Recently in Current Market Category

I've seen more changes in the lending industry in the last six months than the previous five years. But those changes simply restored us to the place we were a few years ago.

Loans are easy to get, rates are good. For all the howling and gnashing and grinding of teeth you see in the media, and elsewhere, I can get loans at rates that are very low, historically speaking. I can get 100% financing quite easily, and not just government programs, either.

You just have to be able to prove you can afford the payments.

Actually, let me modify that. You don't have to prove you can afford the payments. You can get "stated income" and NINA financing. There's actually quite a lot of it out there, and the rates have even fallen a bit in the last couple weeks. The lenders are perfectly willing to make stated income and NINA loans. Want one? I can get it, even A paper, provided you've got the credit score.

You just have to have enough equity that the lender isn't worried about losing the money they loan you.

All you need is one or the other. And that's the rub. Starting a few years ago, and increasing until the house of cards started collapsing back in the beginning of the year, many real estate agents and loan officers stopped worrying about whether or not their client could really afford the property. The question was could they get the loan funded, and let the client worry about whether they could really afford it later.

The relaxation of lending standards was like manna from heaven to the less ethical members of my professions. Agents could sell people who could barely afford a condominium in reality a beautiful huge detached house with its own yard in an affluent community with great schools, and loan officers could make it look like they could afford the payments. Talk about your easy sale! The clients expect a chintzy little condo in a rough neighborhood, and the agents shows them a beautiful five bedroom home half a block from the beach, and says they can get it for the monthly payment they told the agent they could make. Prices skyrocket! People who bought a couple years ago and are strapped for bills refinance into these ridiculously low payments while getting cash out for all of the toys they can imagine! New SUV? How about two new SUVs! Some loan officer needs to get paid for a loan, and everybody has a thirty year fixed rate loan they got in Summer 2003 at 5.25%? Offer to cut the payment in half!

Never mind that the real interest rates on these loans was much higher. People just naturally assumed that if they kept making the payments, they'd pay the loan down, and eventually, off. After all, that's what loans are! Except that wasn't the case in this particular instance. That small minimum payment, way below the real cost of interest, caused thousands of dollars to be added to the loan balances, where the above market interest rate could be charged on that money also - and the lenders could report all of this as income, doing wonderful things for their revenue and stock prices!

Some others may not have gone in for negative amortization loans in a big way. Instead, they put people into "interest only" loans where the loan and interest rate was fixed for two, or maybe even three years. They may have used stated income, or they may not, but they put people in unsustainable loans where the clients could barely afford the initial payment, and never mind thinking about what would happen, sure as gravity, when the adjustment hit. When the loan started to amortize at the same time the rate jumped by two percent, they affect to be somehow surprised that their former clients cannot afford the payments!

Or perhaps they used stated income only because the clients had two thousand dollars of other debt service per month. Well, hello! debt to income ratio is the most critical measure of whether someone qualifies for a loan there is. It protects the lender, and it also protects the borrower, and this intentionally short-circuited it. Yes, they could have afforded the property if they didn't have have this debt. It's not a distraction, it's the central, single most important issue in whether or not they qualify for that loan!

For those who were taken advantage of thusly, may I recommend finding a competent real estate attorney? The last few months have seen some very interesting court decisions. One in Ohio started it off by ordering a negative amortization loan rescinded due to failure to disclose its nature sufficiently. There are all kinds of class action suits going on, which may be the first worthwhile use to which I've seen them put in twenty years. I would not be surprised at all to see some real estate brokers successfully sued over basically the same issues (actually, I'm anticipating it with a fair amount of schadenfreude), and I also expect the regulators to get pretty heavily involved. Licenses are going to be lost, and even a few jail cells are going to be filled.

All of that is neither here nor there, really. My point is that the only thing that's changed is that the lenders have woken up to the fact that was evident all along - that they were the "deep pockets" who were liable to eat most of these losses from the price collapse, and from people who couldn't make payments on unsustainable loans, particularly after the payment started adjusting. The lending standards that contributed to the bubble are gone, and they are not coming back any time soon. Forget about them. That was then. This is now.

The lending standards in effect now are very livable. Bankers transported from the seventies - or even the early nineties - would be horrified at how lax they are. Until 1997, there was precisely one lender that would loan 100 percent of the value of the property (when they bailed out of the 100% loan market in late 2005, it was the first sign that collapse of the lending market had actually started). I've still got at least a dozen lenders who will go 100% now, but they want to see proof you can afford the payments. Failing that, they want to see enough equity (which means down payment in the case of purchases for you real estate agents reading this), so that if the loan were to go south, that lender would still get their money.

This means real affordability and down payment have become a lot more important to the purchase market, and if you're looking at a refinance, you had better be able to afford the real payments. If you can't, you better have equity. If you don't have either, that refinance is not going to happen. I just checked two wholesaler databases, and neither one had a 100% stated income loan, even with verified asset reserves.

If, on the other hand, you're willing to restrict yourself to properties you can really afford, welcome to ownership! As I've said, I've got any number of 100% loan to value ratio programs if you'll do this, and have credit that isn't putrid! As I covered a few weeks ago, affordability has increased a lot, and that's just judging by asking prices. When you judge by actual sales prices, things are more affordable yet!

The catch is that if you can only afford the payments on $300,000, then $300,000 is all you're going to be able to borrow. I've been selling my clients what they can really afford all along - the only difference it makes to me is that I'm no longer competing with the jokers that can only sell houses by showing clients the beautiful property they can't afford. I've been telling people about real, sustainable loans all along. The only difference this makes to my loan business is that I'm not competing with jokers who sell negative amortization loans by the minimum payment to unsuspecting people who don't understand what's going on.

What this means is that lazy agents and loan officers are going to have to bite the bullet and sell the client a property they can really afford with a loan they can really afford. Agents can have people make offers on property they can't afford, but they're wasting their time and the clients'. Loan officers can tell people about this loan and that loan they used to have, but they're wasting their time and the clients'. Possibly the clients deposit, inspection, and appraisal money too, in both cases. The loans to make this nonsense happen do not exist any longer.

On the other hand, 100% financing still exists for those who can afford the payments. But they have to be able to actually afford the payments. This means working within a budget, and settling for what you can afford within that budget. Settling is a very hard message to send someone who's going to be spending six figures on a property and is all emotionally tied up with how they want it to be beautiful, and in a great neighborhood with wonderful schools and all of the usual things that have buyers gushing - particularly when everyone else is telling them they don't have to settle. They really did have to settle, all along, and those that believed ethical practitioners when they were told that are doing just fine, thank you, while those who didn't are in real trouble. The real world has come crashing back into real estate. The fantasy may have been nice while it lasted, but the real world always comes crashing back.

Among those real world facts that have come crashing back is that all of the long term benefits of owning over renting are just as real, just as relevant, and just as true, as I painted them back when I wrote those articles. Let's review a few:

Should I buy a Home?, Leverage in Real Estate - Making a Decent Investment Spectacular, Why Renting Really Is For Suckers (And What To Do About It) (and its counterpoint, When You Should Not Buy Real Estate), Save For A Down Payment or Buy Now?, The High Cost of Waiting To Buy A Home, Real Estate: Getting From Where You Are To Where You Want To Be.

