Chuck Ponzi June 30th, 2008

I recently had a reader pose a question to me via email and I’d like to take some time from our normal programming to see what is on his mind

Our friend, let’s call him Boomer for short, had this to ask of me:

Moved my family to La Costa area (renting) and own a house in AZ which I owe $159k at 6.5% (it adjusted and will again in 8 months) The home was at peak worth $750k now $550k I had it rented last yr for $2200 and just signed a 3 yr lease w/ new tennant for $2,400 . I have $600k in cash..Should I pay this house off?? or should I just refi it and hold on to my cash to buy here in S cal in a yr or two?

First off, I have a couple of thoughts:

1. Whoever Boomer is, he’s in a pretty good position, relatively speaking

2. Without knowing his age, I’d say Boomer is likely Early Xer or Late Boomer.

3. The most important point of all (where he wants or needs to live) is missing from the question. Don’t feel bad, many people forget this little factoid. We’ll assume that he wants to stay in SoCal.

I’ll deal with some important points:

1. What is that house in Arizona really worth long-term?

2. What should Boomer do with the cash?

3. What kind of financing makes the most sense?

What is that house in AZ really worth?

This is the question that wasn’t really asked, but needs to be answered, what is the house in Arizona worth, so we can understand what to do with the money.

Well, Arizona is a big place. It has a varied geography with beautiful vistas, scorching deserts, and some bone chilling mountains. You may not like what I have to say, but I’ll say it anyway. Your perception of the world and finances is the boiled frog syndrome. Not that I blame you. You’ve been raised in a world of ever decreasing interest rates and increasing asset values. The world has been kind to you.

You see, the success of many of the past 30 years (primarily the boomer cohort) is a demographic abnormality. Asset values have increased simply because of the organic demand of the Baby Boomer generation and ever increasing ability to finance that demand. In addition to this, an extremely relaxed monetary policy has increased the value of assets consistently since inflation was trounced back in the late 70s.

Unfortunately for many, that time is over.

In the short run, houses are worth what someone else is willing to pay for it, but in the long run, they are subject to the value of the next best alternative, or substitute pricing. The best substitute for owning a house is renting one. In some cases (such as short-term living), renting is almost always the clear alternative.

There are many formulas for determining the value, but one of the simplest mechanisms is the GRM (Gross Rental Multiplier). Basically, this number is used to multiply the monthly rent to arrive at a fair estimate of rental value. However, this is only a rule of thumb and is not to be taken as gospel; lower interest rates (like I expect we will see for the forseeable future) will increase the GRM, while substitutes (buildable land, locus to employment centers) will decrease it. In certain premium places like Orange County, the upper stretch might be 220 or so, while in places like Las Vegas or Arizona, a more reasonable 120 to 160 is more in line with reality. If we err on the side of optimism (150 GRM), this places the current value based on long-term fundamentals at about $360,000, leaving Boomer with a $190,000 premium over its fair value. If I were evaluating a stock, I’d say SELL! SELL! SELL! Doubly more so if Boomer had lived in the house for more than 2 of the last 5 years since he can walk away with pretty much all of the money tax free. It doesn’t matter what the market is selling at, if there is really that much of a disparity, sell that house and get your money! (of course, it doesn’t help that it was just rented, but there are always ways to let a renter go, if the price is right). At a 229 GRM, his house is badly overpriced. When it was $750K, I haven’t a clue how someone could justify that, since it would have been a GRM of 340. Holy smokes!

The future good in some ways, but bleak in other. The Southwest is largely overbuilt in nearly every city with a real dearth of extensive employment opportunities (unless WalMart is your target), and if energy prices remain elevated (not a given in my mind), the ability to pay will deteriorate along with the economy. Boomer may end up with late (or no) payments from his rental. Rentals are generally difficult to manage from a long distance and I would only advise it if you were planning on returning back to the home at some date. However, that would be hard after living in LaCosta for a few years.

