The California budget is mired with systemic problems and many state and local government are going to be battling with cuts over the next couple of years even if the economy starts recovering.  If we actually look at unadjusted unemployment figures, the unemployment rate for Los Angeles County and California is a stunning 13.2 percent:

Source:  EDD

Very few of us have ever seen an unemployment rate this high for the region.  And we are starting to see some aggressive price cutting from banks in some select mid-tier markets to reflect this lower wage economy.  It is hard to tell what is going on internally on the balance sheet of many banks but it isn’t good.

Today we’ll look at what I would consider a mid-tier city in Los Angeles County that is starting to see some aggressive price cuts.  Today we salute you La Mirada with our Real Homes of Genius Award.

Half Off From 2006

La Mirada like many cities in Los Angeles County saw a massive jump in housing prices.  When prices were out of reach in other locations La Mirada was considered a good middle class place to buy a modest home.  This seemed to be enough to justify massive increases in prices.  The median price peak was reached late in the spring of 2007:

June 2007:           $555,000 (median La Mirada home price)

In that month, 40 homes were sold in the city.  Today the stats look a bit different:

January 2010:     $380,000 (median La Mirada home price)

In January 25 homes sold.  Now, much of this of course has to do with it being winter but a 31 percent price cut in less than three years is significant.  Yet prices are still too high given the household demographics.  We’ll get into that in a minute.  First let us examine the home above in better detail.

The above home is a 4 bedrooms and 1 bath home.  It is listed at 1,312 square feet and was built in 1953.  When I go into the history of California housing this was one of those massive building boom times.  This home was purchased near the peak back in 2006.  This home was financed with toxic mortgages up to the very common 100 percent mark:

Let us run the numbers.  The home was purchased for $514,000 with an 80/20 setup:

1^st mortgage:     $411,200 (80%)

2^nd mortgage:    $102,800 (20%)

Now I know some of you are stunned about this but this was very common in California.  In fact, those toxic option ARMs were being handed out like Pez candy.  The notice of default was filed back in December of 2008, then in March of 2009 the NTS was filed.  It took another nine months from that point for this home to go into bank owned status.  The home hit the MLS on 1/19/2010.

But here is where I’m noticing some reality based pricing.  Back even a few months ago, you would see bank owned homes hit the market at outrageous prices and banks simply sat back and did nothing.  On some areas and some homes, pricing seems to be aggressive on the downside.  Take a look at this place:

Price Reduced: 03/03/10 — $284,900 to $259,900

A 50 percent haircut from the 2006 peak price.  Before you jump up and down this is exactly what we’ve been talking about.  It seems like in some markets banks are being more realistic with their pricing.  And they should be.  Take a look at the household demographics for the city:

So let us run the FHA insured loan numbers here since at the current price, it clearly meets the criteria (4 out of 10 homes sold in SoCal were FHA backed last month).

3.5% down payment:     $9,096

The median household family bringing $61,000 is taking home roughly $3,900 net per month.  So roughly 43 percent of net pay is going to the home payment.  Does this make sense?  It would seem a bit high but it is certainly more in line than other areas and certainly far from the bubble peak.  And this is now the next phase and I expect to see more of this going forward.  We went from areas in the Inland Empire seeing big haircuts, to lower priced L.A. County areas, and now we are seeing certain mid-tier cities cut prices aggressively.  In my book, a 50 percent cut is significant.

Should you rush out and buy a home?  No.  If the numbers work and you find a home you like, go for it.  Yet the reality is, if L.A. County has a headline unemployment rate of 13.2 percent then the unemployment and underemployment rate is closer to 24 percent.  In other words, 1 out of 4 people in L.A. County are either out of work or working part-time for economic reasons.  Does that really sound like a healthy market?  Frankly, many people are focusing on their career and employment and are putting aside the Wall Street and real estate industry obsession with housing as the center of the universe.  Without solid employment, home prices will still go lower.  And keep in mind the current household income figures are based on 2008 Census figures and we won’t have more up to date data until September of 2010.  In other words, the income data is much worse than it appears.

