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Today is the first anniversary of this blog!

Let’s recap where we’ve been over the last year:

1. The daily inventory of houses for sale has grown from approximately 1,200 to 1,750. The inventory usually shrinks in the fourth quarter, we’ll see about this year.  On December 24, 2005 there were a total of 1,092 active listings.

2.  Closed sales have dropped sharply.

Monthly closed escrows:

Sept. ‘04      Sept. ‘05       Sept. ‘06

      302              330                87  (so far)

We’ll add about 100 this week, but that’s still a big drop-off, considering the size of the inventory.

Year-to-date closings (Jan. 1 to Sept. 24):

      2004             2005            2006

     2,741            2,659            1,922    (27.7% fewer than ‘05)

3.  Sellers are slow in getting the message.  The real estate industry has been particularly inept in recognizing the changes in the marketplace.   They rather put a spin on the bubble, than assist people with dealing with it.  I think it’s due to inexperience and ignorance, more than intentional deceit.  If you ask me it’s inexcusable, but at least it helps illuminate the competance of individual agents.  Want to know if an agent is any good?  Just ask him about the bubble, and listen to what comes out of their mouth – their answer will be a great indicator as to how much they can help you.

The #1 goal of this blog is to disseminate accurate data and suggest ways to work with it.

Obviously, looking at these numbers above, I’m doing a lousy job at saving the world of real estate.  But hopefully more individual agents will join in and help educate the clients, especially sellers.

Here how this blog has done over the last year:

Unique users                 27,696

Raw hits                        177,483

Search Engine Hits     50,363

Google PageRank          4/10

I’m not sure what those number mean exactly, but it sounds like a lot of people have been by for a visit.  I am grateful for your attendance and participation – thank you!

You’ll see Option-ARM terms described like this:

$500,000 loan, 1.5% start rate, 2.80% margin over cost of funds, 11.95% lifetime cap, 125%/10-year reset cap

The initial MINIMUM payment is based on the 1.5% start rate, and changes +/- 7.5% per year. That is a mathematical formula that has nothing to do with interest rates.

When you first hear that, it’s hard to fathom how a mortgage payment can adjust with no regard to interest rates.  Because in every other case, it’s the interest rate that determines the payment.

The minimum payment is initially based on an artificially-low ‘teaser’ interest rate, but that’s the only time it has anything to do with interest.

In this example, that MINIMUM payment is:

1st year -  $1,725.60
2nd year -$1,855.02
3rd year – $1,994.15
4th year – $2,143.71
and so on.

(take the last payment X 1.075 to find new pmt.)

The FULLY-AMORTIZED payment IS figured by an interest rate, and it’s determined by adding the margin to the index. Today’s index is 4.11% + 2.80 = 6.91%.

The fully-amortized payment on the $500,000 is $3,296.35.

If you only pay the minimum payment, you ADD THE DIFFERENCE onto the loan balance. – In this case, add $1,570.75/mo.

Once you’ve added/deferred enough to reach 125% of the original loan balance, the loan resets and you then pay principal and interest monthly, amortized over the remainder of the loan.

In this example, the simple math shows that the reset kicks in around month 80, or between the sixth and seventh year. But remember that the minimum payment is going up every year, so if rates stay the same or go down, the gap is narrowed and the reset could be extended further out. In any case, the loan will reset after the tenth year – heck, you have to start paying it down sooner or later.

Obviously if rates go up, the deferred-interest gap widens, and the reset could kick in sooner.

This is your standard World Savings Neg-Am mortgage, also used by Downey Savings and Washington Mutual.

Countrywide and others tweaked the 125%/10-year reset cap to 115% or five years, and those borrowers who didn’t catch it are looking at a reset as soon as 30 months, if they aren’t careful.

There was an example in Business Week that showed a reset after 30 months, and the payment went from $1,600 to $4,000 per month. Ouch.

The mortgage industry better be working on a way to re-negotiate those terms (like raising from 115% to 125%), or they will be owning A LOT of houses in the near future. Not sure how they can re-negotiate on loans sold to MBS buyers, but somebody better do something.

John Dugan, the Comptroller of the Currency, was recently quoted as saying that when rates go from 6% to 8% on a Option-ARM, the payments will double.  That’s incorrect.

Payments could double (or higher) IF THEY ARE RESET EARLY – is the accurate fact.

