Southern California Real Estate Bubble Crash Blog

Chuck’s Back!

After a prolonged hiatus, I have finally returned to some semblance of being able to blog.  If you were wondering what happened, well, it was tax season.  As you can imagine, it really has been time consuming between personal taxes, my employer’s acquisition closing, and numerous other family responsibilities.

However, that doesn’t diminish the importance of the housing bubble crash that is ongoing.  It truly is an amazing spectacle.

So, this year, Southern California Real Estate Bubble Blog is issuing a 2009 forecast.  In 2008, no forecast was issued.  This was due to the inability to predict how far prices would fall.  There simply was no amount of data that could have allowed me to accurately predict the future of prices.  While it is late, it is nevertheless important in light of current events.  These events are:

Rich Toscano (aka Professor Piggington) issuing a call that San Diego has returned to historically-based normal affordability.

Jonathan Lansner says we’re back to 2001 affordability in Orange County

and even Peter Hong at the LA Times says home prices are stabilizing.

You may even be asking yourself, is this as good as it gets?  Is it really going to stay this expensive?

The answer is IT DEPENDS.

I’ll launch right into my forecast:

1.  Southern California homes will lose 9-12% of their value as measured by the median home price.

This one is signalling that we are close to “the bottom”.  While the numbers will likely bottom out in 2010 or 2011, the location and type of house will largely drive whether it loses more or less of its value.  For example, I identified quite a few houses that had lost more than 70% of their peak value so far in the crash.  These were largely undesirable homes in undesirable locations.  Desirable homes in desirable areas are largely still priced much higher than they were in 2004 despite Lansner’s assertion that we have reachieved affordability from 2001.  (besides, I know that affordability takes into account interest rates which are much lower).  Which only exhibits the precariousness of prices on the high end.  There are a couple of issues at hand when analyzing what to buy and when.  I’ll come out and say my personal opinion.

If you’re going to buy a starter home, or a home in an undesirable area, I would aim for anytime from late this year to mid 2011.  You’ll have plenty of time to choose the right place, and don’t worry if you missed one you really like, you’re only going to live in it for 5 or 7 years before you move on to something better.  Just be sure your job is secure and it’s a manageable payment.  Don’t depend on more debt to make your payments.

If you’re buying a more desirable home or one in a desirable location, you’re better served waiting until at least late 2010 through 2012.  You see, while the median is catastrophically pummelled from a year ago and the beginning of the housing bubble, housing tiers have not equally born the brunt of the mistakes of prior years.  As Rich Toscano has put so well, lower priced home have dominated the sales landscape.  That is due in part (in my opinion) to several contributing factors.

First, while headline news about the lowest mortgage rates in 50 years have enticed many buyers out into the marketplace, they’ll be surprised at the current mortgage landscape.  Jumbo loans (even those so-called conforming jumbos) are priced incredibly higher than traditional conforming loans ($417K+).  To put it in perspective, in 1999 when I bought my SoCal house, jumbo rates were .25% higher (25 basis points) than a conforming loan.  During the bubble, that even narrowed to the point where one would have had a hard time distinguishing between the two. You’ll now pay anywhere from 1.5% (150 basis points) to 4.0% (400 basis points) higher than traditional loans.  This is largely caused by the credit event that started in 2007 and continues until today.  In November 2006, I wrote:

Our current housing prices are fueled entirely by easy, cheap credit, as is evidenced by our high ARM content, and astronomical house-price to income ratios. If a credit event does occur, we have the most to lose. However, all other unwinding scenarios depends on many other moving parts of our global economy to work in clockwork like precision. While the current slowdown is a manifestation of the bubble stretching under its own weight, it is likely that the added pressure of a credit event (and likely even the perfect unwinding as described) would pancake the entire housing and local retail economies that are so dependent on lending. While I would admit I still don’t believe the residential real estate bubble has yet popped, the true test of future direction will be in the credit markets over the next year, not in the for-sale housing market.

While I believe rates will stay low for at least another 12 months, there is definite risk in the future to prices as rates once again rise to more reasonable levels as the economy improves.  This will again cause issues with affordability, so it is important that any house purchase be below rental parity in a desirable area to ensure there is an escape hatch if you find yourself unable to stay in your present situation.

Secondly, the lowest price tiers and outlying areas are the only ones which have reached a rental parity or cash-flow state.  With a lack of affordability (requiring housing prices to be cheaper than renting for the average house-holding time frame, fully burdened)

Finally, there is no support for higher house prices since move-up buying has been completely obliterated.  It will not resume until low-end tiers can substantially appreciate and all buyers 2001-2007 are swept out of the system through reposession, principal write-down, or good old fashioned loan amortization.

2.  Volume will remain high, but begin to falter again as evidenced by the # of months in inventory later this year.

This will begin the next downleg of the bubble crash, specifically targeted to middle-tier priced homes.  Upper-tier priced homes will continue to stagnate in lieu of foreclosures that are currently are simply dragging out the inevitable.  There are few buyers there and many, many homes to buy.  It is likely that high priced homes will not begin to appreciate again for 8 years from the peak.  They will likely not reach their bubble prices (in my opinion) for at least 12-15 years.  Because of the length of this call, any number of factors could change that in the meantime, but it will suffice to say that if you’re going to buy a high-end home, don’t expect a good deal anytime soon.  You’re better off moving out of state, building from scratch, or doing teardowns in decent neighborhoods.

