Real Estate Bubble – The "Tidal Wave" of Foreclosures Strikes the Bay Area

Mon, Jan 14, 2008
Real Estate
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8 comments

I have to admit, I’ve been enjoying watching the housing bubble burst. There are lots of great stories, from crazy Realtors on crack to strawberry pickers earning $15,000/year who bought $720,000 homes. These make for quite the entertaining read. But what’s next?

The housing bust is progressing quite nicely, and identical to what I predicted in 2006. It’s now 2008…what does my prediction say for this year?

1991 (2008): A “dead cat bounce”? Some folks wondering if the bust has bottomed out or not. Sales are abysmal (e.g., -42%). Other parts of the country showing some signs of recovery.

2008 is when you might tell me that I was wrong about all of this and that we’re starting to recover. WRONG. 2008 will NOT be the bottom. Remember, we still have our “0” year ahead of us.

An interesting thing happened as I perused the MLS last week. (I log on about once a week to track real estate prices in a few different areas of the country.) For the first time since I started tracking real estate in 2003, I found two houses that were affordable from a historical perspective.

I combed through about 200 houses for sale in San Jose, CA, and Pacifica/Half Moon Bay, CA. San Jose is where I live now and I’m most likely to actually want to buy a house in Pacifica, so I am tracking both areas. San Jose is progressing ahead of Pacifica…the first REO’s (“real estate owned”, or properties foreclosed and taken over by lenders) showed up in San Jose in mid-2007, and did not show up in Pacifica or Half Moon Bay until November.

We’re now at about 7 months after the first REOs appeared in San Jose, and the desperation is clear. I’ve watched mortgage companies post REOs for what the property last sold for (at the peak of the market in 2004 or 2005.) Of course, none of those properties sell for that price, so they get aggressive on the price drops until the property sells.

Through my research, I have found the first two affordable single-family home properties in San Jose since I began tracking in 2003. I’m actually shocked that these exist this early in the bust cycle. This confirms that it’s a bloodbath out there.

Property #1 is 124 Birch Ln, San Jose, CA 95127. In fact, both of these properties are in 95127, which is an outlying area of San Jose (confirming my theory that the “tidal wave” of foreclosures would start from the exurbs and work its way inward.) 3BR, 1 bath, 1564 sq.ft. on a nice-sized lot of 7840 sq.ft. Last sale 7/1/2005 for $601,000. Now asking $399,000. Doing the math, we find that is a 34% discount off peak. The MLS lists 3 pictures of the inside and it seems to be in fairly good condition.

This house would rent, in decent condition, for about $1800/mo. Doing the math for 200x rent comes out to $360,000, which I’m guessing the bank would take as an offer.

Property #2 is 3356 Joanne Ave., San Jose, CA 95127. 3BR, 1 bath, 1075 square feet, on a 4,792 sq.ft. lot. A pretty fair specimen of a house for San Jose, though the MLS listing doesn’t include inside pictures, so it probably needs work. Now asking $400,000. This isn’t as good a deal as the first property — rent probably would be $1500/month, which makes the house a bad value at anything over $300,000 (rent x200).

The thing I find most interesting about this property is that it wasn’t last sold during the 2004-2005 peak. The house last sold on 5/1/2001 for $365,000. Doing the math, we find that there was less than 2% appreciation per year since 2001. Not exactly what the Realtors had in mind when they recommended you buy! 😉

These are only a small slice of what is to come. I predicted a total loss of 35% off peak prices by 2011. I’m amazed to see houses already listing for 34% off peak prices. So do I think this is the bottom? Do I recommend you buy? Not a chance!

The “tidal wave” is spreading inward, with San Mateo County and San Francisco just starting to get hammered. Bargains still require you to hunt them down and do some legwork — I only found these two properties after looking at hundreds of single-family homes for sale. The best values are in the lower end of the single-family home market — the high end still has flippers on the market trying to sell big houses for twice what they paid for them a few years ago. It will take another 12-24 months for this to shake out.

