The casualties of the housing market are hitting Southern California even in middle class neighborhoods. Countrywide CEO Angelo Mozilo is pushing for Fannie and Freddie to raise their caps to $625,000, in a push to socialize the housing bubble. This is on the back of a previous request of raising rates to $850,000. As you will see in today’s Real Home of Genius, we are starting to see decent homes in middle class areas reaching caps that are already in place. There is no need to push for higher caps. If you haven’t noticed unscrupulous lenders will push buyers into the maximum loan caps and buyers will not read their contract and take on whatever debt is put in front of them. The caps are there for a reason and right now isn’t exactly the best time to be asking Freddie and Fannie to take on more responsibility considering they are still trying to shore up liquidity to remain stable. Raising caps by 50 percent isn’t exactly the best thing to do. Keep in mind that a recent Goldman Sachs report highlighted that Fannie and Freddie have about 15 percent of their mortgage portfolio in the California housing market while Countrywide and Washington Mutual have an astounding 45 to 50 percent. Is it any wonder why these lenders are pushing so hard for caps to be raised? This will help no one except irresponsible lenders that fed on greed and now want the government to bail them out for weak lending standards. They try to generalize homeownership and feel that casting a wide enough net, people in other states won’t notice that California home prices are $250,000 to $300,000 above the $213,000 nationwide median home price. But I digress since the housing complex is salivating for a .50 Fed rate cut next week and we are seeing stocks rally especially in the housing sectors since some are betting that the government will allow these lenders to handoff the dung-filled mortgage football to taxpayers.
Up until this year, most of the price cuts we were seeing in California were in lower priced areas or new homes built out in the fringes of the big cities. Now what we are seeing is major price reductions in solidly middle class areas. We’re not talking about minor price drops, we are talking about 20 percent reductions in one year. This is significant for various reasons. For one, many people will reassess their properties next year and state budgets will suffer on overly optimistic predictions. It is yet to be seen the overshoot of state budgets but we should find out by the second quarter in 2008. Looking at Treasury rates it looks like we are already in a recession but contrary information such as solid employment and inflation is keeping the market in a bipolar state.
Today’s Real Home of Genius is located in La Mirada. This 1,700 square foot home has 4 bedrooms and 2 baths. Now we are actually starting to talk about a true starter home for middle class families. I’m not sure I dig the massive chimney but hey, more room for Santa to come down and bring you your mortgage payment. Let us take a look at some of the pricing history on this home:
Sale History
06/05/2006: $545,000
05/16/1978: $60,500
The home was purchased last June for over half a million dollars, not uncommon here in Southern California. Yet with the housing market turmoil and quickly changing market let us take a look at the current activity:
Price Reduced: 10/02/07 — $490,000 to $475,000
Price Reduced: 10/12/07 — $475,000 to $439,000
This short sale has a one year price reduction of $106,000; including sales costs this translates to over a 20 percent decline in one year. We can now safely say that we are in stage 2 of the housing bear market. Short sales are increasing and now middle class areas are having significant price reductions. This again goes back to my critique of the current Hope Now Alliance seeking to freeze rates on subprime borrowers. Many people will be facing issues in prime locations that on paper, look like the model of fiscal responsibility. And let us be honest, subprime has become a pejorative for lower class home buyers when in reality subprime fits a larger portion of the population. This housing decline will impact more people than the government, Wall Street, or lenders would like you to believe.
So let us examine this home further. Let us assume that you are going to buy this home with 5 percent down since no money down and other NINJA loans are slowly disappearing if not completely gone. With 5 percent down ($21,950), guess what, you will be taking on a mortgage of $417,000. This number looks familiar doesn’t it? So much for pushing for larger caps.
Rent vs. Buy Analysis:
Price of Home: $439,000
Down Payment: 5 percent
Mortgage Terms: 30 year fixed at 6 percent
PITI: $3,222
Tax Savings: $607
Net House Payment: $2,616
Median Rent of Home in Area: $2,405
There are many ways to get a quick idea of local rents by doing a quick drive through or looking at sites such as Rent-o-meter. If we are to assume that the additional money saved will yield a 7 percent after tax return, the purchase of this home will break even in 2.7 years. Now we’re starting to get to some more reasonable scenarios. Make no mistake, it will always be more expensive to own a home because of equity build up, tax savings, and other non-tangible factors of being a homeowner. Yet in a declining market depreciation become a liability as we are starting to see. But right now we are in a completely different world. As you can see from this one example, these are the type of ratios that will be more common in 2008-2010 as they should be. The average household income in the area is $74,268. So let us break down the income numbers a bit further:
Monthly gross household income: $6,189
After tax monthly income: $4,830 (with 2 exemptions filing as married)
So with the above scenario you are spending slightly above 50 percent of your gross pay on housing. This in California is common and just take a look at some of the other Real Homes of Genius where the ratio hits 80 and sometimes 90 percent. The main point you should take away from this is that when housing does bottom out, local area incomes will matter in relation to price. No need for increasing caps or absurd complicated proposals; simple historical fundamental standards based on income and financial prudence served us well for many decades and they will continue to do so. Historically this has always been the case and this bubble bursting will return us to the fundamentals. Back to the basics; from CDOs and SIVs to ABCs.
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10 Responses to “Real Homes of Genius: Today we Salute La Mirada. Housing has Entered Stage 2 of the Bear Market. Middle Class Areas $100,000 off in one year.”
