Oct212013

Housing bubble fully reflated in Irvine, California

We haven’t inflated a new bubble yet on this cycle, but we have reached a point where we’ve fully reflated the old one in several markets. Today, I want to take a detailed look at the Irvine, California, housing market. Irvine is a good proxy for other desirable Coastal California markets. What’s happening in Irvine is happening elsewhere.

In a healthy housing market, the cost of ownership in Irvine exceeds the cost of renting by 15%. Much of Irvine is a move-up market, so people take their equity from a previous sale and bid prices up higher than rental parity. Just one year ago, Irvine was undervalued by nearly 25%. The cost of ownership was lower than the cost of renting, and Irvine houses were a relative bargain. My monthly housing markets reports were rating Irvine a 9 or a 10, which is a screaming buy signal.

However, over the last year, house prices have risen more than 20%, and Irvine is no longer a bargain. In fact, September sales figures show Irvine is slightly overvalued relative to historic norms. On a dollars-per-square foot basis, Irvine has rebounded from the low $300s to over $400 per-square-foot since early 2012. The rapidity of the reflation of the old housing bubble is truly remarkable.

Like the rest of Orange County, Irvine has run up against the affordability ceiling, and prices have slowed their dramatic rise in recent months. As I noted last week, there is mounting evidence of housing market’s extreme sensitivity to mortgage interest rates, so I expect Irvine house prices to cool off considerably unless interest rates drop significantly again.

The rate of resale appreciation is clearly not sustainable. The last three times house prices exceeded 7% appreciation rates, it was followed by falling prices. The longer prices sustained excessive appreciation, the longer and steeper the decline. If it is different this time, it would only be because house prices were undervalued before the rise.

Housing bulls like to claim the rise in house prices is supported by fundamentals, and rents are moving higher in Irvine. However, 3% increases in rent does not support a 22% increase in house prices. This basic math eludes bulls looking for a reason to believe what they want to believe.

The rapid price increases has caused my rating system to be less sanguine about the market. Some communities are still rated highly, but several others have fallen to more neutral ratings of a stable market. Only Turtle Ridge is considered overvalued, and since it did not exist in the 1990s, there is no good way to evaluate how inflated house prices should be there.

The community that stands testament to the success of lenders in reflating the housing bubble is Orangetree. The Orangetree community in Irvine is adjacent to the Irvine Valley Community College, and it’s composed almost entirely of low-end condos. These were the units lenders completely stopped foreclosing on, and the inventory dried up. From my earliest housing market reports, this community was rated a 10, and anyone who bought a condo as an investment there has nearly doubled their money in less than 2 years. That’s good timing.

Housing market analysts talk about buyer sticker shock, and when house prices rise more than 20%, interest rates rise significantly, and toxic financing options are not available, sticker shock is inevitable. Since the momentum is unlikely to continue now that we’ve reached the limit of affordability, buyers are simply not motivated — and that’s a good thing. The undervalued frenzy is over, and kool aid intoxication is not likely to push prices much higher. Right now, no lender is willing to fuel that frenzy, and with cash buyers pulling back, demand pressure will lessen. Restricted inventory will keep prices up, but the rapid push of 2013 to reflate the housing bubble has run its course.

Today’s featured property is an example of how silly Irvine house prices have gotten. The owners of this property have listed it off an on over the last two years. Each time they put it on the market at a WTF listing price, and it does not sell. Since they are currently asking about 15% over their peak-of-the-bubble purchase price, I rather doubt they will sell it this time around either.

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[idx-listing mlsnumber=”OC13213528″ showpricehistory=”true”]

41 MIDNIGHT SKY Irvine, CA 92620

$1,100,000 …….. Asking Price
$976,000 ………. Purchase Price
9/2/2006 ………. Purchase Date

$124,000 ………. Gross Gain (Loss)
($88,000) ………… Commissions and Costs at 8%
============================================
$36,000 ………. Net Gain (Loss)
============================================
12.7% ………. Gross Percent Change
3.7% ………. Net Percent Change
1.7% ………… Annual Appreciation

Cost of Home Ownership
——————————————————————————
$1,100,000 …….. Asking Price
$220,000 ………… 20% Down Conventional
4.74% …………. Mortgage Interest Rate
30 ……………… Number of Years
$880,000 …….. Mortgage
$241,072 ………. Income Requirement

$4,585 ………… Monthly Mortgage Payment
$953 ………… Property Tax at 1.04%
$350 ………… Mello Roos & Special Taxes
$229 ………… Homeowners Insurance at 0.25%
$0 ………… Private Mortgage Insurance
$110 ………… Homeowners Association Fees
============================================
$6,228 ………. Monthly Cash Outlays

($1,479) ………. Tax Savings
($1,109) ………. Principal Amortization
$396 ………….. Opportunity Cost of Down Payment
$158 ………….. Maintenance and Replacement Reserves
============================================
$4,193 ………. Monthly Cost of Ownership

Cash Acquisition Demands
——————————————————————————
$12,500 ………… Furnishing and Move-In Costs at 1% + $1,500
$12,500 ………… Closing Costs at 1% + $1,500
$8,800 ………… Interest Points at 1%
$220,000 ………… Down Payment
============================================
$253,800 ………. Total Cash Costs
$64,200 ………. Emergency Cash Reserves
============================================
$318,000 ………. Total Savings Needed
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