Here’s the real change in payment when rates go up 2%:

$3,296.35 at 6.91%

$3,990.78 at 8.91%

A hefty $694.43 per month increase, but not double.

And you still have the MINIMUM payment available, or any amount in between.

An interesting fact: When interest rates dropped from 10% in 1990 to 7% in 1994, those who had these Option-ARMS experieced positive amortization.

Their minimum payment was only coming down by 7.5% each year, and the interest rates came down faster – and you HAD to pay the minimum payment.  As a result, a big chuck of the payment, in some cases, 50%, was going towards principal reduction.

Typically once you get past the first few years of an artificially low minimum payment (which was set by the teaser rate) the minimum payment and the fully-amortized payment tend to stay pretty close to one another.

That’s a lot of explanation, let me know if you have any questions.

Let’s recognize that when talking about a depreciating market, there will always be ‘lucky’ sales.  The right buyer might pay top dollar for a killer one-story house, nestled among a group of low two-story sales.

But generally-speaking, how fast will the market re-calibrate?

Appreciation/Depreciation = change

Velocity = rate of change

My program (superior 5-10%, inferior 40-50%, blended 33%) is the change, and it’s already in place.  Buyers determine the change, and they are thinking these numbers today.

Cote’s program (20% initial change, 7% each year thereafter) is the velocity, or rate of change.  The sellers determine how fast they are going to subscribe to the buyer’s program, and they’ll be slow to catch on.  Hence, the recent 30%-40% drop in sales.  The sales that are happening are a combination of lower and lucky sales.

I think Cote’s 20% initial change will be spread out over 2006 and 2007.  We’ll either have a 10% drop in the median sales price over the next few months, or we’ll see sales slow to a crawl.  It’ll really depend on your neighborhood – where sellers NEED to sell, they’ll lower their price.  Where sellers don’t NEED to sell, or get bad advice, they won’t sell.  Occasionally, they’ll get lucky, but it won’t be the trend.

The peak around here was July 2004, and it’s been flat since.  Plug in your peak price for the 100% mark, whenever that was.

We’ve seen a 2% drop so far in the median sales price, so I have 98% noted for August 2006.

This prediction shows a continued drop off in median sales price until February, then flat to August 2007.

I’m showing flat for all Feb to Aug periods, because that’s the traditional selling season, and once buyers start hearing about the 10% drop from the previous off-season, they’ll come back around to see what’s happening.  Hopefully, some will buy a house.

What happens after August 2009 will depend on rates and how bloody it gets between now and then.  If the mortgage can devise a fix for the resetting ARMs, I’ll guess that we’ll see a prolonged flat spell after 2009.

None of this matters unless you can find the right house though.

I’d like to see the primary focus be on buying the right house.  A house that is so well-suited to your needs that it will last you a lifetime, just in case.

There will be buyers that will find the perfect house for them, but not buy it because they want to wait until prices come down more.  But even if prices continue down, will you be able to find the right house?

You’ll think, if prices were to get better, then I’d get a better house for the same money!  That will be tempered by more competition between buyers, and there are plenty of buyers waiting.  If frustration sets in, and you settle for a house that won’t last a lifetime, then you’ll have to go through this all over again a few years later.

My point – keep looking, because finding the right house is TOUGH!

Admittedly, this prediction and about four bucks will get you a cup of coffee today.  However, if in a few years we look back and I was right, I’ll be happy to take the credit.

From a logical standpoint, there is no way these prices can be sustained – let’s face it, if you want to buy a decent house today you have to spend a million dollars – how many people can REALLY afford that?

But there are intangibles that are hard to assess.  Let’s look at what they are and attempt to assign a value to them, because if we can, we can predict the future.

THE PREDICTION

Let’s use santa monica’s number of 33%.  In the last downturn, most everywhere in Southern California saw prices roll back about 33% between 1990 and 1995.

What about over-shoot?  Aren’t buyers going to be so scared that prices will have to actually go down a little extra, before they have the guts to jump back in?

On June 9th we talked about ‘The Big Split – the Flight to Quality’ (see journal archives).  We’ve seen it happen all year, and I don’t think it’s going to change – that the inferior properties are taking a bath, but the high-quality houses in great locations do a lot better.

