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Tuesday, April 11, 2006

The Trumped Housing Market

Hoo-ha! My eyes are pretty wide, because I've just been grazing through some housing stats. In contrast to last fall, there are beginning to be some good deals out there (10-20% less than 6 months ago), and I expect a spring upsurge in people who are buying in many areas. If they have at least a 10% downpayment and can afford a 30-year fixed mortgage, a substantial number of buyers who could not afford to purchase last year can afford to purchase now. Still, new home sales are plummeting in many areas, and IMO it's because the flippers have bailed. But if flippers walking away from the game produces a 50% drop in new home sales in market, what does that say about the underlying market?

The worrisome factor is that in the hot areas loan underwriting standards don't appear to have adjusted for the new level of risk in the market, and that's insane. In many of these markets, inventory is rising rapidly and is over one year's worth. Because of that, home builders are offering some pretty fearsome incentives, such as a new car, a free lot (buy the house at list, they don't charge for the lot on which the house sits, 90,000 or 100,000 off in a discount, etc). This means that lenders should be requiring a 10% downpayment to offset the risk of falling home prices, and they are not. The sales prices no longer mean much, because the contract price usually doesn't change, but the discount is given back as a "credit" at closing.

Florida has tumbled into a ditch. Try looking at the Craigslist for Orlando and then looking up comps on Zillow. There are a bunch of places in Florida that have well over a year's inventory of housing at current sales rates. That means prices have to fall. Some places have over 4 year's inventory of condos. Yes, that's right. To absorb the condos now on the market, it would take 4 years. See this commentary at Mish's from a Florida realtor:
This was our worst week yet. We went three days this week with not a single showing. That’s incredible. I have 35 listings. We usually get 2-6 showings a day. I noted a few months back that once the snowbirds left Florida in March, that we would be in deep trouble going into the Florida shoulder season of April and May. It is here and the buyers are gone. We will see a small surge in buyers for June and July as buyers jockey for school systems, but then it is a decline from August through December. January picks up with the return of the snowbirds.

Not only did we see three days without a single showing, but I received more desperate calls from sellers than ever. One lady broke down into tears. Her husband bought two investment properties, and they are now going to lose their "life savings" if they sell the homes in today’s market. Her only option is to lose her life savings trying to carry this through the next 12-24 months. I received calls from Utah, California, South Carolina, Vermont, etc. etc. All the same. "We bought a house or a couple of houses for a flip, but we can’t sell them. What do we do, Mike?" I can only tell them that the $400,000 house they bought is now only worth $325,000 - $340,000. Their 10% deposit is gone. Their $3,000 a month in carrying costs is killing them. A year from now these homes MAY be worth $350,000 - $375000 IF we have a strong market. So even a best case scenario means $36,000 in carrying costs to recoup $25,000 - $35,000. That means another $1,000 - $11,000 in losses if they wait . . . and IF the market rallies strong.
The market has to find a way to offset the risk of losing the money lent to borrowers, but it doesn't seem to be doing this:
Last year, roughly 50 percent of all new mortgages in the nation were adjustable loans, according to estimates by the Federal Trade Commission.

Many of the adjustable loans offered borrowers the option to pay interest-only or a minimum amount that was much lower than a fixed-rate mortgage payment.
Despite the rising rates, and fears from some quarters that many borrowers may be in over their heads, so far there hasn't been an exodus from adjustable loans into fixed loans, said several mortgage specialists in Santa Barbara. And the higher rates haven't stopped people from taking out new adjustable loans.

"About 75 percent of the people I see who are making a home purchase are choosing adjustable-rate mortgages. And most of these loans have a five-year fixed rate and are negatively amortized," said Harlan Green, owner of Bankers Pacific Mortgage in Santa Barbara.
The risk for walkaways is staggering, because the odds are substantial that anyone not able to put down at least 20% in these "hot" areas will find themselves upside down in the home within two years. In the meantime, the FRB had put out proposed rules to require that borrowers be qualified for I-O and neg-Am mortgages on the basis of their ability to repay after adjustment. This has produced a firestorm of protests from lenders, who contend that doing so will crush the market and produce an equity collapse.

But continuing on as we are will also produce an equity collapse. If people cannot afford to buy on a traditional 30-year fixed, than they cannot afford to buy using these exotic mortgages unless housing continues to appreciate. The huge growth in these types of mortgages dates from 2002, and the resets are beginning to produce a flood of foreclosure and pre-foreclosure inventory. Many of these mortgages will reset in 2006 and 2007 at payments at least 30% higher than the original. If the buyers don't have equity with which to refi, or to sell and clear their debt, and they cannot afford to make their new payments, they will walk away. This is occurring in areas like Denver, for heaven's sakes! So it would appear that those holding the paper are Trumped - they cannot afford to let housing markets fall.

This cannot continue and it won't, because the examiners will be coming around and looking closely at home loan portfolios held by banks. When they do, they will start demanding portfolio improvements backed by reappraisals. Furthermore, we do have a good economy now, but it is riding on the back of the consumer. Real wages are not rising, and in many areas people have tended to finance their lifestyles by pulling equity out of their homes. Well, the housing ATM has run out, and that is going to spread through the economy by contracting consumer spending.

