Wednesday, September 3, 2008

Beautiful California Home

A Rant About Real Estate

Few people would argue that real estate prices have gone out of whack the past few years, especially here in Southern California. Yet, few seem to realize how much those prices have to correct before getting back to realistic levels.

People's beliefs regarding the housing market seem to be based more on urban myths than facts. Just a year ago an otherwise reasonable person told me that housing prices never go down. It is not true historically, regionally, but was especially oblivious to reality at that time. The current myth that everyone seems to believe is "This is the time to buy. Buy now or miss the window." I don't believe that to be true. The real estate bubble left a psychological mark on people, making them think that completely outrageous prices are normal. Even now after the bubble have burst they can't quite grasp the real scale of things.

People seem to believe that we have almost hit the bottom and that prices are going to be merrily bouncing back up soon. I seriously doubt that. The subprime mess is not even over yet, and the Alt-A crisis is just starting up. Unlike subprime, these loans were given to people with good credit rating. Also these loans were by average larger amounts than the subprime ones. The borrowers of these were set to pay interest only for a set period (5-7 years) after which they have to start paying back the principal too, making their monthly payment jump up significantly. Seventy percent of these type of loans were given in California and Florida during the bubble. Their current state of payment delinquencies and defaults reflect perfectly how the subprime crisis started. There are also the Pay Option ARMs where the buyer could decide how much to actually pay at any month, possibly less than even the interest with the interest getting added to the principal. Many of these people after several years ended up owning more than the purchase price, ending up with negative equity. By all signs it looks like that the second, larger wave of foreclosure tsunami is about to hit our shores.

But lets put away the business talk and just look at the numbers, the basics: the SoCal median income is around $60k, the median house price is over $300k (over $400k in Los Angeles). No amount of urban myth can bridge this gaping chasm. Some people are expecting a mass of buyers rushing in for the now "affordable" prices. Let's be frank, the prices are not there yet, and the number of potential buyers is limited. Sure, lot of people want to buy, but most of those who were likely to make rush decisions, get over their heads have already done it the last five or so years. Those who are left are most likely to sit on their hands, window shop, and simply just wait it out. Not to mention that the tightening lending regulations now don't allow them to borrow more than they can afford.

Another urban myth is that everyone wants to live here and it makes the most outlandish housing prices acceptable. There is a tiny truth to it, you can expect to pay a higher percentage of your income on your mortgage payment here than less desirable places, but you can stretch that only so far, before it snaps like tired old rubber band. It's simple physics. The irresponsible lending practices of yesteryears have masked this simple rule for a while, and even though the market snapped, a lot of people rather put their heads in the sand than accept it.

There are forecasts out there predicting that the downward spiral will last for several more years and that the housing prices will slump to 2003 levels or even lower before starting slowly climb back up. Fortunately this is not like UFOs or the Bermuda Triangle, so in the next few years we'll see who was right and who was wrong.

Bubble/Bust Psychology

Relevant Links:
New York Times
Mr. Mortgage
Federal Reserve Bank of New York
CNN Money
LA Home Search
ABC News
Business Week
Dr. Housing Bubble
More CNN Money

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