What do boiled frogs taste like?
Chuck Ponzi July 19th, 2006
Over the past few years, we have seen unbridled optimism grow so great that it’s difficult to even remember what life was like before the housing bubble. Let’s take a walk down memory lane with a local home in South Orange County…
Remember, this is only a characterization, not specific to everyone’s area although it is likely we could pick a handful of homes at random and get the same response.
Let’s start with a home that was purchased in April 2000 in Laguna Niguel. This is a beautiful home, 4000 sq ft with a pool and good landscaping. The purchase price? a cool Half-mil. $500K. Weather was great, interest rates went down, and the housing bubble went up.
Imagine what that same $500K in LN would buy you today? A 2 bed 950 sq ft condo with $400/month condo fees? A run-down shack in a 55+ community?
The house is now back up for sale. Anyone care to wager what the asking price is? OK, before we get to that, let’s do a little research…
What does Zillow have to say about this house? What estimate would it put on its value now?
How about 950K? What about 1.0M?
Here’s the answer:
Would you believe 1.18M? If that seems a bit scary to you, consider what the seller is asking for this property:
$1,395,000.
What’s even scarier is to look at the value of the home over the past 3 years as a benchmark. About 3 years ago, the home would have been valued in the $550K range. In 3 years, the “zestimate” went up over 120% The current owner believes it went up almost 200%.
Could the home sell for it’s asking price? I doubt it.
While the home is nice, it has no ocean view or ocean breezes. It does not sit on an acre lot, and is surrounded by decidedly “normal” family homes.
Worst of all, interest rates are going up.
At present jumbo California rates of 7.5%, after putting down $280K, the principal and interest would come to $7803/month. Add taxes and insurance of $1417/month, and the total payment to own this property comes to $9,220/month. Not including maintenance and upkeep or HOA dues.
Some hopeful optimists have noted that buyers typically do not put down 20% on a home anymore, so there’s no sense in focusing on the down payments needed. I would normally agree, but that would only increase the monthly payment, not help it, so this is a pretty conservative estimate.
Plugging that into our hand-dandy income calculator gives some recommended income requirements for PITI as a percentage of income as follows:
% of PITI
25%: $442,560/yr
28%: $395,143/yr
33%: $335,273/yr
Even after considering the most dire of circumstances where 50% of your income would go to housing payments (keep in mind that at this level, taxes would consume probably close to 35-40% of your income, leaving you to purchase the rest of your needs with 10-15% of your income), the happy homeowner would need to make $221,280.
Imagine a successful executive who cannot afford to buy a car, eat out, or even save for retirement to afford a home. This is what the prices are suggesting. If you see it any other way, please post it, we are all interested to know how it can work.
Boiled Frogs
The truth is, I had a friend tell me what a great deal this house was, if he could only afford it.
This is where we have all become boiled in the rising temperature of escalating housing prices.
Even though prices have moderated, and in some places fallen, many, if not most, still believe that housing will average 10-15% returns per year. There is still a pervasive fear of being left out. This will continue until it turns the other way. The question on everyone’s mind is the same (regardless of a bubble believer or not); who can afford these homes. How many people in your neighborhood could afford to buy their homes?
I believe we will find ourselves in 3 distinct phases with housing prices, reflected by interest rates.
Phase 1: Wow, I could buy more home because interest rates went down. I had better buy before my neighbor figures out the same thing and buys the house I want. Sure, my payments will be slightly higher, but the low interest rates make them bearable.
Phase 2: Wow, housing prices have escalated quickly. With rates low, I could buy my house again, given the current equity I have, but just barely. My payments would increase just to keep my home.
Phase 3: Wow, housing prices are outrageous. With current interest rates, I couldn’t even afford my own home, even with the equity I have because payments would be much, much higher.
I believe we are now firmly in phase 3, where interest rates have almost returned to a normal level (although still low), but prices have escalated such that most owners could not even buy their current home even with their current equity. This is when transactions stop because in any ponzi pyramid, new entrants are needed to pay off existing participants. Those new entrants are unable to pay a premium over prior periods. The only existing transactions are happening with those still in Phase 2 (not everyone passes at the same time).
I strongly argue that risk premiums are far too low for MBS paper holders, and that we will still see mortgage rates in the 8-9% in the next few years. This would just be a return to normalcy (and almost necessary to retain a strong currency), not a swing the other direction, or a credit event that could still occur.
We are all boiled frogs in the current scenario.
Good post John Doe…
You can’t change everyone’s mind out there…just like there are idiots out there who think Bush is a good pres and the war is all about democracy, you can’t make every idiot believe the housing prices are coming down…
I loved this post - I’m the anonymous poster from the other day too who asked when prices were ever going to come down. And Nozferatu… here here!
Hey, you guys. I appreciate you coming and posting and reading, but I would personally appreciate it if we didn’t start discussing politics.
We all know that the war is/was about oil. The fact that we say it wasn’t in front of the Arab world is just like them saying that they don’t sponsor terrorism. 2 words: Plausible Deniability.
