Let us bring our attention to the Westside of Los Angeles.  Today we salute Palms, Santa Monica, and Culver City with our Real City of Genius Award:

Source:  Wikipedia

Even within this niche area, there is a wide variance of properties.  The halo effect permeates to other cities from the big movers.  Maybe breathing in the Beverly Hills air gets to other surrounding cities at least when it comes to valuing real estate.  These mid-tier markets within a prime area are the next, I believe, place that will face price adjustments.  Even with all evidence pointing to this with massive amounts of shadow inventory building because people can’t afford to pay their mortgage, there is still a lot of doubt as to the extent of the price correction.  There is definitely a trend of more short sales making it to market.  Everyone by now has an understanding of a short sale (the lender agrees to sell a home for less than the mortgage balance) and the impact it has on the market.  Yet short sales are now part of the SoCal real estate market especially in prime locations.

I was meeting with a colleague, good guy but definitely a perma-bull on housing so you can imagine the conversation, but he is actually looking to jump back into Westside real estate.  His impression is that since prices haven’t fallen drastically in this disastrous climate, then nothing will jolt values later on.  However, the collapse of prices at the higher end is merely in the first stages.  The process is sequential and fluid; just because it hasn’t corrected doesn’t mean it won’t.

Let us look at our first short sale example.

Short Sale #1 – Palms, Mar Vista

12844 GREENE AVE, Palms – Mar Vista, CA 90066

Listing Details

Listing price:                      $495,000

Last sold (6/1/2007):       $655,000

Current difference:        -$160,000

Beds:                                     2

Baths:                                   1

Square feet:                       972

Built:                                      1952

On market for:                  90 days

The above property is located in the Palms, Mar Vista area of Los Angeles.  A nice area and certainly a good place for a starter home for a young professional family.  But prices are very much disconnected from fundamentals.  Look at the above home.  It is listed at 972 square feet and supposedly has a sale pending.  However, we are still talking about close to $500,000 for 972 square feet.  Now this is a big discount from the $655,000 peak sales price back in 2007.  So we are definitely seeing more movement with banks being more aggressive on certain homes in terms of taking lower offers.  But again, these are typically the lower priced homes in each area.  There are many higher priced homes with missed payments that are simply sitting in the shadow inventory.

Short Sale #2 – Santa Monica

2712 6TH ST, Santa Monica, CA 90405

Listing Details

Listing price:                      $850,000

Last sold (12/6/2006):    $1,155,000

Current difference:        -$305,000

Beds:                                     3

Baths:                                   2

Square feet:                       1,064

Built:                                      1914

On market for:                  27 days

It’s easy to be a millionaire when you don’t count your liabilities.  Just because you “own” a million dollar home doesn’t make you a millionaire.  The above Santa Monica home is listed for sale at $850,000.  It is 1,064 feet with 3 bedrooms and 2 baths.  At one point, it did sell for $1,155,000 in 2006.  Can prices fall in prime locations?  Absolutely.  And to most, a $300,000 haircut in 4 years is a significant deal.  Still think the Westside is immune to the correction?

Short Sale #3– Culver City

4178 CENTER STREET, Culver City, CA 90232

Listing Details

Listing price:                      $600,000

Last sold (12/2/2005):    $850,000

Current difference:        -$250,000

Beds:                                     3

Baths:                                   2

Square feet:                       1,918

Built:                                      1950

I’ve covered Culver City many times before and the above is a typical short sale in the area.  This home was bought back in 2005, half a decade ago, for $850,000 and is now listed for sale at $600,000.  It is listed at 1,918 square feet with 3 bedrooms and 2 baths.  We still have people willing to pay at these levels but only with the right lending.  For this home, let us run the numbers assuming a 10% down payment:

Sale price:                           $600,000

Down payment:               $60,000

Mortgage PITI:                  $3,606

Is this a good deal?  At the lower end you will need a household income of $175,000 to $200,000 a year to purchase this place.  The Westside is already showing major cracks in housing values.  $100k to $300k discounts are large for most people, even those in the Westside.

