San Diego Housing Market News and Analysis
Guest Commentary: Ramsey on San Diego REO Auctions
Submitted by Rich Toscano on February 11, 2008 - 7:18pm
My old pal Ramsey Su is back with an analysis of the recent REO auctions held here in San Diego by REDC. He's drawn some very interesting conclusions based on the info he's been able to piece together from the auctions. If you'd like to read more after you're done with this one, the search function will meet all your Ramsey-related needs.
REDC has conducted four REO auctions in San Diego during the last 8 months, the most recent being January 26 of this year.
I have extensive data on 3 of the 4 auctions. Here are some of the findings:
Peak/Trough Analysis – currently down 37%
Properties that went to auction likely represented the group that was purchased or refinanced at the peak and sold at the low of what the current market offers. The peak is at a fixed point in the past, the trough is dynamic and continues to change with market conditions.
73% - average auction/PVA* for the May 2007 auction
* PVA (previously valued at) is the number that the auctioneer publishes. Comparing that to the last sales price if a sale was involved or the total encumbrance if a refinance was more recent than the last sale, I only found fractional difference. It is consistent enough to use as a peak price.
Time Line Analysis – Current foreclosures have little to do with reset. BORROWERS SIMPLY WALKED.
These REOs are foreclosures of loans from 2004, 2005 and early 2006 vintages. Loans or purchases made in 2003 or earlier appear to be home free, unless they refinanced in 2004 or later. Using the January auction:
23% were 2004 loans
The average elapsed time between auction date and trustee’s sales date (the day the loans officially become an REO) is 8 months.
If we do a calculation in reverse chronological order:
Jan 08 auction = May 07 trustee’s sales
If borrowers stopped paying May 06 due to a reset, the fastest being the 2-28s, then it implies the loans should be of May 04 vintage. Since the majority of these loans were originated during 2005, or later, it suggested that borrowers are walking long before any reset.
In other words, for a loan originated during 2006 to be foreclosed in 2007, it would have to be an early payment default, defined here as defaulting less than 6 months from origination. These borrowers did not default due to reset--THEY JUST WALKED.
Loss Severity – Currently Estimated at Over 60% in the Aggregate
Loss severity is different for the senior and junior lien holder. Using the January auction:
76% had junior liens
Not only are the junior lien holders wiped out in its entirety, they may have to charge-off interest payments that were accrued but never received.
As for the senior lien holder, in addition to the depreciation of the asset, there is a hard cost related to holding and liquidating this non-performing asset. I am estimating that to be between 20%-25% of the loan amount.
In dollar terms, the average PVA was $425,000 for the properties auctioned in January. Using the 60% loss severity estimate, this is $255,000 loss per property. Granted that San Diego is not only the high end but also one of the most volatile MSAs, this is still quite a shocking number.
Estimating REO Prevalence Including REDC Auctions – over 60%?
San Diego MLS data showed that 44% of January pending sales were REOs. REOs sold at auction are not reported in the MLS. At the current pace of one auction every two months, there should be 6 of these REDC auctions in 2008. Say 100 REOs are sold at each auction, 600 REOs need to be added to the REOs sold via the MLS.
Financing – Agency and FHA Loan Limits Are Non-Issues
In spite of SD being one of the highest priced MSA in the nation, problem properties are clearly well below agency limits of $417k. Using the January auction:
$425,308 – average PVA using auctioneer’s number
While raising agency and FHA loan limits may address liquidity problems for the higher end properties, it has no effect whatsoever on the current pool of REOs. The financing problem is finding qualified borrowers, not availability.
Credit Bubble REOs – Already Setting Records
It is without a doubt that REOs in San Diego to date are credit bubble REOs. I define credit bubble REOs as properties with loans where the borrowers have no ability or no intention of repaying, unless the underlying property value appreciates. The household financial condition has not changed. Defaults are triggered by depreciation in value/equity.
Normal Downcycle REOs – Coming Around the Corner
Normal REOs are results of changes in household financial condition, most common of which are lost of employment or unexpected increases in expenses such as medical bills. Reset is a new factor unique to this cycle.
Auction Properties Quality – JUNK
Eye balling the properties, there are a lot of junk. 44% of the January auction consisted of condos versus 34% of sales during the last 6 months as reported by the MLS. Only 6 properties out of 118 sold for over $500,000 at auction with the highest sale at $761,250. This is confirming that REOs have not spread into mainstream properties, yet.
Looking ahead, the REO pipeline is going to swell as new REOs are added to the unsold inventory. This is a fact, not a guess. In order for the volume of REOs to decline, defaults have to be stabilizing and declining NOW, if not earlier.
Having been in real estate business for over 30 years, I have never seen market conditions like we have today. What is most puzzling is the level of complacency. While market consensus seems to recognize that there is a problem, fear of lost opportunities still appears to be much higher than fear of real loss.
If you think January was volatile, you are not going to like the rest of 2008.
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