Walkaway Consequences

Please consider: Snow Job: Strategic Defaults in an Era of Negative Equity

As more than a million people filing bankruptcy every year learn, life continues even after their credit scores are trashed. They can still buy cars on credit. They still have credit cards (secured) and debit cards. They can still rent apartments and houses.

Bankruptcy is a nuclear strike on a consumer’s credit score. Filing alone delivers a 355-365 point hit (out of top scores of around 800) and outright disqualification from obtaining any extension of credit from many lenders. The black mark follows the borrower for 10 years.

Short sales can trigger drops of 100-130 points; strategic defaults bring slightly heavier penalties, 100-150 points. The negative mark attaches to a credit record for seven years (but diminishes over time).

However, it’s possible to get a government loan only 3 years after foreclosure.

Ironically, late mortgage payments can have a bigger impact than outright default. FICO scores can easily plunge 200 points merely through nonpayment of a mortgage for a period of 60 to 90 days—something that lenders generally require of borrowers seeking loan modifications.

Credit recovery takes place remarkably quickly. Faced with the choice of foregoing credit card payments and incurring stress-related expenses stemming from high debt levels, the temporary black eye could be well worth it. Walkaways also join the crowd: Credit scores have been dropping steadily throughout the recession, especially for those with higher ratings.

Although for some people bankruptcy may be the best option, for most people facing mortgage problems, there is no reason to file bankruptcy.  If you isolate the foreclosure and keep everything else good on your credit, you will be on your way to financial recovery much quicker than one would expect.  Typically after 2 years things will start looking a lot better… credit score wise.  If you are considering bankruptcy, you may wanna re-think it and make sure that your problem doesn’t only revolve around the underwater mortgage.  You may be able to stay free in your home for 12 months and pay off all your other unsecured debt.  You definitely don’t need to nuke a problem that may only need a sniper.

5 Reasons Why The Program Is Doomed To Fail:

Like the federal loan modification program that was put into effect just over a year ago, the federally subsidized short sale program, set to take effect April 5^th, is now being touted as the next great hope for homeowners who either can’t afford to, or are choosing not to, pay their mortgages.

But, just like the Making Home Affordable program that released last year with the promise of saving millions of homes, the federal short sale program is drastically flawed, and if enacted, will more than likely end up with the same exact outcome… after many months and billions of wasted taxpayer dollars, the “experts” will be that it isn’t working for a variety of reasons.

In this Nostradamus like post, we’re going to examine why this new program is doomed to fail… do us a favor – bookmark it, and in a year come back and revisit it, and see how many of these predictions come true. Without further adieu, here are 5 reasons why a federal short sale program won’t work:

1. Second (and third) mortgage holders

Here’s a potential scenario: You owe $500,000 on your home, which was purchased in 2005 with an 80/20 loan, meaning your first loan was for $400,000 (80%) and the second loan is for $100,000 (20%). Due to the collapse of the housing market, the home is now worth $300,000. You put it on the market for $300,000 and get an offer for $250,000, which you take to your first lender. Even if you jump through all their hoops, have a valid hardship, and get your short sale approved, that still leaves the second lender out in the cold, holding the bag to the tune of $100,000. The logical, and typical response from the second lender, will be to block the short sale any way they can.

2. Lack of buyers

Even in a perfect world where every lender agreed to take a loss and accept a short sale, there’s still one major flaw – we’re still in a recession, unemployment is at a multi-decade high and still rising, and consumer confidence is at an all time low. Add to that the fact that due to lack of liquidity and tightening of lending standards, many would be homebuyers are now ineligible for a mortgage anyway. Not exactly a formula for people rushing out to buy all these short sale properties, or to secure the funding to do so even if there were.

3. Bureaucracy & red tape by the banks

Have you ever tried to contact your bank for anything? Loan modification, find about or try to reverse a credit card fee, anything?

If so, you certainly know that it’s not the easiest task in the world. One department sends you over to another, who makes you repeat your info and your story. They tell you to fax in documents, then claim to never receive them. They say you’ll get a call back and you never do.

The point is that if the lender needs an excuse to postpone or make it  difficult for you to do anything, they have it… even if they have the best of intentions, the sheer volume of the requests for modifications, short sales, etc, has most lenders scrambling to play catch up.

Then there’s the fact that has squashed the hopes of so many short sellers in the past – even if you can get all the lenders and investors to agree on the short sale, that usually takes 3-6 months! By that time most qualified buyers have either found another home and lost interest in the current deal.

4. Lack of incentive & penalties

Just like the Federal Loan Modification program, this plan is lacking a huge ingredient… namely the lack of incentive for banks to take less than what they’re owed, and the lack of penalties for delaying or not complying with the rules of the program.

According to a NY Times article on Sunday, the program will offer $1000 apiece for 1^st and 2^nd mortgage holders, and $1500 for the seller.

Sure, there’s a $1,000 incentive payout for a bank to accept a short sale, that’s almost more of a slap in the face than anything. Actually, I’m kind of laughing out loud right now at the absurdity of this.  If someone owed you $100,000, and they came to you and said… “well I can only pay you $25,000, but  don’t worry, because my buddy here has another $1,000 for you…cool?” Haha… Does that really make anything better – it’s still only $26,000!!!

Or it looks more like this…

Borrower:  I know I owe you $100,000, but I can pay you $25,000… Is that ok?

Lender: No

Borrower: Ok, ok… well what if my friend uncle sam gives you $1,000 will that help?

Lender: Sure

I mean come on! Where do these smart people come up with these programs?

You really don’t need to incentivize the seller to sell – the fact that they are out of an underwater mortgage is incentive enough in most cases. The problem is, how can it possibly seem like a good idea for banks to take a $1000 consolation prize to take a loss of 5 or 6 figures on a deal?

Without a real, valuable incentive to accept short sale offers, and without a real penalty to lenders who don’t try to make things happen, there will be no real reason for lenders to go the extra mile to accept the short sales.

5. Lack of clear cut, uniform guidelines

Again, there is another huge comparison to be drawn with the federal loan modification program… the final decision is to be made at the sole discretion of the lender. One of the main reasons that the modification program failed is because you could submit the same application to 2 different lenders, or in some cases to 2 different people at the same lender, and receive 2 completely different answers.

Unless there is a uniform set of guidelines for acceptance, there is no way this will work.

Conclusion:

As with the loan modification program of a year ago, this program is destined for failure unless drastic changes are made to it by the government. By enacting these programs that are meant to be a show of the governments dedication to fixing the economy, but not including any real rules for banks to follow, they are delaying the inevitable, costing taxpayers billions more dollars, and making themselves look foolish and corrupt. Now is no time for token gestures, the economy is at the brink of collapse.

