A friend of mine looking to sell his home in suburban Fort Worth got a rude awakening.  The estimated market value of his home dropped $20,000 almost overnight.  When he asked the realtor what happened, he found out that the last comparable sale in the neighborhood was a foreclosure.  And even though that foreclosure price was not a “normal” market price, by virtue of being the last sale in the neighborhood, it became the new market price, dragging every other home in the neighborhood down.

The greatest benefit of a liquid market is it role in allowing “price discovery.”  The interactions of buyers and sellers send the signal of what an object is worth via the clearing price.  But the key here is “liquid.”  When sales are infrequent, prices become stale and no longer reflect reality.

In the housing market, this can be seen in a couple different ways.  If demand is in freefall and it’s been a while since there was a sale, the “market” price will grossly overstate the “real” price.  But likewise, if demand is relatively strong but the last sale was an aberration (such as a low-ball foreclosure sale), the market price can understate the real price.   In either event, it can make the sale of a house complex and downright tricky to negotiate for both buyer and seller.

The NY Times ran a good story this morning about this topic: “Getting Real About Home Prices”

The Times writes,

Even in the best of times, it’s hard for individuals to objectively value their homes, which often reflect their sense of self and personal style. Making things even more difficult has been general market inactivity lately, if not paralysis, which has provided little in the way of pricing guidance. But by using online resources, investigating neighborhood trends, consulting real estate experts and perhaps even asking the opinions of brutally honest friends, homeowners can arrive at a reasonably accurate appraisal even in these uncertain times.

Of course, as the Times tells us, in the end “the value of a home is the price the buyer is willing to pay.” And in most areas, it is still very much a “buyers market” in the sense that sellers have very little negotiating power.  This is not something we see changing any time soon.

Charles Sizemore, CFA
Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

Apparently state governments are fightin’ mad at the fact that foreclosures are wrecking their economies.  They are eyeing mortgage lenders for creating the debacle, and on top of that, those pesky banks and other lenders are not helping to remedy the situation, often taking much too long to deal with loan modifications and other initiatives aimed at slowing the rate of foreclosure.  In an effort to take control,  states are weighing the possibility of suing mortgage lenders for fraud.  Take a moment to ponder this.  State governments, who have wildly over-promised what they can support through their own funding, are contemplating suing mortgage lenders for fraud because they potentially lent money to people who couldn’t pay it back.  This falls into the “I can’t understand that” category.

If a lender makes a loan that can’t be paid back, isn’t that sort of a bad business practice?  To say that the lender did it for profit is a bit confounding, since the business model - lending to people who were marginal borrowers - seems like it is doomed from the beginning.  In fact, many of those lenders are out of business.

But let’s entertain the idea for a moment.  Someone out there is responsible for creating a boom in economic activity through the promise of cheap home ownership - or at least that is the working theory here.  That boom created an unsustainable flow of capital and economic activity within states that they became accustomed to having.  Now the spigot is turned off, so let’s blame the group that created this mania.  To do this, you have to keep asking for the next step.

It can’t be the mortgage lender.  Barring out and out fraud (which of course happened, and was always illegal), we are talking about the sweet talk of easy home ownership at a low price, getting in on the fastest game in town, the real estate bubble, and directed at those who were at best marginal buyers and at worst non-qualified buyers.  This of course came through the lenders, but it started a little further up the chain.  You have to look at the Fed with their insanely low interest rate policy, which kept prices low.  But that’s not the end of the line. 

For the end of the line, you have to look at the bucket of money that eventually purchased a big chunk of those mortgages backed by low income borrowers who are now in trouble.  That would be me and you, through our agents Fannie Mae and Freddie Mac.  In the 1990s we gave direction to those two government sponsored entersprises (GSEs) to make sure that a large percentage of the loans they purchased were those backed by low or modest income borrowers.  So in this line of thinking - that someone, somewhere, created all this mess in housing by making homes TOO affordable and persuading people to buy homes they couldn’t afford - would have to lead you back to the big buckets of money that kept buying the loans.

When are the states going to sue the federal government for fraud?  I don’t know, but if it does, it will be interesting to watch!

Don’t get me wrong, I do not think Congress is responsible for this mess.  I think this was a group effort - CDS’s which were gussied up insurance contracts with no capital behind them, rating agencies who pandered to issuers, the Federal Reserve, and Congress had a bit part.  There are many others, including borrowers themselves.  In this post I’m just addressing a current issue with states, I’m not agreeing with their analysis.

