In the era of 100% financing, speculation was widespread. Why not, speculators had nothing to lose other than their credit score, and if prices had gone up, they would have reaped a huge windfall. We have documented case after case of this behavior right here on this blog. Are we flagellating the equine after it has already perished? Perhaps, but until this behavior is seen for what it was, lenders will not learn their lessons, and they will do it all over again. Realistically, the only thing that could save housing prices would be a return of 100% financing and the elimination of lending standards like we saw during the bubble. There is only one problem with that: people cannot afford the payments — They have proven that much. The continued use of 100% financing through 2007 was the only thing delaying the crash. Now that the FED is lowering interest rates, they are hoping this will translate into lower borrowing costs and help knife-catchers finance the huge sums necessary to afford today’s pricing and slow the decent of prices. There is only one problem with that: as the FED lowers interest rates it increases inflation expectations, and mortgage interest rates go up. Hmmm… It is really quite a quandary.
The low interest rates we are experiencing now may prompt a few sales in 2008, but the FED will not be able to keep interest rates low for long or inflation will get out of control (anyone remember the 1970s?) If the FED starts raising interest rates later this year to curb inflation, mortgage interest rates will again rise — not because of inflation expectations but because base rates will have increased. Mortgage interest rates hit the floor in 2004. The Federal Funds rate was 1%, inflation was low, and risk premiums were artificially low because investors in mortgage backed securities did not recognize the risks. 5.8% is as low as interest rates on a 30-year fixed-rate mortgage can get. Higher inflation and more rational risk premiums will prevent interest rates from getting that low again. It seems very unlikely mortgage interest rates can get any lower than 5.8%. We will not see 4% mortgage rates to prop up prices.
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Have you noticed when the real estate market bulls are proven wrong, there is always some unforeseen outside factor to blame? David Lereah had the nerve to claim nobody saw the subprime crisis coming despite the fact warnings about subprime lending were widely known and reported. Remember that you read this here: Mortgage interest rates are going to rise. You will probably not see mortgage interest rates on 30 year fixed rate mortgage below 6% again in your lifetime. Sometime in late 2008 or early 2009, the federal reserve will start raising interest rates, and mortgage rates will rise with them. This will be blamed for the big drop in prices and it will be held up as the reason for the faulty forecasts of bullish realtors. If it wasn’t for the FED, trees really would grow to the sky, right?
One of the primary functions of the FED is to provide a stable financial system. Once the Federal Reserve begins to see economic growth and liquidity in the debt markets, interest rates may rise as quickly as they fell in order to stop hyperinflation from occurring. The FED does not want to see its member banks receive worthless currency in return for the loans it made; although I suppose this is better than receiving even less currency in a default.
Mortgage Interest Rates 1972-2006
When a country knowingly devalues its currency, it causes a severe recession as the prices of imported goods and raw materials increases dramatically. Perhaps a severe recession and price inflation is preferable to an economic depression like the one of the 1930s in America, but it is certainly not desirable. There will be some benefits to a devalued currency. A less valuable currency is a boon to exporters. The United States has run a chronic trade deficit for many years, and much of the recent deficit has come from inexpensive goods imported from China. The trade imbalance may correct itself with currency devaluation. Of course, this rebalancing of trade will come at the cost of more expensive imported foreign goods and a commensurate decline in spending power from US consumers. Also, prior to currency devaluation, wages in the United States were so high that jobs were being outsourced to foreign countries where people can be paid much less. Wages could not rise significantly from where they were without devaluing the dollar to prevent wage arbitrage from moving jobs overseas. The devalued currency provided some room for wage increases, and these wage increases could theoretically provide additional support for housing prices. If the FED does chose hyperinflation, there needs to be wage inflation to go along with it or the economy will experience a very deep recession due to the steep drop in consumer spending (It may anyway.) If wages rise, houses become affordable again. I wouldn’t mind paying today’s prices if my salary doubles.
Put today’s problems in perspective: the Federal Reserve is being forced to chose between stagflation and depression, house prices are crashing, and homeowners are being foreclosed on in record numbers. This situation is the result of declining home prices; the declining home prices are a direct result of the unsustainable price levels created during the bubble rally; the unsustainable price levels were created by widespread use of 100% financing and the elimination of lending standards, so this is important stuff worthy of daily exposure on blogs like this one. In today’s 24 hour news cycle, it is easy to focus on the sensational and forget about the root causes of our problems. The roots are here in properties like this one and in borrowers like this one who used 100% financing to speculate in the real estate market at the expense of our banking system.
Asking Price: $590,000
Income Requirement: $147,500
Downpayment Needed: $118,000
Monthly Equity Burn: $4,916
Purchase Price: $762,000
Purchase Date: 4/12/2007
Address: 3691 Scottsdale, Irvine, CA 92606
| Beds: | 6 |
| Baths: | 3 |
| Sq. Ft.: | 2,451 |
| $/Sq. Ft.: | $241 |
| Lot Size: | 5,375 Sq. Ft. |
| Type: | Single Family Residence |
| Style: | Traditional |
| Year Built: | 1973 |
| Stories: | Two Levels |
| View(s): | Park or Green Belt |
| Area: | Walnut |
| County: | Orange |
| MLS#: | S524214 |
| Status: | Active |
| On Redfin: | 12 days |
6 bedrooms total – 4 bedrooms upstairs, 2 bedrooms, 2 dens downstairs, with 2.75 baths. Wood flooring downstairs. Remodeled kitchen with double ovens, flat top cooking surface, large pantry & newer cabinets. Leaded glass front doors, plantation shutters, newer central A/C, newer tile roof, 8 ceiling fans and recently painted in & out. Large backyard. Close to park and community pool.