My local market in San Diego County has been on the bleeding edge of all of this, because it's such a desirable place to live, and our housing supply is probably the second most constricted in the nation (after Manhattan, and although the City of San Francisco also has a decent claim it covers a much smaller area). Between natural obstacles to growth and zoning codes constricting the building of new housing, I think we've had about all the downwards adjustment we're going to get. If you can't afford to buy a detached house, buy a condominium, townhome, or PUD (indeed, how dead the condo market has been the last three summers has been directly attributable to two factors: Over-conversion or apartments, and the fact that lazy agents were selling people properties they couldn't afford because it was easy), or think seriously about moving out of town, because with the number of people who want to live here, it's only the current meltdown in lending that's causing the hiccough in prices (and what effect do you think over-conversion of rentals will have on the rental market?). With local housing demand trends going the way they are going, even the prices at the peak of the bubble two years ago are going to look pathetically cheap in a few years, and that's pretty much the facts of the matter, albeit perhaps not so strongly where there's still room and the building codes to allow growth People are able to qualify here locally. Right now, the only thing preventing them is irrational Fear and Greed, exactly opposite to but caused by exactly the same psychological factors I wrote about in February 2006, back when everybody else thought the market was still going gangbusters, and updated here. But psychological fear and greed are difficult to maintain. It's not going to be very much longer before people figure out, en masse, that the economic basis is there to support those few sales that are actually happening. Actually, the economic basis is more than there to support current prices - I'd look for a significant bounce in prices next spring and summer, and even if I'm wrong about the exact timing, the price turn-around is coming. Buy something you can really afford, and be ready to see it increase in value.

If you buy something you can really afford, the moderate increases in value I expect to see will leverage your money favorably, such that you will be better able to afford something more expensive, more quickly, than if you saved your money, even if you invested those savings in the stock market. Even if you never move up, the fact that you have fixed your costs of housing now means that if you can afford those costs now, you will be even better able to afford those costs in the future, assuming inflation and all of those other economic factors we've gotten accustomed to these last fifty years. Homes are not going to continue at today's prices any more than candy bars are still ten cents, or that you're going to be happy working for today's wages thirty years from now. What's going on right now is an opportunity for buyers, and an opportunity for those who would like to be able to continue to afford to live here for the rest of their lives. If you decide to wait until event prove me right, that's your prerogative, but neither I nor anyone else will be able to bring the market back to today's state. The moving finger writes and moves on.

Caveat Emptor

Let's consider where the rates are: Ever so slightly higher than a year ago. With the Fed boosting liquidity and cutting their short term rates, I expect this to change rapidly, but let's take a look at the actual cost of money on sustainable loans - those same boring thirty year fixed rate loans that ethical providers have been pushing this whole time, rather than the negative amortization loans that has a low payment for a few years while the principal keeps going up every month - just long enough to put you into financial purgatory or worse for the rest of your life. When the forty to sixty percent payment increase hits for those or a short term interest only loan, you're hosed, because if you didn't need all of those tricks to qualify for the loan, you could have had a solid, sustainable loan at a lower interest rate.

One year ago, for one total point retail, I had a thirty year fixed rate loan at 6.00 percent for loan amounts up to $417,000, and not exceeding 80% of the value of the property. If you had credit that wasn't too far below average, you could get a second mortgage back then for the remainder of 100% financing at about 8.25%. Nowadays, second mortgages to bring your CLTV up to 100% just aren't available, so until this changes, if you want financing over 90% of the value of the property, you're probably stuck with Private Mortgage Insurance for a while. In all of the below cases, the best loan for 100% of value I could get right now was a 6.25% 30 year fixed with Private Mortgage Insurance (PMI) of just barely below 1%, which I'll call 1%, until such time as you've got 20% equity. Before I go any further, I want to emphasize that if you don't need 100% financing, all of these current properties are even more affordable now as compared to then. If you could put 10% down (or more), you'd come away a lot better! But the object of this exercise is to shine the hardest, most unfavorable light on today possible. I'm going to assume all monthly homeowner's insurance is $110, either then or now, and I just went through my usual area of operations and found the first 10 properties that were on the market both then and now. Nor am I going to use any qualifying tricks like a Mortgage Credit Certificate or any other form of buyer assistance. These are qualifications for straight up A paper loans with average credit scores, doing it all completely on your own.

Exhibit 1: I noticed it early in the spring of 2007, when it was priced at $399,000. I thought it might be worth $340,000 back then. Now, it's priced at $324,000. (This article should also serve as a warning to owners of the dangers of overpricing the property, especially when you first put it on the market). Monthly Income to qualify then: $6810, now: $6027, an 11.5% decline.

Exhibit 2: This sold in June 2006 for $445,000. It's on the market for $375,000 now, and they're not going to get anything like it, but I've got to be true to my assumptions. Monthly income to qualify then: $7567 Now: $6938, a decline of 8.3%.

Exhibit 3: This is a very nice property I noticed in March when it had a $515,000 asking price on it. I thought it was maybe worth $470,000 then. Now, the asking price is $420,000. Monthly income to qualify then: $8,719. Now: $7,687.59, an 11.8% decline.

Exhibit 4: This is a nice older home on a good size lot with mature trees. It expired last December at $440,000, and I thought it was maybe worth $410,000. It's back on the market now for $380,000. Monthly Income to qualify then: $7,485. Now: $7,027, a 6.1% decline.

Exhibit 5 Is an older home in a really nice suburb. It was put on the market for $440,000 in August of 2006, and if they'd priced it just $10,000 lower, it probably would have sold then. They just put it back on the market for $410,000. Monthly income to qualify then: $7,469. Now: $7,563, a 1.3% increase, due to PMI being more expensive than second mortgages.

Exhibit 6: This was a blue collar redneck neighborhood when I was growing up. Now it's suburbia. It was priced at $470,000 last summer, and was probably worth $440,000 and would have sold for $420,000. Now it's a severe distress sale at $350,000, with the trustee's sale coming any day. Monthly income to qualify then: $7,962. Now: $6,492, an 18.5% decline.

Exhibit 7: This property really does have a nice view. When I first noticed it last year, it was on the market for $499,000 and the agent didn't want to let me preview it even though it was empty. "Bring a client, or not at all," she told me. I told her "then not at all," and my clients ended up with a much nicer property. It's gone into escrow and fallen out twice, but the agent doesn't know a qualified buyer from a hole in the ground, either. It's now on the market for $395,000, and they might get $370,000 if they're lucky, but we're still going to use the asking price for comparison. Monthly Income to qualify then: $8,390. Now $7,295, a 13.1% decline (Meanwhile, the owners are out over $40,000 cash - not exactly a sterling performance on behalf of the agent).

Exhibit 8: Post Probate estate sale in a neighborhood with pretty darned good schools. The heir owns it essentially free and clear, but I first noticed it priced at $480,000, and thought it might have sold for $420,000 then. Now it's priced at $400,000, and I would be astonished if they came within $20,000 of that. Monthly Income to qualify then: $8,143. Now: $7,384, a 9.3% decline.

Exhibit 9: This property gets some significant freeway noise, but the previous owners sold it to someone through Dual Agency about a year ago for $585,000. No way was it really worth anything like that, even then. Maybe $470,000 at the most, but it was marketed on the basis of payment on a negative amortization loan, and a sucker walked into the trap. One hopes regular readers understand by now why I keep saying to Never Choose A Loan (or a House) Based Upon Payment. If I sound like an infinitely repeating loop on this point, you should understand why. Now they're in foreclosure, and the property is on the market again with an asking price of $425,000, which they're not going to get with a recorded Notice of Default. Monthly Income to Qualify then: $9,871. Now: $7,830.38, a 20.7% decline.

