We here at Running of the Bulls have been venerable bears on residential real estate for some time. Too long, in fact, as it was a few years before the top in the housing markets that we started sending out alarms about the real estate nuttiness around the world. But, as never seems to amaze me, what gets stupid can get even more stupid, much more so than one might think.
Perhaps then, ignoring the lessons of the recent past, it is time to start looking for a bottom in the housing market, which I believe will occur either this year or next, though later is more likely than sooner in my opinion.
I do believe we are near a bottom in the homebuilder stocks.
About a year ago, when looking back at where the homebuilders bottomed in 1991, I calculated that the XHB would bottom in the $15-$18 range. I think we still have one more cathartic sell-off to come in the new year, perhaps triggered by the news of a major bankruptcy. However, a move from $19 to $15 is still a 20% decline but most of the pain is done for the homebuilder stocks. For an investor, one should be looking to buy rather than sell.
Anyways, here is a round-up of all things bad in housing from the past month.
Check out this cool real estate map of America.
The forecasters cheerleaders at the National Association of Realtors were basing their forecasts on the red continuing in the above map, falling into the predictable forecasting trap of basing one's prognostications on the rear view mirror. Slate anoints NAR as The Worst Forecasters Ever, though those of us who lived through the Tech Bubble might disagree.
[W]ithin the fraternity of financial and fiscal forecasters, the seers at the National Association of Realtors longtime chief economist David Lereah and his successor Lawrence Yun may be uniquely ill-equipped to deliver sobering forecasts. They work for a trade group whose mission is to buck up the spirits of real-estate brokers. And real-estate brokers" who live to sell, promote, and market" are constitutionally disinclined to hear anything but good news. Indeed, as I noted last summer, Lereah's penchant for putting out positive spin on dismal housing numbers inspired a blog and led critics to dub him the Baghdad Bob of real estate. Lereah has moved on. But Yun has picked up where he left off. ...
In addition to claiming that the sun is shining brilliantly even as rain pours down from the heavens in a mighty stream, Lereah and Yun have also hazarded optimistic, educated guesses about the future. In February 2005, Lereah published a book that is my candidate for Longest Title Ever: Are You Missing the Real Estate Boom?: The Boom Will Not Bust and Why Property Values Will Continue To Climb Through the End of the Decade And How To Profit From Them. Naturally, the boom busted soon after publication, and property values began to descend.
On the other side of the spectrum is Gloomy Gus Robert Shiller
Question: So how rich can you get on real estate?
Answer: From 1890 through 1990, the return on residential real estate was just about zero after inflation.
Question: Excuse me? That's all? Hasn't it been higher lately?
Answer: Since 1987 it's been 6 percent [or about 3 percent a year after inflation].
Question: So real estate doesn't go up roughly 10 percent a year?
Answer: It can't be true that homes rise 10 percent a year. If they did, in the long run no one would be able to afford a house.
Question: Let me grab a calculator. If real estate really rose 10 percent a year, a $25,000 home in 1957 should be worth roughly $3 million now.
Answer: And that flies in the face of common sense. In fact, I'm inclined to think there's a good chance that the return on real estate will be negative, substantially negative, over the next 10 years because all booms reverse in the end.
That common sense seems to have, unsurprisingly, escaped NAR.
The Fox Street Journal has a great interactive presentation on the housing market, via Barry Ritholtz. This is the house price to rental ratio.
How far do prices have to fall? According to Fortune, housing prices are going to decline by 15% from June levels.
A 34% decline to come in Orlando! That's gotta hurt.
In fact, prices have almost certainly declined more than list prices imply as incentives lower the net price received by sellers. And incentives abound.
As the housing market slump deepens, disguised discounts are making it harder to tell exactly how much people are paying for homes.
Buyers, sellers and other market participants typically monitor fluctuating home values through sale records that legally have to be listed with county clerks. But incentives offered to buyers -- ranging from free cars or furniture to cash rebates -- are making those prices less reliable as a sign of what buyers actually paid, netting out the giveaways. And that may be misleading lenders and people shopping for homes, some real-estate lawyers and appraisers warn.
