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No Free Ride! Housing 2007 Recap. 3 Highlights: Subprime Implosion, Record Inventory, and Zero Appreciation.

The best things in life are free. Free hugs from family members. Taking a brisk jog on the coast. And being able to purchase a home for free? Well with zero down, all you need is a pulse and a valid Social Security number (sometimes not even that) and you are set to go. You’ve been given the green light for $500,000. No need to verify your income. If you tell Mike the broker that you make $100,000 a year you obviously make $150,000; come on, what’s $50,000 between amigos? As we approach mid-year, no longer are we hearing the incessantly Pollyanna housing bulls talking about 2007 being a rebound year. How can you rebound when the impact site hasn’t even been reached? Imagine a basketball rebounding half-way through a dribble and align this to the rhetoric housing pundits are pushing. The trajectory is already set and there is no stopping this silver gargantuan of a train from stopping.

In 2007 we’ve already seen major turning points in the housing market. Today I’ll discuss three major turning points. The first, is the implosion of the subprime market. When you have folks considered by the government to be in poverty buying $700,000 homes, we got some explaining to do. The next issue is record inventory and foreclosures. When you build crazy amounts of homes in a declining market what do you think will happen? Hint, 100 – 40 = a lot of extra homes not selling. And finally people realize that housing cannot appreciate 20% forever. In fact, housing can even decline! Trees do have a finite limit of growth. The eerie silence we are hearing is the pent up hope by housing pundits gearing up for the summer bounce which has occurred each summer since 2000. Anyone think that housing economist have a treatise on summer growth on their Vista desktop ready for dispatch once we have a minor increase in selling?

Subprime Quick and Dirty Exit

What happened to all the talk about the subprime implosion? I mean we are talking about $1 trillion in loan resets for 2007. During the first quarter of 2007 we saw absolute devastation in subprime lenders. Let us take a look at a chart below:

Even though subprime companies such as New Century Financial and Quick Loan Funding are pretty much down and out, they have set in motion a domino effect of housing implosion. Many subprime loans have 1 or 2 year teaser rates. We haven’t seen the full impact of this because even in 2006, sellers were able to unload homes once rates reset in a stagnant market. Many people were simply breaking even. Yet now that housing is declining and rates are churning up, what will happen? Well for one, those holding the bill cannot cover the payment and need to unload. Even though we hear many folks rattle off stats regarding record low interest rates, subprime borrowers pay much more above prime because they are subprime! It is the definition of the loan. Why would you give someone tagged as a risk a prime loan? The only way to cover potential losses is hike up the interest rate and charge front-end crazy points and fees.

The mortgage industry made a mint not only from first time buyers but serial refinancers. People saw their home more like a virtual ATM begging for withdrawals and not like a savings account. Lenders weren’t going to tell people that maybe it would be smart and prudent to save for a rainy day at the chance of losing a massive commission. Do you think this isn’t the case? Take a look at the savings rate:

In addition, the subprime loan was a necessary evil for the continued growth of a bubble already reaching the stratosphere. What closed the door on subprime lending? Wall Street essentially lost the appetite for these loans and suddenly started kicking loans back to lenders for violating minimum payment contingencies. Are you kidding? We have the story of the 102 year old man getting a 25 year mortgage. Yeah, I think Wall Street had enough at this buffet.

Record Inventory and Foreclosures

California is now experiencing record jumps in notice of defaults. Foreclosures are now becoming REOs like our previous Real Homes of Genius. Even in 2006, we weren’t seeing many REOs because most lenders were able to unload homes at moderate discounts before going REO. Not anymore. Plus, we still had the flittering flames of subprime keeping the market going last year. The party kept going even after the lights went out. But inventories are going up at a record pace. Pending sales are dropping like its hot. More homes + less sales = too much homes and record inventory. I’m surprised when I hear housing cheerleaders mention that rising inventories are a symptom of demand not realized. The underlying assumption here of course is that the public will get the memo and join the housing revolution and appreciation will start up again. Yet the game is imploding not because of this, but for the primary reason that you cannot build sustained growth on absurd and irresponsible debt. Have we forgotten our lessons with debtor’s prison? How can we blame individuals when our direct government is spending like Paris Hilton at Saks?

