Real Homes of Genius: Today we Salute you Compton with a Short Sale at $375,999. New! Short Sale Search Option.

We are having so much good housing news hit the media that you would think the White House press secretary is suddenly working for the housing industry. Next thing we will find out is the President issuing pardons to anyone who bought a home on negative-interest-option-only-adjustable-rate-suicide mortgages. After all, with the amazing tax cuts the government feels you deserve a get out of jail pass too. Today we salute another Compton property with our Real Homes of Genius award. ZipRealty has a wonderful feature that allows you to search for short sales. This was added in addition to other features, that of “fixer uppers” and “interest level.” I’m thinking that any home hitting as a short sale is probably a fixer upper with low interest level – maybe they should have defaulted the search item and save the buyer a minute. ZipRealty is ahead of the curve on this one since this is a booming market:



On with the home. This 1,089 square foot home includes four bedrooms and two “full” baths. Nestled in the majestic resort town of Compton, you will entertain your friends and family behind U.S. Steel reinforced gates, such as those guarding the Rockefeller Estate. This home uses transcendent features of the 1950s including a patented aqua green color to ward off nuclear attacks from Soviet warships. This moderately priced dream crib is all yours for the rock bottom price of $375,999. This is actually less than the sale price of 2006:

Sale History
06/23/2006: $412,000
10/01/1981: $58,500

So already in less than one year, we are giving you the dear buyer, a $36,001 discount. Or to look at it from another perspective, the median per capita income of someone living in the area. The absurd notion here is that someone paid $412,000 for a home that will rent from $900 to $950 a month. Now the bank is taking it in the shorts, hence the name short sale, and looking at yesteryear appraisals for a market value. Keep in mind this home initially was listed for approximately $400,000 but no bites. I’m not sure how anyone can justify prices like this. It’s almost like sellers went into asylums, removed the straightjacket from patients, showed them pictures of homes, and asked them how much would you pay for this? “$500,000!” Okay. And this home? “$500,000!” When people say we have crazy housing prices they mean it in more than a figurative sense.

And what is the agent thinking? Taking pictures behind bars isn’t exactly making this a hot item. Didn’t they see how unappealing the Paris Hilton mug shots appeared? They need to add some pizzazz or hire some unemployed paparazzi; there is plenty in the LA metro area for a good price. Or maybe you can ask Alan Greenspan to give you a stump speech on how adjustable rate mortgages are good for America. After his speech, he should be dragged to this home, and forced to purchase it via a New Century Financial no money down interest only mortgage. As he stated so eloquently that ARMs are good for the economy. Good job easy credit. Thanks for flooding the world with such lax standards that housing prices are beyond unreliable, we might as well purchase a pregnancy test from the 99 Cent Store to determine whether housing will appreciate in the next year. Let us see…two lines. I guess that means it’ll be 20 percent appreciation again in 2008.

Today we Salute you Compton with our Real Homes of Genius Award.

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Housing and the age of Affluence: Transforming the Definition of Income and Wealth

Most people consider families with 6-figure incomes to be financially secure. Some would even venture to say that this is the upper-middle class. Yet very few housing articles look at income in relation to housing prices if you have noticed. It is almost a foregone conclusion that people earn enough to support Wonderland prices. So how does income distribution really look like in the United States? Looking over data from the Census Bureau, you will be surprised to see how various quintiles breakdown. Considering that a median home in Southern California is over $500,000+, a family earning $100,000 a year is still paying 5 times their annual gross income for a home. Keep in mind a half-million dollar home in California is not what you would see displayed on Lifestyles of the Rich and Famous. You are more likely to find a Real Home of Genius in this price range. I’ve observed housing bulls arguing that housing is being supported by radically high incomes and unbelievable job growth. Do we really have that many people making $100,000 a year to support $500,000 homes? Let us take a look.