On a side note, I’ve added a new forum where people can discuss the specifics of certain areas so make sure to check it out.

Today we salute the Westside of Los Angeles with our Real City of Genius Award.

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Inventory in Southern California is still growing:

Source:  MLS

Now this growth in the MLS inventory is only in the subset of properties that the public can see.  The bulk of properties are sitting hidden in bank balance sheets and are part of the shadow inventory.  I wanted to show you how big of a difference this discrepancy can become when you include these additional properties:

Source:  MLS, MBA

The above chart is looking at MLS and MBA data for the entire state.  For Southern California, the actual breakdown of distressed properties looks like this:

The above chart is probably one of the most telling in regards to where things stand today.  Over 140,000 properties in Southern California have at least a notice of default, are scheduled for auction, or are now bank owned.  The amount of these properties that show up on the MLS is sparse.  We are seeing virtually a 2 to 1 ratio here.  For every one property on the MLS we will likely find two properties being distressed.  In mid-tier areas, it is higher as we will show.

Let us run an experiment to test this out.  We’ve covered Culver City and Pasadena many times in the past so let us use those two areas here again.

MLS Pasadena

Total Listed:                        678

Short sales:                         71

Foreclosures:                     44

Total distressed:               115

Foreclosure Data Pasadena

NODs:                   225

Scheduled for Auction or Bank Owned:                 400

Total distressed:                               625

For Pasadena, for every one listed foreclosure or short sale, you can be assured that there are 5 other properties sitting in the depths of a bank balance sheet.  Keep in mind this is for a highly desirable area.  But if you look at the data closely it wouldn’t appear that way:

Let us run this data now for Culver City:

MLS Culver City

Total Listed:                        148

Short sales:                         25

Foreclosures:                     7

Total distressed:               32

Foreclosure Data Culver City

NODs:                   74

Scheduled for Auction or Bank Owned:                 98

Total distressed:                               172

Well what do you know?  It turns out that the numbers look nearly the same in Culver City.  For every one distressed property on the MLS, you have 5 others hidden in some bank balance sheet.  Now when I look at this data what I see is a façade in Southern California real estate.  Prices in these areas are still extremely high relative to household incomes.  Unless you go out there and buy with an Alt-A or option ARM (no longer available) you will have to show a decent income.  But let us dig deeper a bit.  How much are those foreclosures selling for in Culver City versus what is off the balance sheet?

This is incredibly important.  Banks are listing (what appears) the bottom barrel homes here.  The average listed foreclosure price for Culver City is $330,000.  This is interesting given the median sale price for Culver City in zip code 90230 is $605,000 and in 90232 is $775,000.  Seems like a tiny bit of a discrepancy don’t you think?

I decided to jump deep into the data for this area and pulled up 19 bank owned homes in the area.  This is where you actually see bank behavior stand out.  The “estimated value” of the 19 bank owned homes in Culver City are $443,281 and the average estimated loan balance on each place is $552,159.  These places are massively underwater yet banks seen to be cherry picking which homes they funnel out to the MLS.  So right now you see a trickle at the bottom end but make no mistake, the bigger suckers are only a few months away and are already falling massively behind on payments.  Banks are basically trying to avoid facing the music and realizing the reality that these properties are overpriced (people can’t even keep up with their payments).  Does any of this data look like a healthy market?

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Yet Southern California, a region with over 20 million people is still largely in a housing bubble.  If we look at housing prices on a historical basis, they normally keep pace with inflation.  So we can first use inflation over the past decade to measure the housing bubble:

California CPI

2000 = 172

2010 = 227

Increase of 32 percent

Source:  CA Dept. of Industrial Relations

Over the decade the Consumer Price Index (CPI) for the state has gone up nearly 32 percent.  This includes rent and also the owner’s equivalent of rent figures.  This is the measure that is often used to examine inflation.  It may be flawed since it understated the housing bubble going up and does not capture the crash with home prices going down.  Yet this is the figure often used in government studies and also to base monetary decisions taken by the Federal Reserve.  How did home prices in Southern California perform over the last decade?