As to how to use Zillow, here's an example. Go to the Craigslist for a particular area and check out the real estate for sale listings. Find a house and look it up on Zillow. Here's an Orlando-area 4/3 house offered for $535,000. Zillow has the house listed as a 3/3, but anyway no comparable comes close in price. In January two larger homes sold for $489,000 and $495,000. I have not found one Orlando-area Craigslisting that seems in the ballpark for an actual sale. Furthermore, this is a flipper listing, because the house was bought in January (3 months ago) for $470,000. Yeah, there are suckers, but do they have money and how long will the banks be willing to advance money to fools?

Here's a hilarious one I got from Craigslist. It's in Merritt Island, FL, and is also on Ebay for $479,000. You get a boat with it! This is another flipper special. Zillow has the last sale in January 2006 for $325,000. You see, the market is still nuts, but the buyers have disappeared. This guy might be able to sell for $350,000 or so, but he is going to go deeply in the hole if he keeps it for much longer. If he can't sell within two months he's going to be glad to get out at $330,000 and a minimum $60,000 loss in November. The property insurance on these houses is tremendous and many now have ten to twenty thousand deductibles.

You see, in Florida last year you could walk into a bank and announce "I gotta house! I want some money!". The loan officer would rush up, shake your hand and call over a secretary to drop champagne-soaked grapes into your mouth while they checked the mortgage. They'd send out an appraiser who would wander around without even finding it, stop off at a bar for a few drinks and look up some comparables. And yeah, sure, you bought the thing the previous year for no money down and hadn't paid a penny on the principal, but that didn't matter. You would still leave with a home equity line for $40,000 - $70,000 dollars, and odds were that you wouldn't even pay for closing costs. So you'd leave and go buy a new car or a boat, and everyone was happy.

This year, it's different. The music's stopped.

Report from here in SoCal.

Realtor ads are on incredibly heavy rotation on drive-time radio. I get a "want to sell/buy/refi?" come-on hung on my doorknob every couple of days. Big hype regarding "Donald Trump's Real Estate Wealth Seminar" coming to LA Convention Center (one of the housing crash websites calls it "HALLELUJAH! I'M SAVED! I OWN REAL ESTATE!" and the accompanying picture does look like Pentecostals waving their arms in the air and speaking in tongues).

I cannot mention the "housing bubble" at work without being ridiculed because "Prices Have Nowhere To Go But UP UP UP!" It's like when I admitted I watched Babylon-5 while everybody else in the shop gushed over Seinfeld.

On Zillow.com, running the comps on my place (bought 1997 at $100k) show a "sale value" pushing half a meg; most of that "appreciation" was in the past two years. Zillow price graphs show a steady increase at 10% a year until about two years ago, where it jumps to 50% a year in a hockey-stick curve. Oh, and one-in-six jobs in my county (Orange County, CA) are real estate. Not construction or support, but real-estate sales and mortgage lending.

It's been 10 years since the last real-estate crash out here, and they seem to run on a roughly 10-year cycle. By 2007, I should own in the clear and be able to trade in on some really good repos.

The Headless Unicorn Guy
Well, I'm glad you are not stuck in this. I read that there is 100 billion in loans secured by assets in Orange county.

I think there will be a bad reverberation throughout SoCal and a few other places in the US. I saw the Pentecostal RE picture. It is hilarious!
It's because I got stuck in the last one -- upside-down in 1995 with a homeowners' association power struggle (in which to both sides there was no such thing as collateral damage or innocent bystanders, just "Property Value" snobs), 1/3 of the units in the condo complex "HUD Section 8's" (i.e. welfare bum squatters) and the alcohol-based life-form in the unit below me suing me every time he ran short of booze money. I was skipping meals to buy it down to where I could bail but the prices still dropped faster than I could pay it off. (Did you know that if you throw the key at the bank and walk away under those circumstances, defaulting on the loan becomes "forgiveness of debt", i.e. "taxable income"? The ex-friend who directly ordered me to "STAY IN THE PROPERTY AND BUILD EQUITY!" -- when the sale value was dropping 10% per month -- didn't help.)

I managed to get out (driven out of my own home by the HOA power struggle and housing crash) in '97 after taking a $40k loss. Landed on my feet and bought my current place at the bottom but NEVER AGAIN.

The Headless Unicorn Guy
Ughhh. I have been trying to stay away from the condo debacle. It's sickening. You are so right. An awful lot of people are going to be living in condo slumvilles in two years.

For one thing, when there's a high vacancy rate you get bad renters in there, and then no one wants to move in. And then there's the escalation of HOA fees when you have high vacancy rates and crappy occupants.

Mid-priced condos slide into the sea in these areas. I've got to tell you that last year in the Jupiter area in FL (very pricey) they had houses theoretically worth over a million being occupied by 15 or 20 illegals.

I think there are going to be literal ghost towns in this Flipvilles that were built in areas in which there is little employment. This reminds me of the 20's.
Problem here in SoCal is that even back in the Eighties, the only affordable housing (if you made less than six figures and wanted something other than food stamps after mortgage payments) WAS a condo. I don't figure on being able to get a *real* house (without a Homeowners' Association) until the next cycle or until I retire out-of-state. That's just the way it is out here.

The Headless Unicorn Guy
www.HomePriceMaps.com integrates how much homes SOLD for nationwide using the google mapping technology. Simply select city and state from the city menu and click search. If you don't see data for your area simply email HomePriceMaps@gmail.com with your zipcode and or address and they'll update the site with your info and email you within a few days.

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