California screaming: Tales from the housing bust

People in L.A. are coping in ways they never imagined with a crisis they never saw coming. Like it or not, California's reputation as a national trendsetter is going to remain intact.

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By Pat Regnier, Money Magazine editor-at-large

Real Estate:
Your local forecast
381 markets tracked
1. Select your state
2. Select your city/market
Hard times hit the ranch: Prices in sought-after Ladera Ranch took off during the boom. But they're collapsing in the bust.
What crisis? Laura and Jim Fisher decided home prices were too crazy years ago. They've figured out how to live large without owning.
But not everyone suffers: The Fishers pay just $2,800 a month to live in a five-bedroom house on the water in Huntington Beach while the owner tries to sell the place.
Foreclosure blues: The large number of distressed properties in Ladera Ranch is making it hard for Judy and Stewart Manley to sell their place and move up to a bigger house.
Sticking it out: Scott and Joyce Porter would like to sell their Los Angeles home and downsize, but they're unwilling to cut their asking price.
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(Money Magazine) -- Spring in southern Orange County has come on spectacularly. The autumn fires that blew smoke and ash into neighborhoods here also destroyed a lot of dark-hued scrub and chaparral. Now the hills along the 241 tollway are painted in bright green grasses and yellow and violet wildflowers. Near the end of the 241 lies Ladera Ranch, a nine-year-old (and still growing) planned community of 25,000. Nestled into the foothills, the place is a visual metaphor for the American dream, California division, in which the residents of the postmodern townhouses at the lower elevations aspire to the gated $4 million spreads at the top.

Yet there's a whiff in the air - not of smoke - but of despondency. According to Foreclosure Radar, a Web service that searches public records, more than 100 homes in Ladera Ranch are in "pre-foreclosure," which starts when a bank sends the homeowner a first notice of default. Another 100 are in the hands of the lender or being sold at auction. So many distressed properties translate into fast-falling prices, and an owner trying to sell has a rough go of it when banks are the competition. Climbing that hill is looking harder and harder to do.

There are a lot of Laderas, and far worse, all over greater Los Angeles today. Median prices in the metro area's five counties are down 18% to 28% for the 12 months ended in March, according to DataQuick Information Systems, making Southern California a particularly lousy place to be selling a home right now. But the pain here isn't hard to find elsewhere. The past year has given the lie to the old saw about there being no national real estate market. Of the country's top 100 markets, 56 saw price declines; foreclosures increased in 98 of them. The same mix of crazy loans and speculative frenzy that pushed up and then pulled down L.A. was at work in Florida, the Southwest and much of the Northeast. The Midwest inflated less but in the end still proved vulnerable to a weakening economy and the debased lending standards of the bubble era.

The L.A. story, in other words, is likely to be your story too. Unlike some famous bubble towns - hello, Las Vegas - L.A. has a mature economy and a diverse housing supply. There's a house and a neighborhood like yours here, whether you live in a city, a leafy older suburb or a brand-new exurb.

In Money Magazine's annual special report on real estate, you'll see how homeowners in the greater L.A. area are coping and how the drama might play out here and in your hometown too. We'll also answer some key questions for buyers and sellers in a game where none of the rules are the same as they were just two years ago, and we'll look at five big changes in real estate that will outlive the crash.

First, however, the big question: When will the hurt stop? Judging from what's going on in Southern California, it's likely to be years, not months, before real estate blooms back to life.

The house you can't get out of

To feel the pain of foreclosure, you needn't have borrowed foolishly or suffered a big financial setback. You just have to live near people who did.

"We thought we'd be able to sell pretty quickly because this is a sought-after area," says Stuart Manley, a Ladera Ranch resident who had hoped to unload his townhouse for about $469,000. "But shortly after we went on the market, it was foreclosure, foreclosure, foreclosure."

Manley and his wife Judy moved to Ladera Ranch in early 2006, paying $350,000 for their neighborhood's model home. It was a heady time to live there.

"The natural progression was that renters move up to ownership of a condo, then up to a house and then up to a mansion," says Manley, who owns a wireless services company. In the southern O.C., where home prices were appreciating at double-digit percentages each year, you could hope to squeeze a lifetime of social mobility into just a few years.

Get a loan with a low teaser rate on the first house, sell at a profit and use your new equity and another round of easy credit to get a grander house. Patti Arnold, who handles house closings as an Orange County escrow officer, says many of those loans had minuscule initial payments, allowing borrowers to put off paying back principal. "Everyone just kept moving," recalls Ladera resident Darlene Kelly, speaking on the front porch of the foreclosed home where her husband, a broker, is hosting an open house.

Now few people or properties are moving up. The Manleys, for example, can afford to snap up a house that was out of their reach just a year ago - if only they could get out of their current place. (With a baby on the way, they need more room.) But there are homes nearby listing for more than $80,000 below their asking price. Manley won't slash his price, he says, "out of respect for the neighborhood." So they're resorting to an unusual tack: trying to buy a distressed property and renting their place back to the owners. "We've had people approach us to say they're in foreclosure and need to rent," says Manley. "And I've said, 'Oh, yeah, what's your address?' "

Meanwhile, the wave of foreclosures is changing the neighborhood, and not for the better. Manley complains about the signs that go up outside bank-owned houses on the auction block. "It feels trashy," he says.

Pay my price or I'm not selling

Bubbles, whether they're in stocks or houses, don't explode so much as they start leaking from pinholes. The air near the edge of the bubble that props up dissipates first. Microsoft (MSFT, Fortune 500), meanwhile, won't collapse, but it will weaken too.

In real estate, new neighborhoods built farther out from town are especially vulnerable because no one's had 20 years to build up equity. In more established areas, people who resisted the urge to treat their home like a piggy bank experience only paper losses and can, for the most part, sit tight. This is what economists mean when they say home prices are "sticky"- people just stop selling as prices drop, which slows the rate of decline. Of course, the downside to sticky is, well, you're stuck.

Scott and Joyce Porter, a semiretired couple in their seventies, put their house in the San Fernando Valley on the market six months ago for $979,000. Scott and his now-deceased first wife bought the place in 1981. Near the height of the market, it appraised at $1.2 million. It's a unique house that might turn off buyers reared on HGTV - no granite in the kitchen! - but it has charm to spare and a big, landscaped yard shaded by sequoia trees. "People love it," says Joyce. "It's a prime piece of property."

Apparently not at their asking price, at least not now. The Porters want to sell because it's getting harder for them to maintain so much space. Their aging Doberman struggles with the stairs.

Rather than drop the price though, the Porters have decided to take the home off the market and renovate. It's a gamble: Home values could drop while they get the work done, meaning they would have sunk more money into a place where they no longer want to be and would make even less if they did sell. Now that's stuck.

Walking away from a bad deal

The Porters' gamble, comparatively speaking, is a modest one when looked at against all the horrendously bad bets buyers and lenders made near the top of the market. You know the story. Wall Street figured out how to pool home mortgages into complex securities that promised investors safety even though they were backed by risky loans. That made it easy - and profitable - for mortgage lenders to hand credit to just about anyone with a signature and to give those with good credit ridiculously accommodating terms. People took on huge mortgages with little money down or with low payment rates set to explode upward in a few years. It seemed okay because rising values would make selling at a profit or refinancing a simple matter.

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