$241 / SF is real progress.
The price will have to be reduced for the cost or repainting. The pink and green colors are truly ugly.
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This property was purchased less than one year ago, and if the short sale is approved, and if the seller gets their asking price, the lender (NBGI Inc.) stands to lose $207,400 after a 6% commission. There have been some comments on my equity burn calculation where I take 10% of the purchase price and divide it by 12 to get a monthly equity loss on the property. How much was this lender’s equity burn? $17,283 per month. If this flipper had any of his money in the deal, that would have been his loss, but since it was the lender…
Anyone looking to buy in today’s market really should pay attention to the equity burn number. In today’s market, borrowers have to put money down. It is their money evaporating into the ethers. The phenomenon is real, and it will continue for the foreseeable future.
It is a good time to be a renter.
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Tonights the night well make history, honey, you and i
And Ill take any risk to tie back the hands of time
And stay with you here tonight
I know you feel these are the worst of times
I do believe its true
When people lock their doors and hide inside
Rumor has it its the end of paradise
But I know, if the world just passed us by
Baby I know, you wouldnt have to cry
The best of times are when Im alone with you
Some rain some shine, well make this a world for two
Our memories of yesterday will last a lifetime
Well take the best, forget the rest
And someday well find these are the best of times
These are the best of times
The Best of Times — Styx
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Their $762k ($310/sf) purchase price must have looked like a great deal in 2007. After all, today’s Irvine listings mostly are still asking over $350/sf in 2008.
However, 6 bedroom in 2450 sf must make the room on the small side. I’ll pass.
A large family should jump in at around $500-$550k in the current market condition and plan to stay there for at least 15 years.
—–
I’m sure you could knock out a wall and get at least one more large bedroom 🙂 Better subtract that from the purchase price.
I bet you this house will sell in the 650k to 700k. They have over 300+ showing and received multiple offers
I don’t think this is a flipper. No granite. The paint scheme is very personal and not flipper neutral. (Either an AKA alum or a Lily Pulitzer fan)
I also like..the Sythetic Turf ( GREEN! feature)in the backyard and the weeds in the planter boxes. This was someone working lots of jobs to keep up the payments. No time for gardening or mowing.
There is a home in College Park that looks pretty similar (Pine St.). After being on the market for a loooooooong time as a FSBO, it changed to realtors and this past weekend they moved out.
I am not sure how to locate a link for it, but it would be interesting to see if their prices are similar.
The price per square foot is looking much more reasonable for the average move-up family situation.
You guys, we are dealing with a very smart agent here. This is a short sale, meaning they can list the house at any price they want and they don’t have to accept your offer, or the bank doesn’t have to accept your offer. But because it’s listed much lower than other comp, it generated a lot of traffic…….and multiple offers which bid the price up……remember, bidding up the price is nothing new to Irvine since so many of us were around during those time. Just monitor ipoplaya for the next week or so, it will be in escrow for 650-700k.
You guys, we are dealing with a very smart agent here. This is a short sale, meaning they can list the house at any price they want and they don’t have to accept your offer, or the bank doesn’t have to accept your offer. But because it’s listed much lower than other comp, it generated a lot of traffic…….and multiple offers which bid the price up……remember, bidding up the price is nothing new to Irvine since so many of us were around during those time. Just monitor ipoplaya for the next week or so, it will be in escrow for $650-700k.
Any agent thinking they can ignite a bidding war in this market is still living in 2004. The asking price is below comps because that is where the market is. In a declining market the next sale is going to be below comps.
Are you talking about this one?
http://www.redfin.com/stingray/do/printable-listing?listing-id=1419115
It’s more $ and not a nice looking house at all.
They have not even owned the place for one year! They obviously had no business buying a house in the first place.
These morons are the equivalent of stock day-traders. Although, I guess the day trader usually has to lose his own money.
The bubble was well popped when they bought this place but they could not resist the “It’s a great time to buy” mantra.
Great example of what happens when you catch a falling knife.
Are you the very smart agent? How did you know there has been more than 300 showings and multiple offers?
Most short sales do not go through anyway for one reason or another, right?
The smart agent is just waisting time after all.
They called the bottom and expected a return to the good old days within a couple months. Probably figured the person they bought it from was a desperate chicken-little.
They probably started doing a little housing bubble homework after a half a year of steady bad news and realized the game was over and figured there is no point in continuing to make the crushing payments.
650K, That’s rich!
The bank is just stringing the seller along while they finish lining up all their foreclosure ducks.
Anything to keep the seller from defaulting on a monthly payment.
A large family should jump in at around $500-$550k in the current market condition and plan to stay there for at least 15 years.