The Number Breakdown

F. Scott Fitzgerald once said that the rich are different from us. To which Hemingway responded, “Yes. They have more money.” There is a fascination in this culture with the uber-wealthy. Take a look at shows like Cribs where opulent wealth is showcased. Tabloid magazines make their money from this cultural fascination. What do the rich eat? Do they shop where I shop? What do they do for fun? Where do they live? If you really examine what it means to be rich, you will find some surprising answers. But first, how many rich people are in this country?:

Household income (overall percent of US households over):

Income Percent of Households over:

$65,000 34.72%

$80,000 25.6%

$91,705 20.0%

$100,000 17.8%

$118,200 10%

$166,200 5%

$200,000 2.67%

$250,000 1.5%

$1,600,000 0.12%

Some of you may be surprised to see this data. If anything, it should point out to you that there is not nearly enough of an income base to support the $500,000 median home prices in Southern California or any overpriced metro area in the country. Even a household with dual income earners making $100,000 a year, after taxes they are pulling in a monthly nut of approximately $5,900 without contributing to a 401(k). And what is the monthly mortgage payment on a $500,000 home with 5% down ($25,000) at 6.5% over 30 years? The principle, interest, and taxes will cost you approximately $3,600. After taxes you are paying 61% of your income toward your home. Moreover, this is for families that fall in the top 17% of income earners. Last time I checked, we have a national homeownership rate of 70% and in California, a homeownership rate of approximately 57%. Since we realize that income isn’t the main protagonist of amazingly high home prices, then what is it? Surely there must be an explanation for the radical jump in home prices over the past decade.

Risky Loans and Easy Credit

How can a family earning $65,000 a year, jump into a $500,000 home? Easy. We can lock them into the world of subprime loans. Only a few years ago, it was incredibly easy for a family to go stated income and jump into a 2-year teaser rate mortgage with a 1.25% rate. The rate would adjust but by that time, you could flip your home and make a nice little return. Don’t know how? Just watch the show Flip this House. I remember a mortgage broker telling me, “it is easy to get anyone into any home. All they need is the willingness to find a place and sign.” He even told me about his ability to squeeze in families with $50,000 incomes into $500,000 homes and got joy how he was churning $10,000 a month in commissions. That was 2005. Fast forward to 2007. He is no longer working at the company since it imploded early this year. When I last talked with him, I asked him what his plans are now that he is unemployed. “I’ll go work for another lender but one that focuses on foreclosures. That’s the next big market.” Didn’t want to burst his bubble but in a bear housing market, sales drop massively therefore cutting into the churning of transactions. Therefore, his $10,000 a month will only be seen again if he has some advanced college degree or sells crack on the streets. Ironically, this person has nothing saved up after 3 years of being in the business and making $100,000+ each year. The product of conspicuous consumption and financial irresponsibility – easy come easy go.

This is only one case of many. The person above is young. But so many people got caught up in this housing frenzy and believed it was a ticket for easy street. They under funded their retirement accounts in belief that Social Security will be there for them. But think about the culture of credit that they blossomed in to. They entered the workforce with a national negative savings rate, credit cards being given out like candy at colleges, and cash becoming almost a thing of the past. People even pay for $1 cheeseburgers at McDonalds with a credit card! So is it any wonder that they have no fear issuing out or taking on absurd mortgages? Credit will always be there for them. It was there in the past, why not in the future?

Age and Culture Conflict

I have a colleague telling me how buying a home is always expensive. He tells me about earning only $30,000 a year and buying a home that cost $110,000 back in 1988. He is also proud that he would not be able to afford his current home if he bought it at today’s market value. It is a sense of pride that he can’t afford his own home, “if I were in the market today, I wouldn’t be able to afford my own home!” This from a baby boomer nearing retirement with a locked in pension. Looking deeper into the income stats, we realize that the top earning households are those headed by working baby boomers. The exact range of top earners is 45 – 54. The conflicts of managing a high cost of living seems to be disconnected from those from the 25 – 39 age group. For one, we do not have the luxury of having a Social Security safety net, therefore many of us actually have to over fund our 401(K) if we do not want to live off government cheese. Yet we pay 15% of our income into a fund we will not see. Not only that, but many companies are now eliminating defined pensions and passing on the cost of health insurance to the young working class. The cost of living is much higher even though incomes on the surface may seem high for young working professionals.

In addition, housing has never been this expensive in relation to income. Even though buying a home may stretch a family’s budget, anyone buying a home in today’s market would need the flexibility of Gumby to purchase a starter home. There is a generational divide in our culture. Many young folks feel they are getting advice from a person that has a locked in retirement, years of Social Security, and locked into affordable housing – things that are not in our lexicon. These items are remote to any young professional. So the “live and spend” culture of today has some direct correlation to the psychology of both generations. Even though I disagree with this mentality, I can understand where it comes from.

