How Far Will Prices Drop?

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IrvineRenter_IHB

IrvineRenter_IHB

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There seems to be a general consensus among regular posters here that prices will continue to drop. At this point, the debate centers around "how much."





Since this is a credit bubble, the real question is how tight will credit become. IMO, credit will tighten until 20% down, 28% DTI and 30-year conventional amortization rule the day because lenders know these standards work. I/Os and Option ARMs will prove to have high default rates, and these financing options will either become too expensive to use or they will be eliminated.





Therefore, there are a few simple tests existing homeowners can use to estimate the decline in prices:







<strong>4 times income test.</strong> Estimate the peak value of your house. Calculate 4 times your yearly income. Subtract 4 times yearly income from the peak house value, divide that by peak house value and multply by 100. This will be the percentage of the drop we can expect from peak to trough. For example. Let's say you make the median salary of $85K. Let's say you own a property which peaked at the median of $680K. The math would be as follows: 85 * 4 = 340. 680-340 = 340. 340 / 680 * 100 = 50%. Apply your own numbers from your income and your property to calculate the drop percentage and see what you get.

<strong>Financing test. </strong>This one will require an amortization table. Take 28% of your income and divide by 12 to get your monthly payment. Assume a 6.5% interest rate on a 30 year fixed, and see how much your payment will finance. This will be 80% of the purchase price, so you will need to multiply this number by 1.25 (or divide by 0.8) to arrive at the purchase price. Then you need to repeat the calculation in the 4 times income test to derive the percentage. Lets look at the same variables above (85K salary and 680K property). The monthly payment at 28% DTI on 85K is: 85K * 0.28 / 12 = $1983.33. At 6.5% interest, this will finance $313,750. Multiply that number by 1.25, and you get $392,187 (I will round to 393). The peak minus the resale would be 680-393 = 287. The percentage drop would be 287 / 680 * 100 = 42.2%.

>

The math is what it is. Perform these calculations on your own situation and see what you get. Anyone willing to post the <em>percentages </em>here, it would be interesting to see the numbers. The absolute dollar amount doesn't matter, the percentage is what we are looking for.





You see, people think I am being extreme when I think prices will drop 40%. Somehow thinking prices will drop only 20% is more reasonable or perhaps it is just a "fair and balanced" position between those who don't think prices will drop at all and those who think it will drop a lot. Math isn't "fair and balanced." Math is math. The numbers are what they are.





The real debate should be about the extent to which credit will tighten as this will largely determine the math which, in the end, will determine the depth of the drop.
 
<p>I am getting around 2001 prices with your tests. That's not inflation adjusted. If inflation adjusted, I am getting pre-2000 prices for where I live.</p>

<p>As far as credit tightening, one never knows what the financiers are going to pull out of their butt to save the system. Whether it is the financial companies or Bernanke dropping dollars from his helicopter.</p>

<p>I could see our economy & housing market remaining resilient. I could see the whole thing unravel and make the Great Depression a reality for baby boomers, generation x and y.</p>
 
Trooper,





The last bottom here occurred at 4 times income. Most other areas of the country hover at between 2.5 and 3 times income. Try 3 times income and see what you get.
 
<p>Ok I had to try this out on my house and with a low estimation of my income. I think my income will be higher than what I used but since it isn't consistent I think by going low is financially prudent.</p>

<p>4 times income would be -52%. That would be early to mid-2002 prices and just a little lower than what I paid for my home in late 2002. Nice call IR, I must admit I was somewhat skeptical that this would work.</p>

<p>The financing test paints a much less gloomy picture at -28%. This would be mid to late 2003 prices. Considering there are two homes for sale that are bigger, in a better location and have a few more upgrades priced close to this range at -20% and they are sitting if they were to drop the price by the -28% they would sell. If they ever do sell and judging by the amount of signs for these homes this weekend it may be a while but I imagine it will be the -28% that would make it happen. </p>

<p> </p>
 
And you may want to consider that in order for any market to revert to the mean, it neccessarily by definition of the mean, must decline past the mean for awhile.<p>

Here is an example of a 9.5% drop in price without that price drop showing in cumulative figures:<p>

William Lyon Homes is advertising a 5 year fixed rate @ 3.875% and a broker coop of 4% if you purchase one of their Floralisa homes in San Juan. The funds they are loaning to their buyers costs them more than 3.875% and probably in the range of 5% or more. They are subsidizing a home purchase by (5*1.125%) + 4% or a total of 9.625% which will not show up as a decrease in home prices.
 
