Tuesday, June 14, 2005

The Last, Best Hope For Prosperity, Part II

I’m not going to leave the Time Magazine “Home Sweet Home” story just yet: the feedback is still coming in, and it is interesting.

We have this from the California Association of Realtors: the percentage of San Diego County households able to afford a median-priced home was 10% in April. Statewide, just 17% of California households are able to afford a median-priced house.

And there is this from a downsizing family having trouble selling their house in an enclave of Connecticut: the house is, they are finding, too nicely maintained to be a tear-down, but not up-to-date enough with all the modern conveniences (granite counter-tops, cathedral ceilings, Sub-Zero freezers) that the McMansion Crowd has come to expect.

They’ve had more than twenty lookers and no bids, while, just down the street, poorly built McMansions are going like, well, eToys in 1999.

Finally, a glance at the NASDAQ chart in the months following Time Magazine’s other hair-raising mania-marking cover story (on the dot-com frenzy in September 1999) reminds us that the NASDAQ stood at roughly 2,700 the week Time published “Get Rich.Com” on the front cover…and proceeded to nearly double before peaking out at 5,000 the following spring.

We may yet have a long way to go before the greater fools in the real estate frenzy have gone “all in,” so keep those cards and letters coming!

Jeff Matthews
I Am Not Making This Up

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.


cdub said...

While certain markets are "frothy," housing doesn't strike me as being entirely bubble-like, in the sense that it can't suddenly "pop." A bursting bubble necessarily requires rapid selling. But can this occur in housing? Are people going to start selling their highly-valued homes and move into rentals? Unlikely. Or move into smaller homes? Unlikely. Or move to entirely new states, where they can buy an equivalent house for less money? Possible, but unlikely. So where does the panic selling come from?

cdub said...

btw...another sign of "frothy"-ness: ABC's fall line-up includes a show called "Hot Properties," a sit-com about real estate agents.

dcm1023 said...

A newsletter I get mentioned Northern Trusts economist Asha Bangalore’s comment in the 5/25 WSJ “that 43% of the rise in private sector payrolls since 2002 has been accounted for by housing and housing related industries.” Then I come across this comment on the crash of the Alaskan real estate markets in the 1987 letter to shareholders from the incredibly candid CEO of the now defunct United Bancorporation of Alaska.

I have taken snippets and copied them below:
“Evaluations to estimate current values of real estate collateral for loans and other real estate owned were done throughout 1986 by the Company. When I came on as the new Chairman of the Board and Chief Executive Officer of the Company earlier this year, several of the previous assumptions and estimates of underlying real estate values had changed considerably since the end of 1986……… In the early 1980's, however, the majority of the people in the state felt the real estate development boom would last indefinitely. Unfortunately, the boom came to a crashing halt. ……Many observers have blamed the crash of the Alaskan economy on the decline in oil prices and oil industry activity. ……. However, I believe a more serious problem for the banking industry here is that there is a substantial over-supply of commercial and residential real estate. In more simple terms, Alaska banks were financing the building of condos, houses and shopping centers for the people who were building the condos, houses and shopping centers. When the building stopped and other sectors of the economy began to disintegrate, people working in the construction industry and other ailing businesses began to leave and now we don't need all those condos, houses and shopping centers.

Is what happened in 1987 Alaska happening to a smaller degree here on the coasts in the continental US???? How many of these homes are being built and bought by people who otherwise couldn’t afford them if not for the real estate boom? Makes you wonder how many people are going for a ride when the first pebble loses its upward momentum and starts rolling back down the hill?

Btw- tom brown’s website bankstocks.com has the full text of the shareholder letter I mention above. It is a doozy and well worth the read.

Howie said...

I bought one of those too nice to tear down, not nice enough for the McMansion folks in an established intown Atlanta neighborhood (where according to the BusinesWeek real estate story housing is extremely affordable). The original asking price was 675K, it sat for 10 months and I paid 500K. This was 6 months ago. At the same time somebody paid 700K for a tear down lot slighty larger than mine (.75 acre vs .87), and now somebody else has paid 850k to split an acre+ into 2 lots.

I sold my house 2 years ago, and waited for prices to moderate while I looked for my 'last house'. Prices here really haven't moved much in a few years, but if you build new construction in established in-town areas people are willing to pay up. Maybe with some new appliances and countertops I can sell for 750K....