Exhibit 10 is the star of the show, a relocation company owned property originally priced at $530,000 in summer 2006. I noticed it back then, and thought it was worth every penny at the time. Actually had a client offer $490,000, and they blew us off without a counter. We were within 10% in a very strong buyer's market, so this was pretty silly. My client found just as good of a property, and now the asking price on this property, which has been on the market the whole time, is $450,000, which I'll bet you they're not going to get. Monthly Income to qualify then: $8,966. Now: $8,277, a 7.7% decline.

Average the monthly incomes to qualify a year ago, and you get of $8138. The average now is $7252, a 10.9% decline. It's not like they're making a whole lot of new properties around here. Indeed, the easiest place to find a buildable lot is by tearing down an older existing structure.

These are not really "starter homes." Those are condominiums, these days. These are homes that are really priced for families that have owned condominiums for several years and been well started. Many people may want to move directly into a single family detached home, but most lack the necessary self-discipline. And yet, you can now afford them, with no down payment, with a family income not much over the area median income of $5408 per month, provided you have lived within your means otherwise. If you have a 10% down payment, they become more affordable yet. Even if you don't, as soon as you've got enough equity to get rid of PMI, things become more affordable yet. A few days ago, I found a nice solid four bedroom home that a family making $5000 per month should be able to afford on a currently available thirty year fixed rate loan, in a pretty decent area with above average schools.

My point is this: The days of only 9% of the population being able to afford a single family home are behind us. Rents are experiencing upwards pressure like they haven't seen since the early 1990s, as those people who bought too much home with a loan they couldn't really afford lose them and now have to fit into rentals. Where before landlords didn't want to raise the rents because their tenants would buy, now the people who are looking for rentals have hosed their credit and do not have the option of buying, and will not for several years. The supply of rentals is just as constricted as ever. Last summer the vacancy factor was 3.4%, tight enough in any market. Now it's even lower. I just did a search, and the vacancy factor as of a few days ago was down to 2.6%. Increase the demand side of the equation while constricting the supply, and what happens to price, aka rent in this situation? Add that to the fact that landlords now have to make the cash flow work, as the ability to flip for a profit in a year has dried up, and you have even more upwards pressure on rental rates. Landlords can not only get it, they need it.

Purchasing housing has become much more affordable in the last year. Furthermore, upwards pressure on the price of rentals is increasing, as I have repeatedly predicted over the last year or so. With the federal government looking like it's ready to take over all the bad loans the lenders have made, I wouldn't expect the market to get significantly lower than it has already gotten. Furthermore, another point I and others have repeatedly made is that San Diego has just about saturated its natural and legal boundaries. There isn't a whole lot of dirt left to build more homes upon. It's still a rotten time to sell, but if you have a desire to own the property you live in here in San Diego, I would start looking right now. Because unless something about the situation changes for the worse, I think the market is going to turn from buyers to sellers in the spring of 2008.

Caveat Emptor

My answer is yes.

National Association of Realtors is very proud of their sponsorship of legislation to keep lenders out of the business of real estate. They quote the legislation keeping banks out of the real estate business as being one of the reasons they're worthy of our dues money. They quote all kinds of justification, centering on the fact that they fear that the banks would "drive all the independents" out of business.

Folks, the vast majority of market share goes to a few big chains. You've heard the names. You know who they are. One belongs to one of the world's biggest financial corporations. Four of them, that most people think of as being competitors, are nothing more than different brands owned by the same company. On that scale, independents like the one I work for - thousands of brokerages nationwide, some of them in multiple locations - account for a grand total of about fifteen percent of market share, last I checked. The big national chains get the rest. They're just as corporate as the lenders, and they're anxious to protect their turf from the one group of potential competitors who have some kind of understanding of the business and otherwise low barriers to entry.

In fact, the lenders would compete primarily with the chains. Corporate marketing channels all look remarkably similar, and reach pretty much the same audience. Sure, lenders would probably take some transactions I'd otherwise get, but most of what they'd be getting would be feeding off fellow corporations. If you're the sort of idiot who believes that Major Chain Real Estate is better because you've had their television commercials tell you so, you're also part of the lender's target market.

Now, let me ask about the interests of the consumer, which are supposedly paramount. Our current system amounts to an oligopoly, controlled in fact by fewer than ten chains who can easily control the market, and practices of everyone, based upon what is in the best interest of those chains. How many lenders are there? I know I've done business with dozens, and even if the current meltdown ends up shaking them out to the point that there are only a couple dozen holding corporations, that's still expanding the choices of this sort of consumer by a factor of three. Furthermore, because there are more corporations in the power circle, it becomes easier to get one (or a few) to break ranks, and harder to get all of them to agree to protect each other.

Let us ask about real estate which has become owned by the lender. Why should lenders lack an ability shared by every other citizen, resident, illegal alien, and even people who have never set foot in the country - the ability to sell their own property? There's no requirement for anyone else to use an agent. It may be smart to use an agent, but everyone else has the legal right to go it on their own. Why not lenders?

I'll tell you why. Because not only would lenders being able to get into the business threaten the interests of the major chains that control most real estate, but this requires lenders to pay those same firms money if they want to get the property from their bad loans sold - and they need to get the property sold.

I have to admit, I'm not exactly eager to compete with yet more big corporations with huge advertising budgets. It remains the right thing to do. Right for the industry, and right for the consumers. As I've said many times before, rent-seeking is repugnant, and that's what NAR is doing - seeking rent from lenders who are not permitted to be in the business themselves.

Mortgage brokers have been competing successfully with lenders for decades, to the benefit of consumers. There's no reason real estate brokerages can't.

Caveat Emptor

(I do use one piece of non G-rated language below. I hope you'll agree with me that it was necessary to convey the proper sentiment)

USA Today had an oped, "3 ways to help borrowers without bailing them out"

Their suggestions?

Bankruptcy reform. About the only debt a bankruptcy judge can't modify is a home mortgage. Borrowers used to get into trouble not because of unsustainable mortgages, but because they lost a job or got ill. Now homeowners commonly fall behind because they can't keep up with their mortgages. Bankruptcy judges should get more latitude to rework mortgages along with other debt.

That's because it's a secured debt. Indeed, it's a debt secured by a specific asset.

Indeed, mortgages on owner occupied property are already subject to more and stronger protections than any other kind of debt. It takes a minimum of just under 200 days for a foreclosure to happen in California, and we're one of the shorter period states. Notice of Default can't happen until the mortgage is a minimum of 120 days late. Once that happens, it cannot be followed by a Notice of Trustee's Sale in fewer than sixty days, and there must be a minimum of 17 days between Notice of Trustee's Sale and Trustee's Sale. Absolute minimum, 197 days, and it's usually more like 240 to 300, and it is very subject to delaying tactics. There are lawyers out there who will tell you if you're going to lose your home anyway, they can keep you in it for a year and a half to two years without you writing a check for a single dollar to the mortgage company. It's stupid and hurts most of their clients worse in the long run, but it also happens. Pay a lawyer $500, and not pay your $4000 per month mortgage. Some people see only the immediate cash consequences, and think it's a good deal.

While all this is going on, the mortgage company is losing money. That money isn't free to them; at the very least it has opportunity costs - other things they could be doing with the money and earning a profit. But lenders are paying a daily fee for almost every penny in their portfolio. They make money off of the spread between what they pay and what they earn. But if their earnings are zero for this particular debt, they're losing money on this particular debt, and they've got to make it back elsewhere - which means that everyone who doesn't default is paying a premium on their loans for everyone that does. This would cause future mortgage rates to rise, further exacerbating the decline in housing values and putting even more people into trouble. If you don't understand this, you need to go back to high school or read an elementary economics text.