Yet this housing market also affects baby boomers. Many are counting on their equity in their home for retirement. I’ve talked with many people telling me that in 5 years when they retire, their home will be worth $1 million and they’ll use the equity to downsize. When I ask them how they know 10% annual appreciation will occur from 2007 to 2012, they reply, “real estate always goes up.” So not only does this housing market hurt families looking for a starter home, it also hurts those nearing retirement with an inflated few of their home and a perceived idea that a built in safety net will always be there for them. In general, the young overestimate the difficulty in paying back large amounts of credit (i.e., buying a $50,000 car) and the older generation underestimate the need for a larger retirement nest egg (i.e., American’s nearing retirement have an average nest egg of $50,000).

In the end, looking at income numbers, home prices do not justify their current market rates. These rates are inflated on bubble psychology and easy credit that is slowly evaporating. The market will contract and a major shift in cultural psychology will occur.

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$5 Trillion in Housing Wealth Gone: The Impact of the Housing Bubble Bursting

A sane person surrounded by insanity will at some point, question his or her own mental health. Examining the past decade of housing especially from Southern California, the epicenter of the housing bubble, you begin to question economic fundamentals and simple rules of finance. At this point, we are reaching the overdue housing correction. Housing has created immense wealth in the economy and has propelled us out of a brief recession earlier in the decade. Yet this wealth was created on an illusion of easy credit. It is estimated that the housing bubble has created 5 trillion additional dollars of wealth as compared to a scenario where housing kept pace with inflation. This is important to note because historically, housing has only kept pace with inflation as an investment. When you have certain areas up 80 percent in real terms as the Center for Economic Policy Research has showed, we have speculation and not normal growth.

We will look at the past decade of housing and address the following issues: income, inflation, rental rates, bubble specific regions, and the public policy issue of bursting the bubble.

Income Has Gone Up

In real terms, per capita income has grown 2 percent annually since 1997. This is something positive for our economy. It does show that as a nation, we are growing and thriving. Yet certain industries are now facing the pull back associated with the housing downturn. Consumption and automobile sales are taking massive hits in the last few months. Construction is falling in large numbers. We have only started to see any of this impact in our economy. The $5 trillion in bubble wealth has created an extra $250 billion in consumption that would not be present if it were not for the housing bubble. This works out to be 2 percent of our GDP; in other words, without that wealth we would already be in a recession.

Even though income is up, it does not justify housing prices being up in real terms of 80+ percent. And with income being up, we also have higher cost associated with health care, energy, and household items so the 2 percent increase is really negligible.

Real Estate Has Normally Treaded with Inflation

Decades of data show that real estate normally grows at the rate of inflation. That said, why do we have real increases of 80 percent in certain areas? You may say, 80 percent is large and I doubt this is true. In California, countless homes that cost $175,000 in 1997 are now on the market for $500,000. Pick any of the 88 cities in Los Angeles County and you’ll see that this 80 percent number actually understates the growth. So is it possible for housing to fall 50 percent in a few years? If housing can go up 200 percent in certain areas over 10 years, then yes, a 50 percent drop is plausible. As a caveat, when you are arguing market fundamentals for a bubble, any number is possible but the eventuality is that the bubble will burst and market fundamentals do rear their head again. For example, the long tested rule of housing keeping pace with inflation.

Rents have not Increased Significantly

During the initial stages of the bubble, rental rates did go up in decent numbers. However, in the past few years, real estate has outpaced rental market rates by an unbelievable number. Most investors and economist associate a rental value on the property in terms of deriving the actual value of the home. For example, many investors will divide annual rents - expenses by the price of the home to arrive at a return on the investment. In most cases, it will always be slightly more expensive to purchase a place than renting even after factoring in tax benefits. The premium will always exist because you are purchasing an appreciating asset that is building up equity (normally at the pace of inflation) and will create a real store of value for you.

