The Real Estate Market: Another Rough Year Looming
by Alexander Green, Investment U’s Chief Investment Strategist
Monday, December 20, 2010: Issue #1411
Anyone who reads my investment commentary knows I’m an optimist. But I like to think I’m a rational one.
When the economy tanks, I know it will mend eventually. The same is true with the stock market.
But what’s happening with residential real estate right now is the equivalent of a thousand-year flood. Home prices will not rebound in 2011. Indeed, they’ll only head lower.
And this is more than just a guess…
Why Residential Real Estate is Struggling to Recover
Residential real estate is weak, in part, because the prices leading up to the peak in 2005 were wildly unrealistic and irrational. You can’t explain it with inflation, building costs, or potential rental income. It was just a mania, fueled by ultra-low interest rates, super-EZ credit and the unshakeable belief that “real estate always goes up.”
Look at every bubble of the recent past:
- The Tokyo stock exchange in 1989 – 75% lower today.
- The Nasdaq in March 2000 – 50% lower today.
Manias generally take decades to work out – and we’re not even six years into this one.
The real estate party is over. Now we’re left with the clean-up – and the hangover…
Foreclosure: From Calamity to Crafty
Some analysts say housing is weak because of the tepid recovery and high unemployment. But that doesn’t begin to tell the tale.
At the end of the third quarter, 10.8 million American mortgages were underwater (i.e. when borrowers owe more on their homes than what they’re worth). This accounts for 22.5% of all U.S. homeowners with a mortgage.
Some housing experts say this is a positive development. After all, 11.3 million mortgages were underwater at the beginning of the year. However, this drop doesn’t reflect a rebound in home prices. Rather, the number of underwater homes has declined, as banks have taken back the properties and wiped out their debt through foreclosure.
Unfortunately, foreclosure sales force market prices lower, which puts still more mortgage holders underwater. As time passes, more homeowners will realize that they’re paying a mortgage that is far more than the value of the house and walk away – even if they can afford to keep paying.
This is a troubling development, but the stigma is already gone. It used to be a mark of dishonor to have the bank foreclose on your home. Today, it’s increasingly viewed as a smart business move.
“Why should I keep paying my $400,000 mortgage when the house is worth less than $250,000?” a pharmaceutical rep asked me recently. “I’m not an idiot.”
The Millstones Around the Housing Market’s Neck
Homeowners are realizing that housing prices aren’t going to come roaring back anytime soon. And they’re beginning to feel that paying on the mortgage is simply throwing good money after bad. In fact, financial advisors often encourage borrowers to walk away.
“A bad credit record hurts a lot less than a six-figure negative net worth,” said one.
There are plenty of other pressures on the housing market, too…
- Sales Trouble: Most potential buyers can’t sell the house they’re in. That makes it impossible for them to buy another.
- Banks Get Tough: Duly chastened by all the no-money and low-money down-payments of the recent past, most banks now require a 10% downstroke or more. Plus a decent credit history. But many potential borrowers don’t have both… or either. In turn, that dries up demand. Plus, mortgage rates are rising, making even attractively priced homes less affordable.
- Sentiment: The psychology of the housing market is fragile. For years, people bought all the house they could afford (and then some) and didn’t hesitate to invest in rental properties or vacation homes. Why? Because real estate always goes up, remember?
But now, a second home is more likely to be viewed as an albatross. Speculators rightly see the near-term appreciation potential as nil.
This doesn’t mean there aren’t bargains available. But buyers need to be extra careful. I know plenty of people who bought homes on the courthouse steps a couple of years ago and are now sitting on terrific losses.
If you can buy a home at a great price and find a renter to cover your costs, by all means, consider taking the plunge. But plan to hold on a few years. The chance of turning a home over for a quick profit – unless you’re buying an absolutely distressed property – is remote.
The Real Estate Verdict is in: Another Rough Year Looming
To sum up, a weak economic recovery, high unemployment, rising interest rates, falling house prices, an inventory glut, increasing foreclosures, tight credit, poor psychology and mounting walk-aways will keep residential home prices under pressure in 2011.
And 2012 isn’t likely to be any great shakes either. Please don’t shoot the messenger.
Good investing,
Alexander Green
Any investment contains risk. Please see our disclaimer.
15 Responses to “The Real Estate Market: Another Rough Year Looming”
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For a primary residence, it seems to me that even if someone’s underwater they still have to (or would like to) live somewhere. The financial options in a negative equity situation would then be:
1) Keep paying the mortgage, get a tax deduction on what is equivalent to “rent” (i.e. the mortgage payment), and eventually you might own your home or
2) Abandon it and rent (if anyone will take you if you’ve also declared bankruptcy) with no rental tax deduction (but also no additional upkeep expenses) and the uncertainty that comes with a lease or challenging landlords (of which I’ve had plenty).
It seems to me that these other economic factors – as well as some degree of piece of mind – get buried in the “home as an investment” argument. I’ve never viewed my home as an investment – if that happens, great, but to me it’s a place I want to be. For investments, I want something liquid and with minimal ongoing maintenance expenses. For real estate, REITS seem to have best exposure and exit strategy options.
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Bankers with inflated asset values on their dishonest balance sheets are today’s problem. Mark to market is a great GOP idea, but it’s clear it doesn’t work absent a robust market. So let’s demand that banks and GSEs use real market values – what a real world market will pay – on their balance sheets. Make them sell 1% or more of their mark-to-market assets each year – and adjust their capital requirement up or down depending upon how the proceeds stack up against balance sheet values. Then, cut by one-half the fees paid to the sleazy foreclosure industry – mortgage servicers and their robo-signing paper pushers. Quit nibbling around the edge of the problem – go right for root cause and bring our national agony to a close.