This house is looking at another 250K to 300K haircut over the next 10 to 15 years. Maybe if you plan on negative equity for a long time, jump in at 550K.
The attorney, now divorced, calculated that the mortgage payments, now $6,200 a month, plus taxes consume 96 percent of his net income, which includes occasional rent from vacationers who use the house. He lives with relatives and sleeps on the floor.
“I don’t regret what I did,” he said. But a foreclosure would hurt his career and finances, he said. “And I was raised to pay back what I borrow.”
Wow it really is different in California.
http://www.iht.com/articles/2008/03/19/business/mortgage.php?ref=patrick.net
Nah, no regrets here. I am just sleeping on the floor eating Top Ramen for dinner every night and slaving away at my Loy-ya job to pay for my depreciating house that I used to fund my failed hotel business. Life couldn’t be any better.
REALTROLL(R)
Go over to calculated risk blog to see what they have to say about the article:
http://calculatedrisk.blogspot.com/2008/03/nyt-journalistic-malpractice-again.html
Interest rates will continue to rise regardless of what the Fed may do. The reason is simple: Mortgage rate = short-term risk free rate of return (ie T-bills) plus (longer term) inflation expectation plus risk premium. Although the Fed can affect the short-term risk free rate of return, there is a strong negative correlation between the Fed rate and inflation expectations. So as the Fed lowers their rate, the inflation portion rises and offsets any benefit. Plus, the risk premium just keeps getting bigger and bigger as defaults rise.
Hence, regardless of what the Fed does to short-term rates, any action will be offset by the increase in the long-term inflation expectation, and rates will rise as the risk premium increases. The Fed can’t save housing by lower short-term rates.
Doubt it. It’s probably fairly priced in the $500,000 – $600,000 range. Maybe a bit lower, but not into the lower $400,000. The problem, of course, is finding a buyer who has $100,000 down payment and the requisite income AND who doesn’t have to try to sell an existing property. I suspect a truly well-qualified buyer could pick this up today in the $550,000 range.
IR,
when I studied economics in college many moons ago our wise professor said there were two kinds of people in this world, those who profess to know where interest rates are heading and everyone else.
Last week I was eating with one of my wife’s very swavy friends and she commented, so do you think it’s time to sell gold, she was worried because it had been bid up so high. I told her I thought gold was going to keep rising (conventional wisdon I thought) but wouldn’t you know it, she was right and gold is down 10% since we talked. Don’t know if she sold or not but she her instincts were right on.
Right now the money would be on interest rates rising again in the mid term but you can get burned on making long term calls.
Alan, your Econ professor was wrong.
There are three types of people in this world: Those that can count, and those that can’t.
The low fed funds is not translating to lower mortgage rates. The fed is “pushing on a string” there… The lower rates are just to un-freeze the credit markets and allow banks to re-liquify i.e., much better net-interest margins. As far as long-term forecasts go for rates, I would suggest that IR is more likely to be right than wrong.
The process of global deflation brought on by cheap goods from China and cheap services from India is rapidly turning. We are likely to be entering a long period of gloabal inflation as we all compete for limited commoditites (oil, agribusiness, metals, corn, etc.). A weak dollar only provides more gas on the fire… Higher long-term rates will likely put significant pressures on housing as far out as we can see…..
Thoughts anyone? What would 8, 9 , 10% rates due to housing prices?
BD
I’d like to see some pictures of the bedrooms…
Using two of the three purchase prices since 1987, pricing at list of $590K equates to May/June 2004 in terms of CS index, value of 199, so list is about right in the current market.
As the average rate of recent sales in all Irvine developments has been in index value of 213, I’d expect this one should sell in the 180-190 index value range as it is an older less premium area.
A sale at $550K would put it back to early 2004 pricing so I think it will get bought at a price around $575Kish. I do agree with AZ it has a ways to fall, but not $250-300K.
The cheapest this place will probably get is around $400K. If you inflation adjust the 1997 purchase price by 3% through 2010, it’s just short of $400K. The ’97 price was actually pretty fair one for the buyer. Similarly inflating the ’91 purchase would yield a value of $450K in 2010…
It would be foolish of any buyer to pay that much given recent comps near this house or in any other Irvine neighborhood.
A bank-owned 2500sf place in College Park recently sold for under $600K. It would be a good comparable to this house…
2200sf places in Harvard Square, next to The Colony but 25 years newer, are selling in the low $700K range, possibly high $600Ks. Foreclosures are ripping through College Park and values are sure to head down quickly as the banks get more aggressive with REO pricing.
Thanks for the reminder. I’ll save this listing for when it does sell.
Many shorts go straight from active to pending sale so the listing disappears off consumer-oriented MLS sites.
I do think this will sell, but not for a price much above $600K unless a seriously stupid buyer is found…
I feel pretty confident about this prediction. The base rate cannot get much lower than the 1% we had in 2004, inflation can’t get much lower than the 2.5% we saw in 2004, and risk premiums, well… we all know what is going to happen to those moving forward.
Think they are all pepto pink or limeade color or a mix of the 2?
(Using a CPI calculator)
What cost $270000 in 1997 would cost $353488.34 in 2007.
