The Housing Bubble

Did anyone read Scott Burns column advising not to refinance an I/O loan?
http://www.dallasnews.com/sharedcontent/dws/bus/scottburns/columns/2006/stories/0707dnbusBurns.17a2151.html

Are there times when you shouldn’t?

Anybody besides me doing any home improvement projects right now? I’m finding contractors are actually returning phone calls now… a huge change from only a few months ago.

Reasons we may NOT experience an Armageddon in the stock market
* The richest 10% of the population own 90% of stocks.
* Only a small percentage of the population bought into the bubble in 2004 and 2005; few FB’s will experience serious financial stress.
* China and India and other markets are opening up new opportunities for American business.
* The internet can make us much more productive

I could be wrong..just some thoughts

I think it would be interesting to consolidate anecdotal evidence of layoffs and job slowdowns..all in one place.

Simmssays…Foolish Ways We Spoil Our Kids
http://www.AmericanInventorSpot.com

Let’s do the math.

1) What should a house be worth in your neighborhood, based on rent levels, operating costs, and the capitalization of net income at the mortgage rate?

2) And what have houses recently sold for.

Based on some optimistic assumptions I came up with $540,000 for income-based value. But in January a house sold for $1 million.

Now, as mentioned, home buyers lock in their housing costs, while rents eventually rise. There are also tax considerations. Therefore, I think owner-occupants should be willing to pay somewhat more than current income value. But not that much more. I put the correction here at at least 1/3 off.

How about a sliding scale of terms for cities’ bubblocity? Red hot boiling over (I don’t think there are any of those left) down to officially toast. Toast - Detroit, Indianapolis. Death warmed over - Denver. Still flopping road kill - Phoenix. Help me out here.

So much of the focus on weather there is or isn’t a bubble is the speculation on the future of the large homebuilders (Pulte, KB, Toll Bros etc…) but it seems to me that the bulk of the inflation in housing (at least in the Chicago area where I’m at) is due to the glut of condos which the homebuilders have nothing to do with. So my question is, am I off in my assessment that condo developers have more to do with this boom, as a whole nationally, than homebuilders? How do we track the health of those developers? Who are the largests national and regional developers?

How about a little weekend fun:

translate (a dictionary) all the abbreviations used on this site, e.g. - BK - is NOT Burger King!

How many people are getting emails like this: (Robert Aldana, RE(tm)Santa Cruz):
“Houses are not only holding their value, but actually increasing in value at a much more “normal” rate of appreciation…..It’s all relative when you think about it. We sometimes get spoiled with rates thinking it should always be that way when in reality, it is opportunity knocking and waiting for you to open the door. Buying a property at today’s price and with a good interest rate will have others looking at you tomorrow saying you were lucky to get in the market when you did. But it is not luck, it did not fall in your lap. You sacrificed a little to buy the property today and five years from now you will be realizing the success of your snatching the opportunity. See, luck is preparation meeting opportunity…….If you are a home buyer, you have to be licking your chops today as rates are still pretty darned good if you act right away before they continue to rise. Also, inventory is much more plentiful today than it has been in many years. Sellers are actually selling for asking price or sometimes below asking price. Sellers are paying for closing costs and even doing repairs. Imagine that?!…..
Think about it: the economy is slowly but surely getting better and there are more and more jobs in the area with more and more people moving to this area then are leaving…..The situation is ripe for home buyers. If you come in with a reasonable offer with reasonable terms, you may get that home at a price and terms that are much easier to swallow then yesteryear. Keep your eye on the media. All it will take is for some news publication or story by the media declaring that it is a good time to buy and here we go again!…..So if you are on the fence waiting for prices to come down, you may end up heartbroken next year or two years from now when you are trying to get into the market at higher prices and higher rates which means you will buy less house tomorrow then you can buy today. It never fails…..You should be thinking long term because even though prices get a little flat, if you hold on to that property for a few years you will realize appreciation that will have you looking back saying, “Wow, am I glad I bought when I bought!” I have YET to meet someone who bought and looked back years later saying they wish they hadn’t. Provided of course that they could afford to buy in the first place because I always say, buy what you can afford to buy. But as my twentieth year has passed, I personally have not sold a home to anyone who regretted it. And that is a lot of homes!”

