The Housing Bubble

Rich Toscano writes at the Voice of San Diego “It is a fairly common tactic among housing-industry cheerleaders to cite low interest rates as an ‘economic fundamental’ underpinning current housing valuations. Lower interest rates mean lower monthly payments, and lower monthly payments justify higher home prices. Therefore, low interest rates make homes more valuable.”

“That this point of view is widely accepted is unsurprising. It is seductively simple to think that sale prices are irrelevant as long as monthly payments remain reasonable. But there are some problems with the argument that low interest rates should result in higher home prices.”

“If one treats a home as an investment, and it seems very clear that most San Diegans do view their homes as investments, then the cost of financing that investment is irrelevant.”

“After all, if I lend you money one day to buy a stock, and then the next day I lower the rate I am charging you for the loan; did the stock suddenly become more valuable on that second day? It sure didn’t. So why should a house be considered more valuable based on the rate at which one can borrow money to purchase it?”

“As a matter of fact, this same reasoning applies whether you consider the home an investment or not. If the checker at your local Vons charged you extra for that box of Cap’n Crunch because he found out that the bank had lowered your credit-card rate, would that go over well with you? Apparently the housing permabulls wouldn’t mind, because the monthly payments on the Cap’n Crunch stayed the same.”

“Now that rates have risen somewhat, and monthly payments with them, does this imply that home prices should have declined? If and when rates rise further, will homes become even less valuable?”

“To be clear, interest rates are important. Unusually low rates have allowed San Diego homebuyers to bid home prices up to previously unimaginable levels. But the speculative excess enabled by low rates will prove neither healthy nor long-lasting.”

“The idea that low interest rates make homes more fundamentally valuable is neither logically sound nor supported by the historical data. There are many fundamental factors that legitimately and sustainably influence home prices, but the level of interest rates is not one of them.”

Regular readers will recognize this mortgage REIT. “Annaly Mortgage Management, Inc. today reported a net loss for the quarter ended December 31, 2005 of $136.8 million. During the fourth quarter $2.3 billion face amount of securities were sold, resulting in a realized loss of $65.3 million. In addition, approximately $2.9 billion face amount of securities were reclassified as other-than-temporarily impaired as of December 31, 2005, with an approximate loss of $83 million.”

“‘Our results for the fourth quarter reflect our Company’s response to the persistence of current market conditions,” said Michael A.J. Farrell, CEO. ‘No financial institution is immune from the rise in the cost of funds and the flattening of the yield curve.’”

“For the quarter ended December 31, 2005, the annualized yield on average earning assets was 4.10% and the annualized cost of funds on the average repurchase balance was 4.01%, which equates to an interest rate spread of 0.09%. This is a 118 basis point decrease over the 1.27% annualized interest rate spread for the quarter ended December 31, 2004.”

“Wellington Denahan-Norris, Vice Chairman, COO of Annaly (said), ‘Of the $2.3 billion in assets sold during the quarter, approximately 78% were hybrid adjustable-rate mortgage-backed securities. A significant portion of the assets we sold were replaced with fixed-rate mortgage-backed securities.’”

“‘We are proud of the fact that we have grown our asset management business over 20% in 2005 in the face of a hostile Federal Reserve and the unprecedented long duration of this tightening cycle,’ said Mr. Farrell.”

The California realtors have affordability numbers out. “An affordability index produced by the California Association of Realtors trade group held steady from November to December but was down 5 percentage points since December 2004. The percentage of households in California able to afford a median-priced home stood at 14 percent in December, compared with 19 percent for the same period a year ago.”

“The minimum household income needed to purchase a median-priced home at $548,430 in California in December was $134,200, based on an average effective mortgage interest rate of 6.33 percent and assuming a 20 percent down payment, C.A.R. reported.”

“At 24 percent, the High Desert region was the most affordable C.A.R. region in the state, followed by the Sacramento region at 19 percent. Santa Barbara County was the least affordable region in the state at 6 percent, followed by the Northern Wine Country region at 7 percent.” Affordability was also low in the Northern Wine Country (7 percent), Monterey (9 percent), San Diego (9 percent), Orange County (10 percent), Palm Springs/Lower Desert (10 percent), and San Luis Obispo (10 percent) regions, the association also reported.”

“Home prices increased from $960,000 to $1.3 million (35.4 percent) in the Santa Barbara South Coast area from December 2004 to December 2005, the association reported.” “Prices increased 31.1 percent in the High Desert area, 26.2 percent in the Santa Barbara County area, and 20.6 percent in the Riverside/San Bernardino area in that time, according to the report. Price increases were slightest in the North Santa Barbara County area (4 percent), San Diego area (4.6 percent), San Francisco Bay Area (8.2 percent), and Palm Springs/Lower Desert area (8.2 percent) from December 2004 to December 2005.”

The St Joe company reported results yesterday evening. “Despite a spate of hurricanes, St. Joe Co. officials said they had an increased net profit in 2005, but expect the coming year to bring flatter sales and fewer speculative buyers. ‘We do not expect the fevered market of the past couple of years,’ said Peter Rummell, chairman and CEO of St. Joe, which owns more than 800,000 acres in Florida, most of it in the Panhandle.”