Except it is translating to lower interest rates. Right now on Bloomberg a 30-year mortgage is 5.66%. Which is very interesting, considering IR’s claim:
5.8% is as low as interest rates on a 30-year fixed-rate mortgage can get.
Considering the Fed’s policies have lowered mortgage interest rate to below what’s even possible, how can you say they aren’t lowering interest rates?
Be careful AZ, there are more than a few day-traders on this site.
Uh huh. So you think this house will be 120 dollars a square foot.
And what, houses in AZ will be 30 dollars a square foot? (About a 4x premium to live in irvine vs. phoenix) Yeah. Keep wishing buddy.
Yeah, but they have a real smart agent!
Fed Funds can go to Zero (see Japan). Inflation can go NEGATIVE(unlikely but possible), see 1870-1900, as well as 1930-1940 in the U.S.
Risk premiums blew out in 2007 because of three things (1) liquidity, (2) credit problems (3) normalization. The first item will resolve…eventually (see GNMA spreads historically for a measure of the liquidity contribution to spread widening and path to normalization). Credit problems were real, but again they are currently reflective of far higher than historic default rates and lower than historic recovery rates. Though it may be a roller coaster ride, spreads are attractive. The third component will not return to the pre-June-2007 levels. Spreads were simply too-tight for a host of reasons, and that is unlikely to happen again in the near future (how many times do you touch a hot stove?)
Overall, however, spreads are wider than necessary, and I expect spreads to continue to narrow.
I fully expect mortgage rates to continue to trend down to the all time lows, if not lower over the next 12-18 months. I am looking for a 4.75% 30-year fixed conforming/ 5.5% jumbo.
“What cost $270000 in 1997 would cost $353488.34 in 2007.”
Which would make it $397K or so once we average 4% inflation for the next few years… Like I said, $400K or so it about bottom on this property. If it goes down to $300K, it will be a result of over-correction and it will eventually correct back. AZ does do a bit of wishing now and then…
Are people really getting mortgages at 5.66% though?
Can I just say that this mortgage company deserves this. While I can’t say they are selling house because they can’t keep up the payments (as opposed to someone getting transfered out of state) If someone can’t keep the house for a year, they should have never had it at all and they should never had been approved for a loan.
If you pay 400K for this house – you are a sucker.
Waste of $$$$
I can get a conforming 30-year fixed today for 5.75% with no points at the lender I am looking at, so 5.66% is definitely possible…
Don’t worry, 25w100
You are going to be glad that they drop so far when the recession hits, jobs go away, and your local salaries decline to re-align with the rest of the country.
It will be good for everyone. Especially you!
“If you pay 400K for this house – you are a sucker.”
If someone could get this house for $400K, they would be paying less to own it than rent an equivalent. I wouldn’t call them a sucker, I’d call them smart.
Prices will not fall below rent equivalency for a sustained period of time. When investors can make money buying places and renting them, prices have to go up. Money chases returns…
ipop,
It looks like our visions of where the market is ultimately headed are starting to align. I have noticed since you started looking at the Case-Shiller data, you have seen the same things I have concerning the relationship between current pricing and fundamentals. Perhaps you always have seen this, but the estimates you have been providing lately — including the one above — have been right on. Like you, I believe houses similar to this one will bottom at around $425,000. I imagine you could rent it for $2,650 with a GRM of 160.
Fear not – your rent prices are fixing to drop next!
I made a whopping $28 today.
“I am looking for a 4.75% 30-year fixed conforming/ 5.5% jumbo.”
Anything is possible. If that happens, I will prominently and publicly admit I was wrong, and I will reprint your comment as being prescient. If we could bet on this one, I would bet heavily on it…
My salary has nothing to do with location. Half of my career has been work-from-anywhere jobs regardless of location, and the pay is the same if I live in Manhattan or BFE.
The reason a lot of people have higher salaries here is because of the amount of talent. Do you really not believe there is a correlation between population and talent?
How ’bout this, if I can really get houses for 40 a sq ft. in phoenix around 2010, I’ll buy you a nice condo or two.
The impact of changing interest rates:
$244,900 National Median Home Price
$47,423 National Median Income
$3,952 National Monthly Median Income
28.0% Debt-To-Income Ratio
$1,106.54 Monthly Payment
Interest Rate Loan Amount Value Value Change
4.5% $218,387 $272,984 18%
5.0% $206,127 $257,659 12%
5.5% $194,885 $243,606 6%
6.0% $184,561 $230,701 0%
6.4% $177,046 $221,307 -4%
7.0% $166,321 $207,901 -10%
7.5% $158,254 $197,818 -14%
8.0% $150,803 $188,503 -18%
8.5% $143,909 $179,886 -22%
9.0% $137,522 $171,903 -25%
9.5% $131,597 $164,496 -29%
10.0% $126,091 $157,613 -32%
Note: An increase in interest rates will have a strongly negative impact on house prices.
I noticed the Astroturf in the backyard too. Does everyone do that in California? Like on the Brady Bunch? Is fake grass the new Pergo?
425K for an old house with pink and green walls?
You can practically see the glue and paper clips holding this stick-and-stucco box together.
