Saturday, July 23, 2011

Has Low End Housing Bottomed?

I've been looking 1 and 2 bedroom condos in Southern California, specifically north and south orange county for the last 3 months. In the Inland Empire prices have dropped incredibly low while Orange and Los Angeles Counties are stubbornly holding on to their price levels but still dropping nonetheless. Florida, Arizona and Nevada are dirt cheap as well with Vegas being the epicenter of the subprime fiasco. Today I'll be using data from Orange County, CA.

Rates today on a 30 year conventional are close to 4.5%. In 1997 the index rate was close to 7.5%, basically 300 basis points higher making the cost of money higher than it is today. 1997 is important because it was the year after that when interest rates began their 13 year decline.

1997 rates

Announcement Date Index Month Index Value
28-Jan-98 Dec-97 7.26
24-Dec-97 Nov-97 7.34
26-Nov-97 Oct-97 7.37
28-Oct-97 Sep-97 7.46
25-Sep-97 Aug-97 7.47
26-Aug-97 Jul-97 7.52
28-Jul-97 Jun-97 7.67
26-Jun-97 May-97 7.75
28-May-97 Apr-97 7.73
25-Apr-97 Mar-97 7.61
26-Mar-97 Feb-97 7.53
26-Feb-97 Jan-97 7.55

Subject home: 8636 East Sugarloaf Peak Road #M, Orange CA 92869

This 1 bedroom 1 bath 740 sq ft condo is currently selling for $160,000.00. which a buyer could probably get for 150k after a bit of negotiation. With a 10% down payment of 15k the note will be 135k at 4.5 percent rates. Monthly payment equals $684.03 with $150 property taxes and $50 insurance. Total monthly cost is $864 per month. This same condo will rent for $1200 per month therefore based on market rents this condo is a screaming buy as the owner will also get a interest mortgage tax deduction at the end of the year close to 6k, or $500 per month.

Now lets look at the price history of this little bugger:

04/26/2004 Sold view details $298,000 Public records Public records
06/30/2000 Sold view details $136,000 Public records Public records
09/15/1997 Sold view details $86,000 Public records Public records

From 86k in 1997 to a bubbly 300k in 2004 all the way back to 150k, possibly lower. A nice 50% drop in the middle of Orange County. However the 1997 price is still incredibly lower than it is today. A 76k loan in 1997 (10k down deposit) with 7.5 percent rates would cost $531.40, or $150 less than current prices. Property taxes would be $89 per month with a bit cheaper insurance. Again, a side by side comparison:

150,000 note with 4.5% rates = $684
property taxes $150 per month
total $834

76,000 note with 7.5% rates = $531
property taxes $90 per month
total $621

So prices are close to their 1997 levels in real terms with the above example showing that a 2011 condo with current rates is 34% more expensive than in 1997. Factor in 3% annual inflation (stated by the gov) and on a inflation adjusted basis the price is the same. A big factor to consider is all the millions of people that are getting foreclosed on their mid level homes that will be downshifting to these 1 or 2 bedroom places. Prices on 2 bedroom condos have fallen a similar amount as well.

So is there a bottom in low end housing? I would say that we are close with a possible 15% reduction in price with rates staying in the low fours. The strong evidence for a bottom in this area of housing is low apartment vacancy rates that are pushing rents higher. This same condo rents for at least $1200 per month. Just look at craigslist and see market comparisons.

With so many graduates coming out with student loan debt, their ability to purchase more expensive homes will be diminished. Thus, those that do decide to buy will be looking in the lower end market. In fact, many will not be able to afford at all and will be renters keeping the low end rental market flush will supply for years to come. Finally we have millions of boomers that will be selling their homes in the attempt to downsize and take what little equity they have left for retirement. All these headwinds point to a bottom in low end housing, plus or minus 10%. There is a possibility that rates go even lower if we follow the Japanese with their 1.7% 10 year rates. However, Japan has enjoyed a high trade surplus and an even higher savings rate with most of Japanese government debt held by Japanese while the US has $600 billion trade deficits and a lower savings rate with much of the debt held by foreigners.