And about that shadow inventory?  Let us take a quick look.  The MLS currently lists the following for La Mirada:

Non-distress:     45

Short Sales:        28

Foreclosures:     13

And this is what is lurking on the bank balance sheet:

Pre-foreclosure (NOD):                 124

Scheduled for Auction:                  188

Bank Owned:                                     39

Some had a question about double counting but these are all unique properties, nothing is double counted in the above data except for the 13 MLS foreclosures from the 39 bank owned properties.  86 properties on the MLS and 351 properties in distress.  This above home is one of those “trickle” down homes that is supposedly going to make the market better because we won’t see a flood.   A 50 percent price cut sure doesn’t seem like prices are going to boom as some in the housing industry would like you to believe and even with a drip strategy for the shadow inventory, prices will still come down to reflect economic reality.  And why would it matter how properties are released onto the market?  The distress is as plain as day.  Just look at the above stats.  People with a NOD, auction scheduled, and losing their homes are not in a stellar financial position.  People now have to go with government backed mortgages and even though these are easy to get, they are based on verifying income.  And with 13.2 percent of L.A. unemployed that is proving to be a challenge in itself.

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

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I took a look at data from the Employment Development Department (EDD) of California and last year was another record year for California in terms of unemployment claims paid out:

“(EDD) A record high 1.4 million Californians were certifying for UI benefits in November 2009, according to the most recent information available. In all of 2009, EDD paid $20.2 billion in UI benefits that not only helped sustain families during this difficult time, but also helped support local communities struggling to survive the economic pressures.

The prior record of UI benefits paid in a single year was set not too long ago in 2008, when the EDD paid out $8.1 billion in UI benefits to out of work Californians.

That’s a 149 percent increase in the total UI dollars pumped into the State’s economy in 2009 at a rate of about $80 million a day.

The $20.2 billion paid in benefits in 2009 translates into an economic impact of about $32 billion dollars when you look at how UI dollars spent on basic necessities leads to further spending in the general economy. The U.S. Department of Labor estimates the economic multiplier is $1.60 for every dollar paid out in UI benefits.”

Did you get that?  In 2008, an already bad year $8.1 billion in UI benefits were paid out.  Last year, that number went up to $20.2 billion and we are still near the peak unemployment rate of 12.4 percent:

Source:  BLS

I’ve had this conversation with a few colleagues in the real estate industry.  Whenever they mention that California real estate is at a bottom I always ask them what industry is going to make up for the million and more jobs lost.  They don’t have an answer.  Heck, in the 1990s it was all about the tech sector so that was supposedly going to give every Californian with basic HTML coding abilities and a Geocities account a $60,000 a year job with no college degree.  When that bubble burst, it then was every Californian was going to work for the real estate industry making $100,000 simply by popping on a suit or a skirt and pushing mortgages or property in the mania of the century.  That bubble burst.  So what gig is next?  Can we at least get some jobs going before we start jumping on another real estate price bandwagon?

One major flaw with the current thinking in the housing market is assuming mortgage rates are somehow going to stay low forever:

Examine the above chart very carefully and enjoy that sub-5 percent rate because that is not going to last.  We are at the lower bound.  Even if we revert to historical averages of 9 percent, that will absolutely tank the California housing market.  Keep in mind that a large part of the above is because of the Federal Reserve buying up $1.25 billion in agency mortgage backed securities debt.  That game is quickly ending and this in itself has probably shaved off 100 to 200 basis points.  In other words, mortgages are going to get more expensive.

But let us show this massive disconnection with another on the ground example in Pasadena.  We’ll even pick a prime zip code in the area.  Today we salute you Pasadena with our Real Homes of Genius Award.