KB Home in January sold a new townhome with green siding in the Denver suburb of Parker for $196,000, according to the deed recorded with the Douglas County clerk. But a disclosure form provided to the buyer and seller of a particular property, which isn't part of the public record, shows that home builder KB paid $27,600 to another company, which made a cash payment to the buyer. Netting out that effective discount, the price was $168,400. ...
One risk of these transactions is that they can mislead other buyers into overpaying for similar houses nearby, or give owners of nearby properties an exaggerated notion of their home equity. Lenders can make loans on the basis of an artificially high value, increasing the danger of losses from any default.
The national builder Lennar Corp., for instance, last year offered buyers in certain Florida communities vouchers to purchase Mustangs from a local dealership. Lennar said the voucher was deducted from the recorded sales price of the homes. A few months ago, a small builder in Tacoma, Wash., offered a $20,000 Harley-Davidson to buyers of a $479,000 home. One buyer skipped the Harley and instead took a $20,000 incentive from the builder, which reduced the sales price of the home. But in other cases, " the incentive is not always public knowledge," said an agent involved in the sale, Jeff Jensen of Windermere Professional Partners, Tacoma.
It is a vested interest of many parties to keep the stated price higher than the actual market clearing price. However, the more impediments to reach the clearing price, the longer the crisis drags on.
Seven percent of homeowners owe more than their house is worth. Or at least they did a year ago. The proportion is almost certainly higher today.
Last March, First American CoreLogic, a housing- and mortgage-data supplier in Santa Ana, Calif., calculated that nearly 7% of 32 million U.S. households studied as of December 2006 owed more than their homes were worth, based on computer estimates of the property values. The homes studied had mortgages originated in 2004 through 2006, around the peak in the housing market.
The Dallas Fed has a good article on the housing market.
And, as the Dallas Fed notes, resets will not peak until 2008.
As you know, the government created a bailout plan for submerging prime borrowers. However, it will unlikely have much of an effect. In fact, it may exacerbate the situation.
Although there are mountains of uncertainty as to how the plan will be structured and implemented, there is no question that as lenders factor in the added risk of having their contracts re-written or of being held liable for defaulting borrowers, lending standards for new loans will become increasingly severe (higher down payments, mortgage rates, and required Fico scores, lower loan to income ratios, and perhaps the death of adjustable rate loans altogether). The result will be additional downward pressure on home prices, despite the fact that in the short term fewer homes will be sold in foreclosure than what might have been without the rescue plan.
Most homes temporarily saved from foreclosure will continue to depreciate as new buyers fail to qualify for loans. As a result, lenders will be on the hook for more losses than had the foreclosures taken place sooner.
Even if those who qualify take the help, many will wind up in foreclosure anyways.
The recidivism rate for non-credit-worthy borrowers is high, according to Rosner. Even during the boom in housing prices, the re-default rate on subprime and Alt-A loans (one step above subprime) two years after a modification was 40 percent to 60 percent, he said.
Thus, the plan merely delays the market reaching its clearing price, delaying the eventual recovery, a la Japan c1990s.
The rate of foreclosures may have already peaked.
Foreclosure filings for November surged 68% from a year ago but dropped 10% from October, another sign that foreclosure activity overall may have peaked for the year, a foreclosure-listing service said.
RealtyTrac Inc. Chief Executive James J. Saccacio said that November's 10% drop from October was the first double-digit monthly decrease observed since April 2006.
However, the level of foreclosures has almost certainly not peaked. I mean, 68% growth isn't exactly comforting.
What else may add to foreclosure woes? Try option ARMs.
In a report issued last week, Merrill Lynch economists called option ARMs "ticking time bombs" that will start "ticking louder next year." Merrill estimates that losses on option ARMs could total $100 billion, on top of an estimated $400 billion in losses on subprime and other mortgages.
Option ARMs generally carry a low introductory rate -- in some cases as low as 1% -- and often have high prepayment penalties that make it expensive to refinance. With lending standards getting tighter, refinancing may be impossible in any case. ...
A small number of borrowers with option ARMs are already facing resets that require them to make payments covering interest as well as some principal. The numbers are set to rise sharply: Nearly $156 billion in option ARMs will face payment resets between 2008 and the second quarter of 2012, according to Lehman Brothers estimates, with resets peaking in 2010 and 2011. For more than $90 billion of those loans, borrowers would owe as much as their home is worth or more, according to Lehman, which assumed that home prices will fall 6% both in 2008 and 2009.