One note on the financing test: interest rates will probably rise due to all the defaults, and since nobody needed to save for a 20% downpayment over the last several years, nobody has one. This will likely cause the reversion to the mean drop as people may only come up with 10% down, and they will finance less when interest rates are higher.
 
IR said,


"The real debate should be about the extent to which credit will tighten as this will largely determine the math which, in the end, will determine the depth of the drop."


Amen brother! Can I get a bond market bear-yah! Bear-yah!





My house situation is almost exactly like the example though the only comp to my house that "sold" was a foreclosure for 740K.





Look out below!!!
 
Hi folks,



I used a different approach, and got some interesting results. I used HPI’s price index, and grew it by two rates; first is the average rate of appreciation before the run up began in earnest (I used 2Q2002), and second is the lowest average annual appreciation rate at any one point in the past 30 years (2Q1997). These are not y-o-y, they are cumulative growth annualized. What it resulted in is the following:



45% drop using 2Q97 rate of 6.83%, and 32% drop using 2Q02 rate of 7.57%.



I tend to put more weight on the '02 number since the '97 rate is the historical low, but we should also take into account the houses have been getting bigger on the average over the years, so for a comparable house, the expected drop should be slightly greater. I think a 35-40% drop is reasonable based on historical reversion to mean. That’s surprising to me, as you guys might know I had been advocating a more modest 25-30% drop.



Anyway, a tidbit of info using a different method.
 
<p>Personally, I think the time to put in lowball bids is now. The reason is because it is beyond any doubt a buyers market AND you have very little demand. No matter how low your bid is, you will be one of the few bids out there. Depending on how you play it, someone may bite.</p>

<p>Once prices have dropped appreciably, and one decides to put their bid in, the market may turn unexpectedly yet again. Maybe not in terms of price. But one may be surprised at how many bids are now coming in for homes, so once again, you have to compete against other buyers.</p>

<p>I don't think very many people here have really taken this view. Prices and data points may not be "the low" compared to everyone's own analysis. But shop for the house you want now, and whatever price you have always intended to pay down the road (whether it is 30% or 50% off peak), bid for them now. Might as well, it is a buyer's market. That is the way to take advantage of it. Not just to sit and watch it. You may get realtors that scoff at you, but it's no different then the outlandish 2007 WTF listing prices some of them have up.</p>

<p>Buy when you can, not when you have to.</p>
 
oc-conservative,





I like your idea. You might even be able to offend a few sellers and realtors along the way. Seriously though, if you can obtain bottom-of-the-crash prices today, why not? I think it will take a lot of fishing, but there isn't much to lose -- except maybe the time you spend doing it.
 
<p>oc-conservative,</p>

<p>You got the right idea. I have seen some crazy low ball bids got accepted. I look at the current buyer market as a golden opportunity to buy a great home at a discounted price. I start to see some movements so time may be running out; at least for the moment.</p>
 
<p><i>"so once again, you have to compete against other buyers."</i></p>

<p>What other buyers? Why do you assume there will be more buyers as prices fall? If you study markets, all markets, you will notice that there are less buyers as prices fall and more buyers as prices rise. Although that sounds crazy and counter to intuition, think about it. When did you see the most buying and mania and bidding wars and nuttiness? Yea, when prices were at their highest.</p>

<p>It will be affordability and credit availability that sway price direction. Credit has just started to contract. Time is not running out and never has been. That is another prevarication told by agents to make a commission. There will always be homes for sale. And the only present movement in the re market is in a downward direction.</p>

<p>The current market is not a golden opportunity to buy. It is a depreciating debt trap. I think that even the dead cat bounce is behind us, and it was barely recognizable.</p>

<p><i>"if you can obtain bottom-of-the-crash prices today, why not?"</i> Yea, <strong>if</strong>! What evidence is there that you can obtain a bottom of the crash price? If a seller accepts an offer of less than 10% of their asking price, what does that tell you? It was five years from the last top to bottom. Is there any reason to think that this cycle will take any less?</p>
 