Pasadena Dislocation

I decided to pull data on 91105 zip code in Pasadena.  A middle class two income area where the median home price is now $657,000 (down 25 percent from last year).  So certainly this area has seen a correction but is the correcting over?  A good way to measure market metrics is looking at lease rates and home prices for the immediate area.  First, let us look at our home for sale:

The above home is listed as a short sale which now seems to be gaining further momentum thanks to programs like HAFA.  The home is a 3 bedroom and 2 baths home and is listed at 1,978 square feet.  It has been on the market for over 40 days.  Let us look at previous sales history:

Last Sale Info:

Sold 08/17/2006:              $1,000,000

Not too long ago this was a million dollar home and the current list price is $949,000.  So I went ahead and tried to search for a rental in the immediate area.  These are hard to find but are extremely illuminating in giving us a sense of whether current prices are too high or low.  So I found this home on the next street over:

The rental is a 2 bedrooms and 2 baths home listed at 1,504 square feet.  The current asking rent is $3,500.  Now let us run some numbers.  We’ll assume that you are putting 20 percent down for the home purchase:

20 percent down payment:         $189,800

The latest tax data shows the home running $11,381 in taxes in 2009.  So we’ll assume the monthly carrying costs:

$4,310 (PI) + $948 (T) + $395 (I) = $5,653 for each monthly payment

I’m assuming for the insurance that you are actually vigilant enough to get earthquake insurance in California (many homeowners don’t even have this).  So this is a significant difference.  But let us assume you buy this home.  And rates increase modestly to 7.5 percent in five years and you plan to sell.  What is the future buyer looking at?

$5,308 (PI) + $948 (T) + $395 (I) = $6,651 for each monthly payment

With a modest interest rate increase, the payment jumps up $1,000 to $6,651.  This is why we have a lot of correcting to do.  Rates are artificially low and many are assuming the current environment is going to stay this way for a long time.  It will not.  I’ve mapped out these properties just in case you think they are miles apart:

Are these homes exactly the same?  Of course not.  But this is as close as you are going to get to seeing the insanity in the mid-tier of the market.  Now here is the reason ignoring jobs and subsequently income data will lead to additional corrections.  Let us assume you gross $10,000 a month in Pasadena and want to buy this home.  Can you?

Not even close.  Your monthly payment is up to $5,653 and you are netting $6,731.  Sure you can up your withholdings but that won’t change the numbers drastically.  Your housing payment remains fixed.

When I see examples like this it tells me we still have another phase to this housing story.  Today we salute you Pasadena with our Real Homes of Genius Award.

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If we really look at things objectively you would think that things are really good for housing.  Mortgage rates are at generational lows, there is certainly plenty of inventory, and banks are willing to work with buyers.  But this is all a charade.  The problems we are still experiencing are that in many cities in California prices are still in actual bona fide bubbles.  Would you buy a flat screen for $18,000 if your payment was $50 per month for 30 years?  Santa Monica is one of the markets still in a solid bubble.  Today we salute you Santa Monica with our Real Home of Genius Award.

Short Sale Valentine Special

I’ve been getting a few e-mails on how great it is that banks are now approving short sales.  This is actually bogus because it is in their best interest to do this plus, as the SIGTARP report showed banks will get $1,500 for each approved short sale.  Here are some of the incentives:

• Borrower Relocation Assistance — A $1,500 incentive payment to the borrower.

• Servicer Incentive — A $1,000 incentive payment for the servicer.

• Investor Reimbursement for Subordinate Lien Releases — For every $3 an investor pays to secure release of a subordinate lien, such as a second mortgage or a home equity line of credit, the investor is reimbursed $1, up to a reimbursement limit of $1,000 per transaction.

The most hypocritical can of horse manure coming out from banks is that they are now doing this as some kind of favor!  They are using taxpayer money for something they should already be doing.  But that is beside the point.  With HAMP going down in a wave of flames, we will start seeing more short sales hitting the market.  The above chart breaks down the MLS data and as you can see, short sales are a big part of the MLS while foreclosure listings are virtually non-existent even though 1 out of 7 mortgages are in default.  Where are these homes then?  In the shadow inventory or simply being lived in with no payment.