Now allow bankruptcy judges to play with mortgage indebtedness, and there just isn't anything they can do that doesn't result in the lender losing money involuntarily. This is a government taking of private property, explicitly and without possibility of exception for private use. Anybody remember the Fifth Amendment? If it doesn't protect all of us, it doesn't protect any of us. The Kelo decision, which generated a huge flap, at least had a public entity taking title before deeding it over to a private developer. None of these cases would have even that fig leaf. Not to mention that in many cases, the lenders themselves are victims of fraud to one degree or another. In a large fraction of these cases, the borrowers and loan officers were assisted by the lenders employees and policies, but in others they weren't and the lender is just as much a victim as someone who's been mugged - and now we want them to get mugged again by the legal system?

A few more things on this topic: Real estate, being for high dollar amounts, is one of the most profitable targets for scams and confidence games. I can see the general outlines of half a dozen scams that would be enabled by giving bankruptcy judges the ability to modify mortgage indebtedness. I mean legally. Most people wouldn't do it to start with, but the temptation of having your mortgage debt legally reduced, or the payments that go with it, would quickly become very attractive. Get your mortgage debt reduced by $100,000 because that's what you can afford to pay and now you can turn around and sell for a profit. Get your mortgage payment permanently reduced from $4000 to $2500 per month, and either you have a negative amortization loan imposed by judicial fiat, or you have a loan that the lender is stuck with that's only worth about sixty percent of its face value. Especially given the general non-enforceability of "due on sale" clauses, this is not only taking property from the lender, but it's essentially going to require them to hold it for the full term of the note, as nobody in their right mind is going to want to refinance or pay that loan off. Net result: everyone starts working these scams. You think the situation is bad now? If the lenders were subjected to that, rates would go sky high, minimum down payment requirements would skyrocket, and housing values would crash worse than stocks in the period 1929-1932, because nobody would be able to get a loan on any sort of terms even vaguely comparable to what we've got now. We'd have people putting their houses on credit cards, not only because the rate would be comparatively attractive but also because most folks would be able to get a credit limit high enough to finance 100% of a property. Statistical Abstract has there being 123 million pieces of real estate with a median price of $206,000, giving an approximate total value of $25.3 trillion dollars. Under such a scenario, I'd be surprised if prices didn't collapse by 80%, wiping out $20 trillion dollars in wealth directly, or about twice the size of the national debt. Second order effects would increase, if not multiply, the size of the loss. The Great Depression would look like an economic paradise by comparison. All because you want to give people "a little help" and don't think about the consequences.

Lenders will modify notes on their own without compulsion from the courts if you can come up with a scenario where it's in their best interest - by which I mean they'll get more of the money they loaned you back, complete with interest. And if you cannot supply such a scenario, the lenders are correct to foreclose as promptly as possible. That's not just their money. More than half of all Americans have bond investments. It spreads out the risk and the pain, but don't kid yourself that corporations are the only ones hurt. They're not.

Tax code changes. Sometimes, badly strapped homeowners can persuade lenders to reduce the size of a mortgage to reflect a home's plummeting value or the homeowner's inability to keep up with the payments. Sometimes, the lender forecloses and a homeowner can walk away with no house, but also no debt. That would seem to be the end of the story, but it isn't to the IRS, which often considers either action as income to the borrower, and sends a big tax bill. It makes sense to alter the code to keep the tax collector from making a bad situation worse.

I've written on this tax consequence several times in the past. There are good reasons why tax law and tax policy are written that way. What we're trying to do is give people the greatest reasonable incentive not to try scams of this nature. Not to go into debt figuring that if it all doesn't work out, they can just walk away. We're all supposed to be adults. One of the things adults are is responsible for their debts. This is one reason why lenders are willing to loan money - because there are concrete reasons why it is in the borrower's best interest to pay those loans back. Remove that fact, and you've removed the underpinnings of our entire banking system. If you don't understand the economic consequences of that, at least in broad, have the courts declare you legally incompetent and appoint a guardian. You are not competent for any economic matters. You shouldn't be voting. You probably shouldn't be crossing the street without supervision and assistance.

Lenders give great rates on real estate because secured real estate loans are comparatively low risk. Secured real estate loans are low risk because people will do basically anything not to lose their house. Take away the risk of losing their house, and people will do a lot less. It's effectively no longer a secured loan. Combined with the protections mortgages have already, rates will be higher than any credit card. For all the beating of breasts and loud flapping of keyboards that goes on, most people are still handling their loans. Yes, lenders lose lots of money every time a loan goes bad. Ninety-eight percent of all real estate loans are still performing. Let that change, and risk goes up, rates go up, and nobody can get a loan and nobody can make the payments, and nobody will be able to buy, so prices come crashing down in such a way that everything we've seen so far will be as flatulence in a hurricane compared to what will happen.

The number one thing that puts people into home ownership is the ability to get a loan. Rich folks are going to be able to afford property no matter what. Those of us who are somewhat less well off depend upon our ability to use someone else's money. Take away that, and watch ownership rates plummet. As a society, we'll go back to living in rented massive slum tenements, simply because that's what'll get built because the average person simply won't have the economic leverage to afford decent housing, or to incentivize those well enough off to finance housing to build the sort of housing we want. Lionel Barrymore's character in "It's a Wonderful Life" seems like a caricature to us, sixty years later, but it wasn't a caricature at all at the time. The people who made that movie saw stuff like that and its results on a daily basis. Many of them - the ones who never became big stars or powerful producers and directors - lived through it. It only seems like a caricature now because the lending environment has become such that the average person can easily get a loan.

Education and advice. Sometimes, a home could be saved if its owner only knew that it was possible to renegotiate the mortgage -- and that a lender might prefer getting smaller payments to no payments at all. Scores of state organizations and non-profit community groups are working to educate and counsel homeowners, and in many cases to help them renegotiate their mortgages to keep their homes.

And 100 percent of those people could be saved by people doing a very small amount of research before they signed the contract. No sometimes or occasionally about it. But people won't do it. A lot of the people who did these loans to themselves were warned, and chose to not to believe the warnings. Poor disclosure requirements, blind trust in someone who acted like their friend. Lack of elementary common sense. When someone tells you that your payment on an $800,000 loan is $2573 per month (and there are many loans even worse than that out there), all it takes is the mathematical ability of a fourth grader, at most, to realize that even if it's interest only, you're only paying 3.8 percent interest and there just aren't any other loans out there anything like that, and maybe there's something going on that you don't understand. I told hundreds of people first person (never mind the over two million visitors to my websites) about the perils of those loans, and the vast majority of them bought the complete bullshit that someone else fed them because they wanted that house and this was the only way they could "afford" the payments, so they did the loans with other people. If I had just kept my mouth shut and done ten percent of those loans, I'd be richer than if I had won the lottery, instead of scrabbling for the occasional person who wasn't looking to buy a property they couldn't afford.

I'm not saying don't counsel people on how to make the best of a bad situation. But that's happening now, without this prescription, making it a null act, simply posturing for the cameras. One of the great things about the internet is that you can find the information you're looking for if you will keep looking, and cross check its credibility. "I found it on the internet," may be a joke when it comes to serious research, but you can find the correct information if you keep looking and cross check credibility, rather than just believing whatever you may find on the Flat Earth Society website.

I'm saying that the best time to stop this problem was before it started. People will fool themselves. Indeed, one of the most important measures of how free a society is, is the ability of an adult to decide to do something stupid after being fully informed of the consequences. Indeed, that's also a good definition of an adult - someone competent to make their own mistakes.

