If you refer back to last week’s Inventory post, I had listed the number of home sales for 1st quarter of 2008:

That’s a total of 99 homes sold in Arcadia over the last 3 months. How does this compare to previous quarters when the bubble was in full swing? On the chart below, we’re currently on the very right at just under 100 sales.

Sales skyrocketted during the last half of 2003 and for 4 years Arcadia quarterly sales remained around 200 transactions or more per quarter. That’s averaging about 66 homes a month. We’re currently reporting half those numbers for 2008.

If you look at the Median Price line (in red), it tends to follow the general trend of sales activity. Back in March, our friend over at Dr. Housing Bubble had posted a similar looking chart but it was tracking the median price for LA County.

Unless income increases significantly, it looks like Arcadia will continue to follow the general trend of the rest of the county, state and country. And although real estate here will always command a certain premium in terms of pricing, I see 1,000sf, 67 year-old homes listing for $775,000 and my only question is, “WTF?”

This property was bought on January 4th, 2008 for $600,000. I cannot imagine how this home could have commanded a $175,000 premium in just under 4 months.

From the listing:

MUST SEE TO APPRECIATE, MOTIVATED SELLER WILL LISTEN TO ANY REASONABLE OFFER. HURRY HURRY HURRY!!!!!

Hey, look on the bright side. At least it comes with a professionally installed greenhouse.

Real estate always goes up.

Land is running out.

Rich foreigners are pouring in by the boat load.

Real estate is a great investment.

So why in the world are we facing the largest housing and credit crisis in U.S. history?

The Culprits

Lenders started pushing sub-prime loans so people with bad credit and no down payment could afford to buy homes. Lenders such as Countrywide even scammed prime borrowers into taking out sub-prime loans. Why? Because back-end commissions were higher and Wall Street eagerly paid for these risky loans.

Artificial demand was created when otherwise unqualified borrowers began buying up houses left and right. There was no significant growth in income or even population. Million dollar homes were bought up by people making less than $100k a year on zero down, interest only, adjustable rate mortgages.

Wall Street somehow decided it was a good idea to securitized these sub-prime loans and sell them on the open market.

Builders decided to increase their home production even though there was no marketing data supporting the need for a significant increase in housing.

The Outcome

Greed – Greed – Greed. That’s what this housing bubble comes down to.

• Lender such as Countrywide and New Century are wiped out.
• Homeowners are losing their homes through rapidly increasing foreclosures.
• Wall Street giants such as Bear Stearns, Citi and WAMU are in major distress.
• Public builders such as KB Homes, Lennar and Centex are in a financial mess. Local builders are shutting down left and right.

Feel free to share this post with friends, family and coworkers the next time they ask, “So what got us into this mess?”

I’ve kept a close eye on the rise and fall of the housing boom for the past few years. During that time I’ve heard all sorts of opinions and stories from renters, homeowners, coworkers, relatives, realtors, brokers and even random strangers. For the past many years it was mostly the usual “buy now before you get priced out forever” and how “real estate is the best and safest investment you can make” crap. I’ll never understand how anyone can believe that load of bull, but that’s another discussion.

Even after the initial subprime and credit crunch blowout last year, I was still coming across fairly optimistic outlooks from most people. For a while I was starting to wonder if I’m over-reacting. No one I spoke to seem to understand where I was coming from, what I was talking about and looked at me like I’m from the Looney Tunes whenever I mentioned anything about a major housing crash. I asked myself, how can this be?

It can’t be…at least not for long. As the dull winter gave way to the spring real estate kick-off season, people are starting to turn the corner and realize US housing isn’t going to make a summer come-back. Sure the media spread news of foreclosure numbers, slowing economy and volatile stock market reactions, but nothing hits home more than watching your neighbors’ house sit on the market for months on end. Once people start seeing For-Sale signs going up (and not coming down) in their own community, the ever-popular argument of “not in my area” gets thrown out the window. They can lie to themselves and others all they want, but that doesn’t change the fact that prices are falling all across the country.

The psychology of the market can be very powerful. It takes a long time for people to accept what is happening, but once they have accepted and understood the market conditions, it takes a strong hold on them and their money. All of a sudden real estate goes from one end of the spectrum to the other. People who were on the fence are now on the sidelines and people who have their hand caught in the cookie jar are trying to get out as fast as possible.

In my opinion, we’re at the tipping point in terms of a psychological shift in the SGV market. The conversations have changed regardless of whether you’re at the office water cooler or in line at the drugstore. People are finally realizing the magnitude and depth of the mess we’re in. Is that consistent with the encounters in your daily life? I’d appreciate it if you share with us what you’ve heard and how the people around you feel about the housing market in your particular neighborhood and area.

