The Housing Bubble

The Wall Street Journal has this report on appraisal fraud. “As the housing market cools, Americans are confronting a problem that was easy to ignore during the boom: Inflated appraisals of home values. Critics have long warned that many appraisals are unrealistically high. That’s partly because generous appraisals help loan officers and mortgage brokers, who often choose the appraiser, complete more deals.”

“Prices are leveling off in many places and falling in some. Some homeowners are finding that the market value is below what past appraisals led them to believe.”

“For sellers, that can mean being forced to drop their asking prices. Some people hoping to refinance may be unable to lock in new loan terms. Lenders and mortgage investors, too, could take a hit if it turns out the collateral backing their loans is worth less than expected.”

“Dubious appraisals are a risk for the hundreds of thousands of people who in the past few years have bought homes with little or no down payment, or used almost all of their home equity to finance home improvements or other types of spending. ‘Now it’s pay-the-piper time for people, and they’re finding out they don’t have the value in the house they thought they had,’ says John Taylor, president of a Washington-based nonprofit.”

“In October, when Melinda and Steve Welch refinanced the loan on their four-bedroom home in Centreville, Va., the property was appraised at $682,000. Later they cut the price to $595,000, and recently accepted a bid around that level.”

“Eric Randle, an appraiser in the Los Angeles area, says he frequently receives faxes from loan officers asking whether he could appraise a specified home at a certain level. The implication is that an assignment will be forthcoming only if he’s willing to hit the desired number. Mr. Randle says he declines to work on those terms.”

“One of Mr. Randle’s appraiser friends recently received a fax from a mortgage loan officer in Bakersfield, Calif. The scrawled fax message listed an address in Los Angeles and said, ‘I need 2 get to 750K for this Appraisal. If not please provide a value range or call me.’”

“Consumers often play along with dubious appraisals. Danny Wiley, an appraiser in Nashville, in May was asked by a lender to appraise a condo in Spring Hill, Tenn. The buyer had offered to pay $139,000, but the contract required the seller to pay $10,000 toward the buyer’s closing costs. In effect, Mr. Wiley says, the price had been inflated by $10,000 to allow the seller to provide money to help the buyer cover closing costs.”

“Mr. Wiley estimated the value at $129,000. That should have killed the deal. But Mr. Wiley says the sale later went through, apparently after the lender found another appraiser willing to value the condo at $139,000.”

“Some lenders use appraisal-management companies to create a wall between the appraiser and the loan officers. But appraisers say these companies often choose the cheapest and fastest appraiser rather than the most qualified. ‘You get someone who is not intimately familiar with the local marketplace because they are willing to do it for less,’ says Jeffrey Jackson, chairman of the appraisal firm Mitchell, Maxwell & Jackson in New York.”

“Lenders often play down the issue. Tim Doyle, an official of the Mortgage Bankers Association, says he sees no ‘broad’ problem with inflated appraisals, outside of criminal rings. Even though mortgage lenders typically sell loans to investors shortly after making them, investors can force the lenders to buy back a loan if it goes into default and the appraisal was fraudulent, he says.”

“Even when all parties want an honest appraisal, that can be hard to achieve. In making their value estimates, appraisers rely heavily on prices paid recently for similar homes nearby. But those prices may be misleading. For instance, builders of new homes sometimes include in the sale prices such items as landscaping or contributions toward loan fees or settlement costs.So the resulting inflated price can become a misleading ‘comp’ for nearby homes.”

A pair of reports from the Denver Post. “The cooling housing market has homebuilders throughout the nation girding for fewer sales, larger inventories and stiffer competition for people in the market for new homes. Last week, Denver-based MDC Holdings, which operates as Richmond American, reported a 25 percent drop in quarterly profits, blaming fewer orders and a growing inventory of unsold homes.”

“A competitive market caused orders for new MDC homes in Colorado to decrease from 594 for the second quarter last year to 291 for the same period this year. ‘The magnitude of this drop-off is about as quick as we’ve seen in a long time,’ said Stephen East, a homebuilding analyst.”

“MDC plans to maintain just a two-year supply of lots. As a result, the company chose not to exercise some of its options on building lots. The two-year land supply is a strategy MDC has been following since the early 1990s, CFO Paris Reece said. ‘We saw, in a market where land values cannot be maintained, certain builders can be hurt by holding too much land,’ Reece said.”

