We think we climb so high Up all the backs we've condemned We face our consequence This is the beginning of the end
You wait your turn, you'll be last in line This is the beginning Get out the way, cause I'm getting mine This is the beginning
Nine Inch Nails -- The Beginning of the End
Back at the peak of the housing bubble, it was obvious (at least to me) that prices were too high and were going to crash. Some bears lost their conviction when the false rally of 2009 began, but prices were still too high, affordability was too low, inventory was artificially constricted, and the entire rally was dependent upon government props. With those headwinds plus an enormous shadow inventory to liquidate, there was little or no chance the 2009-2010 rally would be sustained.
Now, with the elimination of many government props, prices at rental parity, and affordability at decade-long highs, the direction of prices is much less certain. I still believe prices will decline for at least a year or two due to the liquidation of shadow inventory and the continuing weak economy. But I could be wrong.
What was most interesting to me when reading the comments on the recent post on Irvine affordability was the difference in opinions among the various astute observers. Most were still bearish, but some were bullish -- not stupidly bullish like many commenters over the last 5 years -- but thoughtfully bullish based on the improvement in conditions we are seeing now.
I selected today's featured article because Peter Schiff has been right about many of the conditions which contributed to the collapse of the housing bubble and the economy. Further, he knows quite a bit about the Orange County housing market, and is he is thoughtfully and unapologetically bearish.
Before Peter Schiff had a national reputation for calling the economic crash of last decade, he was a highly opinionated money manager from Orange County. (Recall his interview with us when he predicted home prices would fall 50%?) He’s returning to Orange County on Nov. 7 for an investment chat and Q&A at 6 p.m. at the Irvine Barclay Theatre. (Details here!) We asked Peter for his real estate outlook in advance fo his local appearance …
Us: Is real estate pain over yet in O.C. and/or SoCal?
Peter: No, it’s going to get worse. The current market is still being propped up by government-subsidized mortgages, artificially low interest rates, and a backlog in the foreclosure process. Prices will not bottom out until these props are removed and true market forces are allowed to clear the market.
IHB: Yes, I agree. In particular the backlog of foreclosures must be cleared out before we can be certain the market has bottomed.
In addition, the California economy is going to get a lot worse. More business will leave the state and more workers will lose their jobs. More people will chose to rent, and many that do will have to have roommates. The vast majority of new home construction is currently taking place in the multi-unit building category, which confirms this trend.
In addition, many unemployed homeowners may take in borders. College grads loaded up with debt and unable to find jobs will likely move back home with their parents. The elderly, stripped of interest income as a result of rock bottom interest rates and thereby unable to cope with rising costs of living will move in with their grown children. All of these factors will continue to put downward pressure on real estate prices for years to come.
IHB: If his macroeconomic call is correct, the housing market will continue to decline. New household formation is essential to a strong housing market. All the conditions Schiff describes above will hinder household formation and keep prices down until conditions improve.
Us: How bad could it get … again?
Peter: Ultimately it will get very bad. The market is already on life support, even with mortgage rates at the lowest levels in nearly 70 years. But imagine if rates rose to the levels they were at just five years ago, to say six or seven per cent? What will that do to property values? I think ultimately mortgage rates will rise farther, maybe even above 10%.
IHB: I have maintained that higher interest rates will work to pummel prices -- when rates finally move higher. Unless higher interest rates are compensated for by wage inflation, the higher interest rates will reduce loan balances, and in areas like ours which are inflated to the limit of income affordability, smaller loan balances will force prices lower.
At the same time, I think the California unemployment rate will continue to rise and taxes in California, will continue to go up. I also think there is a distinct possibility that the ability to deduct mortgage interest from personal income taxes will, at some point in the not too distant future, be curtailed or eliminated, especially for wealthy individuals. What do you think would happen to real estate prices under that scenario? Pretty soon you will not have to imagine this, you will be living it.
IHB: As we discussed yesterday, if the home mortgage interest deduction is curtailed or eliminated, prices locally will likely come down to adjust for the increased cost of ownership.
Us: Do you think the presidential political discourse will be a factor in the 2012 housing market? Why?
Peter: No, housing prices will decline no matter what happens in the election. There is still a large overhang of excess inventory. However, I expect housing and foreclosures will certainly be issues in the campaign. I would imagine that candidates will be looking to outdo one another on ways to bail out overstretched homeowners. Of course, anything the government does to interfere with the foreclosure process, to keep people in homes they can’t afford, and in which they have no equity, only worsens the overall crisis.
IHB: I totally agree with his assessment. The politicians will pander, and if they actually do anything, it will do more harm than good.
Us: Do any political proposals being floated right now stand out as extremely helpful or harmful to real estate?
Peter: Many are harmful. Even those that would help clear the market would mean that housing prices would go a lot lower. The solution to the housing problem can only occur with lower prices. High home prices relative to income are part of the problem, and keeping them artificially propped up only makes that problem worse.
IHB: This describes Orange County, but not Las Vegas. Prices are just now reaching the limit of affordability in Orange County whereas the cost of ownership is a fraction of rent in Las Vegas. In fact, Las Vegas is the example of what happens when prices are allowed to fall freely to reach their market clearing price. Prices there are very low, but the Las Vegas economy will not be near so burdened by mortgage debt in the future. This will have positive repercussions on the local economy.
The best solution would be a vibrant economy that creates productive jobs. We can only achieve that if we reduce government spending, repeal regulations, and lower taxes.
Us: If you had a magic wand and could do one thing overnight to help the housing market … what would it be?