I recently had the opportunity to meet with 3 individuals who “specialize” in real estate investments. I say this with a sarcastic tone because these guys started flipping properties in 2003 and rode the real estate bubble to success. With all the news lately regarding the drop in real estate prices, increase in foreclosures and other record breaking data, these real estate professionals claimed that we’ll hit rock-bottom this Fall and it’ll be time to jump in again. Since I was the youngest in the meeting, my attempts to explain that we are at least 2 years away from bottoming out were dismissed as ludicrous.

There is no doubt that there will be plenty of knife catchers out there and even many self proclaimed real estate gurus will be victims. What many people don’t realize is that unlike stocks, real estate is not a very liquid asset. It takes several years for values to run up and equally as long to crash.

Let’s take Wall Street’s recent poster child for failure as an example. Countrywide Home Loans’ stock soared alongside our current housing bubble. It went from $13 in 2003 and peaked at $45 in early 2007.

As soon at the subprime lending market tanked, it took only 6 months for Countrywide’s stock price to hit $8. It has since bottomed out around $4 before Bank of America decided to bail… sorry, I meant buy them out. Gosh, that sounds awfully familiar.

Unfortunately for us, real estate transactions take 30 days or longer to complete so data is always lagging behind. Because this is the case, historical figures and graphs from providers such as DataQuick and the Case-Shiller Housing Index are valuable resources (below).

According to this data, Los Angeles home prices peaked around mid-2006 and it has been dropping for over 18 months now (20 if you count February and March). If you look at home prices between 1995 and 1997, you will notice that the market bottomed-out and stayed that way for approximately 2 and a half years.

I keep hearing that us Arcadians now have this psychological barrier when it comes to home prices and the days of desirable $200-400k homes or condos are long gone. If you believe this then be my guest and purchase a home this Summer.

As for me, history says that buying in these market conditions is equivalent to catching a falling knife: the pain will come fast and hard as your neighbor’s REO wipes out any equity left in your home.

This post inspired by my clueless associates and Patrick.net’s Don’t Catch a Falling Knife.

How do the proposed Housing Bailouts affect taxpayers? There have been several ideas thrown out there so let’s cover a handful of them. The bailout proposals include:

• Reduction of property taxes.
• Assisting lenders in reducing the mortgage principal of at-risk homeowners.
• Subsidizing the same lenders who intentionally made subprime loans.
• Allowing homebuilders to carry losses up to 5 years back instead of the usual 2; resulting in additional tax refunds.
• Using Federal funds to backup mortgage insurance.
• Giving over $10 billion to distressed homeowners and mortgage companies.

All these plans share one thing in common: The use of Federal funds to bailout risky homeowners, subprime lenders and home builders.

And where do these “funds” come from? You. The hardworking taxpayer. Instead of concentrating on affordable housing and punishing lenders for their reckless lending, politicians would rather use public funds to bailout the very parties who got us into this housing crisis.

While irresponsible home buyers and greedy lenders get a free pass, those of us who are financially responsible pay for it with taxes and overpriced homes.

Patrick.net has a great article on this bailout topic: Can you spare a few thousand dollars to pay somebody else’s mortgage?

Many have used what I like to call the ‘foreigner-rescue-scenario’ as the primary reason why Arcadia and other cities in the San Gabriel Valley will be essentially immune from the housing crash. I happen to disagree and would be remiss if I simply dismissed it without a closer examination.

When kool-aid drinkers state that prices will remain at these elevated levels because of foreigner involvement, they are making several assumptions. These include:

1. Foreigners make up a fairly large percentage of the demographic
2. Foreigners are able to purchase these overpriced properties
3. Foreigners are willing to purchase these overpriced properties

Let’s take this one at a time. From the recent new business developments and general observations in the city’s changes, these foreigners are mostly Asians. According to the 2000 US Census, Asians made up 45.4% of Arcadia residents and out of that 45.4%, about ¾ of them are of Chinese decent. That is not to say other ethnicities aren’t involved, but since the Chinese own the largest piece of the foreigners-in-Arcadia pie, they will be the race of interest for this discussion.

Although the census reported that the median family income in 2000 was around $66k/yr, it doesn’t account for the any of foreign money that have been brought in from the countries of the far east. Since it’s almost impossible to obtain data on how much money we’re talking about, it’s difficult to gauge its effect. However, for this rescue scenario to be effective there must be enough foreigners to carry the entire weight of the cities properties. Since the Chinese only make up one-third of the total population, it doesn’t appear this conglomerate of dim-sum eaters and rice-rocker drivers have enough power to pull everyone through. And even if that is the case, it would require each and every one of them to be fairly wealthy to make that happen. Is it realistic to assume that all Chinese residents in Arcadia are rich? I think not and that conveniently leads to my second point.

