Renewal in the New Year: 2009 & the Mortgage Crisis

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Looking forward to 2009, I daresay that I am an optimist. Yes, indeed, in 2009 we are staring down the gullet of the darkest economic times this nation has seen since the Great Depression.

But then, what comes of such things?

The answer is: it depends.

For one, real estate prices still need to fall further, and with some luck, they will.

"Ouch! No way!", some might retort, failing to understand the realities of real property.

Fundamental of Real Estate Value #1: the present value of a property is never worth more than its market rate rental would support. This means that, assuming that the property were rented, the rental revenues must pay for all expenditures associated with the property, assuming 100% financing of the property. This includes: mortgage, including both principle and interest; maintenance; management; taxes; insurance; utilities; all the rest.

This applies even if the intent is to buy a home to personally live in it. It's ultimate use doesn't matter, the rental rate that it could collect still dictates it's real present economic value.

ANY amount paid for a property in excess of that calculation is a gamble on future appreciation.

This is the most basic, most fundamental, most important reality of real estate for any buyer to know. Unfortunately, few did, and our current mortgage crisis has been caused by fraud committed by the real estate and financing industries upon buyers/borrowers. Industry insiders grievously misled buyers/borrowers into believing that inflationary "comp values" (prices of recent sales in the area of properties of comparable character) represented property values and justified the purchase price.

This was, flatly, fraud. And it was a fraud that led buyers/borrowers to gamble away future appreciation of real present values for the next generation or two or three, or more in some areas.

A quick and easy rule of thumb for determining real present property values: for every $100 rental revenue the property can generate, it is worth very roughly $10,000.

So, indeed, property values remain inflated in many areas, particularly in California. A quick survey of properties for sale, excluding bank owned (REO) properties, in the San Francisco Bay area, particularly the Peninsula, are still generally priced at twice or more of their current real present value. Perhaps, as the economic conditions in the nation worsen progressively through the coming year, this inflation may finally evaporate. Certainly, reform is required, and the past practices of misrepresenting property values should be prosecuted industry-wide. Moreover, laws must be enacted specifically forcing everyone involved in real estate and financing, from real estate agents to financiers to government assessors, to identify those real present values and disclose them to buyers.

More importantly, it is the buyers/borrowers themselves, the victims of this fraud, whom the U.S. Treasury should be disbursing bailout funds to, and not to the perpetrators that helped defraud them.

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fluxlife said...

hey there Prof H., thanks for your post!

maybe current home owners can have their homes revalued and lower their mortgage!

it may be a bit of a sacrifice, takin a hit on the value of the home. but, i'd do it if i wasn't planning on moving out.

Janaki said...

Right on the money Prof H.! Market dictates value.

Lydia said...

Thanks, Prof H. I'm now trying to figure out this fluxlife group.... this marvelous fluxlife group I might add!

I am so glad that we refinanced a few years ago, especially after reading your #1 Fundamental.

This may sound sick, but I think there is a certain exciting opportunity that comes with this time of great challenge. Americans need to grow up and out of the greed that has prevailed since the Reagan years. This may force a real shift in priorities; I hope so.

Michelle's Blogs said...

California's property values appreciated way too fast (just as some parts of FL, AZ and Las Vegas did). Right now the market is just correcting itself in those "hot" areas.

A lot of areas in the US have not seen huge appreciation in home prices and so prices are pretty stable for many different regions.

I think the mortgage crises has a lot to do with the greed of Wall St and subprime mortgage lenders. For example, lenders relaxed their lending criteria--they required little to no money down, some did not verify income, and they allowed higher debt-to-income ratios than normal. Now the pendulum has swung the other way and lenders are back to 5-10% down for owner-occupied (3% down for FHA loans) or 20-25% down for investors (non-owner occupied) and verified income. Many lenders won't even do stated income (sorry to all of us self-employed folks).

Anyway, all these subprime mortgages got bundled and were sold on Wall St. Wall St packaged them into complex financial instruments/derivatives (CDOs). These folks that lenders extended credit to started defaulting on their subprime mortgages (many had substandard credit/may not have been creditworthy to buy a home in the first place). Wall St. didn't know how to unbundle these complex instruments and created serious losses in the market.

Coupled with falling home prices in investor-saturated areas (CA, FL, AZ, NV) and you have a formula for a bad scenario.

Anyway, we've learned a valuable lesson: housing prices do fall, all bubbles do burst and don't extend credit too much (whether it's credit to subprime borrowers or overleveraged portfolio managers).

Sorry for the longwinded comment. I'm pretty opinionated in real etate, inestments and the economy.

Peace out yo,

fluxlife said...

we here at fluxlife love all comments: long, short or otherwise. write to your heart's content!

thanks for your informative and interesting comment, Michelle!

and thank you Janaki and Lydia for your comments as well! :D

Prof.H said...

Thank you all for your great comments. Undoubtedly there will be plenty more to talk about on the issues of the economy and the credit crunch in the coming weeks and months.

I agree, indeed, that the mortgage crisis arose amongst a variety of factors. It is, I believe, critical that we relearn how we have come to talk about real estate: price does not equal value. If we don't make a point of making that distinction, then we will have failed to learn what may be the most valuable lesson that we can learn from this crisis.

Much of the subprime lending was made necessary by the grossly inflated buying prices. In many markets, buyers would have easily qualified for standard mortgages if the market prices had been reasonably nearer values. Sadly, those buyers believed those inflated prices to be actual values, and they weren't.

Stay tuned for more...