“Most homebuilders try to keep a four- to five-year supply of land, but because home sales have slowed, many have as much as an eight-year supply, homebuilding analyst Alex Barron said. ‘A lot of them realize they bought too much land in the last couple of years,’ he said. ‘Now they’re trying to sell the land to somebody else.’”

“‘A lot of builders are..scrambling to get close to rail,’ said Rich Davis, at KB Home in Denver.”

“Homeowner Eric Elkins is struggling to avoid the real estate world’s dreaded F-word. Foreclosure may be his only way out. Elkins says he can no longer afford his payments. He owes $285,000 on his Highlands Ranch house. But it’s worth less than $250,000. ‘I just want to get out of the house and not be too screwed,’ he said.”

“He bought it for $252,000 in 2002. Last year, Elkins put the house on the market for $299,000. At that price, the home attracted only three showings. Increasingly unable to afford his payment, he contacted his lender, U.S. Bank. At first, the bank told him he couldn’t refinance again because he owed more on the house than it was worth, he said.”

“He inquired about selling, but to sell a house for less than it’s worth requires lender approval. Eventually, Elkins’ lender came up with a better idea. ‘He put me into two home-equity lines of credit,’ Elkins said. ‘It was all very creative.’”

“These new loans replaced his mortgages. One was interest-only. Both loans had adjustable interest rates. As for the value of the house versus the size of the loans needed to refinance it, well..no equity, no problem. ‘He got an appraisal for $285,000,’ said Elkins of his lender. ‘I don’t know how he did it. It was exactly the amount I needed.’”

“Unfortunately, Elkins’ financial situation is still disintegrating and his payments keep rising. He put his home up for sale again in May. In June, he got an offer for less than $250,000. His broker submitted it to U.S. Bank for approval. The bank had to decide what to do about the deficiency. One option would be to grant Elkins an unsecured loan for the balance. Another would be for the bank to take the loss. The loss on a short sale is typically smaller than the loss on a foreclosure.”

“The bank did not respond and Elkins’ bidder moved on. ‘This property will end up foreclosed on because the bank cannot respond quickly enough,’ said Elkins’ real estate broker, Gretchen Faber. ‘U.S. Bank is completely uninterested in cooperating with me or with the buyer’s agents. It isn’t just U.S. Bank,’ she said. ‘All banks do this.’”

Some housing bubble reports from Wall Street and Washington. Paul Muolo, “According to a new report by the Mortgage Asset Research Institute, ’stated-income loans’ deserve their nickname of the ‘liar’s loan.’ MARI says that almost 60% of the stated-income amounts are exaggerated by more than 50%.”

From Bloomberg. “Bonds of U.S. home builders, profitable through April, have turned into the biggest losers this year in the market for debt with ratings below-investment grade. Debt sold by D.R. Horton, KB Home and other construction companies have fallen an average 3 percent since May 1, according to Merrill Lynch. That is the worst performance of 37 industries tracked by the investment bank.”

“‘You have to ask yourself if the worst is over or yet to come,’ said Timothy Compan, head of corporate bond strategy at Allegiant Asset Management.”

“D.R. Horton said last week that it would sell 50,000 houses in the year that ends Sept. 30, below the 58,000 estimate it gave on April 18. ‘Every downturn is longer and deeper than people expect,’ Horton’s CEO, Donald Tomnitz, said Thursday after the company reported the first quarterly loss in its 28-year history. ‘We are assuming the worst.’”

From Danielle DiMartino at the Dallas News. “The first stage of grief is denial. That’s the state the few remaining housing bulls seem to be in. In Nevada, foreclosures rose 13 percent over May, nearly double the national rate. In California, foreclosures were up 15 percent, boosting the Golden State to No. 2 in the nation, ahead of Florida.”

“Even the usually gregarious NAHB chief economist, David Seiders, could not muster the levity to mention a ’soft landing’ in Tuesday’s press release. Instead, he spoke of ‘growing builder uncertainty on the heels of reduced sales and increased cancellations’ and builders’ concerns of ‘more monetary tightening by the Federal Reserve.’”

The New York Times. “According to Freddie Mac, homeowners are on pace this year to take $170 billion in cash out of their home equity as they refinance their mortgages. That figure is down from last year’s record, $244 billion, but it is still far higher than in other recent years; in fact, about 10 times higher than it was in 1996.”