425K?! 425?! Just shy of a half-mill?!
For THAT?
Oxymoron.
25w100 –
Where do you factor in lottery winners, Enron executives, trust fund babies, real-estate moguls, mortgage lenders, bank officers, etc into your general population versus talent theories?
I am highly interested.
I am definitely moving more toward the dark side IR. The more I work with the data, evaluate competing rents, etc. the more I become convinced about market bottom being further than I originally anticipated. The timing of which I am less clear about as that will be a function of amount of goverment intervention, depth of recession, interest rates, inflation, yada yada.
To see some houses, like in my area of West Irvine, that have already drifted back into early 2004 price territory in such a short amount of time, is very telling empirical evidence. I think we have on the low side, 30% more to go from today’s prices. On the high side, perhaps 40-45%.
I think your rent estimate is very close for this property. A 5-bedroom 2200sf place in Harvard Square just recently leased for $3000/month. HS is newer, gated, etc. so there is probably a premium there of at least a couple hundred bucks.
Yeah, you are more likely to win the lotto in Clowifornia.
It’s the yoga – the meditation makes you luckier ;).
You can bet if you want… IPO will graciously volunteer to hold escrow for the two of you. As long as you don’t bet enough that I could retire on forever in the Caymans, I’m not going anywhere with your cash…
CA must be cooking up the best hamburgers and french fries too as the higher minimum wage will surely attract the finest and most talented burger flippers that the country has to offer.
Before or after tax?
Yup, we do have the best and most talented burger flippers. That’s why there are like 10 times as many In N Outs here… They limited expansion in AZ because there weren’t enough good grease jockeys to man the grills.
That’s why there are like 10 times as many In N Outs here
Either that or some guy in charge figured that people in AZ don’t eat as much fast food.
I agree with AZ Dave, at 425K this house is grossly overpriced.
Progress on this one is $41/Sq.foot and I still wouldn’t go near it.
Well, maybe as a landlord.
What I fail to understand is how the values on “older” homes continue to hold up.
According to almost everyone we’re in a recession and by some accounts it will be a severe one.
So where’s the flight to quality, aren’t the few buyers out there chasing “newer” homes.
In tough times don’t people gravitate to “newer” product?
The prices on these old and out of date homes should’ve dropped thru the floor by now.
LOL
Don’t worry IPO, unless something in the four digit range is enough to live like a king in the Caymans (an I’m pretty sure it isn’t judging by the advertisements in the Robb Report), I couldn’t muster a wager large enough to fund your extravaganza.
IR, as a side point, I would like to say that even with the cheapest mortgage finance ever recorded (my prediction), we are still in for a wicked repricing in housing. I used to think that cheap money could win the day. Remember when I used to say 15% off peak max.? Well, I was wrong (OBVIOUSLY). At any rate its looking increasingly likely that 20-30% off peak nationally (and even greater declines in the particularly bubbly markets).
The affordability data is simply the only piece of information one need know, in order to predict the direction of the market.
Gosh, I’m going to chip in and say $241/sq. ft. doesn’t look bad at all. That’s 40% off $400/sq. ft., so about the right fall from the bubble price. Old house, so probably a little to go, but definitely in the neighborhood of post-bubble price.
Of course the bubbly peak on this house was probably only $325/sf, so this is perhaps 26% or so off peak at list.
If you guys will undulge me, the following is an explanation of mortgage interest rates I have planned for the book. Tell me if you think it is accurate:
Mortgage interest rates are determined by investor demands for risk adjusted return on their investment. The return investors demand is determined by three primary factors: the riskless rate of return, the inflation premium and the risk premium. The riskless rate of return is the return an investor could obtain in an investment like a short-term Treasury bill. Treasury Bills range in duration from a few days to as long as 26 weeks. Due to their short duration, Treasury Bills contain little if any allowance for inflation. A close approximation to this rate is the federal funds rate controlled by the Federal Reserve. It is one of the reasons this activities of the Federal Reserve are watched so closely by investors. The closest risk-free approximation to mortgage loans is the 10-year Treasury Note. Treasury Notes earn a fixed rate of interest every six months until maturity issued in terms of 2, 5, and 10 years. The 10-year Treasury Note is a close approximation to mortgage loans because most fixed-rate mortgage are paid off before the 30 year maturity with 7 years being a typical payoff timeframe. The difference in yield between a 10-year Treasury Note and a 30-day Treasury Bill is a measure of investor expectation of inflation, and the difference between the yield on a 10-year Treasury Note and the prevailing market mortgage interest rate is a measure of the risk premium. Inflation reduces the buying power of money over time, and if an investor must wait a long period of time to be repaid, as is the case in a home mortgage, they will be receiving dollars that have less value than the ones they provided when the loan was originated. Investors demand compensation to offset the corrosive effect of inflation. This is the inflation premium. The risk premium is the added interest investors demand to compensate them for the possibility the investment may not perform as planned. Investors know exactly how much they will get if they invest in Treasury Notes, but they do not know exactly what they will get back if they invest in residential home mortgages or the investment vehicles created from them. This uncertainty of return causes them to ask for a rate higher than that of Treasury Notes. This additional compensation is the risk premium. Mortgage interest rates are a combination of the riskless rate of return, the risk premium and the inflation premium.
