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?
Jim, the city you live in is probably in the top five "housing bubble" cities.
If the aggregate market drop from peak-to-trough is only 33% in San Diago, I’ll fly down there and buy you a beer.
I suspect you’ll see a 50% in nominal terms at the trough in San Diego.
However, I admit I’m a super-bear. 🙂
I also think we’ll see bigger price drops in some properties: outlying, less desireable, condos, neighborhoods with lots of RVs out front, etc. However, I think even the good stuff will fall at least 30%. Every single property has to revert to its mean, that is the price it would be if it had kept appreciating with inflation; go back to 1997 and make an inflation line for that particular property.
Yes, La Jolla deserves a premium over Vista, but the percentage of premium should NOT be higher today than in 1997. I know the lower priced areas rose MORE percentage wise, because they were the most affordable stuff left, so they will drop more percentagewise.
Another consideration is that many long-time homeonwers got option ARMs. Those people in Del Mar and La Jolla, went out and refinanced their 30 year loan into an Option ARM just like everybody else. As John Dugan explained, an option ARM’s minimum payment goes up 50% when the intro period expires and the interest rate has not changed. If the interest rate has gone up from 6% to 8%, the min. payment DOUBLES!
In the last downturn, there were foreclosures in Rancho Santa Fe, La Jolla, too.This time, when we’ve got people all over San Diego in neutron mortgages, it will be much much worse.
About 70% of San Diegan’s used Option ARMs to refinance and purchase homes in 2004 and 2005. If all those people need to sell in 2008, that would double or triple our inventory, at a time when sales are getting lower and lower. You do the math, but I see an easy 60% nominal drop for SD median prices, with 35% for La Jolla, 80% for Temecula.
The problem with everyone’s predictions so far has been we’ve been way too optimistic. We’ve got to stop that. We must be more accurate, and that means recognizing that the price drops will be double of the last downturns. Our price increases were more than double, so the drops must be more than double too.
Why is everyone continuously too optimistic? The builders are revising their forecast every few months. Nobody seems to be able to get it, that this is going to be really bad.
I have to say that I don’t quite buy your prediction of the superior properties only going down 5-10%. I guess it depends, however, on one’s definition of superior properties. In my opinion there are many thousands of properties (both on and off of the market) in the Carlsbad area that are valued from 900,000 to 1.2M. I believe that there are many owners of these properties that had no business buying such properties. While there are undoubtedly many wealthy people in the north county coastal area, I have a hard time believing that the majority of these individuals have household incomes in the range of 250,000+ (the amount of income it would take to truly "afford" such a house buy conventional means). I also suspect that many of these individuals (at least those who stretched to get into these houses) used I/O and Neg-Am loans. Maybe prices in this range haven’t moved as much yet (emphasis on yet) because there is much more money at stake for these people or they can afford to hold out longer.
Furthermore, I think there already has been at least a five percent correction for houses in the 900,000-1.2M range. There are houses for sale in La Costa Oaks that are listed 5% below purchase price one year ago (when they were bought from the builder). Given the fact that most of these owners invested to complete landscaping also, you are talking about almost a 10% loss. I don’t know that if this area fits into your definition of superior properties but I would think that a 4000sf house in a quiet neighborhood in Encinitas school district would.
Apologies if my interpretation of superior is different than yours.
BTW: I greatly appreciate your efforts on this website. As a potential buyer and bubble-watcher, your real-time observations and data are very helpful.
Mrs. Berkland,
You crack me up. "We must be more accurate"?
Don’t you mean "You guys have to agree with me!"
It’s just my opinion, and I’m sticking with it.
The option-ARMs vary in degree that they adjust. For example, World Savings "initial period" is 10 years before a possible reset. In the meantime, the minimum payment is rising every year to catch up with the fully-indexed period, slowing the deferred interest.
As time permits, I’ll offer more specific evidence to support my case. Can you? I don’t think you can – it’s more speculation than fact on your part.
I agree whole-heartedly that it could get really bad, but it hasn’t yet, so any super-negative comments on the future are just a guess.