Combine the Big Split with over-shoot, and it looks like this:

Inferior properties go down 40% to 50%

Superior properties go down 5% to 10%

Blended rate of decline of median sales price from peak = 33%.

This is where the real estate industrial complex is going to shoot ourselves in the foot – the median sales price will be submarined by the inferior properties.  Where the MSP has been holding artificially high the last 12 months due to fewer sales in general, once the bottom falls out of the inferior homes, the MSP will drop like a rock.

The foreclosures are pouring in right now, and the bulk of them are the inferior properties on the low-end.  The ones that were bought in the last 1-2 years with 100% financing are most susceptible – those homeowners have no skin in the game and are the least likely to find a way to save the house. 

If you are a waiter or landscaper, the only way you can handle an additional pop in your monthly payment is if your parents help out, you add a lot of roommates, or you hit the lotto.  True, there will be plenty on the upper-end in trouble too, but they are more likely to find a way out.  People with more affluence have more resources available to them, and if they have a high-quality home, there are more buyers.

It’s all relative, but if this year is a snapshot of things to come, the low-end is going to be hit harder.  That’s in direct contrast to my previous article on Feb 8th called ‘the big squish-down’.  I thought for sure that the million-dollar market would cause all the trouble, but that hasn’t happened so far.

Three general reasons the high-quality properties will do better:

1.  They’re older houses, owned by older people, with less debt

2.  They have it so good, there’s no better place to go

3.  Buyers are holding out for the good stuff.

Because of these three reasons, the supply-and-demand curve is much more healthy in the high-quality-home market.

THE INTANGIBLES:

A.  If there are serious, meaningful changes in loan underwriting and/or elimination of currently available loan programs, then knock off another 10%.  Not very likely in my opinion, but I’m probably in the minority of those reading this.

B.  Major terrorist attack or earthquake, knock off a temporary 10%, but it’ll come back within 1-2 years.  We were back in business within 3-6 months after 9/11.

C.  Complete failure of pension/retirement systems, and healthcare cost.  Even if you have your house paid off, if those two categories go nuts, you could run out of dough and have to sell your house to live.  God help us all if it gets to this point.  It is possible though, so it’s on the board.

Those are the big three negative intangibles, now for the positive:

A.  Interest rates under 6% would help a lot, and I think they’re coming back.  The recent boom was the hottest when rates were the lowest.  It’s both a financial and a psychological benefit that helps get buyers off the fence.

B.  Sales over the next 1-2 years will be determined by buyers who care more about buying the right house than the bubble.  Whether they are ignorant about the bubble, or just don’t care about the bubble, it doesn’t matter.  If the bubble talk doesn’t bother you, then you probably won’t insist on waiting, or driving the price down another 5-10%, before you buy.  Because people need to live somewhere, there are reasons to buy that can supersede money.

C.  Lower prices should help those who rent to be able to buy – both the first-timers and the bubble-sitters.  Especially the bubble-sitters.  I don’t think there are any previous homeowners that don’t want to own, they just don’t want to buy at these prices.

D.  The OpenMLS would help alot.  If it were easier to find good deals, we’d have more sales.  If there were one centralized, super-duper website open to everyone, not only would it be easier to find deals, the novelty alone would spur activity.  Realtor.com is an embarassment, and the realtor community deserves to be left behind if we can’t do better than that.

 Those four intangibles could greatly temper any steep decline. 

But who cares, all that matters is how you can take advantage, right?

ADVICE FOR SELLERS

1.  If you know you’re moving in the next couple of years, see if you can move your plans up a bit.

2.  You can’t move your house, but see if you can get it into a higher-quality bracket.  Fix it up nice, that’s what buyers want.

3.  Be more attached to getting out, than getting your price.

ADVICE FOR BUYERS

1.   Set your goal at getting a high-quality house at 33% under peak prices.  Who are they, and where do I find them?

         A.  Distressed sellers with both high loan balances and equity

         B.   Long-time owners who still think a half-million is a lot of money

         C.   Dumb listing agents you can take advantage of

2.  Stay educated on the market, especially on recent sales.  That education gives you confidence that you’re doing the right thing when making offers.

3.  Be persistent, but patient.  Be prepared to make 100 offers, and hopefully you’ll only have to make 5-10.

4.  Know what you’re looking for, and keep looking!  A good agent can help.

That’s what I think, what do you think?