In addition, a house can be valued at the cost of money to purchase it. This is a bit more detailed, but an easy rule of thumb is to take the rental equivalent, figure in future increases in rent, and discount the cash flows based on current borrowing rates. It accomplishes about the same thing as GRM, but removes the variability of borrowing rates (especially if it is held as a long-term investment). Using the inverse calculation, you could figure what the “money rent” on the current place would be given a few variables such as the “current value” and current interest rates. Given a current value of $550,000, the money rent valuation using 7% says that Boomer should be collecting about $3,700 in rent on that money. This leaves out taxes, repairs, rental expenses, vacancy, and many other options, so it is by far the most optimistic. By this reckoning, the house would have an imputed value of $357K, pretty darn close to our above $360K value. Sounds like time to sell this puppy no matter how you look at it.

As another way of thinking of it, as interest rates go down, this increases the ability to pay, but that can only increase so much since the risk of buying on low interest rates and being unable to sell into a similar situation will weigh heavily on others’ minds and prices will need to adjust to handle this uncertainty. Since demand for housing is waning as the boomer generation ages in place or downsizes (or simply dies), it is unlikely that houses will be able to continue their rich valuation long into the future without a substantial demographic to replace them with the ability to purchase.

Any way you look at it, the house is currently valued at more than it is “worth”. I can show houses in Orange County that currently have better GRMs than what this house is showing, and Orange County is one of the most overpriced locales in the US.

Tomorrow, I’ll deal with the question of what Boomer should do with his cash. Any thoughts before then?

• Bubble , Boomers , Denial , Deflation , Investing
• Comments(3)

Chuck Ponzi June 26th, 2008

If you haven’t read the big news lately, I suggest you take a trip on over to Jon Lansner’s blog and read about Gary Watts’ Mea Culpa.  Except if you’re expecting him to admit fault and take the blame for blind boosterism, you’ll need to wait for a while.

What does he blame it on?  Banks.  Duh.  Isn’t that what everyone else is blaming it on?

OK, even in a way, I blame the banks too, but that doesn’t excuse the absolute unbelievable disregard for history, facts, trends, or truth.  However, I will extend an olive branch to Gary:  on one condition.  The condition is that I can get some of his speaking engagements (or at least as a ride along).  I figure that if the real estate industry is so brain dead that it can not only believe his past published crap, but buy it hook line and sinker, I have nothing to lose, and a whole lot of speaking fees to gain.

Some choice quotes from Lansner’s bag:

“I apologize for not knowing what Wall Street did to our mortgages,” Watts told about 360 attendees during the associations annual membership meeting at the Irvine Marriott. “I had no idea how Wall Street restructured these loans.”

No accounting for affordability?  No accounting for sales volume preceding price?   No memory of the written lashings he received publicly on blogs?  Does he have no memory of this?

Didn’t I write some verbal poundings here on this blog?  If searching Gary Watts on Google, my articles and sites linking to my articles were consistently on page 1 in the searches.  Did he really not know what was said about him?

What else?

Watts said today, however, that the tide of foreclosures likely will mean that the housing market will remain soft into 2009. He noted that short sales, or sales with asking prices below the owner’s mortgage balance, are taking at least six weeks to gain approval from lenders, forcing even more homeowners into foreclosure.

“It’s just inevitable that (foreclosures are) going to spill into the 2009 market,” he said. While a rebound still is possible this year, Watts said, he called the market too difficult to predict.

This is one thing that I am agreeing with him on.  The market is in such a disarray that it’s nearly impossible to predict what will happen through 2009.

Despite what the bottom callers are now saying, they are forgetting the achilles heel of housing.  It goes like this:

1.  Banks cannot hold nonperforming assets on their balance sheet.  Regulators will not allow it.  Bond covenants of RMBSs will not allow it.  Noone can hold onto REO property for very long.  They will price it to move, and if it doesn’t move, they’ll cut until it does.
2.  A  recession is a terrible time to sell houses, especially in bulk, or if you have to as above.  Buyers need to be assured they are getting a good deal before they are sure.