Record inventory and foreclosures may be the straw that breaks the proverbial camel’s back. In addition we have alternative media outlets. It is amazing that you have the power to find nearly any information on any topic instantaneously. You can read anything you want to read. Think the bubble talk is for folks with tinfoil hats? Simply read the NAR and CAR websites on a daily basis and you’ll be in propaganda heaven. Or you can go to simple blogs like the one here with citizens concerned about the massive credit bubble we are living in. It is hard to reconcile disciplined financial education with what is going on. I’m sure many folks feel the same way. But the majority of the public does not care about the housing bubble. Somehow those interested in being spectators have some vested interest either via investing, purchasing, schadenfreude, or career. After all, California has 500,000+ agents and many more working in lending, construction, and ancillary industries that rely heavily in the housing market. Q1 notice of defaults, that is letters sent to buyers before entering the foreclosure process, jumped an amazing 148% from last year. Q2 results are coming soon and I’m sure many are biting their nails anticipating the results.

Zero Appreciation (aka Bad Investment)

Would you invest in a home if I told you:

• It would not appreciate for 3 to 5 years
• You would pay anywhere from 50% to 80% more than an equivalent rental
• Had a high likelihood of depreciation in the immediate future

If you answered yes then you are the few, the proud, the last people to arrive at the party. No longer is housing going to see double-digit appreciation. No longer will you be able to use your home as the stepsister of WaMu. The well has run dry. I’ve even heard the new party line of many realtors. “Well, if you aren’t planning on selling in 10 years, then you’ll break even.” Say what!? Why not save for 2 to 3 years, buy a distressed property for 20 to 30 percent off, and have the sanctity that your largest asset isn’t tumbling like the Berlin Wall? It is almost like they acknowledge a decrease in price as a minor blip on the radar and appreciation like the best thing next to sliced bread. Housing is done for the near future. I’ve discussed the archaic and skewed stats of the median before. In fact, we may actually see prices move up because:

A: Higher priced homes are still moving

B: Lower priced homes that aren’t selling do not factor into the equation

C: Sellers are still in Wonderland holding out thus increasing inventory

D: Buyers are finally realizing $500,000 for 500 square feet isn’t a good deal

So what you have is a smaller sample size with top heavy assets moving. However I must point out that foreclosures and REOs will equalize this game quickly because they are not in the game of being landlords. They will sell and sell fast.

And as a final caveat, no investor out there has a crystal ball for the future. If that were the case, everyone would have bought in 2000 and sold at peak prices in 2005 and 2006. Wouldn’t we all like a time machine to jump on Intel or Microsoft right? Hindsight is always 20/20. However, there is one universal human certainty; everyone goes into investing to win. Just like every marriage that is consummated it is intended to go the distance. People don’t marry with the intent of divorce but it happens and it happens a lot. This is also the case with investing; you invest to turn a profit. Not everyone does. We have bull and bear markets. However there is a difference between investing and gambling. And not all people that bought in the last few years even care about housing prices; many have enough money that home prices can crater and they wouldn’t sell. The issue arises when massive economic disconnects occur in the system and the underlying asset is no longer reflecting a true return on investment. What are your thoughts for the remainder of 2007?

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Real Homes of Genius: Today we Salute you Lawndale. $529,900 to $454,900 in 2 Months. Breaking the Speed Limit of Cost Cutting!

Today we Salute Lawndale with our Real Homes of Genius Award. Let us become familiar with an acronym that we will be hearing about for years to come, REO. That is, Real Estate Owned. This means a property that goes back to the mortgage company or bank after an unsuccessful foreclosure process. As we can see from this exhibit, we have financial institutions deciding that they will jump in the river of denial with many current sellers. As in Shakespeare’s A Midsummer Night’s Dream, we have a bunch of nut jobs running around the forest wanting things they cannot have. Hermia refuses to marry the man her father has chosen and runs off with her lover Lysander to elope. I am not going to turn this into a literary analysis but suffice it to say that we have a play with many people running around in a drug induced Wonderland. Does this sound familiar? Can you think of another environment where people are delusional about their expectations?

Whatever happened to the “summer bounce” or the “spring bloom” that many housing pundits had promised? Can it be that the piper has finally played his last tune? Let us look at this 1,437 square foot home with 3 bedrooms and 3 baths. When you envision lifestyles of the rich and famous doesn’t this spectacular home come to mind? Like swimming in the public pool, this aqua colored trophy is set to entertain. The borrower converted the garage into a family den. Ergo it is worth nearly half a million dollars. Logic is a blast isn't it?

