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.