Either make changes that have some teeth and force the banks to start playing by some logical rules again, or do nothing, step back and let free market capitalism run its course. Let the market decide what the prices of homes should be, and who can qualify for them.

Sure there will be bank failures, foreclosures, and more pain, but most people who have an understanding of the economy, a few ounces of logic in their head, and don’t have a bank lobbyist at their doorstep daily, will tell you that this is bound to happen anyway. So isn’t it better to “rip the band aid off quickly”? Either let things take their course naturally, or to really take some action to change that course, instead of doing everything and anything, at all costs (literally) to keep playing by the bank’s rules, and stay on the same crash course that we’re currently on?

And then there’s the issue of the millions of people who are facing foreclosure. If they have tried everything possible to get a short sale done – jumped through all their banks hoops, found a buyer, did all the proper negotiation with all involved parties, and the banks still said no… then shouldn’t those people have the right to give the bank their home back with the same ramifications as if they did a short sale? It just seems very illogical to penalize a seller for circumstances that are far beyond their control, and very unproductive… why not penalize the banks who drag their feet and lose deals instead? You’d at least get some more short sales closed.

New York Times Reported on March 7, 2010:

But at the end of the day, the banks would rather make things difficult. According to J. K. Huey, a Wells Fargo vice president, said a short sale, like a loan modification, would have to meet the requirements of the investor who owns the loan.

“This is not an opportunity for the customer to just walk away,” Ms. Huey said. “If someone doesn’t come to us saying, ‘I’ve done everything I can, I used all my savings, I borrowed money and, by the way, I’m losing my job and moving to another city, and have all the documentation,’ we’re not going to do a short sale.”

Please comment below and let us know why you think this new program either will or won’t work. Thanks!

The Tipping Point

In a phone interview yesterday with a writer from the New York Daily News, I was asked…”Jon, where exactly is the tipping point? When do people realize it may be better to just walk away?”  This is a difficult question, I said, because it’s not so clear cut.  It depends on many factors.  However, when it comes to specifically a “strategic defaut”, it may be a little more cut and dry.  At what point does one decide to face the consequences of a foreclosure over pumping more & more money into a home with negative equity every month? Strategic Default can be defined as the growing trend of people who can afford to make their monthly mortgage payment, but due to the fact that they’re upside down on the mortgage or think they can get a better deal elsewhere,  they voluntarily default on the mortgage.  Often times they live in the home for a year or more, using that time to pay down other debts or save up money.  Time will ultimately tell the real answer to this question, but I predict that this year we will see more and more homeowners tipping.

Homeowners Are Technically Renting

An article yesterday in the San Francisco Chronicle said

“The reality is, if you’re 30 percent underwater, you’re effectively going to be a renter in that home while paying your mortgage for the next 10 to 15 years before you get back to break-even with your equity,” said Paul Leonard, director of the California office for the Center for Responsible Lending.

“It’s not enough to have affordable monthly payments, if a borrower can walk across the street and rent some place for less, save money and have a little nest egg by the time their credit score recovers to be able to buy a home.”

And it’s not just a numbers game… in many cases it’s outside factors that cause someone people who have the means to pay to default – changes in jobs, suburban neighborhoods deteriorating as housing values plummet and changes in family life can all act as a catalyst for  a financially stable person to voluntarily choose default.

“We could make our payment every month by doing a little bit of overtime,” said Jose Tolentino of the Bay Area of California. “But we want to start a family. We could rent for half what we’re paying and afford to have kids.”

In many cases, making this choice without needing a catalyst is the best financial decision an individual or a family can make. In a housing market where the majority of signs point to another decline in housing prices, and even the most optimistic of economists and analysts don’t expect any price increases like what we saw during the boom years, it can take years, in many cases decades to recover the equity that’s already been lost.

Brent White, a law professor at the University of Arizona, says that the number of true strategic defaults – people walking away from underwater homes in the absence of other problems such as job loss – seems lower than common sense would dictate.

“People are acting against their own economic self-interest by continuing to pay off houses where they may not have any equity for decades,” he said. “They’re throwing away good money after bad.”

Shame, guilt and fear stop many homeowners from reneging on their mortgages, he said. The government and big banks actively cultivate those emotional constraints because the economic consequences of a large-scale walkaway phenomenon could be dire, he said.

Sure, there’s a credit hit to be considered, and in certain states there may be legal ramifications that a lender can take to try and pursue a deficiency judgment, and then there’s the ever popular “social stigma” attached to walking away, but at the end of the day, when painted in comparison with burdening yourself and future generations with the debt of one bad investment, the consequences start to pale quite a bit. Obviously every situation varies, but when looked at from a purely business standpoint, the Strategic Default option is starting to look better and better to the millions of underwater homeowners out there.

Please let us know what your thoughts are on the Strategic Default debate… at what point does it make sense? Or should one be obliged to pay the monthly mortgage at all costs?

Jon Maddux

CEO

www.YouWalkAway.com

Email me at:  jon@youwalkaway.com

We’ve now come full circle. Instead of trying to get people to stay in their homes, Obama is willing to pay them to leave. Please consider Program Will Pay Homeowners to Sell at a Loss.

In an effort to end the foreclosure crisis, the Obama administration has been trying to keep defaulting owners in their homes. Now it will take a new approach: paying some of them to leave.

This latest program, which will allow owners to sell for less than they owe and will give them a little cash to speed them on their way, is one of the administration’s most aggressive attempts to grapple with a problem that has defied solutions.

Under the new program, the servicing bank, as with all modifications, will get $1,000. Another $1,000 can go toward a second loan, if there is one. And for the first time the government would give money to the distressed homeowners themselves. They will get $1,500 in “relocation assistance.”

Short sales are “tailor-made for fraud,” said Mr. Lawler, a former executive at the mortgage finance company Fannie Mae.

Under the new federal program, a lender will use real estate agents to determine the value of a home and thus the minimum to accept. This figure will not be shared with the owner, but if an offer comes in that is equal to or higher than this amount, the lender must take it.

Big Shell Game

Diana Olick describes the situation perfectly in Mortgage Principal Writedown Won’t Save Housing.

And so it begins. Big gun lawmakers are making the move toward principal writedowns as the last resort to save the housing market.

The problem is prices. Home prices have fallen so far in the hardest hit areas, the areas where the bulk of the troubled loans are, that banks would have to write down principal 30 to 50 percent to put borrowers back in the green. Accounting rules require that banks write down the value of those loans on their books, and experts tell me that if banks really accounted for all the losses in the home loan market, they’d all be insolvent.

That’s why the Obama Administration has created this kind of shell game in the first place.

I stole that shell game idea from housing consultant Howard Glaser: “We’re spending tens of billions of dollars on a tax credit to get people to purchase homes, we’re spending federal money to keep them in their homes through the modification program, and now we’re going to pay them to move out of their homes. This is not a sustainable system for the housing market. It’s a shell game. Bernie Madoff could have created this system,” Glaser told me today.