However, the law and our governments aided and abetted the sharks who took advantage of these people by making them appear to be in compliance with extensive disclosure rules that allow the sharks to hide all of the really important and nasty things behind a smokescreen of unimportant trivia. The people got so bored of details that just aren't important that they signed off on things that killed them financially without reading, presuming it was more of the same nonsense. The stupidity wasn't informed stupidity, because the lenders and agents were able to conceal the real mechanics of what was going on, and what would happen in the future. This gave even the shadiest operations enough of a veneer of legitimacy to pass the casual inspection given by someone who wants to believe it. There was nothing in all of that government mandated paperwork that explained the consequences that would follow, as certain as gravity. If there was anything, it was obscured by all of the nonsense. I can write (and have written) a one page loan disclosure that would guarantee nobody would ever sign off on one of these things without being informed, in big bold type, about the consequences. Such a disclosure is found nowhere in the requirements of any state, and even if it was, government requirements would allow it to be hidden in hundreds of pages of stuff like equal opportunity housing and equal opportunity loan disclosures, things that everyone knows about, and it's often in the lender's interest to comply with anyway (I can't imagine anybody in this day and age being stupid enough to practice loan or housing discrimination, and even if they were that stupid, I can't imagine them getting away with more than a very few instances before the law put them out of business). How about re-writing the disclosure rules so the deadly traps are as obvious as possible, and the sharks can't hide deadly financial traps behind the insignificant minutiae?

This article got a lot longer than I wanted it to be. The point that I am trying to make is that it's very easy to make the damage orders of magnitude worse by trying to be compassionate after the fact, thinking that you're "only" damaging "major corporations who can afford it", when the fact of the matter is that these measures would bring our entire mortgage and real estate system to a screeching halt. The correct tack to take for the future is to make it impossible for people to fool themselves before they get into trouble. As for the present, yes, people are going to get hurt. But the system will work its way through the problems. I am opposed to any mass bail-out of lenders or those who voluntarily signed upon the dotted line. Especially if it's taxpayer financed. Indeed, I want to see the lenders and brokers who did this stuff sued and bankrupted by the investors and borrowers they suckered, and the money managers who should have known better sued and bankrupted by the people whose money they mismanaged. Such results discourage and prevent repeat performances of the sorts of things we have just lived through far more effectively than any mitigation proposal I've heard, with far less long term damage. Bail-outs allow the offenders to escape the full consequences of what they did, much like during the savings and loan crisis, which in many ways, set the stage for what's happening now. The best thing we can do, the best proposal I have heard, is to allow the consequences to happen. Otherwise, we'll be going through the same sorry mess, even worse, in a few years. As hard as it may be to stand by and watch people get hurt, I have yet to hear any better proposal that will help them without making the problem an order of magnitude worse.

Caveat Emptor

In the last week or so, nonconforming A paper has really been hit. While available conforming rates have actually gone down, nonconforming has gone up by over half a percent. Picking one of yesterday's rate sheet at random, I can do a 30 year fixed rate loan at 6.5 percent at retail par (in other words, no points to the consumer). I appear to have picked one of the worse spreads because I know I've got better than this, but the lowest fee from the same lender on the nonconforming table is 8 percent - which costs 2.5 points retail (I just priced one at 7.25 for 2 points retail).

Fannie and Freddie backed loans are doing just fine. The issue is that "stated income" loans of conforming size traditionally use the same rate table as larger "full documentation" loans. Since the real problem appears to be stated income - even at high credit ratings - tarring both customer classes with the sins of one is not exactly the most competitive thing that lenders can do. I can think of three or four possible fixes to the situation right off the bat. I expect that the smart folks who are paid the big bucks by the lenders to be able to think of all of these and more. I further expect the lenders will do something on the individual lender level as quickly as top management can agree upon what to do.

Now conforming is what those whose properties are worth up to 125% of the conforming limit of $417,000, or $521,250, should be looking for. This is most folks, even in high priced San Diego. As long as Fannie or Freddie likes your loan, rates are still good and the loans are easy to do. This is part of the reason for my mantra about "guard your credit and only sign up for loans you can afford."

For Fannie and Freddie, investing in mortgages is what they specialize in. In fact, it's the only thing they're allowed to do, assuming I understand correctly. Other investors are allowed to do other things, and right now The Word is out the mortgage investments aren't as secure as they usually are, so investors are panicking and doing other things even more than is rational. Panicked people do strange and silly things, as anybody who watches the financial markets knows. It'll likely settle out fairly soon. Meantime, the tightened supply of mortgage money means that if Fannie and Freddie don't like your loan, the price of the money is going to be higher.

The buyer's market is rapidly aging. Properties that are priced correctly are moving, and moving well. On properties with potential for profit, they're moving fast, and sometimes getting multiple offers. Of the last twelve properties clients of mine were seriously interested in, four went "Pending" before they put an offer in, and three more were situations where the listing agent claimed there were multiple offers, and in retrospect, I believe that contention. Bargain property is moving.

This isn't just personal experience. I do get a fair amount of exposure to the experiences of other agents. Four other full time agents in my office, and dozens of others through property scouting. Another agent in the office had a Notice of Default hit her listing. We told her she'd get an offer if the client reduced the price to where we told her. She didn't get one offer. She got four offers within forty-eight hours, and we were able to play them against each other to get almost the previous asking price. I wouldn't say that's a statistical argument that can be extended to the entire San Diego market, but with as much direct evidence as I've accumulated, I'd say it goes beyond merely anecdotal evidence. The market is getting ready to turn.

This isn't to say it's a great time to be a seller. It isn't. Many sellers - and listing agents - seem to have their heads stuck in the days of two years ago, where a highly upgraded property meant a major boost in selling price. No longer. The buyers out there now are highly sensitized to both price and condition, and they are looking for the best overall bargain. Not just beautiful, highly upgraded properties, but at a competitive price also. With the seller to buyer ratio having ballooned to 42 to 1 as of the start of August, they are getting both.

Here's what I'm telling my buyer clients: There's nothing out there right now that's worth getting emotionally attached to before the sale is consummated. If you like the property, make an offer of an amount you would be happy to pay for that property. If the seller will sell for a price you're happy with, great. If not, I'll find you something just as good where they will. If this seller won't deal, the next one will. A large proportion of sellers don't have any choice. They have to sell, most of them because they really couldn't afford the property in the first place. Security guards making $33,000 per year should not be getting $800,000 loans, to name one situation I walked into not too long ago.

What I've told prospective listings is "If you have any choice, don't". I've got signed instructions to keep my one listing as a "pocket listing" until next Spring. In other words, if I can bring him a buyer, great, but don't market the property via MLS or other mass media. But he doesn't have any particular need to sell. If he did have a need to sell, I'd tell him to make it as pretty as possible as cheap as possible, price it as low as he can stand, and be willing to negotiate his price so low it hurts - and maybe a little bit more. If he doesn't need to sell so bad that he's willing to do that - and he's doesn't - then he doesn't need to sell and should wait for a better market for sellers. The only way to attract a buyer is to out-compete the other 20,000 sellers out there for one of the about 500 serious buyers' business. Location and physical size are fixed. Condition and price are not. The buyers out there are highly sensitized to everything. Instead of a beautiful gourmet kitchen boosting the sales price by $25,000, what this market means instead is that an otherwise identical property is more attractive at the same price than one that hasn't got it. You are unlikely to get enough extra money to notice. What you are likely to get is the property sold, while the otherwise identical property sits on the market for the same price.