On balance prices have fallen to below market rents with generational lows in interest rates. If your finances allow for it now may be a good time to get in the low end housing market.

Thoughts on this are welcome.


  1. Fox News began getting popular around 1997. Just saying :)

  2. Interest rates will inevitably go back up and consequently push home prices way down. Wait for this to happen. Your monthly payments will probably be the same if you don't wait. However, the value of your home is going to take a dive once rates go up.

  3. It's inevitable that rates will eventually go back up as they are at historical lows and the government's finances are a joke. However, there is also the possibility that the US goes through a Japan type scenario where their rates have continued to plummet with the Japanese 10 yr yielding 1.7 percent versus 3% on the US 10 yr.

    There are still deflationary forces out there that could once again bring velocity back down to a crawl. It's amazing how there is such a thin line between deflation and hyperinflation and the fed is playing with exactly that line. Will we muddle though like Japan did for years to come or will we experience a interest rate blow out ala Greece, Portugal, Ireland, Spain and Italy and hundreds of other governments that have gone bk in the past?

    At this point I'm willing to bet that rates continue to fall for some time as there is still tons of debt out there and sentiments to maintain the status quo are still strong. There is always the black swan that can fly by and fuck everything up too in the interim.

  4. I am constantly amazed at how not one person on Wall Street has been prosecuted for recklessly betting investors' money in CDOs and CDSs on the housing speculation disaster of 2001-2007. Didn't Obama promise "change" by imposing regulations on Wall Street? What happened to all that campaign talk about reinstating Glass-Steagall (which prevented bankers from leveraging against depositors' money) and regulaitng the derivatives market? But no, the Obama Kool-Aid drinkers ignore that he surrounded himself by the people who destroyed our economy (e.g., Larry Summers, Greenspan, Bernanke, Geithner, etc.).

    Do yourself a favor. Don't buy a house yet. Although housing values are declining, they haven't bottomed out yet. I would wait until the dollar implodes, which at our government's current rate, should happen very soon.

  5. I suspect we will not muddle through like Japan. With the Eurozone tanking, it's a bad time to play politics with the debt ceiling. We've now got a choice between a catastrophic outcome (i.e., not raising the debt ceiling) and an awful outcome (i.e., not raising it) - and I don't think that latter case is actually a better result, just that it kicks the catastrophe down the road some - with the . . . ahem . . . theoretical possibility that it buys time for individuals to repair their family accounts. Will they actually be able to? Probably not. But the possibility exists.

    The last time there was this much difference between how the financials performed in the markets and how individuals were doing economically, it ended in the Great Depression. Make no mistake (and, really, I know you're not, but it's a nice flourish, is it not?): This is far from over. I think the worst of the storm is yet to come.

    What did happen to all the campaign talk about re-enacting a version of Glass-Steagall? That's a fantastic point. It will happen. But it should already have happened, shouldn't it have. The thing is that you need countries who are the proverbial outstretched hands from the (not sinking) life raft if you're going to stagnate. What we've got here are countries - see the Eurozone and the U.S. - with no floaties on their arms, flailing around in the water, just about to clutch each other tight and sink to the bottom together.

    This is the second Great Depression. World War I used to be the Great War - until Hitler started doing his thing. This is Great Depression II. Just get used to the thought, if you haven't already. The structural problems are too severe to allow individuals a way out of their current financial circumstances, and when that's the case, it takes a catastrophe to restructure the economy - provide work for honest and willing workers - and without such a restructuring, we're dead in the water. Government can't help. The patience of our creditors has run out. The banks can't, therefore, be helped any more - to any significant degree, anyway. They'll suffer what we, as individuals are suffering, and, ultimately, while the man was a mongrel, George W. Bush was right. Wall Street got drunk. We're done our pathetic fantasy that we're not going to vomit it all up, but vomit the toxins we will.