F.R.A.U.D.

Let’s take real estate agents who might not have had any sales for 6 months or even a year, and agents who have a vested interest (a commission) in selling a home, and let’s put them in charge of figuring out what a home is worth. Good idea.

Oh…there’s no chance real estate agents will sell homes to their friends for cheap or to total strangers for that matter, just to get a commission. Indeed, real estate agents have been the paragon of virtue throughout the crisis so this is the culmination of a perfect idea.

Even appraisers working directly for the bank might be tempted to make special arrangements with favored real estate agents. A final approval process at the bank would make fraud harder, but that is contrary the idea the lender must take an offer if it hits the established minimum bid. A secondary review would also slow things down.

That aside, even with the chance for fraud, lenders are losing money by doing nothing, and in many cases by letting people live in homes rent free for 18 months or longer. Perhaps dealing with fraud issues is the lesser of two evils, assuming of course the banks can afford the loan losses. Then again, what alternative is there besides pretending loans on the books are worth full value?

This is what our affordable housing program has become: Giving tax credits to new home buyers, spending taxpayer money to keep people in their homes, paying people to move out of their homes, and bankrolling Fannie Mae and Freddie Mac with tax dollars for unlimited losses.

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com

Economically-speaking, inexpensive housing is a wonderful thing.  Economically-speaking, a large percentage of our population would be much better off renting.

Government programs like FHA, Fannie Mae, Freddie Mac, HAMP, Tax-Credits, etc, were all designed with the goal of making homeownership more attainable…meaning that more people can now attain a limited supply of homes.  Increased demand leads to higher prices…meaning these programs just made housing less attainable. Economically-speaking, we’d be better off if they never existed in the first place.

It sounds almost un-American to say such things…and that’s a big part of the problem.

Even while acknowledging that high home prices actually harm the economy, Yale economics professor Robert Shiller wrote a piece in The New York Times, making a case that the Government should continue supporting the programs that cause them.  He specifically mentions the F.H.A., Fannie Mae, and Freddie Mac, but all supporting programs were implied.

His reasons for supporting Government actions were basically:

1. Home prices would fall more if the programs ended
2. “The American Dream” is essential to our “sense of national identity”

The Emperor’s clothes are beautiful indeed.

From the article:

…But what is the long-term justification for putting taxpayers on the line to subsidize homeownership? Is this nothing more than a sacred cow in American society — a political necessity because so many voters own homes and are mindful of their resale value?

In fact, there is much more to the history of subsidizing housing. While the crisis in the housing market shows that our current approach is far from perfect, there is a certain wisdom behind it, related not only to economic stimulus but also to the preservation of a sense of national identity. It’s important to remember this as we consider re-engineering our institutions as the crisis ebbs.

…

This time, the best answer isn’t found in traditional economics but rather in American culture: a long-standing feeling that owning homes in healthy communities is connected to individual liberties that embody our national identity. Historically, homeownership has been associated with freedom, while renting — often in tenements or mill villages — has been linked to the oppression of a landlord.

In his classic 1985 book, “Crabgrass Frontier,” Kenneth T. Jackson of Columbia University delineated the complex train of thought that over the last two centuries has produced the American belief that homeownership encourages pride and good citizenship and, ultimately, preservation of liberty. These attitudes are enduring.

Back in 1899, in “The Theory of the Leisure Class,” Thorstein Veblen described homeownership, particularly of large and expensive dwellings, as “conspicuous consumption.” By that, he meant that it was undertaken substantially for the purpose of impressing others by showing the amount of money one can afford to waste on space one doesn’t need.

What is specifically American here — though it’s increasingly seen in other countries, too — may be the modern sense of equal citizenship, engendered by the illusion that we can sustain conspicuous housing consumption even among a majority of the people.

In short, this all has a great deal to do with culture, and little to do with financial wisdom.

On home prices, Shiller writes:

If many of these homes needed to be converted to rental units, home prices might well drop.

Though the policies are economically insane, they are worth the cost in order to perpetuate “a long-standing feeling that owning homes in healthy communities is connected to individual liberties that embody our national identity.”

In other words, the concept of “The American Dream of Homeownership” is worth defending at any cost because it is a central to our culture.

Really?  Is our National Identity really defined by lust for a material good?

Consider the alternatives…

Americans: Smart and Hard-Working

Americans: Gracious and Strong

Americans: Helping Each Other

Americans: Character and Perserverance

No, we’re Americans: People who want to Buy Houses

How twisted and materialistic have we become as a culture to openly define ourselves by something we own?

As a renter, I am offended.  As a citizen and a taxpayer, I am outraged.

Shiller suggests that The American Dream is too sacred…that our fragile national ego would collapse if its credibility were threatened.  But, he’s wrong.  The jig is up and the public knows it.  In fact, they are asking for it, desperately wanting to find some spiritual purity after a decade of decadence. Social mood is shifting.

Shiller mistakenly suggests that home prices are worth propping up.  But the problem isn’t that home prices are falling, it’s that home prices are still too high. Falling prices and foreclosures aren’t the problems, but the solutions, not the illness, but the cure.

The time has come to shout out that the Emperor has no clothes: The American Dream is simply a marketing campaign, a gimmick, perpetuated by industry groups and their lobbyists.  That a home can define one’s success or national identity is simply a symbollic, mutually-shared illusion.

Consider the actual, original American Dream by James Truslow Adams:

“that dream of a land in which life should be better and richer and fuller for everyone, with opportunity for each according to ability or achievement. It is a difficult dream for the European upper classes to interpret adequately, and too many of us ourselves have grown weary and mistrustful of it. It is not a dream of motor cars and high wages merely, but a dream of social order in which each man and each woman shall be able to attain to the fullest stature of which they are innately capable, and be recognized by others for what they are, regardless of the fortuitous circumstances of birth or position.”

Somewhere along the line, corporate marketing departments changed The American Dream to exactly “high wages and motor cars (houses)”.

Somewhere, our heros changed from men-of-character to men-with-credit-cards.

Now, the false American Dream is becoming an American Nightmare.  Many of our friends, neighbors, and family members are in their darkest hours and being forced to re-examine their paths and priorities.  One-by-one, they are emerging from the darkness and rebuilding lives to be recognized by what they are, not what they have.  Their stories are spreading, giving hope and courage to others who are struggling financially.

Social movements are born from crisis such as this. The opportunity is here to redefine American Culture.

It’s time to take back The American Dream.