If you would concur with that, instead of insisting that you are right and I am wrong, it would make it a lot easier for us to examine your opinions.
Hi Jim
Great site. Been reading since summer and agree with most everything here. However, I have to disagree with 5-10% drop for superior properties if bad properties drop 40-50%. More likely, superior properties would drop 10-20% in that scenario. Yes, if you have a great property, then WHY move.
I dont know if you have discussed it, but paying for mortgage after retirement age of 60 is not a great idea. I think average age of mortgage buyer for 400K+ loans is late thirties at a minimum. I hope to start make extra payments now after 3 years in new house. The expenses on new house are incredible and the quality is horrible unless you spend 40K for a professional degreed landscapers and other contractors.
"The option-ARMs vary in degree that they adjust. For example, World Savings "initial period" is 10 years before a possible reset. In the meantime, the minimum payment is rising every year to catch up with the fully-indexed period, slowing the deferred interest."
Jim, I’m curious as to just how the Option ARMS work. Don’t the majority of these products contain a clause that forces an immediate reset if the LTV rises to a certain percentage, which would be the case if the borrower pays only the lowest option?
winjr,
Yes they do, and they vary as well.
World has a 125% cap or at 10 years, which means if you have a $500,000 loan, it will reset when it gets to $625,000, or in year eleven. That’s pretty safe, when the minimum payment rising every year – that lowers the gap, and slows the deferred interest. WaMu is the same, I believe.
Countrywide resets at 115% or every five years, and they, and other lenders who lowered those caps (or the MBS buyers who bought those loans) are at a much higher risk of owning a lot of foreclosed property in the future.
I wouldn’t be surprised if they ease up on those for the borrowers who call to re-negotiate.
If they bump one term (say re-negotiate the cap from 115% to 125%), then the option-ARM problem will be less severe, or at least postponed.
The banks are going to have to offer some relief, or they will own a ton of properties, which they don’t want. If they extend that cap, the MBS owners still have income, instead of defaulted paper.
I’ll buy you that $4 cup of coffee if you can find anything that isn’t off at least 10% from the peak this time next year.
Ok, Jim, here’s something else that has me a bit puzzled.
Let’s talk about Countrywide. They write loads of option ARMS, and let’s assume a high percentage of those loans are offloaded in MBS packages to whoever. Can we assume that Countrywide retains, in most instances, the right to service those mortgages?
Now, let’s also assume we have an Option ARM borrower, who purchased from CFC, and he/she pays only the minimum payment. Let’s say the LTV goes to 116%, CFC writes a letter saying the ARM has reset, borrower responds "I can’t afford it!" How does CFC renegotiate the terms? I mean, it no longer owns the contract. Is CFC, as only the contract servicer, required to obtain permission from the contract owner?
Me thinks you are shooting in the dark, now saying the top-end homes will be less clobbered. They are already (Santa Barbara for one) getting knocked down from 1.4 to 1.2 mil. That sounds like a real hit to me.
I am going to stick to my guns and predicted the “superior properties” will get hit at least as hard as the inferior, if not harder. Those high end homes have higher carrying cost all around: higher payment, higher taxes, higher utility and maintenance costs.
Jim,
Did you ever find out what the foreclosure #3 in your example a few weeks ago ended up going for at auction? That was the one you predicted had been appraised at 1.6M, had a 1.1M loan and you thought would be bought at auction for 750K, or 53% off its peak appraised price.
I’ll sum up Mrs. Berkland’s opinions by saying that she thinks the market is going down.
SMC, Countrywide did take back that La Costa house, but it was never worth $1.6M, even though they might have gotten an appraisal for that.
The seller had it on the market in 1Q06 for $1,025,000 and it didn’t sell.
I guessed it will sell for $750,000 once Countrywide puts it back on the open market.
They did take it back in the name of Countrywide Home Loans, so either they didn’t sell the loan, or had to buy it back because it defaulted in the first 12 months.
winjr, I’m sure Angelo has been making a lot of phone calls lately (CEO of CFC).