“If anything, Rummell said, ’some of the speculators may have exited the market.’”

“Rummell acknowledged sales had slowed in the last six months of the year. Hurricanes and a general slowing of the housing market were key factors, particularly in resort areas in the Panhandle, he said. In all, St. Joe had 43,716 acres in various stages of development across the state, with about 9,000 units of more than 39,000 planned residential units sold or under construction.”

And from the firms press release. “‘We are pleased with our 2005 performance, especially considering the challenges we faced in the third and fourth quarters,’ said Rummell. ‘Traffic and sales activity did slow in the third and fourth quarters, particularly in our resort residential projects. We are looking forward to the spring market with cautious optimism,’ said Rummell. ‘However, resort sales have remained slow thus far in the first quarter.’”

“‘We have remained disciplined in a slowing market, and I believe our discipline will benefit those investing in JOE for the long-term. We see a market returning to a more sustainable growth pattern going forward. Many developers might feel pressure to do any deal they could in a slowing market,’ said Rummell. ‘But because of JOE’s unique advantages, including essentially no holding costs for our low-basis land, we don’t succumb to such pressure. Unlike many developers, we are not a prisoner of land priced at retail and often financed with debt.’”

“In the fourth quarter of 2005, JOE sold 9,110 acres of rural land at an average price of $2,712 per acre, compared to 3,369 acres for an average price of $5,105 per acre in the same quarter a year ago. For the year ended 2005, JOE sold 28,958 acres of rural land at an average price of $2,378 per acre, compared with 20,175 acres of rural land at an average price of $3,372 per acre in 2004.”

“‘The rural land buyer profile continues to shift away from neighbors in Northwest Florida to those living outside the region. Only 28 percent of our rural land customers in 2003, including those purchasing RiverCamps home sites, lived more than 120 miles from the land they purchased. By 2005 buyers from outside the region had increased to 63 percent.”

“On December 31st, JOE owned approximately 838,000 acres, concentrated primarily in Northwest Florida. These holdings included approximately 338,000 acres within 10 miles of the coast of the Gulf of Mexico and approximately 500,000 acres outside the 10-mile coastal perimeter, including approximately 48,000 acres in southwest Georgia. ”

“At the end of 2005, JOE had land use entitlements in hand or in process for approximately 41,700 residential units.”

“Cost of sales for home sites in 2005 consisted of $25.4 million in direct costs, $3.9 million in selling costs and $3.0 million in indirect costs.” The firms financials report that they sold those sites for $402 million.

“Cost of sales for homes in 2005 consisted of $375.4 million in direct costs, $27.8 million in selling costs and $37.1 million in indirect costs.” St. Joe sold those homes for just under $1.8 billion.”

“In this, the second installment of the highly-acclaimed ‘Don’t Judge’ campaign, we are once again reminded of the sadly hilarious consequences that can arise when innocent people, doing completely innocent things, are misjudged by someone else who doesn’t have all the information.”

The Washington Times continues its look into the mortgage business. “Home-financing offers come from an army of mortgage brokers estimated at 250,000 nationwide, many operating outside the reach of banking regulators. They have become the principal source of home financing in the US. In years past, banks and savings and loans provided most mortgages, but their share of the $2.8 trillion market dwindled to less than half in recent years, according to Harvard University.”

“The number of unscrupulous brokers offering ‘junk mortgages’ has multiplied with the housing boom and advent of Internet financing in the past five years, said David Levine of a mortgage information service. Their advertisements ‘are designed to hit consumers where they are most susceptible, their wallet.’ They are often successful, because many consumers never see or understand the fine print, that explains what a bad deal the mortgages can be, he said.”

“The brokers who offer such mortgages often have no licenses or formal training and may have just recently graduated from high school or college. They are essentially salespeople for whom there is no downside to the risky debt propositions they peddle.”

“All this was made possible by an evolution of the mortgage market away from banks and thrifts, which in years past had to follow conservative credit guidelines laid down by regulators. The mortgage companies have been able to bypass the regulated banking industry by tapping into a plentiful source of funding for the loans, private and international investors. ‘The declining importance of bank deposits as a funding source for mortgages has largely driven the structural shift,’ William C. Apgar of the Harvard center said.”

“It is now routine to approve loans that cover 100 percent or more of a home’s value and require up to 60 percent of a borrower’s income to make debt payments. Recently, several wholesale lenders announced that they would offer 100 percent loans to people who just emerged from bankruptcy.”

“Brokers and real estate agents intent on clinching a home sale and mortgage financing have been known, among other things, to pressure home appraisers to ratify inflated prices on homes in overpriced markets, according to the Chicago-based Appraisal Institute. ‘Brokers are immune from the potential adverse consequences of both failing to match the borrower with the best available mortgage and failing to provide accurate data to underwrite the loan,’ Mr. Apgar said. ‘Both affect the odds that the loan will default, which can have devastating consequences for the borrower.’”