Also, there is no perfect president or politician. But, these are all smart and/or savvy guys or gals in all political parties, and every president and political figurehead willing to stick their neck out is going to get pummeled in the forum of public perception. Let’s just not let it spill over, ok?
Thanks,
John Doe
One last thing, they are usually just doing what their constituents want them to do. The same went for when Democrats were in power.
Clinton presided over the tech bubble, Bush the housing bubble. Same Diff.
Can someone tell me why 3020 Vold Avenue Long Beach, CA is not showing up on Zillow? Every home on the street is marked except this one….. This home has been on the market a while and I was wondering what the last purchase price was, date etc.
Sorry typo….the address is 3020 VOLK Avenue Long Beach
Thanks
Anon:
Check out this site:
http://tinyurl.com/8bwmt
You can look it up by address or assesor’s ID (7079-019-010)
It doesn’t seem to show the last date of sale, but the value was recorded on 5/15/2003. (maybe it was an intergenerational transfer?)
The recorded value at the time (and I guess tax basis) was about $324K, though it shows it as a 4 bedroom with 1383 sq feet (that’s small for 4 bed) and built in 1954.
All of this is public information.
nozferatu said:
“just like there are idiots out there who think Bush is a good pres”
There you go again! We don’t give a flying f_ck about your stupid political views. Politics must rule your life … you’re sad!
Hey Anon,
Grow some balls and add a name to your pathetic posts….I couldn’t give a flying fk what you think either…as I already know your thought process is rather lacking.
John Doe,
I’m from Mission Viejo and I do remember the way real estate market was during the prior boom and bust. What’s so sad is that many naive home buyers actually believe these Orange County home prices are sustainable. And yet nothing could be further from the truth … not only are Orange County prices likely to drop, they’ll probably drop more than most places in California.
“not only are Orange County prices likely to drop, they’ll probably drop more than most places in California.”
Except for San Diego of course!
Your analysis is interesting, but it has one flaw. It is based upon the assumption that the buyer would be a first-time buyer and not a move up buyer with a lot of cash from a home he’s owned for ten years or so. Sometimes we who hope the bubble will burst, and soon, forget that there are many people who have owned their homes for many years and have lots of cash to buy up into a nicer community away from the heat and smog of inland SoCal. And if these move up buyers are over 55, they may be able to maintain the same property tax level that they were paying in their previous home. Under this scenario the numbers are completely different.
Swim Mistress said…
Your analysis is interesting, but it has one flaw. It is based upon the assumption that the buyer would be a first-time buyer and not a move up buyer with a lot of cash from a home he’s owned for ten years or so. Sometimes we who hope the bubble will burst, and soon, forget that there are many people who have owned their homes for many years and have lots of cash to buy up into a nicer community away from the heat and smog of inland SoCal. And if these move up buyers are over 55, they may be able to maintain the same property tax level that they were paying in their previous home. Under this scenario the numbers are completely different.
No, you didn’t read the post very well. The suggested buyer would have to put 20% down, or $280,000 which is still a conservative amount. Some people “moving up” do have this amount, but that would be few and far between. If you have substantially more than that, you’re not “moving up”, you’re moving across.
Here’s a simple scenario. Imagine you bought a home in 2000 for 400K. That same house is now worth 800K. After sales commissions, title transfer fees, and closing costs, you’ll walk away with about $730K less the original mortgage amount (which is still pretty close to 400K, but the likelihood of holding the same mortgage without refinancing and cashing out some between that time is admittedly very, very, very unlikely here in OC), your total net proceeds would be $330,000. Closing costs on the new home: $50,000 (easily for a 1.4M house). It’s pretty convenient that this works out to exactly the right number, but you get the picture.
BTW, $400K in 2000 would have bought you a pretty nice home. Homes in my neighborhood are in the 2000 sq ft to 2800 sq ft range and were selling in early 2000 for $299K for the largest models on the largest lot. At the time, it would have likely bought you a 3200 sq ft house, so the scenario is pretty likely.
Most people I know, that have traded up, bought their homes about 2-4 years ago The average equity they had to use was about 200k. With today’s prices and interest rates, no matter how you sliced it, they took on a higher payment than their old one. In some cases , they also traded a fixed loan for a hybrid (IO or option arm). It doesnt make sense to me to even trade up right now, let alone buy for the first time. I currently own a home in SoCal and have over 200k equity but have not touched it once. I did a refi to bring down the rate once but that was it. I wish I could say the same for my friends. Serial refinancers.
Not to belabor the point, but I remember in 1994, I looked at a home in Laguna Beach with an expansive ocean view for $367,000. That same home today would be close to $2 million. Believe me, there is NOTHING in Laguna Beach that’s $365K today, or close to it. That house I looked at was small, but the owner could sell it today with a very, very nice profit and purchase something in Laguna Niguel easily, probably with money left over. So moving up or across, I think sometimes we lose sight of people in this situation. I agree most first time buyers don’t have $280,000 to put down and would be hard put to qualify for huge loan based on income. That is not who is going to be buying the home in Laguna Niguel you write about, however.
