Why I know the Hot California Real Estate Market will go down in flames
Rob Boyle
May 31, 2004
Some friends of my brother just bought a cute little three-bedroom house in Santa Barbara for about ONE MILLION DOLLARS. Sure, it's a nice house. Well maintained and newly-appointed. But it is OLD. Not classic, not antique, not special, just OLD. And here is what it doesn't have: a view, a big lot, a pool, a spa, a prime location, square footage. It is just your average little three-bedroom California bungalow. Utterly mundane and forgettable. And it's a MILLION DOLLARS!
See, my wife and I would love to buy our first home. We are both professionals with graduate degrees. We both make enough money to afford a significant monthly payment. We don't have a lot of debt other than easily-manageable student loans.
But I've been a Southern California resident my entire life and let me tell you, the price of real estate in So. Cal. is INSANE right now.
We live in Orange County and right across the street from us, in a non-fancy area, with no clear extras, the price of a three-bedroom townhouse is $735,000. I'm not making this up, we went open house shopping last weekend. A townhouse/condo with no yard in a new but cramped and crowded development is going for $735K.
So my wife and I, we laughed and laughed at the idea of putting down nearly $150,000 of our hard-earned saved up money for a 20% DOWN PAYMENT on a piece of property that would have sold for less than $200,000 five or ten years ago.
HOW CAN THIS BE POSSIBLE?
My wife and I are savers. We don't waste money, we pay our credit card bills in full every month. We don't live an extravagant lifestyle. We have excellent jobs with good salaries. Yet we cannot afford to buy a house in California. What is wrong with this picture?
After laughing at the price of houses here in Orange County for awhile, I realized that people are actually paying these prices. And I don't understand how. So I sat down and did exhaustive research on the real estate market in California. I read about the history of earlier California real estate crashes.
And I remembered my own experiences. After all, I worked at a Savings and Loan in college in the late 1980's and I remember a time when the banks had BOOKS full of foreclosed properties listed for sale. Ah yes, the California Savings and Loan scandals brought an end to the last California real estate boom. Remember when you could open a regular short-term CD account at your local bank for 8.5%? I do, because I was a bank teller selling those CDs back them. And the richest clients at the West Los Angeles Savings and Loan where I worked were mostly children of the Great Depression who were frugal and careful with their money. They taught me more about macroeconomics than my UCLA Econ professors.
So I finally figured it out. California real estate is overpriced for one of two reasons: 1) first time buyers are getting 1 to 3 year Adjustable Rate Mortgages at 4% or less; and/or 2) people are selling their homes to first time buyers and "trading up to more expensive houses using BIG down payments from the inflated equity they squeezed out of their house.
I can cite references, but you know it's true.
So I realized that my wife and I CAN afford an average standard forgettable single family residence in the middle of So. Cal. suburbia. All we have to do is get an ARM. Why, even the broker standing in the $775,000 single family home in Orange County last week told us the AVERAGE buyer she sees of these houses these days has "EIGHT TO EIGHTEEN THOUSAND DOLLARS IN [CONSUMER] DEBT.
Are the lenders in this country on crack (or just repackaging their loans and passing them off to blind investors)?! This can only lead to heartbreak and pain.
See, anybody who has done their homework KNOWS the rates are going up.
In fact, I studied the LIBOR, the 11th District Cost of Funds, the US Treasury, and other such indexes and have come to the conclusion that for most of the past 40 years the indexes to which ARMs are currently tied have been at a substantially higher rate than current rates. Just from a statistical point of view, it is clear the rates are not staying this low and when they do go up, they will likely stabilize at a significantly higher rate. Anybody who doubts this needs to look at the LIBOR and 11th District Cost of Funds Indexes for the last 40 years. I'd post the charts here, but you KNOW I'm telling it like it is.
I believe the rates are likely to go back to a more "normal" range after 12-24 months. This is evident from the Fed's own statements as well as the general consensus in the market. Both the market and Fed will push rates up in the next 24 months to avoid increasingly obvious inflation.
I know that if this happens, anybody who has a 1 or 3 (and probably 5) year ARM is going to get royally screwed once their fixed term is up. I firmly believe that when the initial fixed rate on 1 year ARMs is back up to 5.5 to 6% we are going to see a clear shift in the dynamics of the California real estate market. Why? Because this is when the monthly payment for the cheapest mortgage will not sustain the price of houses in California. The lowest income qualifiers will have to get cheaper prices to be able to buy. People won't be able to "trade-up" as readily because their down payments will be smaller. Equity will deflate. Prices will come down.
THE LAST TIME THE CHEAPEST MORTGAGES HAD 6% RATES, the price of real estate in California was 40-50% cheaper than it is now. And incomes have NOT risen appreciably since that time. I don't know anybody whose wages have risen more than a few percentage points in the last several years. Think about that for a minute.
I'm sure you know that people who are stretching to get into a $650,000 house (that originally sold for less than $350,000 10-20 years ago) will be simply unable to afford the monthly payment if the rates go up 2-3 percent. And when that happens, they will want to sell. And when they can't get $650K for their house anymore, because NOBODY can afford the new monthly payment at the new rate, they will go into foreclosure. And the price of real estate in California will come down to a more "normal" level.
My guess is that the timeline for this is between 2006 to 2008, which is when the bulk of low interest 1 to 5 year ARMs will be turning variable and UNDOUBTEDLY the interest rates will be 1-3% higher or worse. And who will be able to refinance with higher rates and wiped out equity?
And some moron somewhere would have me believe that the price of housing in California is expensive just because of the high demand! Well, where are all the high income jobs? I don't care how much demand there is. In fact, I DEMAND a house for a fair price! That doesn't mean I can afford it.
To express it in near mathematical terms: my argument is that the price of real estate in California is inversely proportional (on a parabolic curve) to the interest rate on the cheapest mortgage product available to the least qualified borrower. In other words, as the monthly payment for the least qualified buyer goes up or down, the overall price of real estate goes up or down in some proportionate fashion. Only time will prove if my theory is correct.
The California real estate market is going to go down in flames. It isn't going to happen overnight. People will fight long and hard to prevent foreclosure. But the equity bubble in California is going to disappear. How do I know this? Because I desperately want to buy my first house in California, a place I've lived my entire life. But with a rock-solid, high earning, excellent credit, two-income, no children, minimal expense, saver household, my wife and I cannot afford to buy a single family residence in our community for the price of the monthly payment on an 80% 30 year fixed rate loan.
Something is wrong in the world. |