Dr HB,
Unfortunately the houses you put on, even in good neighborhoods, is no where near desirable.
This one for example, looks like a project gone bad. It could need $100k to simply make it livable. The house looks like crumbling or missing part of the roof, and the unfinished construction and destroyed lawn definitely tells you to stay away. I highly doubt that it is not sold AS-IS. You are looking at paying much more than the price tag for this one.
Here in Temecula, CA, (Riverside County) prices have dropped, of course. However, I have seen many, who do not have to sell now, take their homes off the market. I don’t know how long they expect to wait before they can relist and get their price, but I hope they’ve unpacked.
The majority of RHOG are jokes in dangerous areas with horrible schools and still they command $400,000 to $500,000. Now, we are starting to see “middle class” areas adjusting where only a year ago, this was unthinkable in California. This is simply a preview of things to come. We will be in stage 3 when decent starter homes are offered for more typical historical ratios.
Most short sales are sold as is but this will change. You can always put in an offer to counter what is explicitly stated. When banks need to unload REOs nothing is set in stone.
About limits of government supported house buying: Wouldn’t it be better to tie those limits to the INCOMES of a region instead of the prices? This would ensure that low-income households could be helped when houses are affordable and could work as a circuit-breaker in time of housing bubbles when house prices break historical ratios to incomes. That would be true for any limits, FHA, Fannie, Freddie, etc.
Well Dr HB,
I think the bailout is going to happen. Look at this
Five-year mortgage rate freeze looms
http://news.yahoo.com/i/749;_ylt=ApytHVzmf48PvCQnLPSzVJSs0NUE
I’m not very happy about this. I guess laming will come out ahead.
Next time, go with the crowd, and buy what one can’t afford.
I’m so disgusted. Maybe it’s time to sue the government for being so unfair.
Is this constitutional? What about people with fixed rates? Where is their hand out? What about the renter?
It’s a sad day for people who are prudent with their finance, because it doens’t pay to do it.
Thanks.
Crazed
I live in Santa Clarita, which is about 50 miles north of Los Angeles. Houses that are the same model as our’s in this neighborhood are listed for $525,000 to $549,000. The house across the street is on the market as a short sale, being sold “as is”. I understand is has water damage that was never fixed. There is no sign in the yard so I don’t think any of the neighbors know it’s for sale unless they check the MLS. When they find out the asking price is $360,000 they are bound to go bolistic. Who knows what it will actually sell for. Thank God we are renting right now.
The 5-year freeze is a typically horrible government intervention into a semi-free market, and will undoubtably have the typical horrible consequences. Anyone else remember Carter’s attempts at price freezes during the oil embargo?
What the Mozilos of the world need most is more credit crack capitalization so they have more cheap $$ to peddle on the streets. However, investors the world over have seen the hideous risks of derivatives made of derivatives for what they are. They aren’t going to provide the mortgage originators the crack they need. And having government undermine contract law (which may well eventually be found unconstitutional) with this 5-year freeze places much more than just mortgage lending investments at risk in the US. The falling dollar is brutal enough already in the international arena–add to that a flight from US investments due to an even bigger crisis of confidence induced by the complete lack of respect for contracts demonstrated by this poorly advised government meddling, and the picture gets much darker and potentially very quickly.
Fannie and Freddie still have to get their capital from somewhere, cap increases notwithstanding. Freddie just last week decided to issue $6Bn in new preferred stock while cutting its dividend in half (that’s some serious dilution of the current stock capitalization, folks) at the same time they are keeping $4.3Bn in already-realized hedge-fund losses off the books using the same sort of accounting Tomfoolery that Enron was using just before it collapsed. (see [url]http://www.bloomberg.com/apps/news?pid=newsarchive&sid=ahoxGPj68WN0[/url] ) If Freddie were to bring those losses onto their books, they’d now be well below their federally-required core cap floor. So [i]who[/i] is going to be swimming in to buy this new dilution of Freddie’s already arguably worthless stock?
Even without the full wave of subprime foreclosures, the capitalization base needed to support this bubble still isn’t there. And let’s not fool ourselves…a subprime borrower with a sub-660 FICO score is just that due to a history of prior financial misbehavior. How many of those “saves” do we expect to last even a year given the basis of those low FICOs?? Feed these people more rope, and they’ll just make a better noose for themselves.
I’d think Hillary would want to see this thing over with before she moves back in to 1600 Penn Ave. This will almost certainly ensure that whoever wins will get to wallow in this mess for those defining first years in office.
Bob
Excellent blog, Doctor HB. A quick question: where do you find the info about house repricing? I don’t see it on the Redfin site, which is otherwise very informative.
Crazed and Bob,
I wouldn’t get to worked up about the 5 year freeze. For the few that apply to the criteria, many will probably decide to walk away anyways. For those who don’t walk away, many won’t be able to keep their finances together anyway. And for those who can keep their finances together, they likely won’t be able to refi after the 5 years and will end up in a short sale situation anyway.
Lastly, if you’re waiting for the chance to buy after the market returns to reasonable values, don’t worry about the freeze doing anything. The market will correct even if a small percentage of these homes don’t go up for sale.
California’s housing market truly is slacking these days. I recently read on a blog, a real estate company giving advertising buy one home, get one free.
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