After a few years of bubble psychology and straightjacket number crunching, many people modified their equations to factor in 20 to 25 percent annual appreciation rates and thus justified the price of homes even though rental rates were significantly lower and in no way supported the market value of the home. The premium of the home was based on the false assumption of abnormal market returns. In simple terms, pure speculation. Now that more inventory is hitting the market and sales are dropping, we will see certain areas declining in rental rates. In certain prime areas, we will see an inverse reaction with rental rates going up while housing prices go down. It will all be specific to each certain market. In the end real home prices will decline.

Only Certain Areas Have Bubbles

Certain areas such as the South and Midwest actually saw no true real increase in prices over the past decade. Then we have areas such as the Southwest, DC, Northeast, and Florida seeing real price increases of 80 percent in certain regions. The bubble is national in the respect that overall statistics are heavily tilted by regional bubbles. Meaning, the numbers are skewed by certain metro regions being overvalued. Population trends do not justify the upward jump in prices because overall, we are seeing many baby boomers retire. If anything, they are getting ready to downsize their home as opposed to expanding for a growing family.

We also have massive construction that really had no bases in population growth. If anything, as a society families are choosing to have fewer children. The need for larger and bigger homes is spurned on by nothing more than bubble speculation. The demand is simply not there. That is why we are seeing a record number of vacancies hitting the market in many regions of the country. Many people bought homes in other states thinking that they would be able to rent them out as investments but forgot to check local market conditions. The population in many of these areas simply did not meet up with the growth in housing. In fact, some areas didn't even have a population to begin with - these are the future ghost neighborhoods of America.

Public Policy: Bursting the Bubble Now is Good

When you watch shows like American Idol or America’s Got Talent, you can see that some contestants honestly believe they are the greatest thing to walk this Earth when in fact, the sound of mating cats is more enticing. Just like these delusional would be superstars, we have many folks accustomed to the decade long bubble in housing. They feel entitled to this $5 trillion of pseudo-wealth created by a bubble fueled by horrible public policy. Public policy by who? The Federal Reserve and the hunger for mortgage backed securities on Wall Street. The quicker the bubble bursts the better it will be for the overall long-term sustainability of the economy. The bubble has already been left unchecked for too long and the repercussions will be felt to the very core of our nation. You cannot use debt to finance your entire economy. Unfortunately, we have too much credit floating around and we are going to face a radical public policy debacle and potentially a government (read public) bailout.

Many baby boomers are counting on the wealth in their homes. In fact, savings rates and retirement nest eggs for many of these folks are massively under funded. And why should they save? If they have the perception that their home is going up $50,000 per year unabated for the next decade, why fund a 401(K) or IRA when you can make much more simply living in your house. This is reflected in the response many people have regarding their retirement. They assume the money will be there. Like a mirage in the desert, the closer they get to retirement the more they will realize much of what they saw was simply an illusion.

Then we have 8 million people a year buying homes at inflated prices. Like Alan Greenspan has mentioned, bubbles are only identifiable after the fact, it is hard to say the exact start date of the bubble. Was it 1997 or 2000? It also varies on which region. Back to the millions of recent buyers, they are purchasing homes at current bubble market rates. When the market corrects, the negative wealth effect will hit these folks very hard and direct. Even those who bought 10 years ago and never planned to sell, will take a psychological blow because their once valued $500,000 home is now only “worth” $375,000. This will have a major impact in our nation’s consumption.

Even with this tremendous housing wealth, owner’s equity isn’t that high. A startling fact if you think about it. The ability to take money out of your home has been a national phenomenon in the last 10 years. Once thought as an untouchable resource, folks have been more than willingly to extract perceived equity and fuel consumption. This only increased the magnitude of the bubble. For one, the money tapped out of the home creates a 2^nd lien on the property that needs to be paid back. It isn’t free money. Yet people treat it as a grant that doesn’t need to be paid back. In many cases, these loans are paid over 10 years. Now what do you think the impact on a person taking out $50,000 in their home only to realize their home was never worth that additional $50,000? My guess is they will feel slighted and think that they got suckered into signing up for $50,000 of relatively cheap debt.

This irresponsible lending has created an environment where the only recourse is a hard and steep correction in the housing market. The Fed, housing industry, buyers, and sellers were only all too happy to be accomplices in this bubble. Yet this doesn’t mean that what has occurred is based in any economic reality aside from the fundamentals of asset bubbles. It was all an illusion. Now that we are seeing subprime lenders imploding and mortgages resetting, the true cost of this economic expansion is coming to fruition. The more and more I look into this issue, the more it seems that we will not see a soft-landing in housing.

