Let us look at the current data and try to figure out what is going on:

The latest data shows San Francisco still holding at a very high median price.  But San Francisco County only accounts for 6% of all Bay Area home sales.  It should be obvious that price is one of those reasons keeping people from buying in the city.  Yet the reasons don’t seem so obvious when we dig deeper into the data:

The median household income for San Francisco County is $73,000.  So with a current median price of $627,500 we are looking at a household income to home price ratio of over 8.  This is enormous since even looking at historical data a ratio of 3 to 4 seems to be more standard.  Looking at this data tells us that SF County is definitely still in a housing bubble.  As other areas have corrected, this area is still being propped up and it is certainly not because of higher than expected incomes.  In fact, if we look at distress inventory for SF we find that many households are now unable to pay their mortgages:

Distress inventory trumps the actual MLS data viewable to the public.  This is very common throughout many counties in California.  But you would logically think that the most expensive county would have people that are able to pay their mortgages at a higher percentage than other areas.  That is not the case if we are to look at the above.

San Francisco is an interesting case study.  The county is made up of 359,000 households.  But when we look at the housing dynamics we can see why the median income is much lower:

Housing occupied units:                                323,000

Owner-occupied:                             127,000

Renter-occupied:                             195,000                 (60%)

60% of those living in San Francisco County rent.  The obvious reason is that many people don’t have the income to support those current prices.  There is no way a $73,000 income can buy a $625,000 home.  So let us look at the above income chart again.  In order to “afford” a $625,000 a household income will need at least an income of $200,000.  Of those living in San Francisco only 14% make that amount.  Yet 40% occupy their home (i.e., own their place).  So we have a 26% gap of those living in their home that if they were to buy today, would not be able to do so.  We see this when homes were purchased in California:

And for San Francisco, about 40% bought before 2000.  It is interesting to see these numbers because it shows us that many counties in California are still in bubbles.  Given the distress inventory, we would expect more correcting in these areas.  In fact, you’ll notice that the Bay Area is up 20% for the year in price while San Francisco County is down 2%.  This is a long way from making sense but it is heading in the right direction.

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First, let us look at the MLS data:

Source:  MLS

For Los Angeles County 3,349 homes are listed with a price of $1 million or more.  Now for a county with 24,000 homes listed on the MLS, this is a large number.  But again refer to the above data.  Million dollar home sales are lagging.  Why?  Because the pool of million dollar buyers goes away when you require a down payment and actual income verification.  Do we have wealthy families in the county?  Absolutely!  But the products that stretched the dollar to unprecedented proportions are gone.  So this is what happened to sales statewide:

So the trend is definitely heading lower.  As many of you know option ARMs and Alt-A loans are largely absent from the market (option ARMs are now banned in California).  So if these home sales jump it will have to do with actual income verification and funding through jumbo loans.  The million dollar market is interesting.  Roughly 24 percent pay cash.  That isn’t going to change.  Yet that other 76 percent that actually have to get a loan is the game changer.  And make no mistake, there is a large amount of distress in this market:

And here is where we see the massive discrepancy.  2,205 homes with estimated values of $1 million or more are in some stage of foreclosure; either bank owned, with a notice of default filed, or scheduled for auction.  Yet the MLS only lists 32 homes with a $1 million price or higher as foreclosures!  Banks don’t want to move on these places because if you think it is bad trying to move a $250,000 home in a tough market, try moving a $2 million or $5 million home.  Ask Nicholas Cage if it is easy to sell a million dollar home in Southern California in this market.

And he isn’t alone:

“(WSJ) Big borrowers are more likely to default than ordinary people, according to data from First American CoreLogic. Its loan database, reflecting more than 80% of the overall home-loan market, includes 1,700 loans with balances of $4 million or more. About 14.8% of those loans were 90 days or more overdue at the end of January, compared with 8.7% for all home loans tracked by First American. Sam Khater, a senior economist at First American, said the bigger borrowers may be more prone to stop making payments when they have lost all their home equity.

Mr. Fuscone, Merrill Lynch’s one-time head of Latin America, put his mansion up for sale in November, asking $13.9 million. But he couldn’t find a buyer.”