It’s the worst possible nightmare for him. He rigs the option-ARMs with riskier terms to goose the profit higher, thinking all he has to do is unload this paper on fannie or freddie or some of those private-label MBS funds.
But now it’s backfiring, and he has to do something.
They don’t want the properties back, so he has to be making deals with both MBS owners and borrowers. I’d guess CFC has staff calling borrowers who are behind and trying to re-negotiate with them before defaulting.
Jim, when did you start censoring your blog? I spent 30- minutes writing all the data and analysis, and you erased it? Why?
Jim, I spent 30 minutes giving you a detailed analysis of why housing prices will go down. I quoted Jim Dugan, Comptroller of the Currency, option ARM data, sales info, and 3 ways to figure out baseline pricing. I can see why you would erase somebody’s post if there were rude, but I was only giving an analysis. Do you always erase an analysis that you disagree with? Also, I thought we were friends.
Powayseller – quit submitting bad posts, and they won’t get erased.
I think that "superior" properties are down 10% already and we just at the beginning. We still have a long way down to go.
Jim,
Sorry, but I have to jump on the "BIG correction" train here. Although the older, more desirable neighborhoods are more stable, and there is less velocity (turnover) in general, that didn’t stop prices from shooting up here, and I don’t see how it will keep prices from shooting right back down. From what I see and hear, the buyers of these properties used the same types of mortgages as the lower-end buyers, just with bigger incomes and higher prices. I’m seeing a number of the high-end "homeowners" who are in the same boat as the lower-end borrowers. Only difference is the numbers are bigger.
Example: I posted over at Ben’s about a couple I know who have over $1.2 million dollars in mortgages on two homes. Basically, no equity, and they’re trying to sell (one might be sold to a flipper friend, but not closed, yet; the other hasn’t had an offer in over four months). They cannot even afford to get their cars fixed because they "don’t have $1,000 lying around in the bank." Seriously, if this is indicative of who’s been borrowing for these $1M homes, we are in serious trouble.
The way I see it is **true value** is what homes would cost if unqualified borrowers with suicide loans never entered the picture. The high-end market largely depends on move-up buyers. If the middle market can’t unload their homes for a bubble premium, how can they afford to bridge the gap to the high-priced home?
Schahrzad,
You come into my house and deliver 3,000 words of ranting and raving, and then call it data and analysis.
I’ve said a couple of times, as tactfully as possible, that it’s not your message that’s the problem, it’s how you deliver it.
But you insist. Then you say I’m censoring you and question us being friends?
I haven’t erased anybody else. There are some hard-hitting comments in here, but they are brief, and laid out in an orderly fashion.
the perfect compromise would be for powayseller to write that 3000 word dissertation on her own blog and just place a link here.
I’m all for that.
How’s that blog coming?
anyhow, more reportings from the frontline.
Verzano, ranging from 3,000 to 3,400 sqft adjacent to San Elijo Hills but with a tax base of 1.4%, decreased asking price for the 3,000 sqft model from $720,000 in June to $670,000 now in Sept.
Mahagony, also of the same sqft went from $780,000 to $720,000 in roughly the same period.
Within SEH proper, Luminara, a new project with 2,500 sqft homes with 17 phases, dropped from pre-model prices of $720,000 to $620,000 also in 3 months. They sold 2 homes so far.
Atherton, also in SEH, had planned for 11 phases, now advertise they only have 5 phases of homes to sell. did not drop that much, went down to ~$780,000 from low 800,000 for their smallest models.
and it isn’t winter yet!
Thanks OC,
SEH could end up being Foreclosure Hills, by the time this is all done.
Reasons why they are an inferior property:
School district has lower scores
Tax and Mello-roos very high
They overlook the old dump!
When the market is hot, people in their haste don’t think that’s a problem, but now they do.
The good news for the market in general is that most buyers today are being very careful in making their decisions.
