Predicting the Housing Future: Los Angeles and Orange Counties. Using the Case-Shiller Index to Find a Bottom.

Predicting future prices is a dangerous game. Trying to predict peak prices during a mania is like predicting the future behavior of an insane person. By definition their nature is not predictable and thus trying to determine what they’ll do tomorrow may be a fruitless exercise. Yet now that we are slowly moving to historical rubrics to give credit out, we are quickly realizing how insane this bubble got. The straitjacket has been put back on the market and it turns out that someone left the door open on the credit asylum for too long. Time to gather the lunatics back in. This week the weather has been perfect in Southern California. Across many areas we are in the 90s and all the beautiful people are out on the streets. Many are out walking simply because they cannot afford to fill up their gas tank but hey, that is the silver lining. In the end, many folks need to get out there and walk so they can lose some weight. And if you notice that people are not looking as beautiful as they once did in Southern California you can blame it on the credit crunch. Elective cosmetic surgery is down so expect to see more natural looking folks running around minus the fixed nose and other synthetic implants. In a way, we are metaphorically returning to a natural state of things. The time for artificial products will need to be put on the shelf for sometime. California was the epitome of this housing bubble. We had the largest excess and now we are seeing the biggest bust. I would call it spending like a drunken sailor but I really haven’t met too many drunken sailors in my lifetime. How about we try coining a new term with a California twist. Whenever you see someone spending like a maniac blowing cash beyond their means, we can label it “Spending like Laura Richardson” or SLLR. So if you have a friend with a leased Lexus and Hummer and a mortgage that will make Ed McMahon look frugal , you can tell them, “hey Bob. You are spending too much. Why don’t you stop spending like Laura Richardson?” This of course would be a massive insult with a California twist that only a foreclosure specialist can produce. You can watch as they begin to cry with your below the belt insult. After all, if people are willing to elect such a financially irresponsible person, we might as well get something for our tax dollars. A phrase is all we can afford at the moment. Before you feel bad for six-figure politicians, this article is going to attempt to look at the future of Southern California housing. The reason that we can start making educated guesses now is that the party has come to a screeching halt. We now have a static peak that we can work off from and apply some financial logic to what will happen over the next few years. I wrote an article aptly titled Nostradamus in the House. Looking at 4 Potential Scenarios for Southern California Housing on August 4 th , 2007. Of course this was a few days before the massive credit crisis that was supposedly over many months ago. In the article I also have a swipe at WaMu which at the time was trading at $37 a share (today it closed at $6.38). Essentially, we are now at the worst case scenario from that chart. So we will now revise it for the next year. 1 - Looking at the Case-Shiller Index Past Los Angeles Bubble The Case-Shiller Index uses the MSA (metropolitan statistical area) to track housing prices. The Los Angeles component of the index combines Los Angeles and Orange County. Given that these two counties have more than 13 million people, it is a good representation of the housing insanity that is going on in Southern California. Some people may not know that Southern California had a previous bubble in the late 80s to early 90s. At this time our national economy was in a recession and the economy was once again a main focus for politicians. On this constructed chart, I used the previous peak (June 1990) and bottom (March 1996) and superimposed the new peak (September 2006) to give a better idea of how much more further we have to go to reach a bottom: *Click to enlarge for a clearer image The data in the most recent iteration of the Case-Shiller index goes until March of 2008. The startling thing you will notice is it took over 6 years from peak to trough in the last downturn with an overall decline of 27 percent. Now, we are only 1 year and 6 months from our peak and the market is already down 24 percent! And we have yet to see $500 billion in pay option ARMs to recast with 60 percent here in the state. California it would appear was Spending Like Laura Richardson (SLLR). As the market is being slapped around like a mortgage piñata, people are scrambling to gather the little bit of real money that was locked inside. The reality has become that people equate credit with money. To a certain extent it is. But now many that have had their credit lines shut down and lost all their equity are realizing that credit is not as good as cold hard cash. There is a reason people say cash is king. Now back to the chart it would be hard to conjure up any reason why we are nearing a bottom. The California economy is in such shambles, that we are getting cockamamie ideas that only serve as a good laugh. For example, some proposals include letting out inmates early onto the streets where there is