Then you add into the mix L.A. County getting closer to bankruptcy and it is hard to see a market developing for these million dollar homes.  Banks are going to have some major losses coming up.  They can ignore and wait around but this won’t end pretty.  Want to see an example?

This is for a 3 bedrooms and 3 baths home in Beverly Hills that Zillow estimates to be valued at $1.1 million even though it has $5.2 million in loans.  Do the math and you will quickly find out that banks are simply deluding themselves at the moment with what they have on their balance sheet.

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Source:  Census

Now we only have data running up until the end of 2008 but we already know where the trend has been heading.  As you can see from the above chart, the bulk of movement happened from 2005 to 2008 during the peak of the bubble.  It is safe to say that in many areas, 2004 was also a year with inflated prices.  So this can be extended further out.  It is also the case that some harder hit areas like the Central Valley are seeing home prices going back to 1990 levels.  You can only be underwater if you have a mortgage so let us look at more data breaking out ownership status in the state:

The owner occupied rate fell throughout 2009 with the massive number of foreclosures continuing.  Let us look at annual resales:

Between 2004 and 2008 2.4 million resales occurred in California.  It is hard to get an exact estimate here because we had many homes that sold multiple times during this timeframe.  But one thing is certain, many people locked in bubble prices for their home purchase.   Now the current Seasonal Annual Sales Rate (SAAR) is running much higher thanks to lower prices:

Yet that still leaves millions of mortgage holders under water.  One argument I have seen being made is that many bought before the bubble hit and never moved out.  The argument goes, that these people are not underwater simply because they didn’t sell and supposedly have a low mortgage balance.  But as we know, there was an enormous amount of cash out refinancing and home equity loans that actually put people into the underwater category and these don’t register as home sales:

Source:  Calculated Risk

Now this has added hundreds of thousands more into the underwater category.  In 2008, a year when prices were already correcting for California the median price was $467,000.  Since that time, the median price has fallen to $249,000.  If we look at the chart, when 2009 Census data is released this will mean over 1.7 million units (at least) were kicked from the higher priced sectors into the lower range:

Now this above shift is important in understanding why sales have increased.  It has been driven by lower and lower prices.  And the California economy was booming during the bubble and many that bought, even prior to these inflated years, used the inflated prices to cash out.  The chart above clearly demonstrates the massive amount from the home ATM.  Yet that door has now closed.

I think what we will now see is a reality check with actual incomes.  We also tend to forget that the economy wasn’t all that good during the boom times at least when it came to wages for working Californians.  The only reason they were able to push prices so high was because of the criminally lax lending practices available.  Consider this for California:

2000 monthly average unemployment rate:        4.95%

2008 monthly average unemployment rate:        7.22%

2009 monthly average unemployment rate:        11.425%

The latest measure has the unemployment rate at 12.5%.  So the economy is even in worse shape and we will see this drag home prices lower.  The toxic mortgages like option ARMs are banned from the system.  I think some hold this notion that we will somehow go back to “normal” times but mistake normal with a bubble.  Those days are over.  With the FHA and Fannie and Freddie hurting there will be more stringent requirements since banks are only making government backed loans.  They are at the mercy of the government and they should be, this is taxpayer money.  Do we want to go stated income and no money down again?  That has led to a financially disastrous place.

When we look at charts like the above, it is hard to see why prices will be moving up anytime soon.  There is an enormous amount of overpriced housing in the market.  The economy is stagnant and wages have fallen so this will end up reflecting in the price of homes.  A large part of recent purchases have come from investors.  Yet this has pushed rents lower.  Some think they will be flipping that home in a few years for a tidy profit.  If mortgage rates hit their 40 year historical average of 9%, I wouldn’t bet on it:

With the Fed coming to the end on the $1.25 trillion mortgage backed security quantitative easing program, rates have only one way to go.  And with massive deficits, it is hard to see how mortgage rates don’t go up especially with so many loans going bad (even just for the risk premium).  It is likely we will never see mortgage rates this low again in our lifetimes.  But this is not reason enough to buy an overpriced property like some would like you to believe. This is the same kind of allure used by those 0 percent credit card offers.  How well did that turn out?

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