Though option ARMs are a smaller market than submergingprime, there are more ticking time bombs out there, as an insider in an excellent interview with Herb Greenberg notes.
[S]ub-prime loans were only a small piece of the mortgage mess. And sub-prime loans are not the only ones with resets. What we are experiencing should be called The Mortgage Meltdown because many different exotic loan types are imploding currently belonging to what lenders considered qualified or prime borrowers. This will continue to worsen over the next few of years. When prime loans begin to explode to a degree large enough to catch national attention, the ratings agencies will jump on board and we will have Round 2. It is not that far away. ...
Sub-prime aren't the only kind of loans imploding. Second mortgages, hybrid intermediate-term ARMS, and the soon-to-be infamous Pay Option ARM are also feeling substantial pressure. The latter three loan types mostly were considered prime so they are being overlooked, but will haunt the financial markets for years to come. Versions of these loans were made available to sub-prime borrowers of course, but the vast majority were considered prime or Alt-A. The caveat is that the differentiation between Prime and ALT-A got smaller and smaller over the years until finally in late 2005/2006 there was virtually no difference in program type or rate. ...
Most sub-prime loans in existence are refinances not purchase-money loans. This means that more than likely they pulled cash out of their home, bought things and are now going under. ...
The second mortgage implosion, Pay-Option implosion and Hybrid Intermediate-term ARM implosion are all happening simultaneously and about to heat up drastically. Second mortgage liens were done by nearly every large bank in the nation and really heated up in 2005, as first mortgage rates started rising and nobody could benefit from refinancing. This was a way to keep the mortgage money flowing. Second mortgages to 100% of the homes value with no income or asset documentation were among the best sellers at CITI, Wells, WAMU, Chase, National City and Countrywide. We now know these are worthless especially since values have indeed dropped and those who maxed out their liens with a 100% purchase or refi of a second now owe much more than their property is worth. ...
The Pay-Option ARM implosion will carry on for a couple of years. In my opinion, this implosion will dwarf the sub-prime implosion because it cuts across all borrower types and all home values. Some of the most affluent areas in California contain the most Option ARMs due to the ability to buy a $1 million home with payments of a few thousand dollars per month. ...
In Northern California, a household income of $90,000 per year could legitimately pay the minimum monthly payment on an Option ARM on a million home for the past several years. Most Option ARMs allowed zero to 5% down. Therefore, given the average income of the Bay Area, most families could buy that million dollar home. A home seller had a vast pool of available buyers. Now, with all the exotic programs gone, a household income of $175,000 is needed to buy that same home, which is about 10% of the Bay Area households. And, inventories are up 500%. So, in a nutshell we have 90% fewer qualified buyers for five-times the number of homes.
In California, the median home price has fallen by 12% from last year.
Home sales decreased 36.2 percent in November in California compared with the same period a year ago, while the median price of an existing home fell 11.9 percent, the CALIFORNIA ASSOCIATION OF REALTORS (C.A.R.) reported today.
The New York Times has a good article about the bubble if Florida.
FLORIDA real estate has long been synonymous with boom and bust, but the recent cycle has packed an unusual intensity. The Internet made it possible for people ensconced in snowy Minnesota to type "cheap waterfront property" into search engines and scroll through hundreds of ads for properties here. Cape Coral beckoned speculators, retirees and snowbirds with thousands of lots, all beyond winter's reach.
Creative finance lubricated the developing boom, making it easy for buyers to take on more mortgage debt than they could otherwise handle, driving prices skyward. Each upward burst brought more investors as some from as far as California and Europe, real estate agents say. ...
Builders were happy to arrange construction loans, then erect houses in as little as six months. Real estate agents promised to find buyers before the houses were even finished.
"All you needed was a pulse," Mr. Carey said. "The price of dirt was going up. We took that leap of faith and put down $10,000." ...
There is a four year supply of homes in Palm Beach county.