This is where you can see the housing bubble clearly.  In areas like Riverside and San Bernardino (the Inland Empire) home prices have actually come under the overall rate of inflation.  In fact, San Bernardino is seeing prices like those back in the early part of the decade.  So the housing market is not uniform across the spectrum even in a regionally close area like Southern California.  The three areas that are largely in bubbles are Los Angeles, Orange, and Ventura counties and the data above shows why.

In Los Angeles County home prices are up 72 percent over the decade and this is where half of SoCal lives (approximately 10 million people).  This is twice the overall rate of inflation.  If we were to use the 32 percent rate, home prices would be closer to:

$200,000 x 1.32 =             $264,000

That would mean an overall price decline of 23 percent from the current level for the county.  Is this feasible?  Keep in mind that prices can adjust in two ways.  They can nominally correct as they have been or they can be inflated away through inflation (what the Federal Reserve is hoping happens).  Yet without wage inflation and a weak state economy, there is little that can be done here even with gigantic tax credits and historically low interest rates.  So it is very likely prices will adjust lower in these areas.  The amount of the price drop will depend on the rate of inflation and also how well the economy does in the next few years.

Let us dig a little deeper into some cities in the region:

I track various markets closely because this is the only way you will get a better sense of market dynamics.  All the above areas are largely in housing bubbles as measured by their price increases (if we go by income and inflation data).  But if we look at a more recent trend we can see what is happening.  In very high priced areas like Westwood and Santa Monica, we see prices declining in the first half of 2010.  In the 90024 zip code, home sales doubled but the median price fell by $500,000 for these sold homes.  In Santa Monica (90405) the median price fell by $250,000 with the same number of homes moving.  In the 90803 zip code of Long Beach the median price fell by $240,000 over this time.  The higher priced regions are seeing similar trends.

Yet look at the mid-tier market.  This is where you see many fence sitters moving off the sidelines and jumping back into the market.  All these loans qualify under the FHA insured guidelines whereas the other top areas need jumbo loans and a hefty down payment.  For these areas home sales have jumped and so have home prices.  Take a look at the 91104 zip code in Pasadena.  Back in January 16 homes sold for a median price of $465,000.  In May, 30 homes sold for $605,000.  These are reminiscent trends of the housing bubble days.  Or take a look at La Verne.  In January there were 8 home sales at a median price of $465,000.  In May, there were 18 sold homes at a median price of $650,000.

What can we gather from the above?  The higher jumbo market end is adjusting rather drastically.  This market requires high down payments and cash to purchase.  The starter home markets and nicer area markets that qualify for government loans are showing bubble like jumps as many of those sitting on the fence jumped in to capitalize on the government tax credit and have pushed prices up.  With the tax credit and a low down payment it isn’t that hard to jump in.

What is happening in lower priced areas of Southern California?  Let us examine that market as well:

First look at the decade long price increase column.  Interesting how each of these areas falls close or very close to the overall inflation rate (aside from Compton).  What happened in the first half of 2010?  Not much in terms of price.  The only area that saw a nice jump in home sales is the 93551 zip code in Palmdale but prices remained largely at the same level.  You’ll also notice that the amount of home sales in these regions is much higher than the previous chart.  And this isn’t all based on population:

93551 (Palmdale):            est. pop               41,462

91104 (Pasadena):           est. pop               40,882

The Pasadena zip code had 30 home sales and the Palmdale zip code had 106 home sales in the same month.  Clearly something is pushing a three time higher sales rate in an area that has nearly the same population.  For the above lower priced regions, a large part of the home buyer base comes from investors.  But this momentum is stalling out.  With rents declining and a glut of housing on the market, many investors are finding it harder to flip in these regions.  Good luck trying to find steady renters in these markets that are facing challenging economic situations.  Housing can only remain healthy if the overall economy is healthy.

