Tuesday, August 25, 2009

When your home is worth less then you paid...

What do you do when your home is worth less then the price you paid?

California real estate is a cyclical market with values going up and down. The Beach Cities are no exception. While upscale markets tend to hold on longer and pick up faster after a cycle has gone through its course they are still part of the general real estate cycle and subject to the vagaries of the marketplace. The cycles generally run a 7-10 year course with flat price point periods along the way. During the down cycle a property may be worth less then the purchase price. The flip side is that the property usually is worth more when the market moves upward.

Historically these cycles had longer neutral periods between the up and down cycles. In recent years it seems the cycles are running closer together with a shorter cooling time between the up/down swings. This last cycle of course was not limited to California real estate but was a world wide phenomena which was largely caused by cheap credit and a lack of regulation for both financial institutions and borrowers.

When you review real estate prices in Manhattan Beach, Hermosa Beach, Redondo Beach and El Segundo over the last few years there is no question values have declined. If you bought a home in 2005-2007 your property in most cases is worth less then you paid. In some sub markets of the Beach Cities values have dropped to 2004 levels. The big question is what do you do if the value of your home is less then the purchase price...do you stay, try a short sell or walk... The answer to that is it depends on your circumstances.

While many homeowners who are in trouble will try to obtain a loan modification. Most folks in our area will find that is not an option as loans that were made prior to last year, when loan limits increased to $729,750, are not covered. Also the decline in value of properties in most cases is far more then that allowed by the FEDS to qualify for their programs. For some homeowners who owe more then the home is worth a short sale may seem like the answer, others will have no choice but foreclosure. There are folks who will simply walk away believing this is a smart choice. The majority of homeowners however will just wait the market out. The path you take will depend on your economic circumstances and your views on homeownership.

Short sales:

Short sales are not as simple as many believe. Most homeowners think of short sales as an easy way to sell a home that is no longer worth what they paid. They don't understand that a bank will only consider a short sale if the owner can prove that they can no longer make the payment on the loan. That usually means you have lost your job, gotten divorced, had a major medical issue, filed bankruptcy or all of the above. You will need to send the bank a package that includes certifiable proof of your financial problems. Your word that you can't pay is not enough.

Even if you can document your financial issues the bank may reject your plea if they feel they can get more money if they foreclose. You should also know that a short sale will affect your credit rating almost as much as a foreclosure. In addition if you refinanced the property the lender may make you sign a note to pay the bank the difference between what the home sells for and the amount of the loan... and still ding your credit.


Foreclosure is a tough step for most homeowners. Historically homeowners would do almost anything to avoid having their home taken back by the bank. With the record numbers of foreclosures through out the country the stigma that was once associated with the process is not as much of an issue today. However, contrary to what you may find on the internet, a foreclosure will damage your credit for a long time. It may impact your ability to get insurance, buy a car, obtain a credit card or even a job. A foreclosure generally stays on your credit record for 7 years.

While the government is touting loan modification programs, a number of lenders are not working with borrowers. Loan modifications are few and far between in CA. Some of the reasons are that lenders don't have the personnel or the knowledge to deal with the issue. In other cases the bank feels that the owner simply doesn't have the wherewithal to make the payments even if the loan is modified. In some instances the bank would make more if they foreclosed on the property.

One of the biggest issues with foreclosure is that while homeowners may not be able to make their payments many still have equity in the property. This often happens to people who have owned their homes for a long time and suddenly find themselves with unanticipated financial problems. They may try to sell but often they set a price that is too high. They get caught up in what they want for the home rather then what it is worth. These are the folks who say I'm not giving away my house ...I won't take a nickle less then $XXXX... sadly after too long on the market and no deal most wind up with nothing when they could have walked with some cash. In the 90's I worked with a secondary lender who tried to get owners to sell before they actually went into foreclosure. I was constantly amazed at sellers who wouldn't budge from an unrealistic price and wound up losing everything.

Walking away:

This has become a popular option for a number of people... even those who can make the payments but choose to walk because the property has lost value. They usually had very little if any money invested in the property. Most people who take this option view homeownership as an investment rather then as shelter or a lifestyle choice. The internet has popularized this choice as a smart one and many folks believe it. They believe that walking away will have few if any financial issues for them. For some this may even be true.

However as noted above in the foreclosure section there may well be more consequences then folks think. Many lenders are talking about making it very difficult for owners who walk away who do not have financial problems. Banks don't like folks who don't honor their financial obligations.

Last year I spoke with a couple about buying a property. They were adamant about the deal they expected to get. They made sure I knew they had walked away in the 90's from a property that was upside down in value to prove how savvy they were. They walked not because they couldn't make the payment but because it was worth less then they had paid. The funny thing is that the property they walked from is worth three times what they paid for it even in today's market. Had they not chosen to walk they would be sitting on a large chunk of equity instead of starting all over years later.