That's because the same issue that forced sellers to pull their properties off the for-sale market now dogs them in the rental market: inventory. There are nearly 35,000 residential properties for sale in Palm Beach County alone, according to Illustrated Properties Real Estate. That's a staggering four-year supply at the current pace of sales.
I see that the real estate market is falling over on its own weight in red hot Alberta, even with oil prices pushing $100.
Edmonton home prices dropped an average of 6.5 per cent in November from October.
Single-family houses fell 5.3 per cent to $376,267 while condos were down four per cent to $252,277.
Edmonton house prices now are down $50,000 from their May peak of $426,028.
It is too early to call the peak in Alberta, but the laws of economics have not been suspended north of the border. At least not permanently.
Think the problems are limited to the US? Well, when the implosion of the housing market is effecting public offerings in Algeria, you know that the world is truly integrated.
Algeria has suspended the first ever privatisation of a bank in the North African nation due to continuing troubles in global financial markets.
A number of business deals have come unhinged in recent weeks as the cost of borrowing money has risen due to problems in the US housing market.
Algeria was planning to auction off 51% of Credit Populaire d'Algerie.
The finance ministry said that the sale would resume when the "impact of the mortgage crisis" became clearer.
Its only a matter of time in Asia.
Many Chinese families are already deep into speculating on property, a main driver of the surging prices that have Chinese authorities worried that a bubble might be forming. New apartments north of Shanghai's famous Bund waterfront are selling for a record $17,000 per square meter.
Yi Xianrong, a prominent economist at the China Academy of Social Sciences, a government think tank, is one of those sounding the alarm.
He contends that China's housing loans are riskier than those in the U.S., because he said most loan applicants give false information about their assets and income.
Because China lacks a comprehensive credit data system, borrowers often qualify for loans using false information, Yi says. He thinks the quality of property loans in China might be worse than the risky mortgages that are causing so much trouble in the U.S.
"I estimate that the large majority of mortgage holders would not meet the standards for even subprime loans," Yi said in an interview with the state-run magazine Oriental Outlook.
Fascinating stuff.
What seems obvious to me is that here in America, dirtbags were selling this garbage to people who clearly did not need it, in particular to seniors on fixed incomes.
Some loans were more predatory than subprime, with features so onerous that borrowers refinanced their way out of the American dream, losing their houses and substantial equity to mortgages they never stood a chance of repaying.
Lenders persuaded one borrower, a 79-year-old janitor, to obtain 10 subprime refinances over nine years.
Taylor refinanced her home three times in just three years. Those loans stripped away more than $50,000 of her home equity in fees alone and eventually obligated her to mortgage payments that were nearly three times her monthly Social Security check of $761.
Her loans, like many subprime mortgages, came with hefty fees, prepayment penalties, and interest rates that adjusted upward.
Targeting homeowners for mortgages based solely on the financial stake they have in their homes is universally regarded as predatory lending and is illegal under state and federal laws. But experts say that hasn't stopped lenders from doing just that.
I would love to see some of these scumbags do hard time in prison for what they have done, but I doubt that will happen.
Too bad.
What is the picture regarding the inventory of apartment rental units? What will be the direction of apartment rents as people no longer can afford or can qualify for homes?
Posted by: Jerry | January 03, 2008 at 03:09 PM
All true but the bigger problem IMO is that all these other mortgages have wrapped up in CDOs, etc. and marketed. No wonder the banks won't lend to one another. No one knows who's holding what and how far it will drop in value. The real financial crisis is yet to come it would seem. And for the FED & Treasury to encourage the no-disclosure of these "assets" only make matters worse.
Posted by: Douglas Crockett | January 05, 2008 at 10:44 AM
All true but the bigger problem IMO is that all these other mortgages have wrapped up in CDOs, etc. and marketed. No wonder the banks won't lend to one another. No one knows who's holding what and how far it will drop in value. The real financial crisis is yet to come it would seem. And for the FED & Treasury to encourage the no-disclosure of these "assets" only make matters worse.
Posted by: Douglas Crockett | January 05, 2008 at 10:45 AM
Jerry
I am not sure about the figures regarding rental units, though I can only imagine they are rising as speculators who cannot unload their units try rent them out. My guess is that rents will fall.
Posted by: Toro | January 06, 2008 at 11:18 PM