This article originally appear on the Irvine Housing Blog

The ARM Problem has not gone away. Today we examine an updated ARM reset schedule and consider its impact on our local housing market.

it’s time for me to get away from here
just thought you oughta know the end is near
did you honestly think it would’ve worked at all
cuz evrything i’ve seen has only made me fall
there ain’t much i can do now that i’ve seen the truth
there ain’t much i can do now they’ve made me into
one of you

REPENT
for the kingdom of oblivion is at hand
REGRET
not a thing for all’s as it was planned
REJECT
false gods false hopes and false ideals
RESET
push the button game over no more time to steal

Left Spine Down — Reset

Wouldn’t life be much easier if we could hit a reset button and wipe away the excesses of the housing bubble? In the housing bubble era, reset is associated with a bad thing that happens to adjustable rate mortgages. I remember last year a few astute observers much wiser than me chastised me for worrying about adjustable rate mortgages because they were all resetting to lower rates — problem solved. Foolish me. I must be a Chicken Little sounding a false alarm, right?

I wrote most recently about The ARM Problem in the summary post Option ARM story. The problem with adjustable rate mortgages resetting and recasting to higher payments has diminished in importance because many of the loans have defaulted early, so now the major problem is shadow inventory. The ARM problem is still with us, and much of our shadow inventory — and ultimately foreclosure and resale inventory — is spawned from this lending monster.

$1 trillion worth of ARMs still face resets

By Zach Fox

While several industry observers worry about negative equity and unemployment driving foreclosures, a couple of experts point out that interest rates on mortgages remain a cause for concern.

Credit Suisse made waves in 2007 among housing bears with a chart that estimates the volume of adjustable-rate mortgages to face a reset each month. An updated version of the chart, which was provided to SNL, shows resets remain a worrying force over the next few years.

Most of the resets are expected to occur through 2012. Between 2010 and 2012, the chart indicates that $253.25 billion of option ARMs will adjust, while Alt-A loans totaling $163.71 billion will reset over that time. Altogether, $1.010 trillion worth of ARMs will reset or recast during the three-year period.

“Option ARM resets are still pending. … Nothing much has happened yet because rates were so low that resets were pushed back,” Chandrajit Bhattacharya, head of non-agency RMBS and ABS strategy at Credit Suisse, told SNL.

That is not entirely true. Many of these loans are still pending, but the borrowers are not paying. The reset chart is not adjusted for shadow inventory. Many of the loans facing reset are already in default. Numerous of the light blue (Option ARMs) have already defaulted as have many of the light green (Alt-A loans).

Borrowers who already have seen their ARMs reset might be sitting on their hands and not refinancing into fixed-rate products, McBride said. Because mortgage rates have been so low recently, resets can actually lower, not raise, monthly payments. When that happens, borrowers might feel little urge to refinance into a fixed-rate product that would cost more per month.

This is the real problem; people will do anything, no matter how foolish, to lower their monthly payment because they believe the government will bail them out if interest rates move against them. Why wouldn’t they? Moral hazard caused by lending bailouts emboldens both lenders and borrowers and ultimately increases the cost of the bailouts demanded.

“The avoidable scenario is interest rates start to go up over the next couple of years, and all of a sudden, millions of homeowners who are stuck in adjustable rate mortgages and haven’t been able to refinance out of them become sitting ducks for big payment increases,” McBride said. “And then here we go again. It’s like 2007 all over again. And again, the HARP program is key to avoiding that iceberg, and we’re headed right for that iceberg, and no one’s turning the wheel because everyone’s focused on mortgage modifications.”

“If you look at it, there’s almost probably 5 million borrowers sitting there in some sort of delinquency right now who have yet to be foreclosed upon. So if you say [the Home Affordable Modification Program] is going to save only a small fraction of that, the rest of them have to go through in some form of foreclosure or distressed sale,” Bhattacharya said. “So it’s definitely not over by any means.”

Credit Suisse projects 10 million foreclosures over a five-year period starting in 2008.

To put the ARM resets schedule in context, these timelines represent the totality of the carnage the markets face from ARMs, but the actual foreclosures related to these loans may occur early due to unemployment, negative equity or a number of other reasons. Shadow inventory emerges from this schedule and pulls destruction forward. Loan modifications, which are supposed to be the market savior, increase the problem with terms that have escalating interest rates and increasing payments. So why is this a big deal here in California?

… option ARMs are concentrated in just a few states. A Fitch Ratings study from Sept. 8, 2009, The Building Block: Bringing \’cram-down\’ back’,PU_STATUS,’9/14/2009 The Building Block: Bringing \’cram-down\’ back’,PU_CAPTION,’Article’,PU_POPOFF,0));”>reported that three-quarters of all option ARMs were in California, Florida, Nevada and Arizona.

Don’t worry; Irvine has none of those problems, right?

More Foreclosures are Coming

From the OC Register: Foreclosures now are just ‘tip of the iceberg’:

[Bruce] Norris told hundreds of investors attending a seminar he held in Costa Mesa this past weekend that numbers indicating the appearance of  firming home prices and fewer foreclosure auctions are “illusions.”

Government repayment and loan modification programs make foreclosure numbers appear lower for now, but are delaying the inevitable inability or disinclination of homeowners in trouble to hang on to property that has dropped in value by hundreds of thousands of dollars, he says.

Meanwhile, he says,  redefaults on loan modifications are “sabotaging” government efforts.

Mortgage delinquencies will continue “skyrocketing,” he says, because:

• “The resets of the Option-Arm loans will cause a larger number of foreclosures than the subprime loans.
• “Resets are part of the problem, but a bigger concern is the owners who owe more on their home than it’s worth.
• “Commercial loans and credit card losses will soon add to the problem.”
• Unemployment is a signifcant factor. He says: “I think we will fall back into recession by the end of 2010, and the unemployment rate and underemployment rate will be about 20% in 2011.”
• Owners are finding it more and more acceptable not to make their house payments. The mindset, according to Norris: ” ‘I see my next door neighbor has stopped making his payment, and he just bought a camper.’ You can see that coming. We haven’t really been through the biggest part of the problem.”

Updated ARM Reset Schedules

For historical reference, I superimposed the new reset chart onto the old one to see how the original projections have changed.

In the cleaned up graphic below shows the next four years of adjustable rate mortgage resets.

More reason to believe the Bernanke Put, the implied protection of mortgage interest rates, is going to be kept in place.

The results of amend-pretend-extend are apparent, and in case the obvious is overlooked, restructured loans only postpone bank losses.

The amend-pretend-extend policy is like shovelling snow; the more you push the snow, the larger the build-up on the front of the shovel. Eventually, you will need to stop and remove the snow or you get stuck. Similarly, pushing ARMs out further simply adds to the problem and makes correcting the problem costier.