This from a Realtor(tm) who has both tv and radio show in the SJ-SC area.

Is Ben Bernanke’s Fed in the process of slowly strangling the conundrum? And if so, what are the implications for the housing bubble?

A front-page WSJ article today offers many hints:

“Investment Pros Are Losing Their Appetite for Risk”

Among the sectors mentioned which fund managers are avoiding are consumer stocks (”Consumers have pretty much tapped out of their home equity, and that cash register has shown signs of going silent”) and “volatile and increasingly speculative investments that until recently had been soaring — gold, industrial commodities, real estate as well as small stocks and many developing-country stocks.”

My hunch: Ben Bernanke’s “slip of the tongue” to Maria Bartiromo will, in historical retrospect, be seen as the signal that he was serious about defending the dollar and wringing out speculative excesses.

I really want a thread devoted to how people are taking the fight to the Realtors (TM). I myself make sure I email every crackpot that I see either increasing asking prices afters days/months on the market or those that chase the market down with $1,000 decreases on $1MM homes. What are others doing?

An observation: All of the growth in the last 5 years has been driven by debt. We’ve had anemic job growth, no real wage gains, a government going more and more into the red qnd consumers with all time debt and no savings. A housing boom based on loose, unregulated, exotic loans. Which has been responsible for most of the growth in GDP.
So if (or when) we hit a real debt crisis, how much of a sh*t storm will we be in?

Small-Cap Recap: What’s Behind Real Estate Cap Rates?
Fil Zucchi
Mar 28, 2006 10:22 am
The commercial real estate game - at least in major cities - has turned into a game of “flipping.”

Prof Zucchi:

My wife’s family is in commercial and residential real estate. Over the past few years, they’ve gone into the market to buy, and ended up selling stuff that her grandfather and father bought. Properties that we thought our childrens’ children would own. They think the cap rates are ridiculous, how can people make money? They know that some of the people that bought their stuff are choking on it. People are putting in money to pay the enormous mortgages that enabled these prices. Now I see Mills (MLS) and GMH Communities Trust (GCT) in the news with accounting problems. Did they borrow too much money at too low floating rates that are now starting to squeeze their margins? Do these real estate companies really have NO earnings? Is this a Microstrategy (MSTR) in the real estate business? Is it really so simple that companies are starting to hide their losses with “Accounting Problems?” Were they ever really profitable at all over the last few years as they went on an acquisition binge?

Love the ‘Ville.

Best Regards
Minyan Lenny

Hi Lenny -

I don’t know GMH Communities at all so I really can’t add much to that story. I have been following Mills Corp. superficially and I think it is fair to say that, in its current incarnation, it is unraveling. They do have some attractive assets, but they also carry $4b of debt against $430M of reported T12 EBITDA. If it turns out that the accounting problems mean that the cash flow is not there, I think you can write the end of the script for current shareholders. I know Vornado (VNO) has been looking at them and so has the Blackstone Group. It’ll be interesting to see if they step in and for how much.

I don’t know if MLS is the real estate equivalent of Microstrategy, but I doubt it. (For those who don’t remember, MSTR’s implosion due to its accounting shenanigans was arguably the catalyst for the bursting of the internet bubble). Most REIT’s do earn real money. But you are correct that they are paying absurd cap rates for properties. Part of the reason is that REIT’s these days don’t see cap rates as meaningful. (For those not familiar with “capitalization rates,” they reflect the expected rate of return on a property based on the underlying cash flow. If a property is bought at an “8 cap” it means that it will yield 8% return on the price). The commercial real estate game - at least in major cities - has turned into a game of “flipping.” As late as 10 years ago institutional investors had investment time frames of 5-10 years; today they are looking out 2-5 years at the most. In such a short period, cash flow is viewed as a course of funds to spruce up the property until the next fool rushes in to buy it at a higher price. That’s when the return on the investment is realized. Therefore, cap rates are ignored because “this time is different.”