<p>awgee,</p>

<p>By now, you should know I stand to profit nothing by what I post here.</p>

<p>I have seen the market changes very quickly, literally overnight. And I also had seen the market changed over a long course. It's all psychology. As people think the market is depreciating, they will not buy. The key word is THINK.</p>

<p>THINK again, who are the buyers. The answer is everybody. Would someone in Shanghai THINK the same as local folks do? NOPE, not necessarily. YES, if someone in Shanghai has been reading this blog. </p>
 
<p>Over the years, I've picked up axioms in the financial market that are just absolutely invaluable. Not to adhere to without question, but to always keep in mind so that one is better able to view things in a variant perception different from others yet objective and sound.</p>

<p>Buy when you can, not when you have to, is a mantra I learned the hard way and remember everyday. Another is that sometimes the hardest thing to do is the right thing, and the easiest thing to do is the wrong thing.</p>

<p>In other words, I'm thinking it would be easy to sit back and watch the bubble deflating/crashing, just as it was easy to give in to the pressure and buy that home 2 years ago when the hype was pervasive and financing was too easy. However, that may not be the best move. I look at acquaintances and almost all of them are afraid to even put in a bid. They want to wait when things settle. But you don't have to do that. I'm thinking, putting in the necessary leg work (just like you say IrvineRenter) and tough bids may just get one the house one wants at the price one does indeed want to pay. Today.</p>
 
<p>oc-conservative - Good Luck</p>

<p>But, please do not misrepresent me. Price and value are not first and foremost to me. If you look at my previous posts and even the last, I tell we are happy leasing. My family's happiness is first and foremost and it interesting to find that their happiness is not affected one bit by whether we have a mortgage or pay rent.</p>
 
<p>awgee - first let me say that I've no intention to insult you or anything like that. I love your discussion. But you are steadfastly bearish, so I have to come across a little strong as well.</p>

<p>In my opinion, your being a little too cute. The reason is you want it both ways. You say:</p>

<p><em>"What other buyers? Why do you assume there will be more buyers as prices fall? If you study markets, all markets, you will notice that there are less buyers as prices fall and more buyers as prices rise. Although that sounds crazy and counter to intuition, think about it. When did you see the most buying and mania and bidding wars and nuttiness? Yea, when prices were at their highest."</em></p>

<p>I'm not exactly assuming it as I am acknowledging the possibility of more buyers. Also, you are basically saying mass bidders at the peak, no bidders at the bottom. Well, there are virtually no bidders today (save those overmarketed auctions). So wouldn't that by your logic indicate this is some sort of bottom?</p>

<p>As for your other comments, you seem to be missing the idea altogether. IrvineRenter got it. You seem to be missing it completely. I am not saying this is a golden opportunity, nor am I saying that time is running out.</p>

<p><em>"What evidence is there that you can obtain a bottom of the crash price?"</em></p>

<p>I'm not even sure what you are trying to say here. I mean it's called a bid. And it can either be accepted or rejected. I thought we all knew that.</p>

<p> </p>
 
<p><em>"I start to see some movements so time may be running out; at least for the moment."</em></p>

<p>Time just got a little bit <a href="http://blogs.ocregister.com/lansner/archives/2007/07/summer_sellers_bu.html">longer</a>.</p>

<p><em>"More and more homeowners continue to ignore their neighbors' for sale signs, the constant stream of newspaper articles regarding the slow real estate market, and the lack of sold signs, opting to join the crowd and place their homes on the market too. ...


Understandably, with the weather so beautiful and the kids out of school, most consumers mistake the Summer market as THE best time to sell. Historically, that's not true; the Spring market is the best time to sell." </em></p>

<p>And we all know how well the spring selling season went. </p>
 
<p><i>"By now, you should know I stand to profit nothing by what I post here"</i></p>

<p>Actually, it appears to me that you are here to fish for clients. I don't have anything against that, but it seems disingenuous to say you have nothing to profit by by what you post here.</p>

<p>Yes, anything can change, but do you have any evidence that the re market has changed from anything but from bad to worse?</p>
 
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