Lenders believe that a rolling loan gathers no loss, so they would push the problem back endlessly if they could. Eventually, appreciation may bail them out, but the existence of these loans and the inevitability of higher interest rates will weaken appreciation or kill it entirely. Also, despite the foolishness of it, many of these loans are being underwritten today as affordability products. Rather than eliminating ARMs at the bottom of the interest rate cycle, we are expanding their use.

If the ARM problem becomes large enough, politicians will deem it too-big-to-fail and engineer another bailout. At this point it is difficult to advise people to take on conservative financing and do the right thing. So much moral hazard exists that I can not persuasively argue with someone considering an ARM loan. The system is there to be gamed, and everyone seems OK with that. Personally, I find it appalling.

This post originally appeared on the Irvine Housing Blog

The Housing Bubble

Prices went up a large amount during the Great Housing Bubble, but what makes this price increase a bubble? To answer this question it is necessary to accurately measure price levels and review historic measures of affordability to establish these price levels are not sustainable. [1] Measuring house prices is not a simple task, and there are many methods market watchers use to evaluate market prices. These include the median, the average cost per square foot, and the S&P/Case-Shiller indices. Price levels in financial markets represent the collective result of individual actions. There are techniques to measure the actions of the individual market participants and their impact on house prices. These measures are debt-to-income ratios and price-to-income ratios.  The amount of debt people are willing to take on compared to the income they have available is their debt-to-income ratio. The amount of money people are able to put toward the purchase of residential real estate compared to their income is their price-to-income ratio. These ratios are important because they show how much people are borrowing and spending from their earnings to acquire real estate. When these ratios break with historic patterns, they signify a housing bubble.

There is a point where people are not able to bid up prices any higher because they do not have the savings or the borrowing power to pay more. This affordability limit determines where bubble rallies end; however, this limit is not predetermined or in a fixed location. The purpose of exotic financing programs is to expand this limit and bring more customers to the market and generate fees for the lenders. Unfortunately, these products have continually proven to be unstable, and the high default rates and lender losses inevitably lead to a contraction of credit known as a credit crunch. Interest-only and negative amortization loans created the housing rally and their elimination due to borrower default created the housing crash.  As mentioned previously, the housing bubble was a credit bubble.

Price Measurements

There is no perfect measure for any broad financial market activity. Markets for stocks, bonds and other securities are the most widely reported and measured financial markets. It is relatively easy to measure activity in these markets because all sales are recorded at a few central exchanges and the “products” are uniform (one share of stock is equal to another). In contrast, real estate markets are much more difficult to evaluate. [ii] Real estate transactions are recorded into the public record in thousands of locations across the country. Keeping an organized database of these records is such a daunting task that the title insurance industry has taken this responsibility as part of its business model, and many people are devoted to the arduous task of obtaining and organizing these records on a daily basis. Real estate does not have the uniformity of stocks or other financial instruments. Each property has unique qualities that differentiate it from all other properties making like-kind comparisons very difficult. Geographical location is a major influence on the value of real estate. Even if two properties could be found with identical physical characteristics, the values of these properties could vary considerably based on where they are located. Ideally, a market measure would record the changes in sales prices of identical assets or in the case of an index, a group of similar assets. The unique nature of real estate assets makes it difficult to use standard measures of reporting utilized in other financial markets.

Due to the problems of asset uniformity and variability based on location, real estate markets are typically measured using some form of median pricing over a specified geographic area. The median is a statistical measure of central tendency where half the data points are above and half the data points are below. For instance, in a list of 5 numbers sorted by size ($100,000, $200,000, $300,000, $500,000, $900,000,) the third number in the list ($300,000) would be the median because it has two numbers that are larger and two numbers that are smaller. The median ($300,000) is used rather than an average ($400,000) because a few very expensive properties can increase the average significantly, and the resulting number does not represent the bulk of the price activity in the market.

One of the problems with a median as a measure of house prices is a lag between when a top or a bottom actually occurs and when this top or bottom is reflected in the index. During the beginning of a market decline, the lower end of the market has a more dramatic drop in volume than the top of the market. This causes the median to stay at artificially high levels not reflective of pricing of individual properties in the market. In other words, for a time things look better than they are. At the beginning of a market rally, transaction volume picks up at the bottom of the market at first restarting the chain of move ups. During this time, the prices of individual properties can be moving higher, but since the heavy transaction volume is at the low end, the median will actually move lower.

The median is a good measure of general price activity in the market, but it does have a significant weakness: it does not indicate the value buyers are obtaining in the market. The houses or structures built on the land compose the most significant portion of real estate value in most markets. These structures deteriorate over time and require routine maintenance that is often deferred. During times of prosperity, many people renovate homes to add value and improve their living conditions. The impact of deterioration and renovation of individual properties is not reflected in the median resale value. Also, at the time of sale, there are often buyer incentives which inflate the recorded sales price relative to the actual cost to the buyer. These buyer incentives also distort the median sales price as a measure of value.

Many data reporting services measure, record, and report the average sales cost on a per-square-foot basis to address the problem of evaluating what buyers are getting for their money. For instance, in a declining market if people start buying much larger homes at the limit of affordability, the generic median sales price would remain unchanged, but since buyers are getting much larger homes for the same money, the average cost per-square-foot would decline accordingly. This makes the average cost per-square-foot a superior measure for capturing qualitative changes in house prices; however, this method of measurement does not capture the relative quality of the square footage purchased, only the price paid for it. High quality finishes may justify a higher price per square foot. There is no way to objectively evaluate the impact finish quality has on home prices. The main problems with using the average cost per-square-foot to measure price is that it does not provide a number comparable to sales prices since it has been divided by square feet, and it is not widely measured and reported.

Figure 15: National S&P/Case-Shiller Home Price Index, 1987-2007

To address some of the weaknesses of the generic median sales price as a measure of market value, Karl Case and Robert Shiller developed the Case-Shiller indices for measuring market trends. [iii] This index measures the change in price of repeat sales. It solves the dilemma of pricing like-kind properties–almost. Although these indices capture the price movements of individual properties far better than the generic median sales price, it does not take into account value added through renovation and improvement. To address this issue, the index gives less weight to extreme price changes assuming the outlier is a significant renovation. However, if there is a market-wide renovation of properties, as was the case in many markets during the Great Housing Bubble; this will cause a distortion in the index. The other weaknesses of the Case Shiller indices concern how and where it is reported. Since it is an index of relative price change rather than a direct measure of price, the index is reported as an arbitrary number based on a baseline date; therefore, the numbers are not useful for evaluating current pricing. The index is also confined to 20 large metropolitan areas around the United States. The large geographical coverage areas are required to obtain enough repeat sales to construct a smooth index. The broad yet limited geographical coverage fails to capture price changes in smaller markets. Also, since the Case-Shiller index is a measure of changes in prices of sales of the same home, it does not include any newly constructed homes. No measure is perfect, but the Case-Shiller index is the best at measuring historic movements in pricing because its methodology is focused on repeat sales of the same property.