Nobody knows where the bottom is, but I’ll take a stab at it.

I’ll propose that the bottom is at 2003 prices.  At least for now.

Here’s a couple of check points.

Generally-speaking, prices are still flat since 2004.  Calculating all the recent same-house sales (last three months) in the ‘Appreciation rate’ category (in the right column), there is an average $14,000 loss per sale.  I think that’s understating the current market psychology, but it goes to show you that the factual evidence so far isn’t showing huge losses.

I’ll assert that the best way to properly measure market sentiment is with an auction, with no reserve price.

Recently we saw a guy pepper every street corner and freeway off-ramp with ‘dumpingcondos.com’ signs.  He was publicizing a pure auction of a condo in La Costa, with a starting bid of $225,780, less than half of appraised value.  Now on that website he’s reporting that it sold for $380,000.

For the two sellers who are actively trying to sell their identical model for $500,000 and $542,000, that’s not a good thing.

But if a pure auction that is well-publicized is the best way to gauge the market, then let’s look at the history of sales of this model and see how far back we go in time:

4/06          $589,500

4/06          $545,000

4/05          $550,555

3/05          $495,000

2/05          $485,000

4/04          $431,000

1/04          $379,000

7/03         $330,000

6/03         $344,000

4/03         $378,000

In this test case, it looks like a pure sale at "what the market will bear" is around the same price as they were selling for in 2003.  Yes, I’m sure each of these had different upgrades, blah, blah, so there’s a +/- 5% on price.  But when you’re comparing identical models in the same condo complex, it’s as close as you can get for an example like this.

We’ll see if the new owners will try to flip this.  They could at least undercut the other actives and come on at $450,000 and try to make a few bucks.

This condo complex is old and less-desirable, so I’ll assert that this is the real bottom, for now.  If it was newer and really desirable, they may have gotten more.

The bottom of the price range is where the inferior, ugly properties find a buyer.

We have another test case brewing further north in Carlsbad.  The houses on Sierra Morena, specifically the ones at the bottom of the hill that are two-story and either 1,471sf or 1,578sf, and back to the power lines, have always been the cheapest houses in Carlsbad.  

One just sold on August 31 for $410,000, and it wasn’t on the open market.  The flipper put it back on for $487,000, the cheapest of five active listings on that side of the street (the others are $499,500 to $530,000).

Sales History on east side of street:

2/06        $525,000

12/05     $465,000

8/05        $535,000

7/05        $550,000

9/04        $489,000

3/04        $425,000

3/04        $395,000

11/03      $440,000

9/03        $400,000

8/03        $380,000

Mr. Flip bought at 2003 prices, and he is his own comp – there has only been one other sale this year and it was way back in February, an appraiser can’t even use that for a comp because it’s older than six months.

Using these two examples for evidence, the gauge for ‘what the market will bear’ for the inferior properties are prices from the year 2003.  It’s all relative, obviouly if your house is substantially better than those on Sierra Morena, then you’d sell for more money. 

But if you’re wondering how low you’d have to go, right now, to guarantee a sale, use the 2003 value of your home for a marker.

As most of you know, my Dad had a stroke on June 18th.  Turns out it was a basilar stroke.  Mom said she looked it up, and it said ‘usually fatal’.

No surprise to us that he is beating the odds again.  The last time he had a stroke they said he had 2-3 years left, and that was 17 years ago.

After forgettable experiences at two acute hospitals, he’s now at the new sub-acute facility at Rossmoor in Orinda.  The staff have delivered exceptional care, and yesterday he ate his first meal – mashed potatoes.  They’re going for pudding today!

My Mom has been ailing physically, but has been making her daily trips to see him.  Last week, her hip was hurting enough that she had to take a day off Thursday, and then Friday she asked my sister if it would be too much trouble to have someone come give her a ride, so she could spend a hour at the hospital.

My sister, who has been doing a wonderful job, told Mom ‘not to worry’ and stay home to get better and they’d go the next day.  Instead Sis, Pedro, and my brother went to the hopsital with a movie to watch with Dad.

A few minutes into the movie, my Dad started crying, then sobbing. 

When he finally spoke, he said he just wanted to see ‘the love of his life’.

My sister scrambled out to the house and grabbed Mom and brought her back to see him.

I think that’s a pretty good sign that he’ll be around for a long time to come.