Today’s home is an interesting short sale in Santa Monica.  It has only been on the MLS for a week but the story behind the home is much more interesting:

According to the ad this is a “short sale valentine special” so you might need to rethink that tired and old flower routine this weekend.  Maybe a Santa Monica short sale is the aphrodisiac your relationship needs.  The home is listed at 2,044 square feet with 3 bedrooms and 3 baths.  It was built in 1947.  I give California realtors credit for not even mowing the lawn on a listing in an expensive zip code (90405) in Santa Monica.  Let us look at the pricing action:

Price Reduced: 02/05/10 — $930,000 to $899,000

Only a week on the MLS and already a $30,000 reduction.  Looks like someone is looking to move this place!  You might be stunned that a home listed for $900,000 doesn’t even have a manicured lawn but the path this home took to short sale land is symptomatic of the insanity of California real estate:

Let us walk through the above details.  The home was purchased in 2003 for $770,000.  If you do the math, a mortgage of $600,000 and $93,000 meant this buyer went in with 10 percent down ($77,000).  So they definitely had some skin in the game.  But then, the California housing market went into warp speed bubble mode and they managed to refinance for a stunning $1.2 million.  We really don’t know what was done with that money but we do know this:

$1,200,000 – $693,000 = $507,000 cash out

Now the above numbers are for simplicity.  We don’t know what kind of loan they got but all the lenders listed about specialized in let us say, easy money financing.  Also, we are using the $693,000 for ease of calculation because most of your first mortgage payments go to interest (hardly any principal is taken down).  And who knows, these could be option ARMs.  So now we are in 2006 with a mega mortgage but some cash as well.  Let us run the numbers for a $1.2 million mortgage:

Now we are really being generous with the above data.  The above only includes principal and interest.  Let us include taxes and insurance and the monthly nut looks like:

PITI:       $8,394

Now how much time does that $507,000 cash buy you in terms of monthly payments:

$507,000 / $8,394 = 60 months (5 years)

Well you know where this is heading.  In September of 2009 a notice of default was filed.  They were already behind by $138,099.  Now think about this.  Assuming the $7,194 payment how many months was this:

$138,099 / $7,194 = 19 months

Now this is insane of course but we know with all those Alt-A and option ARM products that this is typical with shady bank strategies.  Finally the home was scheduled for auction and is now listed at $899,000.  Who is going to buy this place?  It doesn’t qualify for FHA insured loan financing.  It would appear that the bigger your mortgage the more dubious banks will be on moving to foreclose on your home.  They are happy to move quickly on homes in the Inland Empire but put a prime Westside location and banks are letting people live rent free for what would seem as ages.  The fact that a listing like this doesn’t surprise me anymore shows how desensitized I am to the gaming banks have been doing.

Today we salute you Santa Monica with our Real Home of Genius Award.

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Today we salute you Cerritos with our Real Home of Genius Award.

The Home for Sale in Cerritos

Cerritos currently has a median home sale price of $610,000.  This is simply absurd given that the average household income is $89,000.  This is the prime example of a shadow inventory city.  Each shadow inventory city has a unique attribute that people think is unique to the area.  Pasadena has the idea of the Rose Bowl and the allure of it being close to L.A. and Cerritos has the draw of quality schools.  But that in itself does not sustain an area if incomes don’t match up to housing values.

The above home is 1,106 square feet with 3 bedrooms and 1 bath.  It has been listed on the MLS for 9 days.  The current list price is $549,000 so if you look at the city median price, this seems to be in line with that figure.  But again, this is simply another area that is in a deep bubble and will correct in the next year or two.  Why?

Because only a few houses down, we have a home that is scheduled for auction and a rental that shows a very different market:

Let us first look at the home that is part of the shadow inventory.  The data on the home scheduled for auction is nearly identical with the home that is for sale.  It is a 3 bedroom and 1 bath home.  It is listed at 1,100 square feet so this area seems to be a suburban box neighborhood where many homes are built nearly the same way.  The home for sale was built in 1969 and this foreclosed home was built in 1970.  Let us look at what occurred on this property:

This home was bought during the peak of insanity for $630,000 in 2006.  This was a 100 percent financing deal.  They took out a first mortgage of $503,900 and a second of $125,900.  Greenpoint Mortgage by the way was a toxic mortgage superstar.  So now after three years the home is scheduled for auction.  When the notice of default was filed in October of last year the borrower was already behind by $37,447.  The auction was only scheduled a couple of weeks ago.  This home is nowhere to be found on the public view.  Keep in mind a few houses down the other home above is being sold for $549,000.

