Upside Down

Lately, a phenomenon that has been very common in California, Florida and the Sunbelt states has been trickling into Sullivan County. Some owners who are looking to sell their houses are finding they are "upside down", essentially owing more on the house than they can currently sell it for. It's most common among sellers who either bought or refinanced in the last couple of years, and is by no means universal.

Being upside down in a house is the downside of leverage. Few questioned the magical power of leverage when the market was rising. If you bought a $200,000 house with 5% down, you put $10,000 into the deal. If you sold the house, say, two years later for $260,000, you realized a gain of $60,000 on your $10,000 investment. Not bad. (Yes, I understand there are purchase and sales expenses that adjust the basis, as well as carrying costs, but I'm just focusing on gross numbers to make a point.)

But when a market is declining, leverage can be a hard and unforgiving taskmaster. If someone bought that same $200,000 house with 5% down ($10,000) and the price has now dropped to $160,000, the seller could end up writing a check to the bank for $30,000, plus have their sales expenses. Lots of folks are under the misconception that in a situation like this their lender will agree to a "short sale" — accepting less than the remaining balance on the loan to clear the mortgage lien. But it's not that cut and dried at all, particularly for sellers with other assets.

The situation is not unlike the leverage you get in a margin account at a brokerage. And when you're short, you get a margin call and are expected to make up the difference.

Over the last month, I've had the experience more than once while trying to negotiate a deal on behalf of the buyer of hearing from the listing agent, "Look, the seller can't come down any more. He or she has this into the house, and they have to pay off the bank." Essentially, they're upside down. While I can appreciate the situation a seller is in, it isn't that relevant to the buyer. Buyers today are only interested in paying "market value" at best — the price at which a house will appraise and qualify for financing. Asking a buyer to pay above the current appraised value is essentially asking them to subsidize the seller's margin call.

This is a situation that, unbfortunately, I think will be more and more common over the next year. We're in the very early stages of upside-down acceptance. There is quite a bit of magical thinking floating around among some sellers that spring will usher in a sharp rebound that will turn them downside up. While I'm not bullish about the short term prospects for this market, I'm not as bearish as many visitors to this blog. Whether or not we've hit a bottom (and my point here is not to argue that one way or another), I think the best we can hope for in the short term is a flatlining on the price front. It is wildly optimistic to think we'll see the 10% or 20% rise in prices that can right some of these tilting upside-down ships.

Comments

[B.]

...I wish some of the sellers would read your blog Dave!

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http://www.bloomberg.com/apps/news?pid=20601087&sid=a8SoNNq.FFoM&refer=home

Record 19 Million U.S. Homes Stood Vacant in 2008 (Update2)
By Kathleen M. Howley

Feb. 3 (Bloomberg) -- A record 19 million U.S. houses stood empty at the end of 2008, including properties for sale and for rent, as banks seized homes faster than they could sell them and prices continued to fall.

Vacant homes in the fourth quarter increased by 6.7 percent from the same period a year ago, the U.S. Census Bureau said in a report today. The share of empty homes that are for sale, the so-called vacancy rate, rose to 2.9 percent in the quarter, the most in data that goes back to 1956.

The worst U.S. housing slump since the Great Depression is deepening as foreclosures drain value from neighboring homes and make it more likely owners will walk away from properties worth less than their mortgages. About a third of owners whose home values drop 20 percent or more below their loan principal will “hand the keys back to the bank,” said Norm Miller, director of real estate programs for the School of Business Administration at the University of San Diego.

“When you’re underwater and prices continue to fall, you tend to walk,” Miller said in an interview. “It’s a downward spiral that’s tough to stop because it feeds on itself. Foreclosures encourage other foreclosures and falling prices discourage buying.”
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[St. Louis Commercial Buildings]

wow 19 million houses? wow

[rod]

I guess once you walk away from your house, ruin your credit and your near-term future, all is rosy and happy.

Most people who are walking away from their homes are the people that never should have been allowed to buy in the first place - high-risk borrowers with no or little money down, and bad or non-existent credit history. So the gov't got their higher homeownership rates, as they wanted, and now the rates will return to where they historically have been.

"Character has repaid many more loans than collateral ever will."

[mal]

Being upside down is certainly a bummer, but it's only a crisis if the mortgage is unaffordable and/or the owner is compelled to sell. Last year's review of 2nd-home ownership in Sullivan county suggests that most buy for the long haul (median 16 years before selling), and are financially solvent. Declining value will reduce their flexibility to tap equity, but unless their income is seriously jeopardized (which of course could certainly happen these days) we shouldn't expect an explosion of foreclosures in the 2nd home market. Looking ahead, those who have been buying in recent months are getting significant protection from very conservative appraising in the absence of reliable comparable sales.