Hey Jim, I like you and never meant to upset you. Sorry that what I considered good analysis was perceived as "ranting and raving". Perhaps it was my prediction of MLS inventory going to 80,000, since we’ve got 100,000 – 300,000 option ARMs resetting in San Diego in the next 2 years? It was a very bearish argument, but done in an analytical frame of mind. My apologies to anyone who was offended.
Schahraz, I was serious about you getting a blog started though. you got a lot of good stuff to say and right now it is all scattered around in various forums, would be nice to see everything on one site to go to.
I agree.. SB needs a blog. I’d definitely visit.
Schahrzad,
There are two problems with your "analysis".
1. You don’t know how Option-ARMs work, but you make statements as if you are the God Of Option-ARMs. I’d take your comments a lot more seriously if they were based on factual evidence, instead of wild speculation.
2. You won’t consider anything else possible, other than your "data". I lay out some facts about Option-ARMs, and you ignore it. I have foreclosure evidence available, but you won’t even consider other facts. You are right, and that’s it – end of discussion.
It shuts down the examination of any other possibilities for everyone.
This is the fourth and last time I’m going to try and point out that it’s not your message, it’s your delivery!
You’re not offending me or anybody else, I don’t think.
We just want to share ideas about what might happen in the future, and you come in here and obiliterate the conversation.
Please, start your own blog.
In the meantime, be open to other possibilites, let’s lay ’em all out on the table, and take a look.
Who knows what might happen.
Love, Your friend Jim
Jim,
I’ve been lurking for a long time. I think I originally saw the link to your blog on Ben’s. I appreciate your perspective and the real time information you provide.
I enjoy the different views participants have. While Schahrzad has more of a catastrophic view on what will come, she brings up some good points. I was surprised at your harsh response to her. Perhaps she’ll tweak her analysis when she considers that not all option arms are created equally?
Anyway, I’m firmly in the bear camp and lean more towards a correction somewhere between your predictions and SB’s. I can see superior properties dropping more than you anticipate due to reasons already pointed out by others on the blog. Unfortunately none of us know exactly what will happen. There are too many variables that could be thrown in the mix. Sometimes I think it’s going to be an extremely ugly correction and sometimes I think it’s just going to be ugly.
TicTac,
Thanks for checking in – I don’t mind her catastrophic views if in the end we all have to kiss her feet, I’ll be the first.
I don’t think I was harsh, just trying to get through. I’ve been frustrated, yes, because I don’t think I’ve made a dent.
I probably take it a little personal too.
The World Savings/Great Western/Home Savings Neg-am loan is the best loan ever devised for a guy like me – commissioned sales. I can give myself a break in the slow months, and ramp up in the good months.
But the original neg-am was civil. It had a 7.5% payment cap, 2.35% margin over the 11th District Cost of Funds Index, and a 125% cap before reset, which nobody ever hit.
When Angelo at CFC cranked down the terms, it became the 2nd-worst loan on the planet, after the 2-year fixed with two year prepayment penalty.
Angelo is a brilliant guy, and I have faith that he will get us out of this. If all he does is ease up on his 115% cap, and go back to 125%, it could change the outcome for a lot of homeowners.
Okay, I know this thread is long since dead, but I just discovered this site…
LOL! I swear I was reading the entry above regarding "Why is everyone continuously too optimistic?" and talking about 80% drop in prices in Temecula… and I was thinking to myself "now here’s a person that could give Powayseller a run for her money…" then I scrolled down to see who posted it… Scharzad B.
"Superbear" to the rescue!
A year later, and its funny to see how bearish people were back then. It sure sounded like "Run for the hills, Only rent! Housing prices will plummet!" I wonder where those bears are now…
Sure its gone down some, but 70-80%? Gimme a break. I bought 2 1/2 years ago, paid $780K, financed 460K. House is approx worth the same +/- $20K. I have an ARM (still), been investing the difference I saved each payment, and threw some back on the principal to offset the Neg Am and then some. Loan is about $450K right now, and I have $10K in savings.
There used to be an old TV show in England that I watched called Dad’s Army. Reminds me of a funny line one guy always said "Don’t panic, Mr Mannering!"
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