Even if these foreigners make up the majority of the population, they must be financially able to hold up the current market prices. People buy property in one of two ways. You can either purchase it in cash or take out a loan and pay a mortgage. I don’t know too many people with a million US dollars in cash, but I might just have a circle of poor acquaintances. Generally speaking, the majority of buyers (even Asian buyers) have a mortgage of some sort. With the crunchy credit crunch and tightening lending standards means borrowers must have some sort of downpayment and documented income to take out a loan. Fully documented income for a $800k loan would require a $200k/yr AGI. Even if the family income increased by 3%/year for inflation, it would only be $83/yr in 2008 and would finance a loan of about $350k. Many say there’s lots of Chinese money that isn’t taxed or recorded that can be used. Well, that would pose its own problem since the dirty money from China/Taiwan/Hong Kong isn’t documented, it leaves the only other option of putting down a larger cash downpayment.

So that brings me to the third point – foreigners must be willing to purchase these properties. Are these Asians willing to put down large downpayment and/or make large mortgage payments on what is now widely known to be a depreciating asset for years to come? I can’t answer for them, but if I had wads of cash on hand I certainly won’t be putting it into the housing market any time soon. These people aren’t dumb. Asians are typically frugal, hardworking people and they can be quite the bargain hunters. Many bought because of the good Arcadia schools so their kids can have better opportunities than they did, but assuming that these people will buy property regardless of falling home prices and market trends is absolutely ridiculous.

Yes, the good schools and proximity to Asian businesses and friends is a plus, but the Chinese buyers that bought during the boom were also investors and fellow kool-aid drinkers. They too were promised never ending price appreciation and saw exactly that for the past few years. Now that things don’t look so good anymore, do you think they will simply ignore the pent up volume, price declines, housing crash news and continue to purchase property? I think not.

This has ended up to be a fairly lengthy post. Let’s recap. The ‘foreigner-rescue-scenario’ could be a reason why housing prices in Arcadia will not fall significantly regardless of widespread foreclosure, increasing volume and falling prices across the southland if and only if there are enough rich foreigners willing AND able to purchase the majority of many distressed properties that will come on the market over the next few years.

Personally, I don’t see that happening. Do you?

During the rise and peak of the boom, many homes were remodeled or completely torn down and rebuilt. Lending standards were loose and many people were able to take advantage of the cheap money available. Free-flowing credit allowed home equity withdrawals, refinancing and the means to build one McMansion after another. Widespread McMansion development was especially prominent in San Gabriel Valley cities like Temple City, Monrovia, San Gabriel and Arcadia.

As the credit crunch gets crunchier and flow of cash slows to just a trickle, the market is unable to sustain the rampant development of new homes. Even if investors were willing to take the risk, they can only do so much without the ability to borrow money. Leverage was extremely useful during the boom and it is equally as potent during the downturn. That being said, I still see many new homes in construction right now. What’s going on here?

Once an investor buys property, their money is tied up. From the original close of escrow to the next close of escrow, they are responsible for all the mortgage payments, property taxes, insurance, HOA fees and any other applicable expenses. That was easy to stomach during the boom because prices were going up, but the carrying costs can easily burn a hole in their pocket when prices are falling.

Depending on the city and floorplan, it can take anywhere from 3 months to a year or more to successfully apply for a permit to build a new home. If property lines need to be redrawn or re-zoned, it can really start to complicate things and extend the timeline. Only when the permit is granted can construction begin. City inspections can hinder the progress of the project even if everything is made to code simply because of scheduling. There are also other potential setbacks such as weather delays and construction mishaps.

The investor is shelling out thousands and thousands a month to keep things moving. Once construction begins, there’s no turning back. Many of the properties in construction right now were probably purchased during the spring and summer of 2007 before significantly downturns of the RE market were widely reported by the mass media. I suspect these permits didn’t get approved until Q3/Q4 and that’s why we’re still seeing McMansions being built.

If the old structure is still standing they can try to sell it, but once it’s been bulldozed to nothing but an empty lot, the investors have no choice but to continue on with rebuild in hopes of selling a new construction home for profit. It may not be the profit they were expecting, but at least enough to come out ahead or break even.

Empty Equity Burning McMansions

Lately, I’ve seen plenty of homes in construction, but also many completed homes just sitting on the market. Almost all of these are million dollar McMansions. By default, real estate is not liquid and the higher the price point, the harder it is to sell because the buyer pool is just that much smaller. I’m starting to see quite a few empty, equity burning McMansions sitting on the market and I wouldn’t be surprised to see many more of them in the coming months as more homes are finished with few buyers to absorb them.

When the supply goes up, the prices must come down. When new construction home prices come down, resale home prices will be under a crushing weight. It’s a vicious cycle.