The overall amount of housing making its way onto the market is slowly increasing on a day to day basis:

Since the low MLS inventory figure of October of 2009, MLS inventory for Southern California has increased 23 percent.  The trend shows no signs of stopping.  Much of this is probably due to many Real Homes of Genius and regular homes now entering into the public view as banks move more inventory.  Let us look at Pasadena for example:

What we see is the public MLS inventory moving up while distressed properties move lower.  The amount of shadow inventory has moved slightly lower while MLS inventory has slightly moved up.  In fact, if we add MLS + distressed inventory there has been little change from November of 2009 to our data today in July of 2010; 1,239 for Nov. 2009 and 1,264 for July of 2010.  Keep in mind this trend was made completely possible by government bailouts and intervention.  The question will be whether prices can stand on their own now that every imaginable gimmick has been thrown onto the housing market.  It is also the case that distressed figures are kept lower as banks prolong the first step in foreclosure.

Even with the large amount of home sales from lower priced areas home sales for the region are far from peak levels seen in the bubble:

This gives you a good perspective of where we are at.  We have yet to have a 25,000 sales month since mid-2006.  We are nowhere close to a 30,000 sales month or the insane months of 35,000.  And keep in mind that at certain points over the last year 50 percent of sales were foreclosure resales in the market.  The previous peaks were all done with grade-A bubble herd buying (little distressed to be had).  We are still working through large amounts of toxic mortgages so it will be two years before we have any semblance of a normal market.

What can we conclude from the above?  Large parts of Southern California are still very much in housing bubbles.  It looks like starter home areas have seen a strong jump in price as people rush to suck up government intervention.  Prime markets like Santa Monica and Westwood have seen prices fall but are still high relative to local area incomes.  Lower priced regions seem to have steady sales and prices.  So the bubble is now in the hands of middle class home buyers that moved off the fence and were sold by the government easy money parade.  Yet will this hold going forward?  That is the next trend to follow in the second half of 2010.

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This is probably one of the most important questions going forward.  First let us examine California as it stands today:

Let us go through each category above to make things more clear.  The for sale column is pulling data from the MLS.  This is data that the public can view either through a realtor or through one of the many sites available online.  The next column for distress properties includes all notice of defaults, properties scheduled for auction, and those that are in foreclosure.  As you can see between the differences from the “for sale” item to “distress properties” a large part of this real estate never makes its way to public view.  Finally, we know from banking and current mortgage data that 15 percent of California mortgage holders are at least 30+ days late or are in the process of foreclosure.  This is the most troubling data of all.  Nearly 800,000 properties show up here.  What this tells us is that we have a few years of working through this mess before finding any sign of stability.  Keep in mind a large amount of troubled mortgages have yet to be dealt with in the state.  The above should give you a sense of what we have today in California.

Let us continue the math.  Last month statewide, California had 40,965 home sales.  At the same time, 24,669 new notice of defaults were filed.  So let us do the math here:

40,965 – 24,669 =              16,296 homes cleared out of the massive inventory

Now depending on your perspective, if we only look at MLS data we have roughly 3 months of inventory in the state.  Looking at distress data we have over 6 months of inventory.  If we look at the broadest measure we have 19 months of inventory.  However, we are only looking at the current sales rate and keep in mind this is high because of tax breaks and also the current part of the selling season.  We also have to take into account that last month nearly 25,000 more properties are being put into the pipeline for future distress (not counting regular homeowners who want to sell).  Subtracting this out, we really cleared out about 16,000 properties for the month.

Assuming no new foreclosures (not likely) at the very earliest it will be mid to late 2012 before we have any semblance of a bottom in California.  Keep in mind that California is also battling a troubled state budget.  This will require new revenues (higher taxes) or more cuts (higher unemployment).  Both options are bad for housing going forward.