3.  Increasing numbers of NODs and NOTs ensures a parabolic supply of future REOs coming on the market for at least another 10 months, possibly as much as 36 months for Orange County because of the impending neg-am crisis about to unfold in 2009 and 2010.

4.  Whatever buyers there are today are still just setting bargaining points for future buyers.  The demographics of the situation does not allow it to be the bottom at this point.

5.  Voila!  The longer to wait will ensure lower prices.  This will likely be the case for the rest of the decade.  We’ll refresh predictions in 6 months.

I’ll part with an analysis of Gary’s assessment:

He also believes that subprime lending gets a bum rap for causing the housing slump. Rising subprime delinquencies merely acted as a catalyst, tipping a range of bundled “structured investment vehicles” into increasing trouble that alarmed Wall Street investors.

“It was so complicated. It’s a nightmare. A real estate credit crunch usually lasts six months, and this one, we’re in it almost a year, and it’s still not straightened out,” Watts said.

Jeebus, this guy is just reams of material.  It wasn’t, and isn’t just subprime.  It’s everything and I’m pretty sure he’s referring to MBS, not SIVs.  Credit crunches have been fairly uncommon, the last one of a similar magnitude in US history might have been the one directly preceding the 1930’s Great Depression.  And, those kinds of credit crunches take years to recover from the immediate effects, but the long-term effects were felt for more than a generation.  It’s likely that Gary Watts will be worm food before we see reckless abandon in lending like that again.  (at least I hope for the sake of all fiat currencies everywhere).

• SubPrime , Gary Watts , Denial
• Comments(3)

Brad_Davidson June 24th, 2008

I see every day how badly the banks are getting hammered on the bad loans they made. It’s made me a lot of money shorting banks stocks and writing puts.

Here are some prime examples of the losses they’re taking.

23 Leeds Ln., Aliso Viejo

3bdr 2ba 1800 sqft. On the market for $489,000. This house sold for $685,000 in May 2004. We weren’t even at the peak yet in 2004. The buyers put $75,000 down when they bought but pulled that same $75,000 out a year later. The bank eats the entire $685,000 plus the 4 to 6 month of payments that weren’t made plus 6% of the sales price going to commissions.

Let’s add it up: (all rough numbers but close enough)

Price difference    $196,000

Missed payments $ 18,000

Commission           $ 29,000

                               $ 243,000

2 or 3 different lenders are losing $243,000 on a $685,000 loan. That’s a 35% loss. And we’re talking Aliso Viejo, an area of relative stability.

Next.

21595 Audubon Way, Lake Forest

3brd 2 ba, 1070 sqft. On the market for $372,500. This house sold for $605,000 in November 2005. 100% financing. Interesting fact…. the Trustees sale date in the tax record is dated 5/29/08. The bank took this property back less than a month ago.

Here’s what the banks lost:

Price difference     $233,000

Missed payments $ 17,000

Commission      $ 30,000

                           $270,000

Lenders are losing $270,000 on a $605,000 loan. That’s a 44% loss. I’m really surprised at how hard hit Lake Forest has been. I’ve always thought of it as a desirable area.

Here is the winner, or loser if you own stock in large lending institutions.

1609 S. Woodland Pl., Santa Ana

3 bdr 2 ba 1290 sqft. On the market for $305,000. Sold for $587,000 in August 2005. 100% financing through New Century. Plus they got a $25,000 equity loan from BofA in 2006.

Bank Loses

Price difference     $ 282,000

Missed payments  $   17,000

Equity loan             $  25,000

Commission            $  18,000

                                 $352,000

Lenders are losing $352,000 on a $587,000 loan. That’s a 60% Hit!!!! That is a big fat red mark on the balance sheet and there are hundreds more in Santa Ana.

• Uncategorized
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Chuck Ponzi June 21st, 2008

If you’re not in the know on the recent bailout news, there are 3 main points to be aware of:

1. It seems that Bank of America essentially wrote the Dodd Bailout Bill along with Countrywide (merger expected soon). They have probably the most to gain with a generous bailout bill. It helps noone since it doesn’t resolve the fundamental problem of affordability in house, in fact it makes the problem worse. Ever wonder why the 90’s in Japan were referred to as the “lost decade”? It’s because their banking system did the same thing we’re trying to do here. Anyone else see the problem with not punishing gambling banks and housing speculators?

