Wednesday, January 6, 2010

Housing Bubble still exists, second leg down to come in March 2010

Januay 6, 2010

The housing market in many areas in California is still in a solid bubble. Yes, in a speculative bubble. In the last report we looked at shadow inventory for Los Angeles County in great detail. This generated a lot of questions and hopefully shined more light on what really is going on in the housing market. People in manias have hard times judging things correctly. First, even if nationally home prices might be correcting to more reasonable levels, even in hard hit areas like the Inland Empire, many counties like Los Angeles and Orange are incredibly overpriced. In short, they are still in a bubble. Now this might seem stunning given that the median California home has fallen in price by 50 percent. But keep in mind the fall was not evenly distributed.

It helps to put the numbers in perspective:

Los Angeles County Peak Price: $550,000 May of 2007 (DataQuick)

Los Angeles County Current Price: $329,000 November of 2009 (drop of 40%)

Orange County Peak Price: $645,000 June of 2007

Orange County Current Price: $436,500 (drop of 32%)

Yet as we showed in our last report, most of the drop has occurred for two primary reasons:

[1] The bulk of home sales have come from lower priced homes thus skewing the median price lower

[2] Higher end areas have large numbers of shadow inventory because homes are not moving as fast (aka the volume of buyers is low)

Now when the MLS lists about 19,400 homes for Los Angeles County yet in total close to 100,000 properties are either on the MLS, have a notice of default filed, are scheduled for auction, or are bank owned you know something is sketchy. Plus, we have additional properties that are 90+ days late that just don’t show up anywhere. The fact of the matter is that prices are too expensive in many areas regardless of government intervention. All the government is doing is prolonging the inevitable correction while propping up the failed banking sector. Keep in mind the California unemployment rate is 12.3 percent and if we include underemployment, it goes up to 22 percent. Have people forgotten how households actually pay for the mortgage? You pay from actual income yet somehow this is all lost in the hustle of bailouts.

Today we are going to look at a zip code in Burbank to really deconstruct what is going on. Today we salute you Burbank with our Real Homes of Genius Award.

Burbank California

Let us examine the 91501 zip code of Burbank. This is one of those areas with nice homes that many professionals are looking at but prices still seem to reflect a bubble. Now many real estate agents are now buying the argument that the government has saved the housing market. Really? Let us look at the real data for this zip code in Burbank:

In the latest month of data five homes sold for this zip code. The MLS has 31 homes listed. A little over 6 months of data. On the surface this seems healthy. But look at the shadow data. 130 homes are here. Now one of the big concerns in the last report was how many homes are double counted. Not much. The 91501 has 3 foreclosures listed publicly of the 14 REOs. That is a tiny number. So in total we have 161 properties listed minus the 3 double counts (1.8 percent of the pool) and we have over 31 months of housing inventory if we use shadow inventory figures. Plus, how many homes in this area are 90+ days late with no notice of default filed? But you are skeptical. Fine. Let us run an example. In fact, let us run a fresh example (just listed on 1/5/2010):

Given the e-mails I get from readers, this is probably a sample of the most sought after “starter home” for people that read Real Homes of Genius. They’re looking for a prime city with the cache that’ll make them feel like they’ve made it. It is the same fuel that led many to over leverage but this time, you actually have to have the income to back up your bet and not go gangbusters with an Alt-A or option ARM product to leverage yourself into disaster. Yet prime mortgage defaults are now soaring because the fact that you can buy something doesn’t mean that you can afford it or that employment is still hemorrhaging.

The above home is one example of why we still have much correcting to do in many markets. This is a 4 bedrooms and 2 baths home that is listed at 3,219 square feet. A rather large sized home for a starter but a good structure for working professionals. This home is banked owned but the history of what occurred shows us that delaying the inevitable doesn’t delay a meeting with financial reality:

Let us walk through what happened here. The home was purchased in August of 2007 for $905,000. Amazing and thoughtful Countrywide thought it would be prudent to make the first and second mortgage on this property:

First Mortgage: $614,500

Second Mortgage: $200,000

Total: $814,500

So it looks like these buyers actually came in with 10 percent down ($90,500) if I’m working the numbers out correctly. So even in August of 2007 right when the market was in full implosion Countrywide decided to make a loan at peak value on a property that was “valued” at almost one million with only 10 percent down. Is it any wonder why many Alt-A loans are simply exploding on the balance sheet of banks?

So the home is now purchased. Less than one year in, the borrower is already having problems. The notice of default was filed on September of 2008:

09/04/2008: NOD Filed for $26,461

Now this is what people forget about mega California mortgages. If you miss a payment on say a home in practically any other state, you fall behind $1,000 or so a month. So after the NOD if it is filed after 3 months, you may owe somewhere around $3,000 to $4,000 depending on late fees and penalties. Catching up on that is doable. Try catching up to $26,461 when you are already struggling.

So if the NOD was filed in September of 2008, this probably means the borrowers started missing full payments back in June or July of 2008. Now here is where the process drags out and shadow inventory builds. So the NOD is put on the place in 09/2008 and the first auction is scheduled in January of 2009. Then, it looks like another auction is placed in March of 2009. When is the home finally taken over? By October of 2009. Now do you think this borrower was making payments all that time? Yet the process isn’t complete. Only on Tuesday of this week was the home listed! So let us recap the time it took from first missed payment to MLS listing:

June/July of 2008 first missed payment to January 5, 2010 MLS (18 to 19 month process)

And what is the current listing price?

List Price: $699,900

So the bank is simply writing off that second mortgage completely and hoping to recoup on the first. These kind of cases simply point to a major drawn out housing market for the state. When we consider all the option ARMs and Alt-A loans, many people are going to face similar problems.

It is troubling to see so many people eager to jump on any home even if they have to spend every hard earned penny they have saved during the bubble times (they assume the bubble has fully burst). They somehow think the market has already bottomed. It has not.

Now you might say, people in this zip code of Burbank must be making tons of money. Let us take a look:

It would take over 12 times the median annual income of this zip code to purchase this home! That is flat out bubble land to the next dimension. I mean run the numbers. Let us assume you go with an FHA insured loan with 3.5 percent down:

Down Payment: $24,365

The family looking to buy this home will need an income of $200,000 which doesn’t seem to be reflected from the income tax data pulled for this zip code. Let us run the net income numbers for someone not living in the area:

So even assuming a family with a $200,000 household income wants to buy this home, nearly 50 percent of their net pay is going to their housing payment. That is nuts! Plus, the median household income for the area is not even close to $200,000 but $56,000. This is why California is still largely facing major pocket bubbles in areas like Burbank, Culver City, and Pasadena to name a few.

Incomes do matter by the way. And one thing people forget is that over 40 years, the average 30 year fixed mortgage hovered around 9 percent. You want to run the numbers at 9 percent?

Let us assume you buy this home. In a few years, rates go up to 9 percent. A family looking to buy this home at the current price, no price adjustment, will now need an income of $263,000! And keep in mind mortgage rates can’t go any lower. The Federal Reserve has now gambled the entire security of our nation’s well being. They have purchased some $1.25 trillion in mortgage backed securities since no one else in their right mind would buy these toxic products. That game is going to end badly and rates will go up once that hits as is typical in any high risk investment. When? Who really knows but making a bet on California housing right now is a major gamble. If you feel the need to gamble go to Vegas and satisfy your need. At least there your odds in some games are close to fifty-fifty. In California housing, it is hard to see how you’ll win in many cases.