SAN DIEGO – CANARY IN THE COAL MINE
This report is from Ramsey Su, who is a “guru” in the San Diego real estate market, widely quoted in the press, and knows the number in San Diego better than anyone.
REDC, an auctioneer, conducted a massive Northern and Southern California auction in May. They are in the process of repeating same in August. I attended both the May auction and the August auction for the San Diego area. The August auction drew even more “spectators” than the May auction. The results, unfortunately, were quite the reverse.
The data was far more informative than I had hoped for. Based on this new information, I opine that Wall Street, the rating agencies, the Feds and investors, while a lot less optimistic now, are still in denial, especially the rating agencies.
Time Line
Practically all the SD properties in the auction are foreclosures from loans that originated in 2004 and 2005. The trustee’s sales were almost all in 2007. This is telling us the current lag time from a bad loan to final REO disposition is 2-3 years. We know the 2006 vintage of loans is far worse than 2004 and 2005. Those REOs are not even hitting the market yet but we know with certainty that they are coming. The time line has to be the biggest asymmetry today. I am sure all of you have heard the theory that the “subprime” problem will peak next March when amount of reset hits the peak. While that may be true regarding reset, the actual foreclosure problem will peak about 2-3 years from then, if the market does not deteriorate any further.
HPA – or more accurately, HPD (Home Price Depreciation)
As stated above, almost all the properties on the auction list were the 2004 and 2005 vintage. I removed all the refinances and used only properties that I have a sales price to determine how much the auction properties appreciated (depreciated) from the last sale. Since refinances only consist of a small percentage of the properties, the sample size is quite adequate. The average May auction price was 73% of the previous sales price. The average August auction price was 67% of the previous sales price. This is a 6% drop in just 3 months, far more than my bearish estimates.
More evidence of HPD
29 properties that were in the May auction did not close escrow and were included the August auction. These same properties sold for 87% of the May auction prices. The lenders took a 13% extra loss in just 3 months plus holding cost, that is assuming they will close this time.
Apples and apples comparison
What is most significant about this data is we are using exact apple to apple, property by property comparison to determine actual appreciation/depreciation, not some massaged mean medium blue sky seasonally adjusted number as created by NAR. 2004 and 2005 sales were probably the peak for the San Diego market and have suffered a 25+% decline already. From a positive perspective, properties purchased during 2003 and prior may have enough equity to provide some cushion to weather the current storm.
Cause of foreclosure
Without the actual loan files, it is impossible to determine the exact reasons why these borrowers defaulted. However, there is one common element. Almost all of these properties had 100% LTV and most of them were piggyback 80/20s. All foreclosures were by the senior lien holders implying that all junior liens were totally wiped out. It is clear that while subprime and now Alt-A are capturing all the headlines, no one is mentioning LTV. As HPD accelerates, more and more homeowners are going to be driven into the negative equity territory. It is possible high LTV may be a better predictor of default than a low FICO score.
Estimating losses – junior liens
The loss severity of these loans, amazing as it may seem, could be over 100% when servicing cost and interest advanced are recaptured.
Estimating losses – senior liens
Including all costs, I am estimating that the foreclosing loans will return about 60 cents on the dollar. This is on top of the 100% loss for the junior liens, which is usually 20% of the last sale. In other words, the totally loss is just a little less than 60% for each REO. Based on the recent conference calls by the various agencies, I do not think their models are remotely close to reality.
Condominiums
50% of the properties in the August auction were condos. In the San Diego MLS, there are currently 20,711 listings, out of which 6,797 or just 32% are condos. This shows a disproportional amount of REOs are condos. The average August auction price for condos was 63% of the last sales price versus 72% for SFR. This is a red alert that Wall Street will soon be finding out. In addition to contagion problems, financing is going to be impossible. Owner occupancy ratios (the percentage of units occupied by owner vs. renter) that have been largely ignored during the bubble years will come back into play. While the nation would not be as extreme as Florida, where a lot of lenders have stopped financing all condos, unwarrantable condos are going to tough time finding financing. In addition, HOAs are going to be stressed by owners delinquent on dues, compounding the problem. There are countless condo projects, especially all the condo conversions that were made possible by bubble financing, which may be entirely upside down at the moment. As in previous down cycles, these condo problems are very difficult to work out. I am not aware of any discussion by Moody’s, S&Ps or anyone that separates condo from single family.
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