  6. Anon @ 11:33am

    I agree with your analysis and you hit the big points. The US has big structural problems, huge debts and unfunded liabilities that number in the 100's of trillions. If the US does in fact go bankrupt whether by actual default or currency collapse (more likely of the two) then the shock waves will shake the entire world and we could very well see the start of a world war 3 type scenario.

    All that being said, we are still here and the sun rises every day. And the fact remains that in many markets now the cost of owning is LESS than the cost of renting. In very rare circumstances is this case and we are seeing it right now. In addition, sentiment is so utterly negative on housing with almost every person I've spoken to saying that prices will continue to plunge for years. True for the mid and upper end, but on the low end there is a limited supply.

    At the end of the day we all have to live somewhere. Whether we rent a 1 bedroom apt or rent a room out of a 3 bedroom house or squat with the family eventually people will have to live on there own. Absent a Stalingrad type event where your city gets utterly destroyed the houses will be there. They say not to miss the forest for the tree but I think its important not to miss the gem trees for the forest.

  7. Low end housing in metropolitan cities such as Los Angeles and Philadelphia are actually great buys right now. It looks very doubtful that interest rates are going to rise, but it may be forced to if oil prices continue to go up. I would wait around for one or two more years. In this market, we are not going to see housing prices go up significantly anytime soon. I think it is a much better time to invest in gold, silver, dividend stocks and commodities.

  8. I don't know what problems are, where they are. I know that any houses are too expensive now!

  9. New York City is one of the few areas of the country where the housing market not only hasn't bottomed, but is still rising. But if there's a default or collapse of the dollar, that will take down what remains of the FIRE (finance, insurance and real estate) industries. And New York depends on FIRE as much as any other city does.

    There may well be a WWIII type scenario. The fact is that WWII didn't actually get us out of the Great Depression. Why do you think the US Government initiated as many projects as it did, and passed things like the GI Bill? (I'm not saying the vets didn't deserve those benefits. But how many of them could have gone to college or bought homes without the GI Bill?) This country's--and much of the world's--economies have floated on one bubble or another since the end of WWII. We got recessions when those bubbles deflated or popped: Think of the Market Crash in 1987, the dotcom boom and bust and, of course, the more recent housing and education bubbles. And, during the Cold War, there was, in essence, a military bubble.

  10. I'm expecting in 10-20 years a massive glut of beautiful mid to upper middle class homes to hit the market. You know, the ones that most of us lust after that have been occupied by some boomer that bought the property in 1960 while working as a roofer. The question is how will such homes be priced? Many of the previous posters have mentioned that this market will face a prolonged price decline. This is probably accurate. What I do know is that the market for such homes will be very small. The under 40 generation simply will not be able to afford to maintain such homes due to the declining salaries/benefits/job security they face.

  11. If you buy make sure there is enough land for your garden. If the dollar collapses the ability to grow your own vegtables will be worth the investment in real estate. A condo, less so.

  12. Your analysis omits condo maintenance fees. Condo owners are a notoriously shortsighted bunch who prefer to keep maintenance low instead of keeping an adequate reserve and doing preventative work. The current owners get to pay for the foundation repairs.

    Another thing is the economy was markedly stronger in 1997 than now. At the end of the day, housing cost cannot exceed what people can pay.

    Finally, you omit taxes. There already is a substantial standard deduction that offsets some or all of the purported benefits of ownership.

    The only good thing about ownership is it is a forced savings plan and gives you "roots," though like education, the conventional wisdom is changing.

  13. Prestttige,

    I did not omit taxes as I incorporated taxes in the analysis. The above analysis compares cost of ownership versus rent. The above condo would cost a renter 1300 to 1400 per month while a mortgage with property taxes would be 864 per month . Don't forget about mortgage interest deduction of 7k per year, or 600 per month.