Figure 16: Los Angeles S&P/Case-Shiller Index, 1987-2007

The examples from this work will use the median sales price, not because it is the best method, but because it is the most widely used and best understood of the common measures. Also, since it gives a number reflective of sales values in the marketplace, it is the easiest to understand and interpret. This measure has weaknesses, but over time it does a reasonable job of documenting overall prices and trends in the marketplace.

Figure 17: Median Home Prices, 1968-2006

The Great Housing Bubble was an asset bubble of unprecedented proportions. Between 2000 and 2006, home prices increased 45% nationally, and in California home prices increased 135%. [iv] Had this amazing price increase coincided with a period of high inflation, it may not have been indicative of a price bubble, merely the general increase in prices of all goods and services; however, inflation was low during this period. The inflation adjusted price increases nationwide were 23% and in California it was 100%. There was no great improvement in the quality of houses justifying the higher prices. Although some homeowners made cosmetic improvements, the vast majority of homes were unchanged during this period, and many deteriorated with age. Resale homes did not undergo any form of manufacturing process where value was added to the final product. There was little real wealth created during the bubble, just a temporary exaggeration of value.

Price-To-Income Ratios

Price-to-income ratios represent the amount borrowed relative to the incomes of the borrower. There are many variables that impact house prices, and some of the variability in prices over time can be attributed to changes in these variables; however, since most houses are purchased with lender financing, and since lender financing is linked to income, the price-to-income ratio is the best metric for evaluating long-term housing price trends. The price-to-income ratio does not need to be adjusted for inflation as both prices and income will rise with the general level of inflation. Most of the fluctuations in the ratio are based on changes in financing terms, in particular interest rates, and of course, irrational exuberance.

The Great Housing Bubble saw unprecedented price-to-income ratios because interest rates were at historic lows and the use of exotic financing including negative amortization loans were at historic highs. When measured against historic norms of house price to income, the degree of price inflation was staggering. [v] In markets where bubble behavior is not prevalent, price to income ratios hover between 2.3 and 2.8. In bubble markets there is a tendency to maintain higher ratios, and the range over time is much greater. Any ratio less than 3 is generally considered affordable.

Figure 18: National Ratio of House Price to Income, 1986-2006

In bubble markets ratios of 3 to 4 are as affordable as they get. Anything greater than 4 is a strain on family budgets and generally a sign of an inflated market. Ratios greater than 5 are considered very unaffordable and prone to high rates of default because they tend to be characterized by exotic financing. Price-to-income ratios in the bubble of the early 90s in California did not exceed 6 because interest rates were higher and because negative amortization loans were not widely available. During the Great Housing Bubble, the national ratio of house price to income increased 30% from 4.0 to 5.2. This means 30% more debt is serviced by the same income. Some of this increased ability to service debt is explained by lower interest rates and exotic loan terms, and some of this increase came from people choosing to take on larger debt loads due to the irrational expectation of ever increasing house prices coupled with loose lending standards which enabled the populace to take on these debts. The national trends were small compared to the frenzied activities of bubble markets in California where most markets saw their house price to income ratio double.

Figure 19: Price-To-Income Ratio in California, OC and Irvine, 1986-2006

Buyers were never forced to buy; it was always a choice. During the market rally, greedy buyers motivated by rising prices and fueled by loose lending standards were able to bid prices up to ridiculous levels. The exotic financing was not a result of high prices; it was the cause of high prices. Lenders were keen to offer these products because they were not taking on the risk, and it allowed them to keep transaction volumes high. The lenders profits came from transaction volume. By late 2007, the market balance had shifted from favoring sellers to favoring buyers. The once greedy buyers were becoming desperate sellers: their dreams of riches from perpetual appreciation were in tatters. Many were forced to sell due to their inability to make their mortgage payments. Those that hung on were homeowners with 50% or more of their income going toward paying off an asset which was declining in value. It was not a set of circumstances to be envied.

Price-To-Rent Ratios

Price-to-rent ratios represent the cost of a dwelling unit relative to the cost of a comparable dwelling unit. This ratio is also subject to the same variability exhibited by the price to income ratio. [vi] This is not surprising considering rent is generally paid out of current income, so incomes and rents tend to track one another fairly closely. The ratio of rent to income has stayed within a range from 13.6% to 16.5% from 1988 to 2006. This demonstrates renters have been putting roughly the same percentage of their incomes toward housing for the 18 years period of data examined. The evidence from the sudden and dramatic changes in the price-to-income ratio and the price-to-rent ratio points to a housing bubble. [vii] If these two measures of value had been supported by a rise in the rent-to-income ratio, the increase in prices might have been explainable by a shortage in dwelling units causing all consumers of housing to see an increase in the percentage of their income going toward housing. Evidence from the rent-to-income ratio is to the contrary.

Figure 20: National Price-to-Rent Ratio, 1988-2007

Debt-To-Income Ratios

There was a significant price bubble in residential real estate in the late 1980s crashing in the early 1990s. This coastal bubble was concentrated in California and in some major metropolitan areas in other states, and it did not spread to housing markets nationwide. When comparing this previous bubble to the Great Housing Bubble, the macroeconomic circumstances were different: prices and wages were lower in the last bubble, interest rates were higher, the economies were different, and other factors were also unique; however,  the evaluation of personal circumstances each buyer goes through when contemplating a purchase is constant. The cumulative impact of the decisions of buyers is represented in the debt-to-income ratios–how much each household pays to borrow versus how much they make. Comparing the trends in debt-to-income ratios provides a great tool for elucidating the behavior of buyers.

Typically debt-to-income ratios track interest rates. As interest rates decline, it becomes less expensive to borrow money so borrowers have to put less of their income toward debt service. The inverse is also true. On a national level from 1997 to 2006 interest rates trended lower due to low inflation and a low federal funds rate. During this same period people were increasing the amount of money they were putting toward home mortgage debt service. If the cost of money is declining and the amount of money people are putting toward debt service is increasing, the total amount borrowed increases dramatically. Since most residential real estate is financed, this increased borrowing drove prices up and helped inflate the Great Housing Bubble.

Figure 21: Debt-To-Income Ratio and Mortgage Interest Rates, 1997-2006

The figure on the following page shows the historic debt-to-income ratios for California, Orange County and Irvine from 1986 to 2006. It is calculated based on historic interest rates, median home prices and median incomes. Lenders have traditionally limited a mortgage debt payment to 28% and a total debt service to 36% of a borrower’s gross income. The figure shows these standard affordability levels. During price rallies, these standards are loosened in response to demand from customers when prices are very high. Debt service ratios above traditional standards are prone to high default rates once prices stop increasing. In 1987, 1988 and 1989 people believed they would be “priced out forever,” so they bought in a fear-frenzy creating an obvious bubble. Mostly people stretched with conventional mortgages, but other mortgage programs were used. This helped propel the bubble to a low level of affordability. Basically, prices could not get pushed up any higher because lenders would not loan any more money.