The valuation stick of choice today is “replacement cost.” Would it cost more to put up a property or to buy one already there? This thinking of course is nonsense because the buyers know full well that building a new property is usually not an alternative; but it lets the purchaser assign to replacement cost pretty much whatever number they need to justify the price they are going to pay.

There are three tightly related reasons why this “new paradigm” has taken hold:

1. Flipping commercial properties is extraordinarily profitable for the REIT manager - not to be confused with the REIT investors. People do not realize the staggering amount of fees collected by managers in the form of transaction fees, asset management fees, co-property management fees (a property management fee charged by the REIT manager to the actual property manager to supervise the actual property manager; the actual property manager in turn passes that fee on to the building owner - the investors); professional/build-out fees, feasibility studies fees, and any other kind of fee you can concoct. And of course, if there is an actual gain at the end of the deal, the manager often tags on a performance fee. This is all money that comes off the top and goes to the REIT’s manager rather than the investor.

To give you a sense of the numbers involved, assuming a $200M asset and a 5 yr. holding period and a 20% gain on sale, a manager could rake in: 1.5% for the acquisition and disposal of the asset ( $6.6M); 1% per year in asset management fees ($10M); 1.75% property management fee on gross rents: here we’ll assume the $200M price bought 800k rsf at $250/sq.ft; avg. rents of $30/sq.ft. and a 10% vacancy rate: total management fee $1.9M; 5% of build-out costs: here we’ll assume space roll-over of 50% of the bldg. and tenant improvement allowances of $20/sq.: total fee $400k; 5% of gross profits on sale: $2M. Sum it all up and you get just shy of $21M over a 5-yr. period straight into the manager’s pockets, without a dime of capital at risk. Nice work indeed.

How is this possible? How can investor go along with this type of pillaging? Mostly because of reason No.2:

2. The large investors backing the REIT’s (pension funds, and the likes) could care less about the returns they lose out to the manager, as long as the projected returns on their investment are above the risk-free rate of return. Let’s assume that hurdle rate is 6.5%/yr., the investor requires an unleveraged $65M return over five years. With $35M coming from the projected capital gain (after miscellaneous transaction expenses such as brokerage fees, outsourced due diligence, etc.), the annual cash flow need only be $6M/year. Naturally, the key to the game is the “projected” capital gain factored into the equation at the time the asset is purchased. Over the last 5 years, that type of appreciation has been a no-brainer, and it is now a foregone conclusion that it will continue forever.

The last piece of the puzzle to create the type of frenzied flipping market we are seeing right now is cheap money, which allows buyers to leverage up capital and consummate more and more deals, at the same time. Assume the buyer puts a mortgage of 65% of Loan-To-Value (this is conservative) at Libor+ / interest only, the carrying cost would be about $8.5M/year. With gross cash rents of $21M, minus interest cost of $8.5M, minus management and co-management fees of approx. $5.5M, minus operating and cap-ex costs of $4.8M (I am assuming a conservative $6/sq.ft., though this number can vary a lot), and the net cash flow is about $2.2M or 3.1% on invested equity. This is just about the equivalent of the $6M/yr unleveraged cash flow discussed above.

As the saying goes “it’s all fun and games until someone loses an eye.” Using the assumptions above, the investor has almost no room for error. But not to worry, the manager’s fees have been paid, and if the underperformance is the result of a broader market downturn, how can one blame the manager for a “bad market”?

The next logical question is why would anyone dump money in this type of scheme? There are several reasons. The bulls will tell you that assuming 4%/yr. appreciation for 5 years is nonsense, as annual appreciation has been closer to 15% for the last 5 years. True and I wish them the best of luck that this will continue. They’ll also argue that it makes no sense to invest in Treasuries at 5% when one can get at least 6.5% in something just as solid, and with likely upside. On the topic of “solid,” I have three words for you: Resolution Trust Corporation; if you do not remember it, Google it. Getting away from the pseudo-sarcasm, maybe these investors realize that the all-mighty dollar is fading, and buildings may indeed be a better store of value than treasuries.

