A friend of mine who works in the Southern California real estate industry spoke with me at length about a week ago regarding the status of the sector, buyers, and her own firm's experience.
In order to disguise her firm and the major project on which she works, I'll leave details vague.
However, what she explained both reinforced my sense of the nature and extent of the country's mortgage problems, as well as highlighted how detached from reality a particular locale can become.
One clear signal that the credit woes of the housing market are having real effects is that instead of her project's escrow closing late this fall, she now casually remarked that it won't close until, I believe, sometime late next year. In fact, there was evidently some question as to whether the entire venture was still viable. Which is why I'm being careful to completely avoid any reference to the project, beyond noting that it is residential in nature, and in southern California.
When I related MarketWatch's Herb Greenberg's observations that southern California real estate "values," meaning notional asking prices, in places like Riverside, had risen far above the national average home price, my friend agreed that the regional real estate market had become unsustainably over-valued.
Thus, her firm's project was already selling into an over-priced market, on a national basis.
Yes, I know, you're saying,
"But don't you realize, real estate is local?"
Well, yes, and no. Yes, if it's priced within reasonable, national parameters. No, if it's not, because of the securitized nature of the broad market, and the specialized nature of jumbo mortgage financing.
Put the two together, and you have expensive real estate projects which rely on short-term construction financing, and consumers taking jumbo mortgage loans to buy them, depending upon a very precarious long term credit market.
As I spoke of this situation with my business partner, we agreed that the only way my friend's project could have become insulated to credit forces was to have secured long term lines of construction financing, and, then, secured forward commitments to lend to its buyers who met certain criteria, from jumbo mortgage lenders. Absent such arrangements, a project such as my friend's, located in an area of stratospheric housing prices, was bound to be among the first to experience difficulties, once the credit market tightened.
Did I mention, by the way, that my friend told me she does not know of one person, directly, who has not bought a home in southern California without using two mortgages? The main mortgage for 80% of the purchase price, and the piggybacked alt-A or sub-prime for the remaining 20%.
That second part? That's what we in the Midwest, where I grew up, and even out here, in the East, call the "down payment." That's the part that assures all other parties that you have sufficient personal equity invested in your commitment to buy and pay for your home.
My friend is well aware that the California market, like Las Vegas, Florida, and a few other well-contained markets, simply became over-priced, with respect to what the now-national, if not global, ultimate holders of mortgage paper, would consider affordable by the borrowers.
Thus, new residential purchases on the same old terms is finished. And my friend's project is in somewhat dire straits. Essentially, they can only complete their sales by attracting buyers who can afford the full 20% down payment, in order to take a conventional jumbo mortgage for the balance.
It's ironic. My friend is educated, intelligent, and very competent. She chose to work in an area that, until recently, added considerable value to the local economy, and promised her substantial rewards for successful job performance.
No more. As she told me recently,
"I might well be able to visit you next week, or the week after. Because I may not have a job tying me down."
Such is the manner in which a thousand or more similar stories, combined, make for a national economic event. Everyone in California, in the housing-related sectors, knew that some of their real estate values were indefensible to the larger financial markets, should credit conditions change in a tighter direction. But they still behaved as if it would not, did not, matter.
Perhaps this fact, more than any other, demonstrates why financial-related businesses need to remain vigilant about creditworthiness. Financial lending bubbles and high-growth businesses always implode when lowered lending standards at least meet initial defaults and delinquencies. It has ever been thus, and, probably, ever shall be.
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