“Homeowners have not only completed more of these transactions in recent years than ever, but they have also grown more aggressive in how much cash they are taking out. More than 20 percent of each refinanced loan will be taken as cash this year, virtually the same as last year. That is more than double the average of the previous five years.”

“Instead of saving or investing, some of these borrowers will spend $6 of every $10 they take out in home equity, said Raphael Bostic, a professor of economics at the University of Southern California.”

“He cited cars, which typically carry five-year loans. ‘If you pay for that car through a house refinance,’ he said, ‘you’re paying for that car for 30 years; long after you’ve stopped getting value from it. Talk to financial folks, and they’ll say you shouldn’t buy short-term pleasures with long-term money.’”

And from Bill Fleckenstein. “I continue to believe that worrying about the Fed being tough is exactly the wrong thing to worry about. This, after all, is the Fed that precipitated a stock bubble, and then a housing bubble to address what ensued. The Fed only knows how to do one thing, which is to print money and bail out whatever problem it previously created. If one wants to worry, one should worry about the consequences of Fed recklessness.”

“Some folks are beginning to rethink the notion of loans against homes as impregnable assets. In my opinion, any company that has profited by aiding and abetting the housing ATM is in trouble, if it has a leveraged balance sheet with its assets being loans to houses.”

“I make those comments based on what I can see has gone on, and I’m sure that lots of unusual business practices have gone on that we have no knowledge of. Just as we didn’t find out about Enron, WorldCom, options-backdating, etc. until the tide went out, we have yet to discover what borderline, if not outright criminal, behavior occurred in the housing mania. When the stock market begins to connect the dots, all hell is going to break loose.”

The Palm Beach Post has a preview of tomorrows existing home sales number. “Have existing home prices in Palm Beach County finally started to fall? After peaking in November at a median of $421,500, existing home prices have languished around $390,000 all year. Some observers are privately saying that home prices have begun a downturn.”

“Palm Beach County home sales in June, according to the MLS report, plunged 39 percent compared with June 2005: to 947 from 1,551. If the Florida Association of Realtors report echoes this, June will mark the seventh straight month of significantly declining sales.”

“Active listings in June represent an 18-month supply of homes at the most-recent sales pace, notes a correspondent. The MLS’ new-listings report for June also gives a vivid snapshot of our real estate market, and just how unaffordable it is. Of 3,495 new listings in Palm Beach County last month, nearly 80 percent had asking prices of $300,000 or more. Nearly a third had price tags topping $500,000.”

“Housing consultant Thomas Lawler thinks South Florida’s real estate market has entered what the respected ‘death-and-dying’ psychiatrist Elisabeth Kubler-Ross called the first of five stages of grief.”

“This process takes time, Lawler says, which is why home prices in hot markets that cool fast don’t immediately start falling.”

The Sun Sentinel reports on the states schools. “After decades of runaway school growth, educators across much of Florida are asking, ‘Where are all the kids?’ Enrollment has swung into reverse in several of the largest school districts and slowed dramatically in others.”

“‘We used to grow by 10,000 kids a year,’ said Jane Turner, budget director for the Broward district. This past year, however, it lost almost 2,500 students. Some districts, including Seminole and Palm Beach, are teetering on the edge of an enrollment drop.”

“Although no one can cite a definite cause, school officials blame the growth stall on such influences as fear of hurricanes, curbs on immigration and high housing prices that drive away families.”

“In Palm Beach County, schools have struggled to handle 5,000 or more additional students a year. Last year only 270 more students arrived. ‘This year we expect to be flat. I figure we will get three kids,’ said Mike Burke, budget director for Palm Beach County schools. He was not joking. He said he came up with the total after crunching the numbers.”

“‘The only thing I really have evidence for is that fewer students came into the state,’ said Carolyn DuBard, an analyst with the Florida Legislature. In Seminole and Palm Beach counties, officials say low-income residents may have been forced out by the high cost of houses and conversion of apartments to condominiums.”

The Voice of San Diego has this report on the condo market. “A couple of weeks ago, Bob Pinnegar was discussing with his colleagues what to call the phenomenon in San Diego real estate: the condo conversions that are now reverting back to rental units.”