Here’s a headline we all saw coming: “Mortgage applications slide as tax credit expiration looms.”
CNN Money reports that “Mortgage applications fell last week for the third week in a row, even as interest rates edged lower…  The drop in activity came as a popular tax credit for first-time homebuyers faced an uncertain future. The credit, which can be worth up to $8,000 for eligible buyers, is set to expire at the end of next month.”

Economics is always best understood “at the margin.”  The aggressive selling and lax mortgage lending practices in the mid-2000s pulled forward a significant number of sales of marginal buyers.  This includes both subprime borrowers (who probably should have never considered home ownership in the first place) and higher-quality borrowers who were persuaded to buy a home sooner than they might have due to the attractive financing options.

We see the same basic conditions today: the tax credit for first-time buyers has also convinced more than a few marginal buyers to step up and buy a house sooner than they might have in the absence of the tax credit. This has been one of the biggest forces driving the nascent recovery in new home sales.

There are two big problems with this, however Read the rest of this entry »

Cheers to the Wall Street Journal for publishing Brett Arends excellent piece on the housing market: “Home Prices: There’s No Quick Recovery Ahead.”

Arends makes a quick summary of the bullish points for the housing market: The Case-Shiller Home Price Index has more or less flattened after falling for three years, while some cities actually showed mild improvement.  Inventories of unsold homes have also improved, falling to 3.8 million from 4.5 million the month before.  This improvement is deceptive, however.  As Arends writes,

The picture on inventories isn’t as good as it sounds, either. A lot of unsold homes have simply been put up for rent instead, especially in the most difficult markets like Miami. The result? A glut of empty rentals as well.

It is likely that many of these money-losing rentals will be put back on the market within the next few years, nipping any would-be recoveries in the bud.  Arends continues,

New waves of foreclosures and distressed sales may be coming, too. In states such as California, it can take many months for delinquencies to turn to foreclosures, which means last winter’s bad news may still be coming down the pike. Meanwhile, vast tranches of teaser-rate mortgages are due to reset later this year and in 2010.

So, while there is indeed some improvement in the housing markets (and by improvement, we mean going from truly horrid to just plain bad), it’s still not time to break out the cognac and cubanos.   Demand from Echo Boomers will eventually absorb the excess supply of starter homes and rentals in many areas, even creating a mini-boom in some.  But we expect weakness to persist in McMansions for years…if not decades.

Charles Sizemore, CFA

Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

With all the talk of economic recovery — even in these pages — we think it’s a good idea to keep things in perspective.  Yes, nationwide, things are getting less bad.  But the aftermath of the property bust will be with us for quite some time, particularly in Southern California, where there was overbuilding of practically everything — houses, retails, offices, you name it.

This WSJ headline pretty well sums up the situation: “Vacancies Suppress Southern California Recovery.”

How  bad is it?  Office vacancies in San Bernardino and Riverside counties have more than tripled, rising to 24.6% from 8% in 2006.   Orange County’s office vacancy rates stands at a comparable 20%.   The Inland Empire’s retail vacancy rate has more than doubled to 10.6% from 5% in 2006 (and will likely rise further in the sluggish consumer environment we see ahead).  Anecdotal reports tell of new office buildings sitting completely empty and shopping malls defaulting on bank loans.  It is truly a depressing picture. Read the rest of this entry »

We read today in a press release that President Obama said “We may be seeing the beginning of the end of the recession.”  Our own analysis of the leading economic indicators has led us to the same conclusion; things are getting less bad, and we may enjoy a mild recovery in the months ahead.  But this does not at ALL suggest that we are going to return to a period of robust growth.  As we’ve said before, “less bad” does not mean “good.”

After a true bubble like the one we witnessed in Florida real estate, it can take years or even decades to work off the excesses.  Earlier today, a friend sent me a story about a high-end, 34-story condo tower in Fort Myers, Florida.  The building has exactly one resident — yes, one!

So, the rest of the building remains vacant, a monument to the most absurd American real estate bubble in history.  Will it ever be leased or owner occupied?  Maybe.  Maybe not.  Dallas, Texas — our hometown — was one of the centers of the late 1980s condo binge associated with the S&L debacle.  The I-30 corridor was littered with condo developments that FAR exceeded local demand.   Many properties remained vacant eyesores for years before finally being demolished — having NEVER been occupied.  The areas most affected are still blighted, 20 years later.   That part of the city is hideously ugly, and probably always will be.

When development finally returned to the DFW metroplex, builders largely ignored the area and chose instead to go a different direction.  Quite frankly, that part of the city may never recover.   Perhaps some of the federal stimulus money could be used to build a monument there — “Speculative Bust National Park.”

At any rate, the recession may or may not be ending.  But we are definitely NOT returning to the way things were, at least not any time soon.