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The Cost of Mortgaged Suburbia: 3 Modern Housing Psychological Shifts

As we firmly enter the summer selling season, we have a wonderful aroma of massive mortgage debt and overpriced homes filling the air. It is the smell of burning American Express plastic in the wallets of many itching to buy anything imported. Then we have home equity lines of credit and home loans fueling the real estate market to another dimension. Let’s face it, we are a debtor nation in every sense of the word. We are running massive trade deficits and are content turning on the printing press and letting inflation devour our green dollar. But there is a cost to this. This mixed panacea of suburbia creates mixed emotions in the hearts of many. Many families want a nice sized home and good schools for their children. But are you willing to sacrifice the quality of your own life by commuting one-hour each way simply to purchase a home? Are you willing to spend 50+ percent of your income servicing the debt on your home? The mental vision of a home with a stunning green lawn and a white picket fence are etched into the American psyche even if you grew up in a concrete jungle like Manhattan. And we also have urban sprawl dominating our nation’s landscape. With the housing boom that occurred during the watch of Sir Alan Greenspan, we’ve seen builders subdivide and conquer the landscape of our nation with 3/2s popping up everywhere. It almost came down to a science; subdivide here, put 100 homes here, put a shopping center there with a Starbucks and Wal-Mart, and voila, you have yourself a new town. But will the people come?

There are 3 quality of life points that many metropolitan areas are facing. One has to do with commuting. The second point discusses that extent to which sprawl can be supported. And finally we discuss our sudden nonchalant cultural acceptance of debt.

Commuting

Love it or hate it, most Americans in metro areas commute. According to an ABC poll, American’s spend an average of 1.5 hours a day commuting to and from work. Below are some interesting figures:

Commute Time:

Average 26 minutes

On a good day 19 minutes

On a bad day 46 minutes

The survey also found that those in congested cities found their commute “bad” as compared to those in rural areas. Aside, from that obvious tidbit, commuting does have a major impact on our society aside from the time lost on the highway. The average American family spends approximately $4,200 a year on fuel cost and another $2,000 in car insurance. According to Edmunds, the average MSRP of a new car is $30,000+. So total it all up and we are spending a large portion of our disposable income on automobile cost.

The highway system was constructed under the National Interstate and Defense Highways Act of 1956. The purpose was two-fold, to create standards of driving such as speed limits and for civil defense/emergency evacuation. Well of course we saw how well it handled an emergency evacuation with Katrina. The highway system was championed by the auto industry and has been a major reason for the economic growth of our nation for the past decades. However, the system itself is having challenges supporting urban sprawl and massive jumps in our population. 56% of the system is funded via taxes (largely the gasoline tax) and other federal and state taxes. Given the inordinate amount of money spent on fuel, do you wonder where this money is going? In large established areas such as Los Angeles County, there isn’t any land surrounding areas to add additional lanes or expand alternative routes. We’ve heard numerous times that they’ll double-deck certain congested areas but any work would take a decade at the very minimum. This talk occurs in the background while commute times increase every year.

So what does this have to do with housing? For many people, it has a lot to do with their quality of life and where they choose to live. It is becoming obvious that living near your work is a luxury in Southern California. Each day the 405, 5, 10, 210, and other highways become flooded with millions of drivers heading to work. Red lights fill the lanes like busy ants. How much are people willing to take of commuting to realize the American dream of that big house on a nice plot of land? Is this dream really a nightmare in disguise for many metro residents? This leads us into our next discussion, the urban sprawl caused by growing cities.

Salton City and Other Outskirt Boom Areas

You are left with a few options regarding commuting. You can either rent near your work thus improving your commute time. You can buy near your work and pay market rates for a home in that area. Or you can buy miles away and increase your commute. The latter option has emerged as a booming trend for many in Southern California pursuing the dream of homeownership. Examples include areas such as Temecula, Hesperia, Victorville, and Rancho Cucamonga. Once thought to be too far away from the hub of the city, are now home to hundreds of thousands of commuters that now own a home.