“Pinnegar, executive director of the San Diego County Apartment Association, isn’t sure if they ever pinned down a final moniker. But he does know that everyone in the business is asking what’s going to happen to all the people who jumped on the condo conversion bandwagon in San Diego, only to find a sinking condo market at the end of the road.”

“Many developers in the niche market of condo conversions bought apartment buildings at high costs, but now find themselves left with little option but to put their units back into the rental market, hence conversion-conversions.”

“‘”It’s sort of a game of musical chairs, and those who were the last ones to find a seat are going to get hurt,’ Pinnegar said.”

“As more and more condo conversions and new condo projects have come on the market, developers have faced tighter competition to sell units. That’s led to falling prices in the condo market and a glut of condo conversions with fewer and fewer buyers to go around. More than one-third of the 23,221 homes currently listed for sale in the county are condos, according to a real estate brokerage firm.”

“‘The condo market’s weak,’ said Alan Gin, professor of economics at the University of San Diego. ‘On the supply side, there’s been an overdoing of the conversions, there’s probably too much out there and you see that by these people trying to pull supply off.’”

“(Consultant) Gary London estimates that there are 7,000 to 10,000 condo conversions in the pipeline for the city of San Diego alone. He thinks many of those properties will revert to the rental market. For companies who bought into the conversion craze late, that could spell trouble.”

“‘There was a glut of purchases of apartments over the past 36 months, in the past 18 months in particular, where the price that was paid for the building could only be justified by converting the units,’ London said.”

“Kent Williams, who manages the San Diego office of (a) real estate brokerage firm, said his company is being approached by many investors and companies looking to offload their planned condo-conversion properties.”

“‘They can’t take them to the market and sell them as individual condos, so they’re coming to us and probably other brokers and saying ‘I want to sell these as a bulk condo sale.’ We’re telling them there’s really no premium for that; it’s really an apartment building,’ he said.”

“Chuck Hoffman, president of Apartment Consultants, Inc., cited as an example a small apartment building in North Park that has sold four times in six years. The building sold in March 2004 for $2.1 million to an investor who planned on converting the property to condos. The investor spent tens of thousands of dollars getting the building permitted for condos but then decided to bail on the project as the condo market slumped.”

“He then sold the property as an apartment building in May 2006 for $1.7 million, netting a loss of at least $365,000.”

“Condo conversion-conversions are not a new phenomenon. Industry players said they’ve seen this happen before in response to other market shifts.”

The Asbury Park Press has this update from New Jersey. “Once red hot, the market for new homes in New Jersey has begun to cool. ‘The frenzy in the real estate market that we have experienced in the last three or four years is no longer in existence,’ said Tom Critelli, president of Danitom Development, which has offices in Holmdel and Paramus. ‘We are seeing good traffic, but not necessarily anyone overreacting to having to buy now (and) worrying about the price going up later.’”

“From 2000 to 2005, housing prices statewide were up 86 percent, O’Keefe said. But household income only rose about 15 percent, O’Keefe said. Higher interest rates worsened the situation. ‘Simply put, buyers can’t afford what’s on the market,’ O’Keefe said.”

“Meanwhile, buyers are uncertain whether prices will decline and fear purchasing at the top of the market, said economist James W. Hughes, at Rutgers University. ‘The golden years are certainly over,’ Hughes said.”

“So, O’Keefe said, home builders are reacting by: Not starting new construction until they have a firm commitment for a sale. Not increasing prices. ‘The builders have become price conscious as the customers have become price conscious,’ O’Keefe said.”

“K. Hovnanian Homes, the largest home builder in New Jersey, has not raised its prices for the past six months, said Barry T. McCarron, a division president. K. Hovnanian is making sure its own homes are priced right. It may include some discounting of upgrades or options on certain homes, McCarron said. ‘We are doing it a little more frequently than we have in recent years,’ he said.”

“East Brunswick-based Kara Homes, which has built several developments in Monmouth and Ocean counties, has also been adjusting to the market, owner Zudi Karagjozi said. The company started to see a slowdown in sales in October and November, he said. It had to cut costs, including laying off 20 to 25 percent of its work force over the past six months, he said.”

“The company also has given incentives to buyers, to help make a sale, he said. Kara Homes also has reduced the price of some of its homes, he added.”

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