Its_strange said...

when one rebuilds or turns thier place into a McMansion that doesn't show up in the housing data , does it ? .....Perhaps there is more speculation out there than we think ???

The Unknown Broker said...

To cdub:

A fast-bursting bubble may require rapid selling (although I'm not sure that you are really correct in that assumption) but the air can be slowly and painfully let out. And it can hurt just as bad.

In the stock market there are 1987 type crashes and there are the 1972-1974 grinding declines and there are are the 2000-2003 variety. It's not so much the rapidity of the decline that is the issue, it is rather the magnitude of the drop.

In the case of real estate - which I think is bubbly in some areas and not as much in others -- you are assuming that the owners of the properties are primary residence owners. In fact, recents statistics indicate that fully 1/3 of the houses being bought in the U.S. are by investors (translation - those who hope to flip the properties.) Oh, in some cases they are called "second homes" or "vacation homes" but the inflow of money that is spiking prices in so many cases is from those who are intending to turn the property over in short order.

And they are doing it largely with borrowed money.

There is a term in investing/market pricing of any asset called "the buyer at the margin." In oil for example for some time the issue has been that China was the buyer at the margin -- the difference between equilibrium for supply and demand - that pushed prices higher. Without that additional buying pressure (and it can be small as a percentage of the overall market) prices would not be rising. If one were to theoretically (and magically) remove the real estate speculators from the equation, the true, underlying, traditional, buy-my-house-and-live-in-it demand would have been moving real estate forward at the traditional, maybe mid-single digit rates of increase instead of the completely out character 30% and 50% we've seen.

Instead the speculators have become the buyers at the margin - competing with traditional buyers and bidding prices up. And the spikes in prices have brought in more panicked buyers -- unwilling to buy real estate in the manner that was the norm prior to this spiky period -- by waiting, shopping, making offers, etc. Buyers are afraid to wait and they buy at the asking price, or above. With 1/3 more competition for houses (the investor/speculator crowd), and more people catching the bug - prices are being pushed up.

At some point though, there is a price at which properties can't be bought. They simply cannot be afforded. People do not have an infinite capacity to absorb higher prices. So finally the unwinding process begins. And unlike in your assumption of rapid selling, the process starts slow and stays that way for a good while possibly.

First, as the affordability issue finally becomes a factor -- when there is simply not the ability to buy with cash or service a mortgage at such a high price -- the market flattens. It doesn't tank right away it just stops rising. Perhaps, for example, higher mortgage rates impact affordability. What does that do? Well, the first "marginal" buyer exits the market -- the folks who were stretching to think about buying in the first place. Then the ones who were excited about trading up because they saw rapid apprection. And then the potential new speculators -- it doesn't look like so much fun since prices have stalled. And then it really gets interesting. The leveraged speculators who -- that 1/3-of-the homes-being-bought crowd -- find themselves for the first time unable to turn over the properties quickly enough for a profit. In fact, they look around and realize that prices have actually dropped a little. And Mr. Former Flipper owns 2, 5, 10 houses (that's not uncommon by the way)-- and now he has to deal with making payments on the debt. "Payments? I've always just flipped 'em and rolled the money over." Not anymore, and the bankers aren't quite so friendly any longer. They want to know about how these interest-only-low-initial-rate-negative-amortization-fancy-dancy loans are going to be paid off. And with property values actually underwater, some of these guys will have no means to pay them. so they start having to try to liquidate in a down market. And they're sure not buying anymore.

What does this mean? The buyers at the margin -- the people who were throwing the supply and demand equation out of whack -- become the SELLERS at the margin. And the reverse picture of constantly rising prices is seen.

Prices drop a bit more, and the former speculator (now a screwed seller) gets in real trouble, the bank has to foreclose, and they become sloppy sellers. Prices drift down and down, "For Sale" signs stay in place for a long time and don't attract hordes of interested people anymore, prices drop some more, people can't sell their house for anything close to what they paid, and eventually the magazines run cover stories on "The Death Of Real Estate" and "Why You Should Now Own _______fill in the blank)"

The rapidity of the selling is irrelevant.

That's an oversimplification of course, there are lots of factors at work. But anyone who thinks real estate is a one-way train wasn't around during the mid-1980s when tax law changes killed commercial real estate, or in the early 1990s when commercial overbuilding led to a slew of loans that about sunk a number of banks and caused real estate to take a number of years to get back to previous price levels.