When we talk about foreign cars going from zero to sixty we get a sense of thrill in our gut. Red Ferrari Enzo’s that hum like exotic birds only to be crashed by Eddie Griffin for a charity event promoting Redline; a film funded by the now infamous Quick Loan Funding high roller, Daniel Sadek. The film was a bomb and apparently, his company is following the same fate as the Ferrari. Let us dig deeper into the history of this home:

Sale History

02/16/2007: $438,847

11/29/2004: $465,000
09/09/2002: $216,000

What do we have here? Can it be possible that we are back to 2004 prices? Like Wal-Mart, we’re rolling back the prices apparently. Blasphemy you say! How can an architectural masterpiece like this be worth any less than the peak price? Well let us take a look at rental rates in the immediate area:

We find that the median rent in the area is $2,200. Moreover, the monthly carrying cost for this place, at the current asking price is approximately $3,500. So a difference of $1,300 a month. Banks unlike sellers do not have the luxury of holding onto property for eternity until reality meets their hallucinations. Let us see what a motivated seller looks like in full action:

Price Reduced: 04/03/07 -- $529,900 to $499,900
Price Reduced: 04/25/07 -- $499,900 to $491,900
Price Reduced: 05/23/07 -- $491,900 to $454,900

Now we’re talking! In two months we have a $75,000 discount not including the sacred 6% agent commission. Why would you buy now when the momentum is clearly on the downside? Foreclosures may be the X-Factor in breaking the stalemate we’ve been in for countless months. The bank is not a property manager. They are not Robert Kiyosaki looking to rehab the place and flip-it to showboat on HGTV. They need to unload a costly asset from their books as soon as humanely possible. California carrying costs are not Ohio carrying costs. That is, each home the bank now owns has the weight of Atlas carrying the world. They unload now or bleed fast. Let us take a look at current foreclosure rates in Southern California:

California Statewide

2006 Q1 Notices of Default: 18,856

2007 Q1 Notices of Default: 46,760

That is a whopping increase of 148%. With inventories rising and pending sales dropping, the market is quickly becoming a buyers market. But why listen to the facts? Go out and buy this house because this price won’t last! Contrary to reason, trends, and everything rational this house makes perfect economic sense.

Today we salute you Lawndale with our Real Homes of Genius Award.

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Comparative Analysis of 3 U.S. Cities: Contrary to What Your Parents Told You, Not all Bubbles are Created Equally.

As we are witnessing the mortgage debacle unfold in California, there are other parts of the country that felt very little impact by this seven year credit bubble. For the most part, this bubble has been isolated to coastal metro areas. Not uncommon in beach locales, housing in prime locations always yields a commanding price in the market. But to what extent? Actually to the extent the market can sustain the price, sellers will ask for Pollyanna if they have the inclination they will get it. Yet this desire for higher and riskier mortgages has added fuel to a housing craze unparalleled in history.

While the belief is that housing appreciated independently of any crutch, that is the crutch of the Federal Reserve and absolutely irresponsible mortgage lending, housing is vastly overvalued in many areas. This seduction of pseudo-wealth based on debt is slowly unraveling; if anything this is a policy that the current administration seems to champion. Do things quick, fast, and dirty without any regard for future ramifications. Debt does need repayment and actions in life do have consequences much deeper than the instant gratification of buying a McMansion, loading up the box with a Plasma, and then having your Benz in the driveway. After all, you being a debt slave doesn’t matter so long as you have the illusionary item in your possession. Ironically, the majority of the public rents these high priced items yet calls it ownership. True ownership comes from wealth yielding assets. Last time I check a leased overpriced luxury car does not throw off a monthly check. Debt is a form of slavery yet we equate this in modern society in some dejected form of wealth and status. Run national deficits to the point of bleeding rivers and let our kids and grand kids pay for it. Smart.

Today we will examine three cities, from coast to coast, and even in the heartland showing three very different environments in one nation. We will look at Los Angeles, West Palm Beach, and Memphis. After looking at these places in detail, we will realize that the housing craze was based on isolated pocket epidemics in metro areas that seemed global. While the reality is, many metro areas remained immune from the bubble and are actually fairly priced. However as most bubbles get out of control, they create a halo effect dragging all surrounding webs into its self implosion and ultimate pop.