Double dip recession

I’m surprised that many in California are talking about a double dip recession.  In this state at least, we never got out of the recession to begin with.  All we need to do is look at the unemployment data to show us this:

Does that look like we double dipped?  Unemployment is still sky high for the state.  Without a solid economy there is little prospect that real estate in California will somehow enter another golden era.  We have lost over 1 million jobs in the state since the recession started.  Even last month when we added 28,000 workers it will take us 35 months before getting back to pre-recession unemployment at this rate.  And looking at the data carefully, we see that the bulk of employment growth came from the government sector.  This provides more evidence that we are still at least two years away from any housing bottom.

Drag of shadow inventory

Looking at the first chart you realize that there is a tremendous amount of distress property on the market that is hidden from the public.  This large amount of shadow inventory will be a drag on California real estate prices going forward.  Nearly 800,000 mortgages in California are at least 30+ days late or are in the process of foreclosure.  Yet only 132,000 homes are listed on the MLS.  That is why it is hard for any honest realtor to tell you with a straight face that there is “only” 3 months of inventory so you need to move fast.  Most understand that the real market is full of troubled properties.  Plus, you realize that we still have thousands of homeowners not keeping up with their mortgages and many more being added per month.

We all realize the issues with Alt-A and option ARM products.  These are still out there and will not finish resetting/recasting until 2012 (at least the bulk).  But now, the bigger problem revolves around the larger prime market having major problems.  Fannie Mae and Freddie Mac are losing money left and right (which means we as taxpayers are losing money left and right).  FHA insured loans are plagued with sharply rising defaults and these make up about 4 out of 10 loans in California (this trend has held for nearly a year).

The massive drag of shadow inventory will keep a lid on real estate prices going forward.  Throw in the fact that higher priced properties have yet to adjust significantly and we have another market that will take a hit (i.e., Culver City, Pasadena, etc).

2012 bottom?

Predictions in this market are a losing game.  With the government intervention it is creating an artificial buffer to the correction.  Yet prices have fallen.  So things get dragged out.  When we look at the data as a whole it looks like 2012 at the earliest will be a bottom.  This doesn’t necessarily mean a bottom in prices but a time when we will work through this massive amount of shadow inventory.  There is little reason to buy right now in many cities and renting is a much better option for many.  Until we work through these 800,000 properties, California is going to have a highly volatile market.  Buyer beware.

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Today we are going to look at two case examples right here in Southern California between a bubble city and one that has popped.  Today we salute you Culver City with our Real Homes of Genius Award.

Buy at $925,000 or rent at $3,795?

It is rare to find any city in the United States that didn’t have a taste of the housing bubble.  Some dabbled in it.  Some indulged in it.  California as a state gorged itself on the housing mania and is now paying the price of relying too much on a bubble for the source of economic growth.  Some cities especially many in the Inland Empire have corrected and are showing signs of more affordable home prices.  Yet affordability also relates to the local area economy.  Take a look at Detroit and home prices there.  They are cheap but for a reason and this can be explained by economics.  If you ask people in Culver City to justify home prices you will get some emotional response that has very little connection to market fundamentals.

For example, throughout the country a really quick and dirty rule of thumb is a home is a good deal if it sells for 100 times the monthly rental rate.  For example, a home that rents out for $1,500/per month is a good deal at $150,000 or less.  As investors, you look for these kinds of disequilibrium.  A good investor would look for an area where rents were high relative to home prices.  For example a home that would rent for $2,000 selling at $150,000.  These deals were hard to find prior to the bubble and once real estate got juiced, many forgot about the basic fundamentals.  We are slowly going back to them.