Figure 22: Debt-To-Income Ratio, California 1986-2006

Changes in debt-to-income ratios are not a passive phenomenon only responding to changes in price. The psychology of buyers reflected in debt-to-income ratio is the facilitator of price action. In market rallies people put larger and larger percentages of their income toward purchasing houses because they are appreciating assets. People are not passively responding to market prices, they are actively choosing to bid prices higher out of greed and the desire to capture the appreciation their buying activity is creating. This will go on as long as there are sufficient buyers to push prices higher. The Great Housing Bubble proved that as long as credit is available there is no rational price level where people choose not to buy due to prices that are perceived to be expensive. No price is too high as long as they are ever increasing.

In market busts, people put smaller and smaller percentages of their income toward house purchases because the value is declining. In fact, it is possible for house prices to decline so quickly that no mortgage program can reduce the cost of ownership to be less than renting. The only thing justifying a DTI greater than 50% is the belief in high rates of appreciation. Why would anyone pay double the cost of rental to “own” unless ownership provided a return on that investment? Once it is obvious that prices are not increasing and even beginning to decrease, the party is over. Why would anyone stretch to buy a house when prices are dropping? Prices decline at least until house payments reach affordable levels approximating their rental equivalent value. At the bottom, it makes sense to buy because it is cheaper than renting. In a bubble market when the market debt-to-income ratio falls below 30%, the bottom is near.

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[1] There were some valiant attempts during the bubble to determine if the price increases really were a bubble. The literature of the time almost universally missed it despite the obvious signs in the data. In the paper Assessing High House Prices: Bubbles, Fundamentals, and Misperceptions (Himmelberg, Mayer, & Sinai, 2005) the authors used almost the same approach to the analysis presented in this writing and reached the opposite conclusion, “As of the end of 2004, our analysis reveals little evidence of a housing bubble. In high appreciation markets like San Francisco, Boston, and New York, current housing prices are not cheap, but our calculations do not reveal large price increases in excess of fundamentals.” By the end of 2004, the data was unambiguously in support of a financial bubble. One of the few authors who recognized the problems early on was John Krainer an economist with the Federal Reserve Board of San Francisco (Krainer, House Price Bubbles, 2003).

[ii] Jordan Rappaport provides an overview of the various methods of house price measurement in A Guide to Aggregate House Price Measures (Rappaport, 2006).

[iii]  In the paper A Note on the Differences between the OFHEO and S&P/Case-Shiller House Price Indexes by Andrew Leventis (Leventis, 2007), the author makes the following observation: “OFHEO’s House Price Indexes (the “HPI”) and home price indexes produced by S&P/Case-Shiller are constructed using the same basic methodology. Both use the repeat-valuations framework initially proposed in the 1960s and later enhanced by Karl Case and Robert Shiller. Important differences between the indexes remain, however. The two models use different data sources and implement the mechanics of the basic algorithm in distinct ways.”

[iv] Praveen Kujal and Vernon L. Smith noticed an interesting phenomenon in the studies of perceptions of fairness in their paper (Kujal & Smith, Fairness and Short Run Price Adjustment in Posted Offer Markets, 2003), “perceptions of fairness cause people to resist price increases following abrupt changes in conditions with no cost justification. Fairness is thus interpreted as being a result of expectations that are not sustainable.” This implies that people have an intuitive sense that nothing is justifying the dramatic increase in prices during a bubble rally. There is no perception of fairness because houses are not any better, nor are houses any more expensive to build. The increase in prices has no justification in cost. Carl Case and Robert Shiller also noticed the same behavior among sellers in financial manias who felt guilty that the buyer paid so much (Case & Shiller, The Behavior of Home Buyers in Boom and Post-Boom Markets, 1988).

[v]  In the paper Are House Prices the Next “Bubble?” (McCarthy & Peach, 2004) the authors completely missed the implications of the rising price-to-income ratio. Some amount of the increase in price (less than 50%) nationally can be attributed to lower interest rates. The authors make the statement, “The marked upturn in home prices is largely attributable to strong market fundamentals: Home prices have essentially moved in line with increases in family income and declines in nominal mortgage interest rates.” An analysis of the impact on lower interest rates on actual payments and debt-to-income ratios would have revealed their conclusion erroneous, but no such analysis was undertaken. In the paper (Gallin, The Long-Run Relationship between House Prices and Income: Evidence from Local Housing Markets, 2003) Joshua Gallin reaches the following, completely erroneous conclusion, “More formally, many in the housing literature argue that house prices and income are cointegrated. In this paper, I show that the data do not support this view. Standard tests using 27 years of national-level data do not find evidence of cointegration.”

[vi] The paper for the Federal Reserve Board by Joshua Gallin, (Gallin, The Long-Run Relationship between House Prices and Rents, 2004) demonstrates there is a relationship between these variables long term. What is interesting is the Mr. Gallin did not reach the same conclusion with respects to the relationship between house prices and income (Gallin, The Long-Run Relationship between House Prices and Income: Evidence from Local Housing Markets., 2006) despite the fact that rents and income track each other very closely.

[vii] In the paper Housing: Boom or Bubble (Schiller, 2007), author Tim Schiller shows a chart on page 17 that looks very similar to the one in this work (He used a different data source, but the results were almost the same.) The chart shows the obvious sign of a massive housing bubble with prices showing a deviation in the price-to-rent relationship 5 times the previous high of the coastal bubble of the early 1990s. Despite the visual appearance of the chart, he goes on to say the rally in prices was supported by fundamentals. Obviously, he was proven wrong. There is a history of scholarly papers on the price-to-income ratio that completely missed the housing bubble.

This post first appeared in the March edition of: Cirios Trends: In Search of Real Estate Opportunities.

As the infamous “Summer Buying Season” looms a few months out, it remains to be seen whether or not recent market strength can continue. In a way, the housing market has been turned on its head in the past year: The weakest markets are now the strongest, while some of the most well-to-do areas remain shaky and illiquid. The bifurcation in today’s housing market is persistent, and we believe will continue to be the dominant trend in 2010. Taking a look around the Bay Area, data support this theory, as can be seen the charts on the following pages.