    While it is true the economy is weaker now than it was in 1997, demand for low end housing is higher now than it was then. Back then and especially during the 2000's the demand was for bigger homes not these smaller places. Studies show that there is a shortage of low cost housing as the developers went nuts and built 2500 sq ft homes instead of smaller homes and condos.

    And in the event of a dollar wipe out then the mortgage goes poof lol.

  14. Subprime,

    I actually feel house prices may actually be bullish in the long term. Below is a comment I left in one of your other articles that I feel also pertains to the assertion above.


    Great post as usual. The only thing I will disagree with you here is that housing prices will continue to fall a long way.

    In addition to the many bubbles that we're in right now, we're also in the midst of a treasury bubble. In the end, the rich will need to find something else to throw their $ at. That thing might well be real estate. I don't know what part of socal you live in, but I see many rich Asian immigrants in both LA (San Gabriel Valley) and San Jose (Cupertino area) snagging up one house after another via cash only purchases. Eventually, this will drive housing prices up once inflation goes into full throttle.

    In my block alone, I have seen a huge influx of Chinese and other investment groups snagging real estate for pennies on the dollar and renting out half a block.

    Regardless, this trend is only expected to accelerate and it'll only reinforce the paradigm of the growing wealth disparity gap.



    Be interested to hear your thoughts.

  15. Sadly, I really don’t think the low end housing market has bottomed out. There is a huge amount of regional variation, but so much of the housing stock across the nation that is aimed at the low end market is in horrible condition and will not be kept up in the future.

    To make matters even worse, many houses are falling apart as they are kept in limbo by banks and the foreclosure mess. The cost to repair houses for the lower end housing market is often greater than the market value, which makes them a bad investment, which ironically causes the houses to spiral even further down in price, as they are not worth putting any more money into them.

    I work in local government and I don’t think the average person realizes how much of the current housing stock needs to be torn down. We are already too late to save many of these houses.

    I believe that more people are going to be forced to live with each other in houses, many poor families are already used to multiple generations living in one house, but I am certain that it will become more common place.

    It is kind of sad how often bubbles don't really count until they impact middle class. It will be interesting to see how much the middle of the housing market goes down in quality and price.

  16. It just occurred to me that what I consider to be low-end is probably only the very low end portion for you. I work with the homeless and near homeless so I am skewed toward the very bottom of the housing market.

  17. Check out this overpriced bugger:

    List price 409k
    built in 1955
    1400 sq ft
    3 bd 2 bth
    City of Fullerton

    2004 sold for 385k
    1997 sold for 146k

    Listed price is 2.8 times 1997 levels. Has a way to go down before a bottom is seen as this house is clearly overvalued.

    This 400k to 600k market area will be declining for years to come.

  18. So you're saying that with all of the unemployed, up-to-their-gullible-asses-in-debt law school graduates and over 20% real unemployment that it's a good time to invest in shit housing?

    What about investing is cardboard boxes to live in?

  19. Obama says: "My pussy hurts."

  20. Anon said:

    So you're saying that with all of the unemployed, up-to-their-gullible-asses-in-debt law school graduates and over 20% real unemployment that it's a good time to invest in shit housing?

    No. What I'm saying is that lower end housing (1 to 2 bd condos) is pricing well relative to historical pricing and the cost of money (low interest rates). And its an investment in the sense that one can live in one of these for half of the price of a equivalent market rent (after taking into account mortgage tax deduction). Not everyone has big loans and although the unemployment rate is high and there are 140 million employed.

  21. Maybe you can get a family of 10 - 20 drunk, horny Mexicans, or Filippinos, or Samoans to move into wunna dese 3 bedroom dream homes right next to one owned by some recent law school graduate doing slip-and-fall, or document review work?


  23. What about investing is cardboard boxes to live in?:) That's funny! The houses were expensive and they are now are expensive. It is a pity and we are not in charge to change something. The most qualified ​dissertation editing services can be ordered at cheaply.


Real Time Analytics