An interesting article appeared in the LA Times discussing the boom/bust of Salton City. This city is near Salton Sea over in the inland empire desert area of Southern California. Builders with the current run-up in real estate prices figured that those retiring will see this area as a Mecca of growth. Salton City decades ago was thought to become a large resort like area rivaling Palm Springs. Big names like Sinatra and the Rat Pack made the desert area famous and are booming to this day. But the sea did not boom. The salinity levels in the water are much too high for biodiversity and it turns out that you can in fact be too far from metro hubs. There is a limit to what people will drive. The California land mentality has taken hold many times and builders point to areas such as those in the inland empire that once were thought too far away, and now are thriving suburbs.

I’m not sure much thought was put into this land development. There is a point where working commuters will no longer travel. The breaking point seems to be about 2 hours each way. This part of the desert falls within that category. Homes are cheap in this area but you are in the desert where temperatures reach 120+ on hot summer days and you are far from any large metro area. If the argument is people will leave the area for more peaceful locations to retire, why won’t people simply move to Arizona or New Mexico where you get the same desert for hundreds of thousand less? After all, Social Security and other retirement funds are directly deposited into your account so you can retire anywhere. The money you save on your home, you can use at local airports to fly into the Southland should you need to (might even be faster than hitting the road). I’m not sure much thought was given to certain booming areas in California and other parts of the nation. They figured that if they built it, people would come. So much is based on the American dream of homeownership that builders believed folks would fork over 3 to 4 hours a day simply to make the mortgage payment. Many middle class Californians are voting with their feet and leaving the state to places such as Arkansas, Arizona, Oregon, and other diverse locations.

The argument has been made time and time again that we need more housing. This is correct. But the type of housing needed to support our population is high density affordable housing. Look at New York or London. The idea of a home on a large plot of land is nearly non-existent for the middle-class in these highly populated areas. Southern California will become that way or we will see a two-tier system solidly emerge; the lower and middle-classes paying rent or buying in the boondocks, and the upper-class staying put. Demand will be high in these prime areas because people are willing to pay to be near work. That is why I believe many of the 88 cities in Los Angeles County will decline in prices in the upcoming years while few select cities will stay put or even increase. Orange County will follow a similar path. When you factor in commuting cost and the median for LA County at $550,000 and Orange County at $635,000, you start to realize that most families simply work for their family and car with practically nothing left over at the end of the month.

Married to Debt

This seems gloomy but here is the good news. We love debt as a nation. Want to see the average and median on a few items? Take a look at this:

Average Wedding Cost: $27,000

Average New Car Cost: $30,000

Average New Home Cost: $236,100

Average American Credit Card Debt: $9,200

Average American Median Income: $46,300

The willingness to take on inordinate amounts of debt has also fueled the housing bubble. Given that our savings rate is negative, we are realizing that spending (via debt) is the way we keep the economy afloat. Whether people refinance their home or take money on through loans and credit card debt, consumer spending is by many estimates 70% of our economy. Now that credit is tightening up, we are seeing how quickly the economy is contracting. Many pundits are crying foul and blaming the Federal Reserve for spoiling the party. Yet we have set a standard that isn’t sustainable. I’m sure many of you saw the Saturday Night Live skit of debt reduction where they parody a commercial and a man comes out with a breakthrough idea, “spend less than you earn!” Somehow this idea hasn’t caught on. The fact that many Americans are locking themselves into 30 year mortgages in areas that will face market declines, will cause a negative wealth effect on the overall economy. Economics show that during recessions, people spend less especially if they perceive their employment being tenuous. This massive credit bubble will no doubt lead us to a recession because in reality, there is no other way out. We have few options. We can create more money by lowering credit rates thus fueling more spending via debt – with this the economy at least has the perception of staying afloat because spending is so vital to our growth. Or we increase rates, and flush out the excess credit. This will be a painful experience. The amount of credit through mortgage equity withdrawals, credit card debt, auto debt, student loan debt, is so incredibly high, any credit contraction will cause a major shift in the economy.

We are married to debt and seeing how expensive marriages are, we have put ourselves in debt for this matrimony. But one thing is more expensive than marriage and that is divorce. Soon we will face the divorcing of massive credit and it will be painful. It was fun while it lasted.

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