Indeed, the property in less than desirable condition is going to sell at a substantial discount, if it sells at all. There's starting to be substantial opportunity for flippers once again, albeit with the mirror image of the way things were going two years ago. Instead of buying at the market price and selling the upgraded property at a premium, now they're buying at a large discount and selling the upgraded property at about market price. It may be intelligent, but the average buyers out there aren't interested, and they're not willing to deal with the ten people who'd rather be foreclosed upon than take the only offer they're going to get to get to the one who will take the offer. I hate short sales and I admit it. Most of the profitable opportunities for buyers out there right now are nonetheless ugly properties in a short sale situation. Not just for flippers and investors, either. A family that wants a place to live that they're willing to fix up can do extra-ordinarily well for itself right now. It's better to buy at a discount now, when you are in complete control, than to hope for a premium when you eventually sell. This is also the historically normal way of the market.

The San Diego market has been on the bleeding edge of the national trends through this whole boom and bust cycle. The "good news" that came out of that was that all of the exotic programs that are usually dead were still available to the less ethical loan officers, at a point in the cycle where they're usually historical toast. The bad news was that while the rest of the country was still going gangbusters, we were basically banging our heads on concrete walls in trying to get short sales approved by lenders. Well, the lenders now have their heads in the right place to approve short sales, just when there's signs of a rebound in the local market.

Indeed, the slopes and inflections in trend lines had me believing we might see a small bit of recovery this year, and we actually have, if only at the most competitive edge of the market. Now, with the peak spring and summer season largely past us, I think we're going to see the buyer's market mostly continue until spring of next year. This means another several months where those buyers who are willing to come off the sidelines at a time of year when most buyers aren't are going to be able to drive hard bargains. Sellers can either choose to out-compete other sellers for the buyers that are out there, or have the property sit unsold until the market turns. Even in trendy, highly desirable communities, buyers currently have the power. As a seller, you can accept this or your property can sit unsold. The longer it sits unsold, the less bargaining power you have.

Here's the statistical run-down on the most recent six months: 13,272 properties sold, 3335 in escrow - versus 19,265 canceled, withdrawn, and expired. Assuming seventy percent of those in escrow eventually close, that's about a 43.5 percent probability of any sale at all - in the best time for sellers there is. On the other hand, the comparable figure last year at this time was 39.8% - and last year I didn't discount pending sales by thirty percent - I just took them as presumptive sales.

Furthermore, we're now in the period where most of the unsustainable loans that were written have already bitten the people they are going to bite. We're coming up on two years since the music stopped and everyone ran for the sidelines locally, which means that most of the two year fixed rate loans have already adjusted, and many, if not most, of the negative amortization loans have already hit recast. Furthermore, unless they've been living in a cave, and they haven't - they bought a home - almost everybody who has an upcoming adjustment they can't afford has figured it out. Their homes are already on the market. The difference between selling now, before the Trustee Sale, and later, after the Trustee has deeded it to the lender, are not large as far as the buyers are concerned. The only difference is that after the Trustee Sale, the lender knows how much money they're losing every day.

My point is this: There's only so much desperation out there, and we've already seen the largest influx of it into the sellers' listings here locally. San Diego is a resilient market, one of the most resilient in the country. People want to live here. People are willing to pay higher prices to live here. The ones making more income than national average - a large percentage with technology and biotech and defense and other highly paid industries here - can afford to pay those prices. That's the demand side. On the supply side, there just isn't a lot of dirt left. Unless we change our laws and attitudes about what constitutes a buildable lot and the acceptability of high density housing, there just isn't a lot of room for our population to grow further. We're hemmed in by immovable obstacles on about 330 degrees of the circle (The Pacific Ocean, Mexico, Camp Pendleton, and Cleveland National Forest). Since this is the United States, and we don't tell our citizens where they can live, the way we discourage people from living here is that the price will keep going up until enough people decide voluntarily that they're not willing to pay it. Thus far, we haven't lost as many people to out-migration this cycle as we did last cycle. Back in 1991 and 1992, U-Haul was essentially allowing people to move here for free, there was such a demand for their inventory on one way trips out. They haven't gone nearly so far of late.

I'm also seeing a lot more pent-up demand this cycle than we had last cycle. Instead of moving out, people are waiting for the market to hit bottom. Well, the local market isn't going down as far as most people think it is. As I've said, at the most competitive edge of the current market, sellers are seeing not only fast action but lots of interest. People are willing to pay those prices. People are very willing to pay those prices. Even with the psychological fear of further market decreases, those who are willing to buy are not only willing but also able to pay current prices. So much so that they're practically racing to be first in line when they find something that is a worthwhile bargain. What do you think is going to happen as soon as the average buyer, who's been holding off for two years, gets it into their head that the market may have hit bottom? Without the psychological fear that's keeping them on the sidelines now, expect to see a large influx of serious buyers, drastically curbing the ability of buyers to drive harder bargains. In short, a seller's market. It's a positive feedback effect. The more people come off the sidelines, the more strongly the market will turn, and the more people will want to come off the sidelines.

As I said yesterday in my loan market article, the gonzo 100% stated income low credit score programs are gone, and they're not coming back any time soon. This means you're not going to see the same kind of frenzy as drove the market three or four years ago. Personally, I doubt that sellers - or listing agents - are ever going to have that kind of power again. The loans that enabled that stuff are no longer being offered. People are going to have to have at least two of three things: Good credit score, a significant down payment, and ability to prove they make enough to afford the loan. Failing that, they're going to pay very high interest rates, high enough to keep them out of properties that they could otherwise qualify for. That's going to keep a damper on market increases, at least until the lenders develop collective amnesia again.

At this point, where most of the buyers who are going to buy this year are already out there in the market, I don't think the market is actually going to turn until next Spring. Meanwhile, those buyers who are willing to come off the sidelines now, before the market has actually turned, are going to be much happier than those who wait until the market has already turned. The time of very best bargains locally is already past, but since I don't know anyone with a time machine, we have to consider what we've got looking forward.

Caveat Emptor

While the subprime meltdown continues, A paper rates have actually dropped a little bit in recent weeks.

Subprime is in a world of hurt. Lenders are fleeing the market for below average credit in droves. It seems like every day, we lose the capability to do something or other, and the rates have gotten high as well. I just priced a 580 credit score on an 85% loan. Rate/term, no cash out. Six months ago, I could have found something around 7% par. Today's best rate? 10.7% at par.

The last several years, with real estate values rapidly appreciating, it was hard for lenders to lose money. Even if the property did go into foreclosure, it would have appreciated in the meantime, and the lender would get their money. That's no longer the case. Properties aren't appreciating, and as a result, subprime lenders are now having to price loans for the borrowers to bear the full risk of their low credit score.

I've been saying for some time that if you don't have good credit, the rates are going to have to rise. That prediction has now come true. As of when I'm writing this, I could do that same loan A paper at 6.25 at par. Cost of having a below average credit score? 4.45 percent! If your loan balance was $400,000, that equates to $17,800 per year in increased cost of interest!

Alternatively, that below average credit score means that instead of a $400,000 loan someone with good credit and a monthly income of about $7000 can afford, you can only afford a $265,000 loan. Instead of a 3 bedroom house with a decent size lot, you're in a two bedroom condo, at best! If you could have paid the bills but chose not to, you have only yourself to blame. It's hard for me to imagine anything but a house or a business that's worth spending that kind of money, and credit scores can be improved if you're willing to try.

Furthermore, it's getting harder to find subprime lenders willing to loan at high Loan to Value ratio (or CLTV). This means that you have to have a bigger down payment than someone with a better credit score. I can still do 100% loans, usually split 80/20, pretty darned easy if you qualify for A paper. It's getting to the point where it's a waste of breath to ask subprime lenders for 100% financing. This means that you can either have a substantial down payment, or you can improve your credit, or you can remain a renter. Given the economic advantages of home ownership, you don't want to remain a renter. Of the remaining two options, it's usually quicker and easier to improve your credit than it is to save 10% of the price of a $400,000 property. How quickly could you save $40,000 if you had to?

