vista, Imperial Beach, etc.) that will decline by 50% and other areas (think La Jolla and RSF) that will decline by 20%. We have seen similar outcomes in previous downturns. (“Location, location, location” won’t save anyone from a decline, but it may save a lot of folks from the dramatic declines witnessed in other areas.)

I think we will see something similar on the CRE front going forward. All will suffer, but to dramatically varying degrees. But I could be wrong.

[davelj]

A few comments and observations on CRE…

I was at a banking conference last week and there were three CEOs from California banks (“community banks” – $800 million to $6 billion in assets) on a panel discussing Southern California CRE credit trends. Here’s a summary of their thoughts and observations:

– We’re in the third or fourth inning of the downside of the (general) credit cycle; it will get meaningfully worse before it gets better.
– Bottom of the cycle/Recovery will be late-2009/early-2010.
– There’s a notable bifurcation in the CRE market. In general, properties closer to the coast (10 miles) and/or surrounded by “established” neighborhoods are doing pretty well, although problems are expected to crop up. Properties further from the coast – Inland Empire, Murietta, Temecula, East SD County, East Chula Vista, etc. – are struggling and it will get much worse; it will be like the early-90s in these areas.
– CRE in the coastal/established areas will have problems but not as bad as the early-90s due to: (1) A more diversified economy – that is, we won’t have the same proportion of people simply leaving the state as when the defense industry left the state in the early-90s, and (2) Less overbuilding this time around – the early-90s CRE meltdown was exacerbated by dramatic overbuilt conditions throughout SoCal.
– The CRE-oriented REITS with lots of exposure to Class A office towers in Orange County will have big problems as this market is in shambles due to all the high-end mortgage broker-related space available.

These three bankers were all operating their banks during the early-90s and survived without needing to be recapitalized. They are generally thought of as relatively conservative underwriters.

Now, there is a distinction that needs to be made between existing CRE and CRE that’s under construction or recently completed and not leased up. Probably anything that’s under construction or recently completed (and not leased up) is a bad deal for the bank, almost regardless of its location.

The main thing that separates CRE from SFR is that, ultimately, there’s gotta be a debt coverage ratio when the loan is underwritten, generally between 1.1x and 1.2x (now it’s almost exclusively 1.2x because banks are tightening up on underwriting). And the minimum LTV has generally been 85%, even during the boom times, although cap rates have been very (re: too) low. BUT, the debt coverage ratio puts a cap on how much the bank is willing to lend regardless of what value gets generated from the cap rate. So, things got crazy in CRE, but not nearly as crazy as SFR, because there is real income involved (although it will certainly decline for the next few years) and there is real equity involved (again, this too will almost certainly decline in aggregate).

So, my guess is that we’ll see the coastal/established properties, in aggregate, lose some tenants and have to re-lease at lower rates, plus cap rates will inch up and net/net many of these properties will be underwater for a couple of years, but not REALLY underwater. Most will continue to make their interest payments, some loans will need to get restructured (with attendant losses for the banks) and some will get foreclosed, with larger losses for the banks. But – and I could be wrong – while I see impending pain and discomfort, I don’t foresee a total disaster in this property type.

But the stuff in the Inland Empire, East County, etc… that will be a bloodbath largely because the customers (the people who are in foreclosure and/or never moved into their homes) simply aren’t there to support the businesses.

What are your thoughts on some of this Bugs?

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