“The prices on these old and out of date homes should’ve dropped thru the floor by now.”
Given the unprecedented rates of decline we are currently seeing, I would argue that prices have fallen through the floor, and they will continue to fall until they reach a more solid floor when prices are affordable again.
LOL! like it makes a difference…
I caught a great move this morning when CIT collapsed, then I gave it all back shorting into the rally. When I start up early in the morning and give it back, I quit trading. There is little that is more annoying as a trader than starting out well ahead and finishing down on the day.
I would suggest referencing Fabozzi, Handbook of Mortgage Backed Securities.
The spread between Treasuries and Mortgages is due to the value of the prepayment put option of which the mortgage investor is short (earns a premium) and the borrower is long (can put back the paper). As such mortgage spreads to treasuries generally capture implied volatility. Implied volatility typically overestimates actual volatility making holding MBS a solid long term trade (relative to Treasuries).
I would suggest using TIPS vs. Treasuries Break evens as a clearer measure of inflation expectations (though it does involved introducing TIPS?!?). The reasoning is that the term premium is not solely a result of inflation expecations (certainly it is a factor), however the liquidity premium (basically the couple of Trillion dollars parked in money markets), causes a large portion of the positive slope in the yield curve, thus the relative steepness between the 3 month and 1 year portion of the curve ( that roll down is the highest sharpe ratio play btw). This is also extended to the 2 year portion of the curve as that is typically the demarcation point for inclusion in short term indices. So it is not exactly accurate to state that the term premium equals inflation.
I silently wept when I first visited my parents in AZ and saw In N Outs there. I’m not quite sure why I’m paying the California premium now.
It’s certainly possible, if not likely, that rents will fall. It has happened before.
“So it is not exactly accurate to state that the term premium equals inflation.”
Do you think the nuance is important enough to introduce the added complexity to the explanation? How much does the spread between short-term treasury bills and 10-year treasury notes deviate from a true measure of the inflation expectation?
The battle in any of these explanations is keeping the information accurate without having to devote entire chapters to background information. I had to write the entire primer on structured finance for this reason, but understanding structured finance was fundamental to understanding CDOs and their impact on the housing market.
IR,
I have been a lurker now for 15 months (two weeks before you started posting). Your analysis posts have been the most valuable knowledge I have gain in explaining why a single Electrical Engineer with no kids couldn’t afford to buy a home and yet a single income, assistant manager of Kragen Auto Parts with a wife and two kids managed to purchase a 1500 sqft house (ridden with cat urine and was a former drug stop with featured drive-up window cut out of the garage door) for $400K in the IE.
Your analyses with supporting facts have assured me to be patient, to continue to save, and to not purchase anything I cannot afford. I felt that I was “Squeezed out of California like a zit” and almost moved away from my family, friends, and the lifestyle that is SoCal. Luckily I have saved some of my friends from being the next knife catcher by moving their decisions from emotion back to logic. Now I understand that I will not be priced out forever, and that the Escalades, boats, and RVs have been printed out of thin air.
For all of this I am grateful that you have been able to put The Great Housing Bubble into perspective and into a series of easily readable articles. Thank you!
Now for the question…
After viewing the ARM reset charts, housing inventory, # of for sale signs in bubble zones, and knowing how much people make out here, I have made the decision to drag my future wife into an apartment and wait for at least a couple of years. Many still believe that I’m too “bearish” about the housing market, but I haven’t seen any evidence to support it otherwise. Simply people don’t make enough out here to support the housing prices.
The only gamble I see in waiting is the interest rate. The Fed “should” be raising interest rates when inflation is becoming apparent. This isn’t happening. Also I’ve been seeing the rate climb slowly since January even though the Fed is hacking and slashing the rate. I know that the longer I wait, the higher interest rates will be.
Now, really the question(s)…
1. Do you believe that housing prices will fall even further due to the buyers’ purchasing ability being lowered with higher rates in order to reach the fundamental value?
2. Does anyone know what forces would compel the Fed to start raising rates as inflation is no longer a concern?
~IE renter
If you really believe that then buy it and flip it. Otherwise stfu.
Given the current market conditions you might also want to clarify the difference between uncertainty and risk. Was it Rumsfield that said it (or was he quoting someone else). Risk is the unknowns that I know. So uncertainty would be the unknowns that I don’t know. The symptoms are the same, namely higher interest rates, but the root causes and therefore the fixes are very different.
10 types. Those who understand binary, and those who don’t.
Changes in uncertainty are reflected in changes in the spread between different investments that have close to the same risk. For example between the Feds fund rate (or is it the T-bill?) and the LIBOR.
Over at Calculated Risk one of the blogsters was saying that rates were closer to swaps and then had an explanation which I failed to understand.
“Does anyone know what forces would compel the Fed to start raising rates as inflation is no longer a concern?”
That’s easy, one word “China”. China holds vast quantities of dollars taken in exchange for all the goods they have been selling here. If the dollar starts to tank, China could dump dollars for say Euro’s, Yen, gold, oil. The Fed will then have to defend the dollar and the only way to do that will be to raise interest rates.