Sticking it out:

No matter what you read this is the choice of most homeowners. Generally owners will stay in their homes and make their monthly payment no matter how much the value goes up or down. A few years ago the in thing was to make fun of people who had lived here for a long time and had a lot of equity in their homes. But the fact is the owners had that equity because they rode out the cycles of the market. They paid the mortgage every month whether the value was up or down. They didn't walk away when their home lost value because it was a bad investment. Their ultimate goal was to pay the mortgage off and own their home.

In the last 10 years or so the idea of owning a home over the long term and paying off the mortgage disappeared. It was replaced by the concept of moving every few years to a bigger and better property. Leverage became the in word for homeowners rather then equity. Now of course a lot of folks who moved into bigger and better too quickly have found themselves underwater as the value of their homes plummeted.

I'm not really surprised to see a number of consumer blogs advising owners to walk away from their property if the value has decreased. It has become the smart thing to view a house as a stock market commodity rather then as shelter and a lifestyle choice. If you are in financial difficulty then you may not have many options other then those listed above. However if you aren't in a financial bind then I can't help but wonder why a smart owner would walk away because the value has changed. While it is true the market is currently down it is also true that it will go back up. It may take time but the winners in real estate are those who are in it for the long not the short term.

Many years ago it was a popular pastime for young ladies to learn stitchery and show off their skills in a sampler. One of the most popular sayings was ... home is where the heart is...It may sound corny but a lot of people still believe this to be true.


wayne said...

Good advice, though it's hard to counter the broader message many people might be getting from the national media: sales are up and the bottom is in. Seasonality, locality, and the difference in numbers between the low end and mid to high is easy to ignore if you don't want to face it.

Your observation in your last post about Hermosa dragging behind the curve and prices being skewed by a few very high end sales seems spot on from what I've observed. So many homes east of PCH--and really clustered up south of Pier but north of Valley--that sit around forever at 950 to 1.2/2005ish prices and never seem to sell or chop.

It seems to me these homeowners are now squeezed by higher end places in Manhattan that have dropped more in price due to tougher financing and narrowed the gap between high and middle...and lower end places next door in Redondo where the market is picking up and money goes further? Does the fact that Hermosa is smaller than the other cities have something to do with why the arc is slower--comps are fewer and farther between? I know bubbles usually collapse from low end to high, but why locally do things seem stuck most in the middle?

Kaye said...


North Redondo was the first of the Beach Cities to see prices move downward. The market responded fairly quickly because there were more short sales and foreclosures then in the other Beach Cities.

Many MB and HB homeowners have a stronger financial base so they are not "desperate" sellers. MB and HB have not had a large number of either foreclosures or short sales which put pressure on the market so they have remained fairly sticky. However that is changing for mid range homes in MB.

Prices in the Tree section in MB started moving downward after a number of new construction homes were sold as short sales. With new comps in place the rest of the market had to follow.

Hermosa has only had a few larger homes that were either short sales or foreclosure properties. They also have had fewer sales so the comps are not there to push the market downward.

However they are facing pressure from both MB and South RB so I think you will begin to see prices becoming more flexible. A recent example in the Hermosa Valley. A great house hit the market, was priced on target and sold in days.

I fully expect to see prices moving in HB fairly soon as a couple of homes that have been on the market for a long time are now trying for short sales.

wayne said...

Interesting, can you say which house you thought was the quick seller at the right price?

Kaye said...

The house was at 551 24th... 2616 sq ft on a 6000 sq ft lot.. in good condition.. list price was $1,375,000. Not much comes on the market there... this was priced to sell and it did!

wayne said...

Redfin shows they are still looking for backup, and I have to ask--why should a house that sold for 928,500 in mid-2002 sell for more than 50% higher than that in today's market? Do you think it sold low in 2002?

Kaye said...

The home was listed for $895,000 and sold for $929,00 so may have had multiple offers at a time when they were not that common.. but there are rarely any homes for sale in the area.

Considering prices increased roughly 150% in the area this is not a huge increase over 7 years. The house has undergone some upgrades although nothing major but I believe the pond was put in by the current owners.

This area still has a high demand factor and folks will pay a premium for homes in the area as the lots are larger then in other nearby area of HB. Also an easy walk to the school and downtown. The price comps out with other properties east of Valley.

Last year a property sold on Power around the corner (large lot21,00 sq ft now being split for 2 homes) it sold at $2.875 lot value in 2008. In May 2009 a new home closed escrow at $2.3 so the area supports the value.