In the end however, I am convinced that the overriding reason these deals are getting done all over the place is the issue we harp on daily in the ‘Ville: when there is too much of something floating around - in this case printed dollars - those dollars not only depreciate from an economic standpoint, but they also depreciate in the psyche of the money “handlers”; the less something is worth the less people take care of it; and the less care is taken with money the more accounting shenanigans, and/or busted investments we are going to see. Welcome to the dark side of the “Greenspan Put”.

No positions in stocks mentioned.

THIS CONTENT IS FOR EDUCATIONAL PURPOSES AND IS NOT INTENDED AS ADVICE.

One OT item:

Businessweek had an interview with Larry Summers.

Q: How do you see the ecomony playing out?
A: The end of this expansion is not in sight, [but] there is a gathering constellation of risk. The major risks include price inflation, asset deflation in the housing market, and the risks associated with our substantial dependence on foreign capital and oil imports from less than stable parts of the world. All of this means that negative surprises are more likely over the next year than in the typical year.

Q: Is the economy on the verge of higher inflation, requiring more Fed hikes, or do you anticipate a weakening in the second half that would cool inflationary pressures?
A: I think the FED is trying to navigate its way across a very narrow ledge on a fairly high precipice. [Below are] the risks of a slowdown and housing problems on the one hand and inflation on the other. It will take both very [precise] readings of the economy and good luck for us to come through smoothly over the next year and a half.
…….

Q: Why are people so nervous about the global markets?
A: I think that there is a growing awareness that there are substantial risks…AS the old joke goes, the three most dangerous words on a ski slope are: Follow me dad. And the four most dangerous words in markets are: It’s different this time.

I think that this interview is pretty impressive and Summers brings up housings risks without any prompting.

No link as the article is behind the firewall at Businessweek.

MBA - same at the blasted company I am working for. It is all a bunch of BULL$HIT. Many are losing their jobs anyway, and a lot more to follow.

For those interested in the Northern New Jersey market.. Off topic, but as good a place as any..

Sales data for North Jersey is now available:

January
Average Sales (2003-2005): 2000
2005 Sales: 2013
2006 Sales: 1705
(Down 15.3% Year Over Year)

February
Average Sales (2003-2005): 1583
2005 Sales: 1578
2006 Sales: 1395
(Down 11.6% Year Over Year)

March
Average Sales (2003-2005): 2193
2005 Sales: 2256
2006 Sales: 2033
(Down 9.9% Year Over Year)

April
Average Sales (2003-2005): 2322
2005 Sales: 2383
2006 Sales: 1817
(Down 23.8% Year Over Year)

May
Average Sales (2003-2005): 2615
2005 Sales: 2725
2006 Sales: 2298
(Down 15.7% Year Over Year)

June
Average Sales (2003-2005): 3486
2005 Sales: 3682
2006 Sales: 2911
(Down 20.9% Year Over Year)

More data available here:

Northern New Jersey June Residential Home Sales

June statistics for Northern VA (and all counties around D.C.) are out at http://www.mris.com/reports/stats/

The first column is 2006 and the second is 2005

Arlington County, VA

Median Sold Price: $ 535,000 $ 500,375 6.92 %
Total Units Sold: 300 402 - 25.37 %

Alexandria City, VA

Median Sold Price: $ 459,900 $ 443,000 3.81 %
Total Units Sold: 232 348 - 33.33 %

Fairfax County, VA

Median Sold Price: $ 500,000 $ 500,500 - 0.10 %
Total Units Sold: 1,680 2,737 - 38.62 %

Prince William County, VA

Median Sold Price: $ 392,250 $ 385,500 1.75 %
Total Units Sold: 732 1,301 - 43.74 %

Loudoun County, VA

Median Sold Price: $ 485,000 $ 491,000 - 1.22 %
Total Units Sold: 515 994 - 48.19 %

Someday I hope to read a satisfactory explanation for one of the most puzzling aspects of the aftermath of the housing bubble: The tendency of housing sector stocks to rise on bad news. In the wake of analyst downgrades, a steady stream of bad news on cancelled orders, falling new home orders and housing starts, and a drop in the broad market indexes, the homebuilder stocks blithely hold their ground in consort…

http://tinyurl.com/n49cp

During the last RE bust (commercial and rediential) in the US, I recall reading that foreigners (e.g., Japanese investors in Hawaii and California) lost their shirts by buying high then selling low.