You can see the problem already growing.  This home if it were to be added to the inventory would add pressure to the price of the other home.  Clearly the current borrowers have stopped making their payments.  So who really knows where this is at but this is a clear case of shadow inventory.

But let us run the numbers on that $549,000 home if we go with 3.5% down and a wonderful FHA insured loan:

First, you will need a household income of $154,000 (nearly twice the average for the city) to qualify for the loan.  Next, your monthly housing payment (PITI) is going to come out to be $3,600.  But did you notice that the above rental is going for $2,150?  You are paying 40 67 percent more per month to own the home ($1,450 more per month).  This is insanity.  It will always be more expensive to own, that is correct.  But nothing like this.  In other words, this area is in a gigantic bubble.  Keep in mind your total housing payment is coming out of your net income.  All your wonderful tax subsidies and breaks come at the end of the year when you file your taxes.  The rental rate is more reflective of the actual local market because it is subsidy free and what a local area renter is able and willing to pay out of their net income.

Let us now look at the rental:

The rental is identical in size to the other two homes.  A 3 bedrooms and 1.75 bath home listed at 1,100 square feet.  This is an excellent example of what is going on because we have virtually three identical homes all in the same block but telling us very different stories.  You would have to be out of your mind to pay the current price.  You would be buying at a peak low in mortgage rates in an area that can clearly only support a rental income of $2,150.  Think about that.  No investor in their right mind would pay this amount.  And rates will go up.  Just look what happened to the markets today once people realize a country can’t pay their debt (hello California!).  If you bought this home as an investor, you would be negative cash flowing by over $1,000 per month depending on your down payment.  That would be a dumb move right off the bat and keep in mind, for investment properties the interest rate is much higher and you have to go in with at least 20 percent down.  This is why I believe we are far from a bottom in many markets that are filled with shadow inventory.  And let us run those numbers.

Cerritos in our last month of data had 21 homes sell.  The MLS has 49 homes listed.  Not bad right?  After all, that is about 2 months of inventory.  But let us run the shadow inventory numbers:

Notice of defaults:          83

Auction Scheduled:        143

Bank owned:                     16

242 homes in the shadow inventory versus 49 homes on the MLS.  In other words, you would be speculating into a bubble area right now if you decided to buy.

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

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Yet in many other cities in the mid to upper tier markets prices are still with bubble valuations.  People have a hard time visualizing what a bubble city looks like versus a more normal market so we’ll use an example today.  Today we salute Culver City with our Real Home of Genius Award.

Culver City Rent or Buy Analysis

How do you know if a home is priced at a right level?  We have various metrics that we can use including common sense which seems to run in short supply.  That is how we spotted the epic California housing bubble years ago while the real estate denial cheerleading crew thought that prices would simply continue to go up.  In these mid-tier markets underlying incomes do not support current prices.  It really is that simple.  What is happening in these markets is this; homes are building up in the shadow inventory since fewer homes are actually selling but defaults are still rising as many Californians are unable to make their payments.  The above home is an excellent example in mid-tier Culver City.  This home is a 3 bedroom and 2 baths home that was built in 1950.  This is what many would consider a starter home.