Like an accordian, lower priced homes will reach the bottom first.  Then, as sales resume for middle-tier homes, the median may actually post gains as the mix of sold homes begins to once again stabilize to a more recognizable trend.  This is not likely to reach bottom for another 2 years.  High-end homes will not stop depreciating on the average for another 3-4 years.  Again, because of the length of time between now and then, that is subject to revisions based on household incomes, tax treatments, lending, and the overall economy.

3.  The recession that began in December 2007 will end in Q4 2009 or Q1 2010.

Because this will be the longest post-war recession, we will see the effects for a long time.  If you as Mike Shedlock, he would likely state that a secular shift of consumers to a more austere and frugal lifestyle is in the works, I am doubtful that this will be a generational shift like the one experienced after the Great Depression.  This might be more aptly called “The Great Recession”, or “The Great Credit Crunch”, or even “The New Depression”.  Remember, that while I am calling the bottom of the recession to be the end of this year or beginning of next, that doesn’t mean that we’ll have the typical post-war v-shaped recovery on the other end of it.  I believe that we’ll need to see quite a bit of supply destruction to account for the demand destruction we are witnessing.  This recession will be marked by a L-shaped or U-shaped recovery.  Personally, I’m hoping for a U-shaped recovery within 18 months of the end of the recession, making a sustantive return of significant spending somewhere off in then 2011 or 2012 area.  While this would have been considered impossibly bearish just over a year ago, many might consider this optimistic given the current circumstances.  Still, I believe that markets contain significant momentum simply because of learned processes.  The optimism and flexibility that the American economic system afford create a self-fulfilling prophecy of optimism and success.

4.  Substantial job-loss will continue in California, reaching 11.5% by year’s end.

California is a terrible place to do business.  Between anti-business policies and oppressive taxes and cost of living, many business are simply folding up shop.  Having endured crippling worker’s compensation premiums, high payroll taxes and salaries, and insurance premiums along with disaster-recovery requirements  before the recession removed a substantial amount of discretionary spending, once the recession hit, many businesses lacked the savings to relocate and are simply folding up.

While California holds a great deal of talent in pharmaceuticals, high-tech, and financial services, support functions are nearly nonexistent, and require a highly educated work force.  Even in tough times, employers are finding it difficult to retain top talent because of the draw of higher salaries and greater opportunities elsewhere.  (not necessarily out of state).  This creates a drag on companies since the constant churn of talent means substantial cost to the organizations.  While this may seem like a platitude, the real cost of locating a business in California is too high for it to make sense unless it is a game-changing business (think Google).  Normal companies simply cannot compete.  Add in the budget shortfalls that portend higher taxes after this years staggering tax increase of more than 10% and the it’s a good time to get out of Dodge.

All of this is to answer one question, should you buy a house this year or not?

It depends.

If you don’t, you’re not going to miss anything, and I believe the risks are simply too great as described above.  I would recommend against it, but there are indeed fleeting opportunities available that can make sense.  In particular, while I believe that the tax incentives given out incentivize bad behavior, if you are going to buy anyway, consider 2 different tax breaks that seem to be temporary in nature.

1.  US Federal $8,000 credit up to 10% of the value of a house.  This credit is for buyers who have not owned a home in the last 3 years.  It is available as a tax credit so you recoup it when you do your taxes.  Be sure to consult a tax specialist before purchasing to ensure if you are eligible.  You must stay in the home for a certain amount of time to claim it.  This credit is set to expire in November 2009.

2.  A California $10,000 credit for new homes.  This is also a credit that is offered to buyers of new homes in California that is credited over 3 years, up to $3,333 per year.  This money is capped and going quickly.  Check the site for more information.

Bear in mind that these credits only skew prices by the offsetting amount of the credit in most cases, and draw buyers from the future.  In other words, after the credit expires, prices will readjust downward and there will be fewer buyers since they bought earlier.  Such manipulation often depresses prices further after the manipulation ends.  Either way, economic law states that demand will readjust to the new conditions to provide that there is no such thing as a better deal except by chance.  (That’s the theory, anyway).

As for the original posts, there are 3 great counter arguments to the articles presented:

1.  Rich Toscano even followed up to his affordability assertions with a deeper analysis of plunging price tiers.  He admits freely that the mix of properties has largely created the plunging median prices, not that the market is approaching normalcy.  It is still a long way off, and you’re more likely than not to catch a falling knife.

2.  Jonathan Lansner’s sources unfortunately are removing from view the significant backlog of notice of defaults and pending foreclosures, deteriorating labor markets, and increased taxes.  The fundamentals of owning a home have changed, and never in the last 30 years has there been more risk than now to buy a house.  While affordability has increased, it is a mixture of bad data and comparing apples to oranges.  If you think affordability is good now, just wait another 12 months!  Dr. Housing Bubble has an excellent recent analysis.

3.  Peter Hong’s analysis lacks the detailed breakdowns of location and sales mix.  Rich’s more detailed analysis provides a much clearer picture.  If you’re buying investment properties in the high desert with significant cash flow and substantial reserves, you might want to buy on that news, but if you’re stretching to buy in LA or OC, you had better wait.