Stated Income, especially for low credit scores and high Loan to Value Ratios, is rapidly going the way of the dodo. 100 percent stated income is essentially gone. The lenders want you to have some serious equity, so that if the property gets foreclosed upon, they're likely to get their money back. The lower your credit score, the more of a down payment you're going to need. negative amortization loans are finally hitting this wall, as well. Not only do those lenders living on those abominations want a higher rate, they also want you to have enough equity so that they're going to get every penny when they foreclose. As a result, fewer people are willing to sign up for them, and fewer still qualify, a development I am all in favor of.

Lenders, specifically sub-prime lenders, have in the past few months suddenly re-awakened to the possibility that they're going to lose money in the real estate market. Those who have been advising people that they're not risking anything with 100% purchase money loans because "purchase money loans are non-recourse" are soon going to be the subject of court and regulatory action, not to mention that the lenders are no longer willing to cater to that line of thinking - at least not for those who have demonstrated that their credit rating isn't important to them.

It is not difficult to qualify A paper. I have in the past done A paper loans with 100% financing at a 630 credit score. More people qualify A paper than think they do - and if you'll work at it, getting yourself a thoroughly acceptable credit score of 680 or better usually doesn't take very long. Now, more than in the last few years anyway, being able to show that you make a habit of paying your bills on time is worth some serious money. It also means you can get the loan now, instead of several months in the future at best. And, as tomorrow's article will attest, you really want to buy now if you can.

Caveat Emptor

Market Resilience

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Most Resilient U.S. Real Estate Markets

Market corrections follow three basic recovery patterns. A V-shaped recovery where a market experiences a sharp, fast decline but comes out strong once it hits bottom; a U-shaped recovery, where prices decline gradually and recover slowly; and an L-shaped curve, a hard, fast fall with paltry price bounceback following the market trough.

The differences between a V-shaped market and a U-shaped one has to do with barriers to growth. High vacancy rates and high investor share can hurt a market, but if the local economy remains strong and housing stock affordable it's only a matter of how long it takes to absorb the excess inventory.

San Diego is portrayed as a V shaped market, albeit one whose recovery is dependent upon external factors. However, the fact that there just isn't anywhere new to build is going to be a major factor, as is the desirability of living in San Diego.

Those who wait for confirmation of market bottom are likely to completely miss out on the best bargains. It wasn't until prices had been decreasing for almost a year that official statistics admitted it. October 2005 is generally seen as having been the top, but the statistics confirming this didn't emerge until July or August of 2006.

This isn't any double-talk. I ran an article just a few days ago telling people that it's a rotten time to sell. Inventory is high, and there aren't a lot of buyers who have come off the sidelines yet. But this precise combination of factors is what makes right now one of the best times possible to buy. But it's not going to last forever. The seller to buyer ratio is nearly twenty percent lower than it was last year at this time (32 versus 39). It's getting harder to find the very best bargains. Stuff that's beautiful is selling, but properties that aren't reach out and grab you beautiful are sitting on the market. Great if you can afford to fix it. Not so hot if you can't. On the other hand, if you're willing to be the one to deal with a few minor cosmetic issues, this is a great time to end up with a great bargain. Particularly if you've got a few thousand in your pocket to redecorate once you've bought, now is a great time to be finding those properties where $10,000 in easy stuff like carpets and paint can add $100,000 in value. Whether you then want to live in it for ever and ever or simply take your profits and run, that's not at all a bad situation to be in.

San Diego is a resilient market, and I'm seeing a huge number of people who want to buy but are "waiting for the market to hit bottom." When you've got a situation like that, as soon as those people see some indication that things have turned, they're likely to come swarming, thereby boosting demand and depleting inventory (i.e. supply) over a very short period of time. I haven't been among those thinking San Diego is likely to see any kind of a double digit gain any time soon, but the longer it takes to start getting people off the sidelines, the more demand will build, and the stronger the turn will be. I still don't think we're likely to see double digit gains in the next couple of years, but I'm starting to see evidence that I could be wrong about that. I predicted losing thirty percent of peak value, and we're at about 25% off peak right now. The number of bad loans could make the housing bear run a little bit further, but there's also a large amount of pent up demand, in the form of people who are eager, willing, and able to buy a home, but are only "waiting for the right time". Based upon purely anecdotal evidence, I think we're at the point where the latter significantly outnumber the former. If you're one of those on the sidelines waiting for the right time, I'd be very careful not to be late onto the field.

Caveat Emptor

Precis: Still an excellent good time to buy and a poor time to sell. Matter of fact, don't put the property on the market if you've got a reasonable alternative. If you're looking to buy, though, you're not likely to find a better time soon.

The hard fact is that there's a lot of inventory, and most owners have priced their property over the market. There's an awful lot of agents out there that "buy" listings by telling owners they can get more than the property is worth. There are comparatively few buyers out there, and there are 32.6 sellers for every one of them. I hope those readers who aren't hetero bear with us, but imagine you're at a dance where one sex outnumbers the other thirty to one. Those few members of the outnumbered sex can be incredibly picky, while the multitudes of the outnumbering sex are going to have to do a lot to compete with their thirty plus rivals.

Real estate isn't a dance of course. For one thing, in the real world boys can dance with boys and girls can dance with girls, at least if they're so inclined. But in real estate, two sellers can't really dance - it doesn't do them any good. In the real world, you have the ability to leave this dance and go find another one. In real estate, you can't do that. The property is where it is. You can leave the dance and go home, but there's only one dance to go to.

For sellers, you can either do what is necessary to out-compete the other sellers for the buyer's attention, or you can decide it's not that important to sell. If you take the latter option, get your property off the market. If you want to sell, look at what properties like yours are actually selling for. For most, it's thousands to tens of thousands less than asking price. Properties that are correctly priced are selling, while properties that are overpriced aren't. If you need to sell, it doesn't do any good to price it too high. If you don't need to sell, and I mean need to sell, then why is your property on the market? If you do need to sell, you might as well list it for what it's going to sell for and get it done, because until you're ready to accept an appropriate offer, it's going to sit unsold, which costs you money. You can have $X now, or you can have $X three months from now, after you've spent another $10,000 on taxes and mortgage. Your choice. $X plus thirty thousand is not on the list of options.

For buyers, the pickings are still very rich, if not quite as good as they were earlier in the year. Where earlier in the year you could take all the time you wanted to think it over, no matter how good the bargain was, I've had three properties go "Pending" on interested buyers in the last month. People are out there, looking for bargains. Properties that are priced appropriately are selling.

One thing that distresses me is what a large proportion of Vampire properties are out there, and what some of them are selling for. There was a Vampire some clients of mind got interested in because it had a large lot, four bedrooms and a pool. However, it also had foundation, structure, and settling issues. I talked my clients out of it, but somebody else paid essentially full price despite the fact that the foundation is cracked through and the structure is settling unevenly. Spotting Vampires is one of the areas where a good buyer's agent earns every penny they make - in this instance, my clients aren't going to have to find thirty or forty thousand to fix the foundation and another twenty plus for the structure. It seems like the proportion of Vampire is increasing, also. People are trying to unload their problem properties rather than fixing them correctly - and other people are buying them. It's one thing if it's disclosed and everybody is negotiating on the same page. It's something else again if the sellers are trying to pretend those problems don't exist, or even worse, trying to hide them. If you try and hide it, I guarantee it will come back to haunt you - it's not like those buyers are going to say, "Oh, well, we're just out fifty thousand dollars!" Not that winning the lawsuit is going to be any comfort to those buyers in the meantime, but the sellers can pretty much count on having to make it good.