very little employment. Guess what will ensue if that happens? Also, the Governor is throwing around a lottery idea which is the absolute stupidest thing one can propose. Yes, we are broke therefore let us exploit the most primal part of our humanity and take money away from those that do not understand basic statistics. Good job amigo! The fiscal year starts in July and it looks like we are going to have a bunch of arse grapping and posturing before we get any budget through. Ironically the budget is following the trajectory of our old governor Gray Davis. Can prices go down for 6 years like the previous burst? Absolutely. The economy is in much worse shape and the types of mortgages floating out there would make Enron seem like a walk in the park. 2 - Income is Stagnant and Credit is Closing Shop I can tell you as someone who has gotten mortgages at the peak, things are radically different now. All my investment properties are financed the old school way with 30-year fixed mortgage even though many brokers and lenders tried to convince me otherwise. Many of those folks are no longer working. Trying to get a loan in 2008 is a world away from a getting a loan in 2003, 2004, or even 2005. The market has dried up. Getting a loan in today’s market requires good credit, solid DTI ratios, and basically if you want a good rate it will have to be a primary residence. So now, income apparently matters. And as it turns out, we have a crew of people that were living in an economy were income didn’t matter. Welcome to a quick reality check. Here are some basic statistics for the Los Angeles and Orange County markets: Los Angeles County: Median Household income (2004 census): $43,518 Orange County: Median Household income (2004 census): $58,605 Now I know many of you are going to cherry pick tiny enclaves in Newport Beach and Beverly Hills but you need to remember that the Case-Shiller data looks at the entire metro area. As much as you would like to siphon off 80 percent of the population and only examine 20 percent of the prime areas, this is not how the data is compiled. The above figures show us how out of whack prices have gotten here in Southern California. Let us look at the current median price in both areas: May 2008 Data Los Angeles County Median Home Price: $422,000 Orange County Median Home Price: $485,000 Compare that to the previous peaks of $550,000 for Los Angeles and $645,000 for Orange County. Given the current income we have the following ratios: Home to Yearly Income ratio Los Angeles: 9.69 Orange: 8.27 Let us compare this to data from 2000 to highlight how much of a correction we will need to come back in line with historical ratios: Los Angeles County Household income 1999: $46,452 Orange County Household income 1999: $57,706 June 2000 Los Angeles County Median Price: $203,000 Orange County Median Price: $273,000 Home to Yearly Income ratio: Los Angeles: 4.3 Orange: 4.7 So given the ratios starting in 2000, we would need a few things to happen. Either incomes double in the next few years or prices go down by half. Given the state of our economy and stagnant wages, you can rest assured that we are going to reach more reasonable rates by prices continuing to fall. 3 - Inventory on the Market Given the vast amount of inventory floating out in the market, we can say with authority that simply looking at demand and supply prices will continue to fall. Let us look at inventory: Current Data June 2008: Los Angeles County: 52,956 Orange County: 16,250 Sales for May 2008: Los Angeles County: 5,445 Orange County: 2,266 Months of inventory: Los Angeles County: 9.7 months Orange County: 7.1 months Now you also have to remember this is based on MLS inventory. We all know that lenders are being owned by REO inventory and with record amounts of NODs, this number is artificially low. So we can add 2 or 3 months of inventory for each county. Bottom line is until we get closer to 5 or 6 months of inventory you can rule out any stabilization talk. My estimate is we are going to see shadow inventory “surprise” people in the next few months. So when will things bottom? To be blunt, not in a very long time. Just look at the above data. Do you really see prices jumping up anytime soon? I will safely say that when all this is said and done, Los Angeles and Orange counties will be off by 40 to 50 percent from their peak. And this is being conservative knowing what we know now. If someone has some reasonable argument to the contrary I’m completely open to hearing it but all I’ve heard is a bunch of hot air and fluff that sidesteps the hard facts. Enjoy the great California weather and if your significant other is pressuring you to buy a home tell her you are not going to be Spending Like Laura Richardson. They’ll understand. Did You Enjoy The Post? Subscribe to Dr. Housing Bubble’s Blog to get updated housing commentary, analysis, and information Share This Related Posts: ■ How Many People Overpaid for Their Home in Los Angeles County? Trying to get a Raw Number of Households Underwater. ■ Housing Contradiction: Home Prices Down = Sales Up. Any Questions? ■ There will be Housing: How we’ve Returned to Selective Market Ignorance. ■ The Abyss is Deep: The Housing Abyss is Deep: 4 Major Reasons Why Housing in Southern California is Nowhere Near a Bottom. ■ The Quest for Accurate Housing Prices: Three Counties and Multiple Prices.