Peter: Specifically for the housing market I would abolish Freddie Mac, Fannie Mae, and the FHA. Then I would reform the tax code to lower marginal rates and abolish the mortgage interest deduction.
IHB: All great ideas. This would eliminate all government subsidies in the housing market. It likely won't happen, but it would be the best thing for the housing market.
Actually, I would abolish the income tax completely, which would make the mortgage deduction moot anyway. If we do that we will have a free market in housing. That will lower prices, and produce a viable market. We will clear up the excess inventory, bring down housing costs, and remove the risk to taxpayers for future mortgage defaults.
IHB: It would also dramatically lower prices and cause the bankruptcy of most of America's banks. I love it.
The free market will make sure that only people who can afford houses buy them, and that there are adequate down payments product lenders in the event of default. At that point, prices will find a real and sustainable bottom. When that happens, the dynamics will change and homes will become a wiser purchase and home lending will become a profitable use of capital, even without government guarantees.
IHB: The housing market would survive the transition to a truly free market. Many loan owners wouldn't like the impact of prices during the transition, but the economy would be much better off without the various subsidies we currently have in place which only serve to inflate prices and shift the risk of loss to taxpayers.
The owners of today's featured property show why the FHA loan limits need to go down and why FHA insurance premiums are on the rise.
This property was purchased on 5/8/1998 for $312,000. The owners used a $245,000 first mortgage and a $67,000 down payment.
On 12/6/1999 they obtained a stand-alone second for $35,000.
On 4/10/2001 they opened a $60,000 HELOC.
On 8/3/2001 they refinanced with a $340,000 first mortgage.
On 3/20/2002 they got a $40,000 stand-alone second.
On 5/23/2002 they refinanced with a $400,000 first mortgage.
On 6/13/2002 they obtained a $20,000 HELOC.
On 5/5/2003 they got a $65,000 stand-alone second.
On 12/10/2003 they refinanced with a $478,100 first mortgage.
On 12/12/2003 they opened a $50,000 stand-alone second.
On 7/26/2004 they obtained a $78,000 stand-alone second.
On 3/17/2005 they got a $116,674 stand-alone second.
On 12/15/2006 they raided the bank for a $234,000 stand-alone second.
On 1/18/2008 they went back again for a $262,000 stand-alone second.
Their mortgage broker must love them. BTW, based on the behavior of these borrowers, do you think it would have been difficult for a lender to recognize these borrowers were Ponzis? Thirteen refinances in nine years! The total disregard of obvious red flags shows just how bad banking standards were during the bubble.
But it gets worse.
Despite the obvious signs of a Ponzi, the FHA approved a $677,407 loan to these people on 8/2/2011 -- just a few months before the conforming limit dropped. So how did these borrowers behave after they got their debt-consolidation loan from the FHA?
They opted to sell the house short. They are screwing the FHA and ultimately the US taxpayer -- you. I am forced to wonder if they even bothered to make a payment. The loan is only two months old. Given their obvious experience with mortgages, they probably made the first two payments to avoid being charged with mortgage fraud, so now after making the September and October payments, they are selling short.
The started with a $245,000 first mortgage, and now they have a $677,407 first mortgage. That's 432,407 in mortgage equity withdrawal. I wonder how they will adjust to life without a home ATM machine?
------------------------------------------------------------------------------------------------------------------------------------------- This property is available for sale via the MLS. Please contact Shevy Akason, #01836707 949.769.1599 sales@idealhomebrokers.com
Beds: 4 Baths: 2 Sq. Ft.: 2453 $275/SF Property Type: Residential, Single Family Style: Two Level, Cape Cod View: Faces East Year Built: 1978 Community: Northwood County: Orange MLS#: S677010 Source: SoCalMLS On Redfin: 4 days ------------------------------------------------------------------------------ This will be a DEAL for someone! Inviting curb appeal and a GREAT 4 bedroom floorplan with bonus room. Granite in kitchen, all baths and bar area. Kitchen features sunny breakfast nook, gas cooking and loads of cabinets. Low maintenance ceramic tile floors throughout downstairs living areas. Family room with cozy fireplace. 3 car garage and full driveway. Extra large backyard with room for pool. Slumpstone fence and over 10 fruit trees. One block to elementary school. Don't miss out on this bargain! ------------------------------------------------------------------------------------------------------------------------------------------- Proprietary IHB commentary and analysis
Resale Home Price ...... $675,000 House Purchase Price … $312,000 House Purchase Date .... 5/8/1998
Net Gain (Loss) .......... $322,500 Percent Change .......... 103.4% Annual Appreciation … 5.7%
Cost of Home Ownership ------------------------------------------------- $675,000 .......... Asking Price $135,000 .......... 20% Down Conventional 4.18% ............... Mortgage Interest Rate $540,000 .......... 30-Year Mortgage $130,065 .......... Income Requirement
-$432 .......... Tax Savings (% of Interest and Property Tax) -$753 .......... Equity Hidden in Payment (Amortization) $201 .......... Lost Income to Down Payment (net of taxes) $189 .......... Maintenance and Replacement Reserves ============================================ $2,565 .......... Monthly Cost of Ownership
Cash Acquisition Demands ------------------------------------------------------------------------------ $6,750 .......... Furnishing and Move In @1% $6,750 .......... Closing Costs @1% $5,400 ............ Interest Points @1% of Loan $135,000 .......... Down Payment ============================================ $153,900 .......... Total Cash Costs $39,300 ............ Emergency Cash Reserves ============================================ $193,200 .......... Total Savings Needed -------------------------------------------------------------------------------------------------------------------------------------------------------
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