Do we have a profile of the domestic/foreign risk in the current market? We hear a lot about California-based flippers infiltrating the west, but do we have empirical data on the breakdown of investors in particular?

Now that Fall elections are looming, I wish we could have a thread that skewers all the politicians who have failed either to bank all of the windfall property taxes the bubble generated, or to reduce the millage (rate) to compensate. The electorate is going to be really pissed when, in the middle of all their other coming financial woes, local governments raise property tax rates to support the bloated bureaucracies they bought with the falsely-based revenues of the housing bubble. I’m sure that somewhere, some local governments acted responsibly, but I don’t know where they are. For the rest, throw the bums out.

How will retirees really effect the housing market? a recent article said financial assets will come under stress as the population sells their assets as they age. I believe this is happening somewhat in Japan and Europe right now.

I have another suggestion.

where are the cautious real estate bubble, besides on this blog?

it’s funny that when I read articles about this new oil boom, everyone is cautious about not getting burned again. yet in real estate, nobody remembers the last downturn. nobody. how can that be?

there was an article about a wyoming rancher the other day who was also involved in the oil biz. he was being very careful, buying used machinery, keeping out of crushing debt and not buying something for his oil biz that he can’t use for his ranch. where are these people in the housing boom?

Mid-East ‘learns oil-boom lesson’s

I should say though, the stock markets in the ME weren’t showing much restraint.

I’d appreciate more input from people in the business on their market observations, good and bad. What are those in the business going to be doing if they decide to go back to a prior work environment. There are thousands of support staff in escrow, title, mortgage etc….that will be affected by markets slowing down. This doesn’t include the construction industry, which is vast.

For example, we know a wonderful husband & wife Realtor team that is really struggling in sales. They are considering alternatives to real estate and we happen to be in market that is still plugging along rather well Seattle-Puget Sound area.

Assuming the majority of these single women will eventually cohabitate with a life partner, is their collective effect on demand (+25%!!!) permanent, or a transient artifact of the bubble?
———————————————————————————

“GENDER GAP
Single women jump into realty market
By Dana Dratch, Bankrate.com
Last Update: 9:56 AM ET Jul 6, 2006

NORTH PALM BEACH, Fla. (Bankrate.com) — These days more than one in five home buyers is a single woman. Spurred on by a healthy real estate market, a variety of new loan options and more buying power than they had in the past, single women have become a powerful demographic in the real estate market.”

http://tinyurl.com/epblz

Ran across this story on the PilotOnline.com (Hampton Roads, Virginia online news):

“Developer Plans 1,096 Homes Near Lesner Bridge”
http://tinyurl.com/z8mqf

VIRGINIA BEACH - A developer filed plans Thursday to build 1,096 homes on Pleasure House Point, one of the largest undeveloped waterfront tracts left in the city.

The sandy parcel on the Lynnhaven River, southwest of the Lesner Bridge, sports nearly a mile of shoreline. It winds toward the Chesapeake Bay and offers a wooded vista along Shore Drive.

The proposal is expected to spark a community debate as the city wrestles with concerns about housing density, traffic and the lack of open space along Shore Drive.

Developer L.M. Sandler & Sons calls the proposed community Indigo Dunes.

The company has a contract to buy the 69 acres from Virginia Beach businessman Wayne McLeskey, who has owned the site for more than 30 years. City Council approval is needed to develop it.

On Thursday, the developer submitted a site plan and requests for a rezoning and a conditional-use permit.

The development would feature a mix of apartments, condominiums, town houses and detached single-family homes. The tallest buildings would be twin 11-story condo high-rises. A small retail area designed to serve residents of the complex is included.

The planned community would take about 10 years to build and would be valued at $1 billion when finished. The developer is pitching it as “sophisticated coastal living.”

*******************************************

There is much more to the article, plus comments from residents who live in the area at the end of the article. It looks like there is a lot of overbuilding in Virginia Beach. Anyone from the area care to comment with first-hand accounts?

BayQT~