Not sure if you are talking to me or looker Genius.
If these sellers would take an offer of $400K right, I’d buy the place in a heartbeat, spruce it up, and flip it quick for $500K.
ipop has seen the light, guess I don’t need to post anymore…
This house reminds me of a drug rehab place or a board and care….. seems like some of the 6 bedroom homes are being purchased for this reason- especially in the older neighborhoods.
Welcome IE. Depending on where you are, prices in the IE have come down quite significantly and probably don’t have a huge amount more to fall:
Case in point, the former Case De IPO in Berdooky, my maison from 5th grade through HS graduation:
http://www.redfin.com/stingray/do/printable-listing?listing-id=1417026
Note the almost 50% decline already from bubble peak on this property.
Knowing what my parents paid for this puppy in 1979, and inflating it by a mere 3% per year through 2007, suggests that the value today for this home should be around $160K. Take the ’96 purchase and inflate by 3% per year to 2008 and you get $154K. At list price, it is probably a 160 GRM as I’d expect it could rent for $1200 or so.
Conclusion, if you can find something in the IE that is 50-60% off peak, buying it today would not be an imprudent move IMO. The crash hit areas like the IE, Sacramento, etc. first and has been moving toward higher cost areas. If Irvine is 20-25%, the many IE areas are probably 40-50% already. Just because Irvine moves to 40-45% down from peak, doesn’t mean the IE will head to 65-75% necessarily…
And for anyone that buys this house, I want to come over one day and extract the “time capsule” I put into the wall when I helped my pops add another room to the house. I can’t remember what’s in there, but I know it has to be cool!
I agree that there are a few diamonds in the rough. Your listed property @ $190K is definately affordable and can be sustained by local incomes. The IE is a leading indicator for Irvine by probably about a year so I will probably buy before the OC crew.
The new housing developments (laste 2003 – current) there is a sign every other house and an essense of cow poo. Searching on Redfin in these areas will crash the computer.
These areas (Eastvale, Super South Corona, Mira Loma [hahaha]and parts of Riverside) are still listed at $500-600K are certainly not affordable. There hasn’t been entry level home contruction in a decade and everything is a monopoly hotel stucco box which the overall population can afford. After seeing how the 91 looks now (and the 15 for that matter) I can’t imagine anyone moving out here from the OC for more house.
Eastvale:
http://www.redfin.com/stingray/do/listings-search#residential=true&condo=true&lat=33.964665159552354&long=-117.57295846939087&zoomLevel=15&market=socal
Hopefully the link will work and show block, zoom out just once and there will be too many listings to display.
I only said it was similar, not great looking 😉
There was a ton of clutter taken out. It was finally vacated last weekend.
Wow, that’s a lotta homes for sale… Wish Irvine inventory looked like that. I’d be lickin’ my chops.
Here’s an exampe I found in the area:
http://www.redfin.com/stingray/do/printable-listing?listing-id=1575166
Peak price around $600K. Almost 50% off already and sitting near $100/sf. Put it into Case-Shiller index terms and this is a rollback to a 140 index value, which puts it mid 2002 pricing.
IMO, the cheapest such a house will get will be around $250K, so if someone could pick it up for $300K today for instance, it wouldn’t be a financial blunder. I don’t know that area well, but I’d think this house could rent for $2K per month couldn’t it. $320K puts it at a 160 GRM in that case…
If the price on houses in an area you like are close to rent equivalent today, there isn’t much incentive to keep waiting it out. Ultimate bottoms are very hard to time…
Nice find. This would rent for around 2000.
I can’t look too far into this listing right now but I have seen a lot of short sales listed, unless this is a bank owned property, I don’t know if an offer would go through at this listed price.
As far as house listing density, there are SEVERAL areas like this that were built recently.
Would I ever talk in that tone to you sweetheart?
As a matter of fact, it is bank-owned. Owned by Citi actually…
There doesn’t appear to be much that ISN’T bank-owned or soon to be bank-owned in that area. Check this out:
http://www.ipoplaya.com/corona.jpg
Totally amazing and sickening… The B’s are bank-owned, P’s are pre-foreclosure, A’s are going up for auction. The entire neighborhood is decimated.
If I was a buyer willing to live in that area, I’d be rolling from bank-owned to bank-owned with 60-70% off peak pricing offers. One of the lenders would eventually take a lowball with the volume of competition out there…
Although CapitalismWorks is correct on the technical aspects, in my opinion you are going down the rat-hole if you introduce a nuanced explanation like TIPS vs. Treasuries to explain spreads. The old maxim is K.I.S.S. (Keep it Simple Stupid)
Many here have taken the time to understand the nuances of finance and some are even professionals but I would say that represents a fraction of a fraction of the population as a whole. I’m guessing the aim of the book is to help educate the “layman” on how all these parts fit together in an effort to provide knowledge and how to recognize aberrant financial trends and avoid such traps in the future.
Let’s not forget too that spreads are sometimes set by what the broker thinks they can get in form of pure profit. Perhaps overly simplified but it is a factor these deals.
My two point two cents. 😀
Alan- one small point. China is VERY reliant on the US trade imbalance for it’s lifeblood. We’re linked at the hip with them now.