Take for example this Culver City home:

This is a really nice home in a good area.  The home is currently listed at $925,000.  This is a 4 bedrooms and 2.5 baths home listed at 2,341 square feet.  This place was built in 1950.  Now we are seeing more of this trend where homes are listed for sale but also for rent.  Let us look at the rent details:

The monthly rental rate is $3,795.  You might look up at the home sale listing and see the monthly payment at $3,766.  Keep in mind this assumption is based on a 20% down payment ($185,000) and a 4.56 percent 30 year fixed mortgage.  That is not going to happen so this figure is much too optimistic.  I’ve talked with colleagues in the industry that have stated jumbo loans are between 5.5 and 6 percent with near perfect credit and a 20 percent down payment.  Keep in mind the estimated monthly payment does not include taxes and insurance that will run you another $1,000.  So let us run the numbers once again:

Down payment:                               $185,000              (20%)

Mortgage:                           $740,000

PITI:                                       $5,201                   (30 year fixed at 5.5%)

The carrying cost is very different from the “best case” scenario presented online.  If you were to buy this home with a 20 percent down payment, your monthly net cost out of pocket to service all your home needs would be over $5,200.  Your rental cost is $3,795 a difference of $1,405.  By our simple rule of thumb, this home price is too high.  Culver City still has many homes valued at bubble level prices.  Now if we used the simple rule of thumb we would do the following:

$3,795 x 100        =             $379,500

This seems so far off from the current asking price that some will laugh.  Yet in some areas of California this kind of metric is appearing.  Let us take a look at Hemet for example.

Here we have a 4 bedroom and 3 baths home listed at 2,689 square feet.  The place is currently up for rent for $1,400 per month.  If we use our quick and dirty analysis we would find:

$1,400 x 100        =            $140,000

Think we can find a similar place for close to this price point?  Yes we can:

We find on the same street a very comparable home.  The above is listed as having 6 bedrooms and 2 baths and is listed at 2,389 feet.  It is a short sale and is currently listed at $150,000.  This place is actually selling for less than the sale price in 2000 ($173,500).  Hemet is 96 miles away from Culver City but they might as well be worlds apart in terms of real estate valuations.  It would be one thing if the market in Culver City was able to support a $9,250 per month rent on the above place.  But clearly it cannot.  Why?  The market is saturated with rentals and prices are just too high

“(Lanser OC Register) Veteran Orange County apartment owner and manager Ray Maggi says this the current rental market “is the worst I’ve ever seen” for landlords.

Maggi, a past president of the Apartment Association of Orange County, says in his three decades in the rental game hasn’t seen as harsh a mix of falling rents, empty apartments and rising costs.

Contrary to popular belief, we don’t make money with 90% occupancy,” he says of current historically high counts of empty units across the county that run roughly at 10 percent vacancy.

Maggi notes a 96-unit complex he’s owned in Buena Park since 1978 as a good market gauge. Before this slump, he never started a month at this complex with more than 10 vacancies — and now he’s got 14.

“Lots of hard times,” he says explaining why it’s so hard to fill up apartments.

High unemployment means that many prospective tenants are either doubled up with roommates or have moved in with family members. With landlords fighting for a limited number of customers, the winner is the renter. Last year, landlords usually offered free months of rent as lures for new tenants. This year, Maggi says, more landlords have simply slashed rents to meet tight-fisted renters who have plenty of choice.

Making matters worse for property owners is that a growing number of tenants aren’t keeping up with payments. Charge-offs have roughly tripled to nearly 3 percent of rents due.

“It’s a tough road out there,” Maggi says.”

The rental market overall is tight across Southern California.  These hybrid homes for sale/rental are good indicators of any market price imbalance.  The sale price is the optimal dream point while the actual market rent is really what someone can support in the current market.  Culver City has enormous disequilibrium.  We don’t even need to look out of state to see a more sensible market.  What justifies this massive price discrepancy?  Better schools?  If that is the issue then just rent in this area.  Sense of homeownership?  Is it really worth this big of a price gap?  Clearly these kinds of bubbles don’t last long.  The $925,000 home sold for $185,000 back in 1993.  The rate of inflation from California from 1993 to 2010 is 53 percent according to the California Department of Finance.  As we have seen through many studies, real estate over the long run tracks the general rate of inflation.  So if that is the case, this home would have a value of $283,000!  But if the place can yield $3,795 a month it clearly has a value of at least the 100 time multiple.   You can judge for yourself whether some cities are in bubbles.  I think the data speaks rather clearly.  It is a great time to rent.

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

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