2. The “Subprime Six” were a group of lawmakers given special treatment in exchange for what? What exactly did Senator Dodd besides favorable treatment in his housing financing? What else could be lurking in his past? If you haven’t read about the “Subprime Six”, follow the link. Investor Business Daily, the Wall Street Journal, and the LA times have picked up the story. It’s a story of insider grift and political pandering. If it weren’t so real and true, it might remind me of one of my favorite film lines:

Stuart: Well, it’s a well-known fact, Sunny Jim, that there’s a secret society of the five wealthiest people in the world, known as “The Pentavret.” Who run everything in the world, including the newspapers, and meet tri-annually at a secret country mansion in Colorado known as “The Meadows.”
Tony: So, who’s in this “Pentavret?”
Stuart: The Queen, the Vatican, the Gettys, the Rothschilds, and Colonel Sanders before he went tits up. Oooh, I hated the Colonel, with his wee beady eyes and that smug look on his face. “Oooh you’re gonna buy my chicken, oooh…”
Charlie: Dad? How can you hate the Colonel?
Stuart: Because he puts an addictive chemical in his chicken that makes you crave it fortnightly, smartass.

3. For all of the crap that our President Bush gets, at least he has the foresight to threaten a veto to said bill. There should be no bailout, not just because it’s not fair and would embolden speculators, but because it’s destined to put our banking system in jeapordy for the forseeable future with taxpayers footing the bill. It’s generally understood that this bill has to be done and voted on by July 4th if it is to carry. Any senator that signs this (if it passes) is hopefully going to be thoroughly trounced in the upcoming elections. This is not only unreasonable, it’s unamerican. This place is going to hell in a handbasket. If something like that goes through, I’ll be posting a list of every person that voted for it and their political affiliation here as a feature story.

So, what do I recommend? I’d say get a year’s worth of food and 6 month’s worth of remaining expenses together, if our politicians have any say in it, this is going to be one whopper of a crash and accompanying recession. On the lighter side of things, our grandchildren will be still paying so that people like this can “keep” their homes (and by homes, I mean plural, because, isn’t every good American not just entitled, but guaranteed to own more than one house?).

• Credit Bubble , Debt , Foreclosures
• Comments(3)

Brad_Davidson June 20th, 2008

Greetings fellow real estate watchers. I appreciate this opportunity to share my thoughts on the Southern California Real Estate market. I know real estate agents are not held in the highest esteem here but please, give me the benefit of the doubt before passing judgement.

You can go back and read my initial interview with Chuck Ponzi (then known as John Doe) about my We Help-U-Buy Realty concept from June 2006 and see my thoughts from then on “The Bubble”. I prefer my crow medium well please, because I was wrong , wrong, wrong. I knew the market couldn’t keep going up and that there would be a correction but I didn’t understand the implications of the ridiculously lax credit standards and what would happen when banks stopped handing out free money. At the time I thought there would be a softer landing.

The Option ARM loans made me see the light. I was still dabbling in the lending business 18 months ago and when the lenders started offering up to 4% commissions to sell people negative amortization loans I could smell trouble. By last summer, before the credit crisis, I was telling clients to not buy houses. It tends to have a significant impact on sales when you start telling your clients not to buy what you sell. However, I sleep very well at night and have a very loyal client base.

There are still storm clouds on the horizon as foreclosures continue to rise, the median price continues to fall and sales gains are driven by low priced bank owned properties. I do see some stability in prices at the levels at which banks are selling their REO properties. People are lining up to buy the REO’s and if they continue to show up and buy these properties a base will be established. If sales die off, as they usually do at the end of summer, inventory will rise again and prices could fall some more.