The above home has been listed on the market for nearly 60 days.  The last sale price on this home takes us way back in history:

11/02/1972: $27,500

Now what is the current sale price?  The current sale price is $744,500 for a 3 bedroom in Culver City.  The median sale price for this zip code in Culver City is $540,000 so I’m not sure exactly what pricing angle they are going for here.  Now prices like this are common.  These are the markets where people really think this price point is “fair” and what the cheerleading crew will try to tell you is the market value is what anyone is willing to pay.  This to a certain extent is correct.  Yet that doesn’t make financial sense in the long-run.  It means another sucker is lining up to buy like many that took on Alt-A and option ARMs and now find themselves massively underwater.  And those that think prices are without bubble valuations rarely use thorough analysis or market valuation methods because their analysis falls apart when you think of more macro issues.  We’ll look at a rental right on this street to prove our point but also, interest rates:

One flaw used in many current analyses is assuming the current mortgage rate is going to stay static.  It will not.  We are at historical lows.  The average 30 year rate over 40 years of data is 9 percent.  We are a long way from that.  But let us assume you buy this above home with an FHA insured loan with a 5 percent down payment:

Down payment:                               $37,225

Monthly PITI:                                 $5,015

Needed Income to qualify:          $214,000

Now something tells me that a person or couple making $214,000 a year is not going to buy this home (by the way, the median household income for Culver City is $82,000).  Even if they did, are they willing to shell out $5,015 in a monthly nut for a 3 bedroom home in Culver City?  And let us hypothetically say that things somehow change in the next five years forcing rates up.  Let us now assume mortgage rates are back to their historical average.  How do the numbers workout?

And here is where people miss the point.  Say you want to sell the home in the future, say 5 to 7 years but rates are up to 9 percent.  Now, to sell for the same price (no increase in home price) a prospective buyer will need an income of over $277,000 to buy this home!  Their monthly payment shoots up to $6,400 just because rates went up by 3 percent.  Of course, this part of the analysis is missed by those cheerleaders.  These markets are littered with examples like this.  Alt-A and option ARMs were tools used for people to buy homes like this during the peak with teaser rates.  After all, over 93 percent of option ARM borrowers went with the minimum payment.

But you want more data right?  Okay, let us look at a rental on this same exact street:

You can see the home we’ve been talking about highlighted above in red with the $744,500 listing price.  I’ve circled the other home on the same street that is currently a rental in this market.  The rental listing has the place at 2 bedrooms and 2 baths.  Only a few houses away and 1 bedroom less.  What is the monthly rental price?  $2,250.  You can rent two of these places for the price of the mortgage on the other place!

This is the kind of metrics that scream housing bubble.  And keep in mind rental prices are more sensitive to monthly data because you are paying this amount out of your net income.  No tax breaks, toxic mortgages, or any other gimmick.  One simple rule when evaluating real estate is trying to figure out a home price based on rental income.  One I use is the following:

$2,250 x 12 months x 10 = $270,000

Now this is a quick analysis that I use when viewing potential investment properties and trying to gather a starting price point (other factors will shift the price up or lower but not by much).  So what we do is multiply the annual net rent income times ten to get a rough estimate of value.  Now of course, the other home is a 3 bedroom but here we are being told that we shouldn’t expect much more than say $2,250 in rents for a 2 bedroom.  Let us guess high and say we can rent the home for $2,750 because of the extra room:

$2,750 x 12 months x 10 = $330,000

$330,000 is a long way from $744,500.  There are places in the Inland Empire where these numbers actually work on certain homes.  I’m not sure if I would buy them as rentals given the local economies but if you live there and your income is secure, then buying might make sense.  But not in Culver City.  And keep in mind the California unemployment rate is up to 12.4 percent, a number unseen since the Great Depression.  The actual underemployment rate is up to 22 percent and the California budget is in such a deep mess, that it is hard to see what will be done to remedy the shortfall.

It should be obvious that prices are much too high in these market.  Plus, people don’t even have the income to support these levels!  A couple making $100,000 or $120,000 trying to buy this home is way out of their league.  This isn’t stretching your budget but more like putting a financial albatross around your family budget.  No matter how you slice it, the above home does not make sense.  Yet this is real market data.

The MLS lists 93 homes for sale in Culver City.  Yet the shadow inventory is much higher:

Notice of defaults:          79

Auctions scheduled:      90

Bank Owned:                     18

On the MLS only 2 foreclosures show up and 17 short sales show up (most of the short sales are condos).  Yeah, this looks like a healthy market.

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

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