[henry]

Mal,

I agree.... but I would add that it is the margin that is important. It doesn't take many in the "jeopardized income" camp (especially true if you count people that are now over-levered given asset declines and that can't take small changes in income) to cause a large increase in foreclosures GIVEN the small base. ie. A small percent of vacation homes is on the market at any time. If a small percent of vacation homeowners have to sell, then it could create a large increase ("explosion") in the number of homes on the market... and worse, an even larger percent of the homes selling given forced nature of sale.

Further, a small number of foreclosures can have a large effect given negative feedback loops. Foreclosures -> lower comps (forced sales) -> more difficult to refinance -> more foreclosures. Also, foreclosures -> lower comps -> more homeowners underwater -> more foreclosure.

That said, I don't think that we have seen many foreclosures in the second home market in SC. Still, it is a significant downside accelerator if that changes and therefore a risk.

[henry]

Putting in some numbers may make it easier to see... Assuming 100K people in SC (given 74K in 2000 census according to Wikipedia). If 0.5% defaults in a year, then get 500 foreclosures. ~50% increase in inventory. Further, 500 defaults in a year implies ~42 forced sales per month. Massive relative to the 33 homes that sold in december.

[Nightly News]

An interesting local real estate article that appeared today.

http://www.sc-democrat.com/news/002February/03/fosterdale.htm

Developer plans to 'rehabilitate' property

[DN]

You're on the mark, David. A buyer wants to pay the market price for a house, and that's not necessarily the price that makes the seller happy. A friend of mine who bought a coop apartment in Brooklyn was called by his real estate attorney who in turn had been called by the sellers' real estate attorney. The husband and wife selling the apartment were getting a divorce. The wife called her real estate attorney to ask if the buyer would consider raising his offer even though a fully executed contract was in force because she wouldn't be left with enough money to buy a decent apartment on her own. My friend told his attorney to tell the seller's attorney absolutely not. My friend said he was sorry about the lady's situation but he wasn't his problem. They had a signed contract for a set amount. A deal is a deal.

[ar]

regarding the Democrat article linked in the post above, can you imagine the reaction if somebody suggested building a drug-abuse treatment center in a prime rural setting in Columbia or Dutchess Counties? Hey, why not a prison on the 88 acres for sale in Bethel that used to be part of the Max Yeager farm? There's a REASON why houses are cheaper here than in the Hudson Valley.......

[morning news]

And, how about this?

An article in today's Times Herald Record...

At:

http://www.recordonline.com/apps/pbcs.dll/article?AID=/20090204/NEWS/902040324/-1/NEWS

-----------------------------------------

Sand and gravel mine gets OK in Cochecton

By Victor Whitman
Times Herald-Record
February 04, 2009

COCHECTON — A Long Island company plans a sand and gravel mine in the heart of the Upper Delaware Scenic Byway and next to a proposed $1 million state-and-county-funded visitors center...[article continues - click link above]

[JJ]

Article on upstate real estate market (small blurb on Sullivan County)

[JJ]

Dave..URL Field doesn't work....here is link.

http://www.thedailystar.com/local/local_story_035073413.html

[Jackson]

Optimism can keep you smiling but it will not keep you in business.

Good Luck to them if that is how they feel!

[coyote pellet]

Looks like the Prozac is working for Frank Lumia!! LOL

[Fred]

America, A Tale of Two Cities

1. Millions lose jobs, Wall Street celebrates.
2. Millions are taxed, benefits go to Wall Street.
3. Banks rape customers, Fed gives banks bailout money.
4. (repeat, lather, and rinse)

[naida]

Obama needs to stay off TV until he has something that will pass... he keeps changing, like his campiagn pronise of 2.5 Million jobs created to 3 Million jobs created to 3 million jobs saved and created to now 4 million jobs saved and created.... he is surrounded by incompetent finacial people with Geithner at the haed of the table. I'm sick of hearing Obama continually say he does not know much about economics and finance. he makes himslef look inept. he is making more mistakes than you can shake a stick at.... So much for his change.... he needs to get VERY BOLD and piss wall street and the idiot congress off...

[David Knudsen]

JJ, thanks for the link to that upstate article focusing on Delaware County. Like most news articles, it focuses more on sound bits and doesn't dig into the data. First, any NYSAR sales data regarding Delaware County needs to be taken with a grain of salt. Delaware County doesn't have a universally adopted Multiple Listing System (which is the source, via reporting from the Board of Realtors, of the NYSAR data.) The Otsego-Delaware MLS has been gaining inroads, with more brokers participating --- so if the source is the MLS, there could be more brokers contributing to the 2008 data than the 2007 data.

Also, I think there is possibly a unique phenomenon happening in Oneonta (as well as the other NY cities with state universities, like Binghamton.) Houses are pretty cheap in many of the upstate university towns. Enrollment at state universities is expected to surge as a result of the recession, with more cash-strapped parents choosing public versus private colleges for their children. Over the past decade, quite a few parents are buying houses for their kids to use while they're in college. Some version of that could likely be happening in Oneonta. Or investors, expecting rising enrollments, could be trolling for bargains to turn into off campus housing. Just a thought.