Two reports on the cash-out phenomenon. “As Durango real estate becomes pricier, some locals said they have been forced outside city limits while newcomers seize land they still consider cheap. A realtor in Aztec, Gary Jinks noted Colorado workers are crossing the border into New Mexico to find affordable housing.’Who wants to pay $300 a square foot in Durango’ he asked, ‘when they could pay between $80 and $120 a square foot in Aztec?’”

“Over the past year, the median house price within the Durango city limits rose to $357,000, increasing nearly 20 percent. Prices for housing in Bayfield, Colo., jumped more drastically during the same time frame from $187,000 to $268,650, or just more than 40 percent.”

“There are some, however, who find housing prices in Durango a relief. Travis and Jennifer Jones relocated here from California this month. They toured a newly finished five-bedroom home in Forest Lakes north of Bayfield with Wells Group realtor John Ralph on Monday and found its $379,000 price tag warranted.”

“‘You can’t beat that,’ said Travis Jones, adding a comparable home in California would easily reach $800,000. He and his wife took pay cuts to move to Durango but said the cost of living is also cheaper. They said they have been pleased by what they have seen. ‘The market hasn’t been too shocking,’ he said. ‘But then I compare everything to where I came from.’”

“Durango Assistant City Manager Greg Caton called housing a hot-button issue and agreed the supply within Durango has not met the demand. However, as more than 2,000 homes are constructed in Grandview, the housing market may stabilize, he noted.”

And from the Dallas News. “January was the second consecutive month with a year-over-year sales decline. More than 4,300 preowned homes were sold last month through the real estate agents’ MLS. At the same time sales were easing, the median price of homes sold in North Texas jumped 9 percent to $144,000. That’s the biggest annual increase in prices in more than two years.”

“At the same time, more higher-priced homes are trading. In January, the number of million dollar and up homes sold in North Texas almost doubled from a year earlier. ‘Starting last spring and summer, a lot of our buyers are coming from out of town,’ agent Barry Huffer said. ‘A lot of the country has enjoyed significant price appreciation in the last three or four years. Some of those homeowners are relocating and buying expensive houses here, he said.’”

A mortgage REIT reported a loss this morning. “Luminent Mortgage Capital, Inc. (NYSE: LUM - News) today reported a net loss for the quarter ended December 31, 2005 of $113.4 million, or $2.79 loss per share. ‘We have accelerated the repositioning of our portfolio due to the persistence of yield curve flattening and ongoing increases in short-term rates,” said Gail P. Seneca, CEO.”

“For the latest fourth quarter, three analysts on average expected the company to earn 4 cents per share, excluding special items. The real-estate investment trust said the difference between its net loss and the REIT taxable net income for the latest quarter mainly relates to a $112 million non-cash impairment charge on mortgage-backed securities.”

“In November 2005, Luminent announced a share repurchase program permitting the Company to acquire up to 2,000,000 shares of its common stock. To date, Luminent has repurchased 1,501,750 shares. Today, Luminent announced the initiation of an additional share repurchase program to acquire an incremental 3,000,000 shares.”

“Luminent Mortgage Capital, Inc. invests primarily in the United States agency and other single-family, adjustable-rate, hybrid adjustable-rate, and fixed rate mortgage-backed securities.”

From the LA Times. “Demand for mortgages and consumer loans weakened at U.S. banks in recent months, a Federal Reserve survey released Wednesday found.” “‘On net, 44% of domestic banks reported weaker demand for mortgages to purchase homes, a notably larger fraction than in the October survey,’ the Fed said in its quarterly survey of senior loan officers.”

“Banks said they expected loan quality on loans to businesses and households to deteriorate this year from current high levels. About 40% of domestic banks said they expected the quality of their nontraditional mortgages, which include interest-only loans, to decline. Bank regulators have recently cautioned banks on risks associated with commercial real estate lending and nontraditional mortgages.”

A television station in Las Vegas has this news. “Fewer homes are moving off the market here in Las Vegas and those that are selling are going for less. According to the Greater Las Vegas Association of Realtors, an average single family home went for $310,000 in January, a slight decline from December.”

“For condos and townhouses, the average selling price was around $196,000. That too was down about four percent from December.”

“From December to January, about 25 percent fewer homes and condos sold. However, the number of homes listed for sale increased significantly during that time.”

“Realtors say despite this trend of Vegas becoming a buyer’s market, the Valley remains strong and stable with housing prices still appreciating at a healthy annual rate.”

The business press has this. “Signature Homes, in a unique twist, is developing a new residential subdivision for rent near downtown, marking a major departure from the long-established industry practice of building to sell.”

“Homebuilders typically want to sell units as soon as possible in order to recoup expenses and realize profits, but Signature Homes is building the 92-unit subdivision as an experiment in rental housing.”

“The development, when it went for city approval, was going to be a single-family detached-home subdivision for sale. ‘We worked on that project before it was developed,’ said Las Vegas City Councilman Lawrence Weekly, who represents Ward 5. ‘For the developer to come in and lower the boom on us like that, it just really, really disappointed me.’”

And a reader sent in this Las Vegas data.