California Real Estate Prices Back To Earth

The percentage of households that could afford to buy an entry-level home in California stood at 59 percent in the fourth quarter of 2008, compared with 33 percent for the same period a year ago, according to a report released Wednesday [February 18, 2009] by the California Association of Realtors.

The minimum household income needed to purchase an entry-level home at $248,030 in California in the fourth quarter of 2008 was $48,900, based on an adjustable interest rate of 6.02 percent and assuming a 10 percent down payment. The monthly payment including taxes and insurance was $1,630 for the fourth quarter of 2008.

At $48,900, the minimum qualifying income was 42 percent lower than a year earlier when households needed $83,700 to qualify for a loan on an entry-level home. Recent decreases in home prices and mortgage rates have brought affordability into better alignment with income levels of the typical California households, where the median household income is $59,160.

At 76 percent, the high desert region was the most affordable area in the state. The San Luis Obispo County region was the least affordable in the state at 44 percent, followed by the Los Angeles County region at 46 percent.

From here (emphasis added).

Nationally, about two-thirds of Americans are homeowners.

Not all of the fallout from the financial crisis has been bad news. California real estate prices had put home ownership out of reach for tens of millions of people in California and other markets experience housing bubble prices.

When entry level housing costs more than affluent home buyers can afford on terms that are themselves less than conventional, housing prices are higher than the market can bear and a disruptive collapse is inevitable sooner or later. Excessively high housing prices have been an important factor driving migration out of California and impairing its economic growth.

The powerful draw of the American Dream, which includes the notion that middle class families ought to be able to own their own homes, also helps explain the reckless financial arrangements that people entered into in order to cope with the bubble. People were willing to enter into adjustable rate loans that they knew they couldn't pay if the interest rates adjusted up from record low levels, skimp on down payments, and accept very long amortizations or even "interest only" loans, because without the lowest possible monthly payments they simply couldn't buy any home. Borrowers and lenders alike justified these risks, and stopped worrying about traditional underwriting tools like income documentation, because most of these loans were fundamentally "hard money" loans. In other words, the house that served as collateral seemed likely to increase in value so quickly, that foreclosure sales could easily cover the amount of the loan and the bank's foreclosure costs, as long as loan payments were kept current for even a year or two.

After the dramatic collapse in housing prices, would be California home buyers can buy the same home, with a similar or lower payment, with far more reasonable terms and down payment arrangements, from more traditional lenders like commercial banks, thrifts and credit unions, rather than mortgage companies financed with securitized loan sales.

Affordable housing is something that California hasn't had for a long time, and will once again make the state attractive for people wanting to start businesses and find work.

It would, of course, have been better if California hadn't seen a housing bubble in the first place. The collapse of a similar real estate bubble in Japan thrust that country into what was arguably the worst recession in the industrialized world since the Great Depression. Americans can't expect to be held harmless or nearly so from this real estate bubble collapse of comparable proportions.

The collapse of any real estate price bubble, particularly one with a drop of more than 20%, the cushion customarily provided to first mortgage lenders through some combination of a down payment, private mortgage insurance and a second mortgage at a higher rate, means that mortgage lenders lose some of the principal they lent, in addition to failing to earn the anticipated interest payments.

These losses, of course, hurt the financial institutions that are most leveraged, and made the least conservative loans, the worst. We've already seen the subprime and Alt-A lending industries virtually eliminated, banks with weak lending standards like Washington Mutual wiped out, and highly leveraged independent investment banks, which financed the nation's mortgage company based lending, cease to exist.

In the banking industry, the survivors seem to be commercial banks, thrifts and credit unions, particularly those with a local orientation disentangled from national financial markets more than major money center banks, that were conservative in their mortgage underwriting practices during the housing bubble.

Real estate construction is based upon assumptions about real estate prices in the year or two it takes from the time it takes to buy land, get zoning approvals and build new structures, until the time properties are sold, typically with third party financing. When real estate prices are unreasonably high, construction companies build too many buildings. So, the construction industry will probably remain anemic until all of the excess building inventory errected based upon unreasonably high prices is absorbed by economic and population growth. The temporary near demise of this industry, of course, will produce lots of job losses in the construction trades and related industries, and will in turn, weaking spending demand in the economy. It will also put pressure on wages in all industries that people who used to work in the construction trades are able to do, fields that have mostly seen declines in inflation adjusted wages since the 1970s already.

I expect that construction wages will plummet (ironically just as the proportion of the construction workforce that is composed as undocumented immigrations declines greatly as immigrant workers return to their countries of origin, discouraged by poor job prospects), as demand for construction work falls, and that in the face of a dearth of new construction work, that firms offering rennovation work at very competitive prices will spring up. Bids for government construction jobs, which may be the only game left in the industry in many cases, should also become more competitive, easing strained government capital budgets.

Who gets hurt, besides bankers, builders and merchants hurt by a generalized decline in economic demand? The people who bought property at real estate bubble prices and are now upside down on their real estate investments, and the parallel group of people who felt comfortable running up consumer debt based upon high real estate and financial investment values.

In California, which is one of the few places in the country where mortgages on owner-occupied homes are generally non-recourse (i.e. the owners can't be sued for the bank's losses net of the collateral after a foreclosure), homeowners who were swept up into the trend of taking out loans bigger than they could afford, may end up with battered credit records, but will typically lose only their down payments, which were often five percent or less of the purchase price. Some of these homeowners may even secure mortgage modifications in or out of bankrutpcy, and get to keep their homes with reduced loan amounts, lower interest, or more slowly amortized mortgage debts. Others may be able to buy different homes at the current more affordable prices.

For them, who on avearge and as a class were less thrifty than they probably should have been with debt financed consumer spending, a weakened credit rating may not even be a bad thing. Poor credit may discourage or prevent them from making purchases that they can't actually afford.

Real estate owners who made larger down payments who bought at bubble prices have been hurt more. Their large real estate investments will be gone, and neither the lenders nor the government will cushion their pain. They will be making the same big monthly mortgage payments that new buyers with almost no down payments make on their properties. And, falling real estate prices almost likely will lead to falling rental prices, so financial projections for investment properties may fall apart.

Investment real estate owners also aren't going to receive the mortgage modification benefits that were made available to owner occupied home owners, and typically don't have non-resource mortgage loans, so their other assets may have to be sold when their properties go upside down. Many will probably be forced into bankrutcy.

This whole class of once wealthy and influential investors will now be virtually wiped out, and will have to start over from scratch, something not easy for a group of investors who tend to be older and hence not as malliable when it comes to learning to start over in new endeavors, despite the fact that these investors tend to be smart, well educated individuals.

Real estate investors also make up a disproportionately large share of upper middle class black and Hispanic investors, so the black and Hispanic upper middle class may be particularly hard hit. Another area in which affluent black and middle class families have disproportionate investments is car dealerships, and General Motors has plans to cut a third of its dealerships, while other major car companies are also making some cuts to their dealership ranks. Members of the black and Hispanic middle classes were already asset poor compared to white family with comparable incomes. The crash leaves all people with substantial investments much less wealthy, but will probably widen rather than narrow this divide.

On the other hand, the financial crisis may bring to an end, for now, at least, the gross excessives of executive compensation in the financial sector, and for the first time in a very long time, will put a dent in the seemingly endless trend of the rich getting a larger and larger share of the nation's economic wealth. The link between productivity and wealth, which was very tight until a few decades ago, is beginning to be restored, over decades in which productivity growth was not shared with those who created it.

As previously noted, those who don't own businesses and vacation homes have seen their net worths fall by about 12%, while those who do have seen losses several times as large.