With the banks foreclosing on over 2,000 Orange County properties in May and June, REO’s are piling up in the banks inventories faster than they can be sold. Even though I see considerable pent up demand, and I’m busier than I’ve ever been, prices will be stagnant at best through next year.  It’s going to take at least that long to work through all the distressed properties that will come onto the market.

I hope I’m better with my predictions in June 2008 than I was in June 2006. These are very interesting times and I look forward to passing along what I see in the marketplace and getting your opinions about real estate in Southern California.

• Uncategorized
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Chuck Ponzi June 20th, 2008

I’ve had opportunities to show how much I trounce the market before.  And, frankly, some wondered why I wasn’t spending as much time on the blog lately.  Well, here’s why:

If I had followed conventional wisdom and sold in may, I’d be a bit behind where I am now.  It’s not bad that I’m outpacing the S&P500 by 30% this year.  I’m happy with the results so far.

Investing takes a lot of time to get it right, and frankly, I’m just now reaping the rewards of investments made more than 1 year ago.

Thanks for all of you sticking around, and most of all listening to my jack-assed comments about how great I am at market timing.

There’s still room for a fund in the future!

• Housing Crash , Investing
• Comments(1)

Chuck Ponzi June 19th, 2008

For some time, I has been difficult for me to keep all of my priorities and keep fresh content up on my site.  While the site is a great place to find aggregated housing and bubble news and commentary from other sites, I like to keep the information coming here as much as possible.

As such, I have asked a friend of mine, Brad Davidson of Help-U-Buy realty to join me as a blogger on the site.

Bear in mind that this was no easy decision.  Brad and I don’t share the same opinions, not in the least.  In fact, we have had very different opinions about what is going on in the local real estate market.  This, I think, however will allow you to have a different opinion about what is going on the local markets.  However, Brad brings a lot of depth to the discussion about what is going on in the immediate market.  He is a licensed real estate professional, and has what I think is a model of the future of real estate sales.

Please be sure to read his analysis when it is presented, since it is a boots-on-the ground reference to the local goings-on in the OC real estate world.

Besides, if he really sucks, I can just revoke his blogging privelidges.  Welcome Brad when he makes his first post.

• Uncategorized
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Chuck Ponzi June 19th, 2008

I always said we didn’t have a bubble until we had some perp walks.  These are from today thanks to Bloomberg:

Ralph Cioffi

Matthew Tannin:

The NYT has a great piece on the indictments of former Bear Stearns Fund managers.

In an April 22 e-mail from Mr. Tannin — which the indictment said was sent not from Mr. Tannin’s account at Bear Stearns, but from his personal account to the personal e-mail account of Mr. Cioffi’s wife — Mr. Tannin wrote:

the subprime market looks pretty damn ugly… If we believe the [CDOs report is] ANYWHERE CLOSE to accurate I think we should close the funds now. The reason for this is that if [the CDO report] is correct then the entire supbrime market is toast… If AAA bonds are systematically downgraded then there is simply now way for us to make money — ever.

Three days later, Mr. Cioffi and Mr. Tannin hosted a conference call for investors in the funds. This time, his tone was very different.

Lying openly like that to garner more money needs to be treated pretty harshly.  Maybe some in the securitization business can get some religion.  If not, they can always find Jesus in the clink.

• Bubble , Speculation , SubPrime
• Comments(3)

Chuck Ponzi June 10th, 2008

I have taken a reprieve from blogging for a little while. Sometimes that is needed when so many things are going on in life. The bloggity blog is just a side diversion. Unfortunately, my interests have been competing for my attention much more lately.

1. Family - My girls are the best in the world. I am lucky

2. Wife’s business - taking off, and has needed my attention.

3. I have a day job - really?

4. I invest as my “side job” - the market has been difficult to keep up with.

5. The market is crashing whether I watch it or not… it’s like watching grass grow in Iowa.

BTW, here’s the latest message for Gary Watts:

Any interesting listings, thoughts, etc?

Anyone want to be a cob logger like James over at Bubble Meter?

• Gary Watts
• Comments(6)