Based on the information above and my own prediction timelines, I am going to say that 2009 will probably be the first year you will want to consider buying a house. Even then, you’ll still have declines to deal with for a few years, and flat prices for a few years after that. However, by the end of 2009, if you can find a house that is selling for 45-50% off its peak price (and those deals will be out there, if not more discounted), that you actually see yourself living in for at least 5-6 years, I’d recommend a buy at that point.

This is just the beginning. We are in for a long ride. I am enjoying seeing prices finally become more reasonable, but I’m still a happy renter. I’m holding out for ocean-view property discounted from $1M peak price to $575,000 or so, where I will happily snap it up. I expect I will be renting for at least another year or two!

Ksilebo says:

1/14/2008 at 8:46 pm

It’ll be interesting to see what happens here in Colorado.

dhuberma says:

1/15/2008 at 1:47 pm

You indicate properties #1 and #2 only have 1 bath listed. Is that full bath, with an assumed 1/2 bath? Or do the houses you’re looking at really only have one bathroom, because . . . 🙂

ericabiz says:

1/16/2008 at 12:18 am

@Ksilebo: Colorado has already had some major real estate losses. It’s probably not going to be as bad there. I use ZipRealty, which has an “Estimated Value” tab where you can easily see what the property last sold for. If ZipRealty doesn’t work in your area, just check zillow.com and it can usually tell you. 50% off the last price = a pretty good deal. 😉

@dhuberma: Darn good question. They both say “Partial Baths: 0”, so I guess 1 does really mean 1 and not 1.5 when it comes to these two houses.

cheri says:

1/16/2008 at 9:04 am

Love your blog! We too want to live in Pacifica too. My partner and I have been looking since the summer and have seen the prices slowly decline…when do you see the prices truly drop considerably, if ever, in Pacifica? Anyone…?…

eric77 says:

1/17/2008 at 3:03 am

I agree with Erica’s prediction that prices will continue to drop in ’08, and maybe early ’09 even just from looking at Credit-Suisse Boston’s graph of the #’s of mortgage resets.

One side question, what make you all want to live in Pacifica?

ericabiz says:

1/17/2008 at 12:31 pm

@cheri – Pacifica has had a few good ocean-view REOs at about 15% off peak prices, so the decline has started there. While San Jose will have some good values toward the end of this year, I don’t realistically see very many good deals in Pacifica until mid-to-late 2009. I’m watching closely and will update as things change. Keep yourself subscribed to my blog — have it send you an email update whenever I post. I expect to post about once a month on the state of the real estate industry.

@eric77 – I rented in Pacifica for a year. Beautiful place. It made me smile to see the ocean every time I commuted anywhere. No air conditioning needed since it is a nice coastal temperature all year long, and the air just smells really clean and wonderful. Hard to describe unless you’ve hung out on the coast. Rentals are few and far between with ocean views, so I’m cool with San Jose for now.

Kanwar says:

1/27/2008 at 8:09 am

Another way to value real estate is to look at the P/E ratio -> Price to Earnings ratio of a property. i.e what does a house cost per month to own (mortgage payment=price) vs. what does it cost to rent(rent=earning potential). The historical P/E ration of residential real estate in the US over the last 100 years has been 1.33. For example, if the house on Birch Ln above rents for $1800, it would be a good buy if the primary mortgage payment on it was no more than $2400/mo (1800×1.33). Based on current interest rates, a $2400 payment would service a loan of approximately $320k, resulting in the property being valued at $400k (primary mortgage=80% of the total price), which is what it is listed for. This is a bit higher than your estimate of $360k because of the historically low interest rates at present. This methodology takes into account fluctuating interest rates. Affordability is based on your ability to sustain a payment, rather than the price of a house. For example, if the interest rates were to go to 10% next year (historically we have had them at over 15%), then the property value would go down because as a consumer, I can only qualify for $2400/month and in a case of higher interest rates, a greater percentage of my payment will go towards the interest.