Don’t forget China artificially surpresses the Yuan against other currencies. If the dollar continues to de-value against world currencies, China must continue to further surpress their currency or it loses it’s single largest competitive edge, the value of labor. They’ve not yet diversified their economy enough to suffer a “wage war” or leveling of the trade imbalance with the US. We are still their single greatest importer. Or at least that’s how I understand the situation from a series of articles I’ve read on the subject.
Don’t forget too that they’re demand for energy (oil) on the world marketplace is increasing making their energy costs rise, perhaps more so than ours. They could be headed for an inflationary spiral along with us.
Welcome IE Renter
I myself (and a couple of friends) are exactly in the same position as you (except we’re out here on the coast). After graduating with an EE degree and my newly married wife with the same degree, we also realized that we couldn’t afford any of the houses in our area (or the stuff we could afford was equivalent to a small condo)… It was very disheartening to see that nothing, but apartment living was in our near future.
I’ve spent the last two and a half years at work puzzling out what the hell is up and why I couldn’t get anything of value… while making a decent wage. It’s taken that long and sitting patiently for the bubble to burst and the prices to slowly start dropping to feel that I wasn’t crazy or abnormal. I still remember the day when my dad (about two years ago) told me that I should find a place that’s only 3 times my gross salary and me going wtf I can’t even get a condo in westwood at that level. I’ve only recently found out about the IR Housing blog, but earlier was a strong follower of Shiller and Kindleberger and tried to learn as much as possible on my own.
The coast is only about 18 months behind the IE and hopefully within the next 2 to 3 years my wife and I will finally be able to find and buy our first house (here’s hoping!!).
If and when you do find your affordable house, tell the blog the good news ASAP, once the IE becomes affordable, our area should follow soon.
Ipop:
” I have noticed since you started looking at the Case-Shiller data, you have seen the same things I have concerning the relationship between current pricing and fundamentals. Perhaps you always have seen this, but the estimates you have been providing lately — including the one above — have been right on. Like you, I believe houses similar to this one will bottom at around $425,000. I imagine you could rent it for $2,650 with a GRM of 160. ”
NAILED it !
correction: Those within quote is from IrvineRenter, when you guys find equilibrium with each other, I pay very close attention.
1. Do you believe that housing prices will fall even further due to the buyers’ purchasing ability being lowered with higher rates in order to reach the fundamental value?
As interest rates move higher, prices will move lower because the amounts financed will decrease. This is a good thing because you can buy when interest rates are high and refinance later when interest rates are lower and reduce your payment. You can never refinance into a smaller loan (unless you pay the balance down with cash.)
2. Does anyone know what forces would compel the Fed to start raising rates as inflation is no longer a concern?
Inflation is the only reason the FED ever raises rates. Inflation is bad and getting worse, but Bernanke does not feel he has a choice right now. Once liquidity returns to the broader market, he will likely start to raise rates to curb inflation.
Right now, I think some people are having a hard time getting financing. I think things have changed in that arena. If difficulty getting a loan continues, it will put downward pressure on prices.
From 03 to 05 we saw a 100% rise in prices.
Why do you all think that prices are only gonna drop 25%?
My take -and I’m a homeowner- is that house values in Irvine will drop ( at the bottom ):
40%+ for existing stock
60%+ for homes built since 02.
Rents will drop too.
There, now I can go back and watch UCLA beat that poor other team.
China is screwed too. They can not dump dollars. For all we know, they’ve been burning their dollar stockpiles behind the Great Wall because they can not dump it without cratering themselves.
So long as China is the big economic parasite to the US with a currency fixed to our dollar they are hugely screwed.
Time to buy Euros and Pesos.
It is possible Saudi Arabia and/or China will unpeg their currency in an attempt to bring their inflation under control. If either or both unpeg, interest rates in this country will rise. And rise. And rise.
That’s about what I expected. How did you generate that pic? It looks like it’s from Redfin, but I can’t find the option for it.
Yup, Carona @ $100 sq/ft … and Irvine @$150 sq/ft. You heard it here first.
Not sure why I couldn’t respond to the actual post above, but hopefully you find this…
IR – I have a copy of Fabozzi if you want to borrow it.
“That’s about what I expected. How did you generate that pic? It looks like it’s from Redfin, but I can’t find the option for it.”
The pic was generated from RealtTrac. You can list properties via map… Redfin doesn’t have foreclosure info.
That would be http://www.realtytrac.com
>>The pink and green colors are truly ugly.
Looks like Crockett & Tubbs barfed on the walls 8^D
“Do you think the nuance is important enough to introduce the added complexity to the explanation?”
I don’t know. I struggle with this all the time. Probably better keeping it simple, using T-Bills vs. 10-year, and providing a footnote mentioning that the method used is a shortcut and though more precise measurements exist the general themes are the same.
If I understand your intended message it is that mortgage rates will generally be higher over the next two decades as the Fed wrestles with the twin deficits, and inflation driven by global demand. Certainly a sobering message for homeowners.
OMFG!! Sold for $375k in 2006??????????????????????????
Guess the lender wouldn’t take below $600K on this house. The price just got increased to $690K…