#1 – Los Angeles (Code Red on the Bubble Scale)

Current Median Price: $565,000
Current Down Payment: $113,000
Current Income: $53,389
Payment/Income Ratio: 212%
Current Annual Mortgage Payment: $33,080
Current Mortgage Payment/Income Ratio: 62%

The city of glamour and glitz. The heart and epicenter of the housing mania. Fast money and fast cars. This is Hollywood baby! We even have the financier of the massive blockbuster bomb Redline, Daniel Sadek going belly up with his company Quick Loan Funding. Over 5 years Quick Loan issued $3.8 Billion in loans. Once with a staff of 700 he is now down to 125. His company is not the only one. We also have New Century Financial and their historic shenanigans that make Enron seem like a Girl Scout party. Los Angeles and Orange County are different beast. If you look at the above data for Los Angeles, you find that payment to income ratios are so out of whack, that ratios for LA are in the 212% range. After all, if the current metro median income is $53,389 and a median home is priced at $565,000, you don’t need to be a mathematician to figure out that you will not be able to comfortably afford this place. In addition, with tested ratios of 30%, housing to income cost were closely monitored by banks, yet we are now seeing ratios of 62%! Essentially if you want to play the housing game in LA you will be owned by your primary residence.

In Los Angeles we are in Wonderland. No need trying to apply economics to something driven by greed, corruption, and rules that are so inconsistent that you would think Angelie Jolie was a stable personality. A recent study by the L.A. Times found that 50% of stated income loans were overstated by 50%. And given the massive number of exotic loans, is it any wonder why these numbers are skewed? A lie built on a lie cannot stand on truth. Eventually reality does chip away at the cement of deception and this bubble and credit malfeasance will end.

#2 – West Palm Beach (Code Yellow on the Bubble Scale)

Current Median Price: $315,000
Current Down Payment: $63,000
Current Income: $55,319
Payment/Income Ratio: 114%
Current Annual Mortgage Payment: $18,443
Current Mortgage Payment/Income Ratio: 33%

Our next area takes us to West Palm Beach. Looking at the above data, we are still in a bubble but relatively minor compared to California. At this point, tens of thousands of dollars are thrown around like flies in the summer sky. Here at least we see a payment/income ratio nearly half of what it is in Los Angeles. Income is actually higher in this area and you still have sun and beaches. No protest there. The payment/income ratios seems to be in line but why is this area in a bubble? Because rents are vastly cheaper than a mortgage payment. Where you can rent a condo for $1,200 you will be carrying $2,200 in monthly mortgage cost for the same place. In addition, Florida is vastly over built and has created a quicker breakdown of housing prices than in California where archaic laws and regulations make it hard and profitable to create high density affordable housing which is needed.

Again Florida is no stranger to massive land and housing speculation. In the 1920s Florida was the main destination for people trying to escape the cold (sound familiar?). The population was expanding and housing needed to grow. Anecdotal examples given are land that was bought for $800,000 one year, would be sold the next for $4 million before crashing to pre-boom levels. Again, once everyone had the perception that land would go down the bubble burst with panic selling. Yet most savvy investors and those with common sense smelled this and jumped ship leaving the bag held by novice amateurs (which at that time was a large portion of the local population). How many speculators do we have in 2007?

#3 – Memphis (Code What? Bubble What?)

Current Median Price: $144,105
Current Down Payment: $28,821
Current Income: $44,006
Payment/Income Ratio: 65%
Current Annual Mortgage Payment: $8,437
Current Mortgage Payment/Income Ratio: 19%

Finally we arrive at Memphis Tennessee. A large city with 680,768 people, this is no little city and has plenty of economic diversification. For those of you only confined to the coastal regions I suggest for your own sanity to take a trip to numerous metro areas in the heartland and you’ll quickly realize that bubbles are very much local yet when they pop, they impact everyone. When we look at the median price of $144,105 we suddenly have images of Real Homes of Genius but we are actually talking about nice family starter homes in safe areas with good schools. This may sound like Latin to most readers of this blog but housing and speculation follows the quick and easy money. Much has been said about cultural differences even within our own country. For instance, the prevailing Southern California professional culture is all work and pure play. Balance in life seems to be an exercise in futility. And any new family buying a starter home is driven by this because of the gravitational pull of a massive mortgage. Even Newtonian physics has something to say about this; the larger the mass of an item the stronger its pull. With all the massive mortgages being issued I’m surprised the Earth isn’t shifting out of orbit.

However Memphis characterizes many areas where this housing mayhem is something of a spectator sport. They have pockets of overpriced homes but aren’t housing obsessed like those in high priced areas. We need to keep this in mind because our immediate area tends to be the epicenter of the universe. What we do, eat, and breath tends to be generalized to the whole. Yet taking a brief trip to other metro areas you will quickly understand basic tenets of this housing bubble. I recommend new readers to click on one of the four housing article buttons to the left sidebar to get a quick and fast education on the many angles and future impacts of this credit orgy. Even if you aren’t in a high priced area, you will be impacted. And all of us here in Southern California are all too familiar with the 500 square foot box for $400,000. It has become our credit induced hallucination of what constitutes a starter home.

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