You've heard the term "greater fool" -- meaning that one fool is buying something at an inflated price and counting on a greater fool to bail him out by buying it at a still higher price. It has also been called "passing around a burning match." Eventually somebody gets burned.

The Sandman said...

As a follow on from my previous comment on the Fortune article, I note there is more, in the issue with Michael Douglas on the front (No. 10 June 13, 2005). No, I don’t work for Fortune Magazine, and yes I do wonder if Michael Douglas knew when he posed for the photo that the caption would include eating him for breakfast. Seeing as he and Zeta like suing newspapers so much, I hope Fortune cleared it with him first. But on to real estate markets.

This article can be found here Collective Insanity - Betting Against the House - "The only thing crazier than buying in a bubble? Gambling on when it's going to pop". It’s well written and includes a nifty little chart from the second edition of Robert Shiller’s book "Irrational Exuberance", which shows 115-year inflation-adjusted home prices in the U.S.

There are many comparisons to bubbles in the stock markets in the comments here but none to actual housing market bubbles. The only one I am familiar with, and lived through, was the London/UK bubble of the late 1980’s when the dread phrase “negative equity” entered the British conscience. Meaning: your mortgage is greater than the current price of your house.

I brought a house in south east England in the October of 1988 for £138,000. For various reasons the City job I had taken up did not pan out and I moved back to Europe in summer 1989, and put the house on the market for about £145,000. House prices had rocketed for most of the eighties since Thatcher had come to power and we thought a 5% increase to go was fine; little did we realize. The summer of 1989 was just about the very top of that market. The most eerie thing about it was putting the house on the market and seeing none, but zilch interest. The market had frozen, dried up and become more or less completely illiquid at the level of prices of sellers like us. I was a forced seller, and after about 2 months of no interest, and with the move back just about to happen, I walked into a local real estate agent and we had a talk (I had been advertising via one of the big national chains). He knew the property, the market and more importantly had been around for years. “Put it on at £135,000 and it will go” he says. I told him he was nuts but that he should do his best. It sold just before Christmas for £128,000. Six months later I rang him up and asked what was it worth now? He said you would be lucky to get £95,000 for it.

Negative equity indeed. Some poor folks suffered that for most of the nineties in the UK.

The Sandman said...

Ha! Barron's just picking up on the Time Magazine, front page, it's time (sorry) for a bubble debate, quoting research done by 'Redwood Technimentals Research; bit slow aren't they Jeff?

This is a subsciber only page which can be found here Sentiment Oozes of a Real Estate Bubble if people have an account. (Feel it's not correct to copy and past this story here as this is a public blog - if you don't have a WSJ online account, go and get one, it's good value)

Its_strange said...

WSJ mentions vacation homes at the Jersey shore ....well i'm from NJ...and without any facts i gotta figure the Mob loves shore realestate right now....And in Fl and Vegas ......i still smell that rat

DaleW said...

the percentage of San Diego County households able to afford a median-priced home was 10% in April. Statewide, just 17% of California households are able to afford a median-priced house.

I believe there is an unusual dynamic with Prop 13 in California that may skew real estate prices. Since property tax increases are generally limited to 2% a year in California, future increases in real estate costs below inflation and below the rates of other states may be captured in a higher selling price today. This may draw outside elements into the state as well. Since the rate re-sets on the purchas of a home, the capitalized values of homes after high periods of turnover, relative to incomes, should be higher than at other times (say, the end of the low price appreciation phase, around 1994-1995).

recent statistics indicate that fully 1/3 of the houses being bought in the U.S. are by investors (translation - those who hope to flip the properties.)

There is not one market I know where efficiency is enhanced by a homogenous population -- heterogeneity among market participants usually leads to more efficient prices. Not that currnent prices are correct, I am agnostic on the national question and a little more decided regionally, but the mere presence of speculators surely cannot be bad. It would be quite absurd for people to denounce the level of speculators in the stock market -- imagine that as a WSJ headline. Who knows the correct level of shorter-term players in the real estate market?

I agree things are frothy and the anecdotal evidence, but I'm personally not a big believer in the "speculator" theory of things and I think the California situation is a little more dynamic than the straight data indicate.

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