Alameda is truly an island unto itself. It is after all, an island. And in some ways a whole different world. The western half of the island is dominated by the quasi-vacant Alameda Naval Complex, which is part maritime ghost-town, part industrial development opportunity in the making: Years of potential development deals have hung over the area, which remains one of the choicest pieces of undeveloped land in the Bay Area. Meanwhile, strong schools, a bustling downtown and a unique sense of community draw middle class families from around the Bay to call Alameda home. As the chart above illustrates, Alameda has seen its share of price declines, but this decidedly middle class town has experienced decidedly middle of the road housing troubles. With prices off “just” 24% from the peak and stabilizing of late, homeowners couldn’t have asked for a much better outcome from the worst housing slump since the Great Depression.

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We at Cirios have shown chart upon chart, graph upon graph, data upon data to illustrate that low end housing markets have been the first to recover, while high end markets have remained troubled. At first, we were called loony, since conventional wisdom knows that when housing starts to recover, it’s the strong markets that bounce back first. Not so this time. It has now been well documented that luxury real estate is still under pressure even as distressed markets start to stabilize. In case you weren’t convinced, we offer you yet another fascinating example of why buying in the high end can still be a risky proposition if not done smartly. The graph above shows condo prices in Burlingame, one of the most desirable locales on the Peninsula. There aren’t a ton of condos in the town in the first place, as evidenced by the spotty dots, but the trend is clear: Prices have come down, but not by much, and if the cluster of dots below the trend line in 2009 are any indication, stability isn’t likely in the cards in the immediate future. Flip the page to see the polar opposite situation across the Bay in Concord.

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Wow, now that is a chart. (Commodity-watchers of recent years will recognize this pattern, to be sure). The price correction above was nothing short of spectacular. Unless, of course, you owned a condo in Concord. In addition to all the other factors pushing down prices, as condo buildings got into financial trouble, they were crossed off the FHA and Fannie Mae Approved list, effectively locking buyers out of financial options. When your only buyer is an all-cash investor, prices really crater. Dig into the data above at the complex-by-complex level and you can literally identify the point at which the complex got removed from the Approved list. But as rental yields once again started to make sense, investors returned to the market. With prices having tumbled all the way back to 2000 levels, even though Concord doesn’t have the caché of Burlingame (nor the schools, of course), where would you rather put your money?

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Just like the statement “the housing market has bottomed” is meaningless to anyone but the most macro-focused economists, trying to look at even city-wide home price trends is often a fruitless endeavor. And while sometimes even zip codes hide the true trends (as we saw last month with Menlo Park, CA), zip codes are the only way to even begin to examine home price trends effectively, especially within large cities. For example, the question “How far off the peak are home prices in San Jose?” is impossible to answer. The chart above shows the zip of 95127, which lies to the east of Highway 680. From the peak, prices are down more than 50%, all the way back to levels not seen since 1999. Note also that there was nary a pop during the dotcom bubble, which means this area isn’t chalk full of technology execs, to say the least. Flip to the next page for a very different perspective from a very different part of town.

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The zip code of 95120 is home to the Almaden Valley, one of the most desirable parts of San Jose, and, by extension, Silicon Valley. All one needs to do to is look at the spike in expensive homes sold in this area during the peak of the dotcom craze to get a sense of the area’s demographics. Prices in 95120 are off a mere 20% from the peak, which occurred a full year after that of our previous area of 95127. Interestingly, Almaden has seen a touch of stabilization since the beginning of last year, and even a small rise in prices. But, with prices only back to 2004 levels, during the height of the housing boom, we would caution that it’s more than likely that 2010 could bring some pricing pressure, as a weak job market begin to stress Silicon Valley’s more well-to-do residents.

This post first appeared in the March edition of: Cirios Trends: In Search of Real Estate Opportunities.

Opportunity Overview:2730 Sherwood Dr., San Bruno, CA 94066
For many people familiar with the Bay Area, the Peninsula is a place where only the wealthy can afford to live. And while this holds true for most areas, there remain some desirable areas that still afford first-time buyers a place to call home. One of these towns is San Bruno. Known more for its poor weather than affordable homes, San Bruno often gets a bad rap: There are plenty of neighborhoods that aren’t buried within the fog belt. San Francisco International airport is close (although in some cases too close), and job centers are a short drive North or South. Homes frequently sell for less than $600,000 which, on the Peninsula, is downright cheap.

Property Details
Bedrooms: 3
Bathrooms: 2
Living Area: 1,140 square feet
Lot Size: 5,432 square feet
List Price: $549,000
Sale Price: IN ESCROW (8 days on market)
List Date: 2/12/2010

This property was purchased at Trustee Sale on January 4, 2010 for $444,000. In just over 30 days, the buyer was able to relist the property for more than $100,000 above acquisition cost. The quick turnaround indicates that improvements were more than likely cosmetic in nature. Given the lack of equivalent homes on the market, it ‘s safe to assume this property will sell at or above its asking price.

Here is one potential scenario of how an investor would make out:

(Note that the cost figures below are estimates)

$444,000: Purchase price
$30,000: Repairs and remodel
$1,520: Taxes
$3,500: Insurance
$5,000: Escrow costs
$484,020 Total Investment

Although a $30,000 budget is not especially large, given the small size of the home, many high quality improvements could have been made. The final numbers in our scenario look like this:

$570,000: Sale price (estimated)
$28,500: Less Real Estate Commissions
$484,020: Less Total Investment
$57,480: Profit
11.9% ROI

A return of 11.9% is not as high as other deals we have seen come across the steps, but escrow is scheduled to close on March 11th, so the deal took just under 70 days from purchase to eventual resale. The annualized return on this deal was meaningful, indeed.

This post first appeared in the March edition of: Cirios Trends: In Search of Real Estate Opportunities.

This month’s zip code spotlight moves to what can truly be called the heart of the San Francisco Peninsula. Nestled between South San Francisco and Burlingame, San Bruno is a suburban haven only minutes from the city.

Homes in the area range widely in cost, from $1.3 Million dollar mansions on the hill to affordable, $300,000 row homes closer to the bay. In the midst of all this, a solid core of reasonably priced (by peninsula standards) homes provides an excellent alternative to more expensive south peninsula locales. The median listing price currently rests at around $650,000. For this price, homebuyers can get a reasonably large 3 bedroom home with a good sized lot.

With a housing stock largely consisting of homes built in the 1950’s and 60’s, opportunities abound for rehab investments. Foreclosure activity has been on the rise in the area of late, while prices seem to have leveled off somewhat. As you can see from the graph below, the moving average sale price for homes has actually increased slightly over the last 6 months. During that time, supply has come down from its spike in 2008 but is still slightly elevated from traditional levels, likely due to the increase in foreclosure activity.

What this means is that home values in the area are increasing despite downward pressure from increased supply. This is a good indicator for the medium term prospects of San Bruno real estate, as it indicates that demand is higher (relative to supply) than it has been traditionally in this area. If supply does taper off, prices should go even higher. In the meantime, we feel that price stability for this area is very likely, making rehab investments in the area quite attractive.