John,
I’m not a big fan of frogs (the food - not the French, whom I like a lot),
but I suppose they taste reasonably good whether boiled or fried.
Your post is right on the mark. All ponzi schemes unwind eventually, and this one will not be any different. I can’t say I understand what will happen politically, but let’s discuss that next year.
Meanwhile, keep up the good work.
Great post. I linked to it.
Would you consider a “guest post” where you repeat this analysis for a house in Marin?
Swim Mistress said…
Not to belabor the point, but I remember in 1994, I looked at a home in Laguna Beach with an expansive ocean view for $367,000. That same home today would be close to $2 million. Believe me, there is NOTHING in Laguna Beach that’s $365K today, or close to it. That house I looked at was small, but the owner could sell it today with a very, very nice profit and purchase something in Laguna Niguel easily, probably with money left over. So moving up or across, I think sometimes we lose sight of people in this situation. I agree most first time buyers don’t have $280,000 to put down and would be hard put to qualify for huge loan based on income. That is not who is going to be buying the home in Laguna Niguel you write about, however.
Ok, you like to make a lot of generalizations to prove your point and facts don’t seem to be your facy, so I will make a few generalizations of my own to prove you wrong.
1. No one is going to move from Laguna Beach to Inland Laguna Niguel. NO ONE. Zip, Nada, Zero, Zilch. That’s like moving from the 310 to the 919.
2. No one stays in their home for 12 years and then decides to trade down to a 4000 sq ft house with much higher taxes. (sorry to all of those over 55 homeowners who, thanks to prop 13 can afford this tax change due to a loophole created by a corrupt group of politicians and sold to the unsuspecting public as an affordability assistance)
3. Noone’s even discussing first-time buyers except for you.
4. You’re obviously a permabull who believes in the MIRAGE theory. Moneyed Immigrants, Rich Ancestors, Generous Expatriates. Come back and live in the area and see how many of these people there really are. Despite all of the Gary Watts predictions, I have not met a single one. If you can find even one, please send me this person’s email (or their assistants’ so I can confirm the identity of even one person like this). BTW, this is not an exception in the area, it is a Moderately Priced home here. It’s a normal home in a family community, not a mansion in Nellie Gail, Kite Hill, or off Pacific Ridge, and they’re advertising it as having taken 100K off the asking already. There’s no view, no breezes, and no back yard.
Nope, no bubble here, just tons of rich people, tons of rich immigrants, and tons of rich baby boomers. Good thing you solved that mystery for us, we were all worried that housing might go down, but you’ve assured us that Housing Never Goes Down! Thanks
John Doe, that was kind of a prickly response. I am NOT a permabull and have no idea what the mirage theory is. I’m just like everyone else here, waiting for housing prices to tumble. My point is that some people do indeed have a lot of equity built up in their homes that they’ve lived in for many years. Okay, so there’s flaws in my example. Here’s another one: the same person who owned the $365K could sell it today and move into a $1.7 million home in Laguna Beach, esp. if that person is 55 or over. In fact, my parent’s neighbor did exactly that, except the house he bought was $1.4 million. He did it with equity built up in his Laguna Beach home he had lived in for several years. Hey, I want a home in SoCal as much as anyone else here and can’t afford it. My family has resided and owned the same house in Laguna Beach for ages, so I know what I’m talking about. I’m on your side, don’t misunderstand me. I’m certainly no permabull.
John Doe,
Swim Mistress is right….your response was kind of mean spirited. She makes a valid point, those who are trading up may be able to cover more costs than many of us hope. I still believe this market will correct but I admit that the wait has been long.
Sorry for the prickly response. I was still amped about the Gary Watts prediction, and let it get the better of me.
I agree that there is a trade-up factor, but believe that this was adequately accounted with by a $280K downpayment estimation. (If you bougth a $400K house and sold it for $800K, you still have to consider at least $100K in transaction costs in switching up to this more expensive home). No matter how you look at asking prices, $50K or even an extra $100K isn’t going to mean a substantial affordability movement. Prices in most areas would need to drop $300k to $400k to reestablish equilibrium in transactions.
There will always be trade-up factors, but there is little argument that this will drive the market for the forseeable future because it is all dependent on an ever-increasing bottom-end of the market and decreasing interest rates. We have established that we have a shrinking bottom-end and increasing interest rates. Buyers are squeezed, and despite what the CAR would tells us, this is most definitely not a Buyers Market.
i can think of countless homes and condos that are 5 - 7 times the price they were 9-10 years ago all over so cal. i could give you hundreds of them.
I was happy to see you updated your blog. I am a non real estate guy trying to get a handle on things.
But sometimes cannot follow your blog though I try. I wish it were a bit more layman friendly. Though you discuss economic theory, there has to be a way to be clearer.
And are you sometimes taking snippets of peoples comments left f or you and then responding to them? If so, it would be cool to link to the whole post so I don’t feel so lost.
I have about five or six housing bubble blogs that I am following and I am about to give up on yours. Don’t want to though.
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