Charles Sizemore, CFA

Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

One of our readers passed on an article of note: “Fewer New Households Formed in Recession.”

The headline caught our eye, because with the huge number of Echo Boomers graduating from high school and college the number of new households being formed should be exploding.  It appears, however, that the recession has kept quite a few nests from getting empty.  As the Washington Post writes,

The recession has wreaked havoc on all sorts of life plans. Tumbling stock prices have cut retirements short. Layoffs have forced middle-aged children to move in with mom. Falling home prices prompt unhappy couples to rethink divorce. The larger consequence of all these discrete decisions is that Americans are forming fewer households, which in turn helps prolong the downturn….

Demographers and housing experts attribute the drop in household formations to millions of individual decisions to forgo immigrating to the United States, to put off a move, or to bunk with friends and family for a while.

The highlighted sentence summarizes HS Dent’s research methodology.  What we think of as “the economy” is nothing more than the sum of millions of Americans going about their business, buying and selling.   During recessions, EVERYONE does not simultaneously stop spending money.  But at the margin, one person forgoes a Starbucks coffee here, another forgoes a new car stereo there…and in aggregate, we buy less, businesses invest less, and the economy shrinks.  And sometimes, it shrinks by quite a lot.

In the article, we see that the number of new households — defined as a group of people sharing living arrangements — grew by 772,000 in the year ended March 31, compared with an increase of 1.63 million a year earlier.  That is an incredible 53% drop!  And this, as we said earlier, was in a year in which million of young adults graduated from high school and college!

With immigration all but grinding to a halt, we have lost one major contributor to household formation that is not likely to return any time soon.   But, we still have the Echo Boomers, who can’t continue living with mommy forever.   Recession or not, most of these teenagers and 20-somethings will set out on their own in the years to come, and when they do, they will mop up a fair amount of the excess housing supply.  They won’t be buying McMansions, of course.  But they will be buying starter homes and renting entry-level apartments.  Perhaps some will live with roommates for a few years, and there will be a few that continue to live with family.  But given the size of this generation — the largest since the original Boomers — there will be enough of them to populate many of the apartments and houses we see vacant today.  

The controversial housing report released last month by Harvard University calculates that the glut of 1.5 million surplus homes from the boom years would have already been soaked up if household formation rates had remained at normal levels.  This fails to consider price, of course, and in many areas home prices would need to continue falling for them to be affordable for these young would-be buyers.

The sooner the household formation rate increases, the better.   Because in the meantime, we still have a housing glut and a massive amount of oversupply throughout the economy. For our economy to recover, we need the Echo Boomers to get off of Mom’s couch…and buy their own…preferably on credit.

Charles Sizemore, CFA

Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

Most readers are probably aware of the $8,000 tax credit currently being offered to first-time home buyers in an attempt to lure them out of hiding.   $8,000 is a nice inducement, to be sure, but it would do very little for a California or Florida homeowner who has recently seen their home value drop by $80,000 or more, as many have.  Given the risks out there and the difficulty of many would-be buyers in getting mortgage financing, it’s not surprising that the measure has failed to live up to expectations. Read the rest of this entry »

By now, stories of homeowners who cannot continue to pay their mortgages abandoning their homes and sneaking away in the middle of the night have become old news.  This trend has continued for more than two years, and there is nothing new to report that hasn’t already been reported 1,000 times.  Or so we thought.  Just when we thought that there was nothing new under the sun, we saw a headline that made us pause:  ”In Foreclosures, A Rise in Banks Walking Away.”  Read the rest of this entry »

HS Dent’s offices are in Tampa, Florida–one of the areas hardest hit by the downturn.  The housing market reached some of its most absurd excesses in this formerly-sleepy coastal city.   This is a metro area known for its port operations, cigar rolling, and retirement communities, and incomes are not particularly high.  Yet million-dollar luxury condos seemed to sprout up like weeds for most of the 2000s, and rural areas were converted into subdivisions at a rather impressive rate.  It was an odd, circular economy based on housing; construction workers built homes that were bought by other construction workers in a cycle that was clearly not sustainable.  It continued as long as it did only because lending standards became ever more lax.  In some ways, it came to resemble an enormous Ponzi scheme that stayed afloat so long as there were a larger and larger number of new buyers.  The bust that ensued has proved what we all instinctively knew: you can’t base an entire economy on home construction.  Home construction is one of those auxiliary industries, like food and other basic staples, that supplies a need.  But in order for that service to be needed, you need a steady influx of new people; new people that are attracted to the area for its jobs.   Read the rest of this entry »