I've saved the most important recent development for last. Rates on loans, particularly thirty year fixed rate loans, are up. A month ago, I could get 5.875% on a thirty year fixed for one point retail. The equivalent rate today is 6.50 percent. So if someone qualified for a payment of $2500 then, they could afford a loan for $422,500, while at today's rates the equivalent loan is only $395,500 - more than a six percent drop. Now I'm neglecting other factors in the equation, but the point is this: Unless rates go back down, they're exerting downwards pressure on prices. With the trade deficit, budget deficit, and microscopic US Savings rate, I don't expect rates to fall, nor does the federal reserve. In the longer term, prices will continue to rise, but in the short term, together with the huge glut of inventory on the market and the high ratio of sellers to buyers, we may see further price drops until this inventory clears. If you don't need to sell right now, no biggie. But if you do, it's even more reason to price the property correctly and get it sold now, because the odds are that the prices will be at least a little lower in the next few months.

Some people are going to read that and think, "We'll wait to buy until prices have bottomed out!" This is an excellent way to miss the buying opportunity we have now. How will you know that prices have bottomed out? The answer is, "When prices start rising again," but if you wait until then, there's a reason why prices will be rising again. The excess inventory will have cleared, there will be a lower ratio of sellers to buyers, and in general, things will be much better for sellers than they are now, while not being as good for buyers. There is also a tremendous pent up demand out there, people who want to buy houses but figure they'll be better waiting. When those folks finally decide to come off the sidelines, as they will when government starts reporting housing prices increasing again, watch out for another year like 2003 where prices go crazy because everybody wants to buy and nobody wants to sell. But in order to cash in on it, you have to have bought previously.

Caveat Emptor

(This was originally published March 31, 2006)

Doing my workout this morning I asked myself what's next for the real estate market.

The state of the market here locally is that prices are and have been in decline. There is no longer any mystery about whether they will decline, only how much and for how long. One of these days, the Association of Realtors and those pollyannas who preach that you always make money on real estate will admit it.

What comes next? Obviously increased defaults, as short term loans come up for adjustment and people are unable to make the payments, as I've said any number of times, and unable to refinance because they owe more than the property is worth. Short sales also increase, as people try to just get out. More Notices of Default means more trustee sales, as well. If the property sells at auction, somebody probably got a bargain. If it doesn't, the lienholder owns it (subject to senior liens) and that may be even better.

All of these are happening already. Daily foreclosure lists have more than doubled locally from a year ago. Trustee Sales are up, and so are REO's (Real Estate Owned by those who were originally lienholders). Check, check, and check. All about as surprising as gravity. What I'm trying for here is at least one prediction that has not already come true.

Rates have been rising of late, but there is a limit as to how far they are likely to go, if only because Bernanke and company are very shortly going to have irrefutable evidence of all of the above stuff nationwide. A nationwide economy has a lot of something analogous to inertia. Takes a while to move things in the direction you want them to go. More time, and more effort, than most folks, particularly bankers running our money supply, are likely to realize and sit still for without further pushing, which they have done a bit too much of, in my opinion, by about one full percent on the overnight funds rate. Once things get going in the direction that the Fed has been pushing them for the last two years, they are similarly going to have a lot of momentum built up. Bond investors are going to dry up at attractive rates, and Sarbanes Oxley or no, you're going to see private companies going public again because it's the only way they can raise capital at attractive prices, and the flow of public companies going private is likely to mostly stop. (Hard to think of Sarbanes-Oxley as a brake upon economic activity, but in the short term, that's what it's likely to prove. CEOs and CFOs are not used to the idea of personal responsibility for corporate activity, and while the cost of private capital is even vaguely competitive with public, private will be their choice. It's going to take a while for countervailing forces to come into play).

When bond rates rise, so do mortgage rates. When mortgage rates rise, and people can only afford the same payments, prices fall, further exacerbating the price fall that's already happening. Lenders are already between a rock and a hard place to a certain extent, but it's going to get worse. Keep in mind also that aggregated mortgage bonds are an attractive investment because of their historical level of security, and even though that's going to be compromised to a certain extent, rates are going to rise if for no other reason than that is what the money costs. I expect rates on A paper thirty year fixed rate home loans to stabilize somewhere around seven percent, at least for a while. Shorter term fixed rates will be cheaper once the yield curve normalizes. Given the prices things have sold at in highly appreciated markets, this is likely to permanently popularize medium term hybrid ARMs, as saving one percent in interest on $500,000 is well worth the cost of refinancing every few years, and people are refinancing every two years on average anyway. Two and three years fixed is really too short for most folks, but five is probably more than fine.

Here's another newsflash. I'm not going out very far on a limb here, but a three bedroom single family residence in a reasonable neighborhood here locally is likely never to drop back into the sub $300,000 range again. I'd bet money it's not going below $250,000. Yes, the market got badly overheated - but not that badly overheated. Furthermore, if past Southern California history is any guide, we'll lose about 30 percent of peak value, and then start going back up again. No fun if you're a semi-skilled worker trying to raise a family, but the most likely scenario nonetheless.

Now what's going to happen to the people who have bought highly appreciated properties who can actually make the payments? Well, if prices fall, they can't sell for what they bought for until they recover. They don't want to do that. But they don't want to be in a negative cash flow situation, where the rent they get from the property doesn't cover their expenses, if they can avoid it. They definitely don't want to be in that situation to a larger extent than they can avoid. A $500,000 purchase with a 6 percent first and 10 percent second yields principle and interest payments of $3276, plus property taxes of $520 and insurance costs of $120 per month, means that the owner is out $3916 per month without any repairs or management expense. A monthly rental of $1900 isn't going to cover that. A monthly rental of $2500 isn't going to cover that. This is going to put more upwards pressure on rental rates. $2500 is the entire gross monthly income of someone making $14.75 per hour, by the way. But the people feeding the mortgage alligator don't really care, all they know is that they have to pay the bank so much per month, and set aside so much for the state and the insurance company. This is also going to put upwards pressure on wages, and therefore prices. Inflation kicks into higher gear, which puts more upwards pressure on interest rates. Vicious cycle.

And this phenomenon is going to be part of what eventually helps prices make a comeback. If somebody is feeding the landlord $3000 per month, they're going to be more amenable to paying it to the bank instead. Especially since they get tax breaks, and most especially because when you buy the property you intend to live in, you take your monthly cost of housing out of the column that says "what the market will bear," which is subject to changes - and usually increases - and put it into the column that says "this is under my control." If you buy with a sustainable loan, your monthly payment is going to be under your control forever.

(It is to be noted that even if that $500,000 property loses $150,000 in value the day after you buy it, historical 7 percent per year increases will have you back in the black in about five years, and ahead of a market return on the rent you would have saved in about ten. Thirty years down the line, your net benefit from the purchase as opposed to invest the extra money over the cost of renting and investing the excess in the stock market, will be somewhere between $800,000 to $1,000,000. An almost irrefutable argument in favor of buying a home, if you plan to live there a while. Yeah, it's no fun being upside down while it happens. But the eventual payoff isn't exactly chump change, even by the projected standards of thirty years from now.)

Caveat Emptor.

Copyright 2005, 2006, 2007 Dan Melson. All Rights Reserved


Dan Melson's San Diego Real Estate and Mortgage Website

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