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Charles said, “Then, cut by one-half the fees paid to the sleazy foreclosure industry – mortgage servicers and their robo-signing paper pushers.”
Why just cut by one-half? The interest rate on the loan is the payment to the lender. These fees are nothing but stealing. They should be illegal. Get your heads on straight, folks. If the banks can’t pay the paper-pushers out of the interest, then perhaps it’s time to get rid of the excess phony paper. My God, Americans are sheep and stupid.
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Would 2011 be a good year to buy a second house in Florida?
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Mr. Green,
Having rental properties in SoCal and Canada (where we live, now), I read your article with interest.
But interestingly, I recently had a longish conversation with a real estate agent in SoCal who said she has both plenty of buyers and plenty of sellers who agree on prices, but no bank to lend money.
Also interesting, the demand for our rental properties is strong. We renovated several last year and are getting higher rates and grateful tenants.
I’m at the end of another renovation in SoCal and the property manager has a waiting list of people wanting to rent.
While we have spent hundreds of hours seeking refinancing (mostly to leave space to weather the downturn) and have only prime loans with substantial down payments and have never missed a payment, we are denied for having too many loans. Huh?
Except in Canada, where we refied two properties in three days flat, start to finish.
Our goal at this stage is to hold on, but sell when sensible, pay down remaining loans and never, ever borrow money from a bank again.
Our further goal is to check out of the mainstream economy. Why be subjected to manipulation and scams and why put your fate in the hands of people who don’t share common values?
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I do not know how much more wrong Alexander could be. Let’s go through the issues mentioned.
1. The banks are not having to take all of the loss of a foreclosure in the first place. Their investors are having the loss. On top of that, the banks were “insured” by AIG against any loss greater than XX. Look at the inside of the indy mac deal bought by one of the Goldman Sachs directors. Banks want to slow foreclosure,( and go to short sales, which will not reduce prices as much), because they are still making money “processing” the loan. Eventually and i predict sooner rather than later, the banks will be lending again with “normal” underwriting criteria in stead of the stupid ones now in place. The banks got us in this mess, and could take us out of this mess easily, but they refuse. Here is another reason to keep foreclosures on the books only. As long as it is on the books, the bank can borrow at the discount window at 0.45%, and reinvest that money in treasuries at 3.45% for a NET 3% profit on money that is not theirs.
2. Many area’s of the countries have already seen prices rebound. Yes there are still “bad” area’s, but here in the SF bay, that is where many people do not want to live anyways, rented or bought.
3. Historical trend. Prices in many area’s are back to 2002,2003 levels or earlier). That is in line with the historical trend of price increases over the past 50 years or so in the bay area.
4 Purchase power is UP, not down. As a reflection of income , home prices are more affordable now than (almost) ever.
5. Why do you think many hedge funds are buying real estate? BECAUSE IT IS CHEAP ENOUGH NOW!.
6. Population growth rate in CA will influence demand, which will increase prices.
7. Yes, there is the tax advantages ( still at least) of amortization and depreciation ( on investment). In the past 5 years here in the bay you could not buy a house and rent it out for a zero cash flow. Now you can.
These are all reasons why you should buy real estate NOW. One more very important aspect: the mortgage rates are so low these days you HAVE to use that cheap money NOW. Leverage at 4 or 5 times, and your investment returns will be great!!
Antoine
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Lets see, you are under water in your house value. So what? If you do not need to sell and can make the payments, why cause yourself problems, unless you have a plan to get another house before you default on your existing “under water house”. Because unless you do that before you default, you are likely to be a renter for many years in the future. Your default and foreclosure will be on your credit report for years with all the negative implications that brings.
Absent a strongly increasing market value increase of housing prices, which happens, but infrequently, anyone can be under water for awhile after house purchase. It takes time to have sufficent value increase to safely get a house on the market and advantageously sold. It seldom happens immediately.
Lets face it, aside from the pride and covenience of home ownership, the return on the buying and maintaining a home is best viewed as a forced savings account. You have to make your home mortgage in order to stay in it, need a place to live, want your own place, and over time it usually works. Where this notion has arisen that a home is a good short term investment, and that if you owe more on the home than its worth you should walk, befuddles me. As a real estate professional for 45 years I have not found it as such. That is flawed thinking.
A word of warning to the chap mentioned in the above post who questions still paying on his mortgage because his home value is below his outstanding debt: be sure you plan your default carefully and be certain you are in another home you like and own before you default. Once you go bad on your mortgage, you better like renting otherwise. And, while banks are under the gun to be able to legally pursue every defaulter, bear in mind that at some point they may chase you for a deficiency, or worse, sell your debt to one of the “bad debt scavengers”. Wait till they unleash thir legal tricks on you. The only way to be immune from this stuff is to go bankrupt or be a worthless bum. Are you sure that’s what you want?
I know people who have defaulted on their home mortgage, planned well in advance, got out their home which was under water and into one which had already gone on a financial value diet. It worked, but only because they had great credit before their default. After the default, there were and will be issues, legal and otherwise. Careful!!
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I totally disagree with this article. No one knows for sure when housing will turn, but it will eventually turn. An increase in employment will help, and an increase in the bank’s willingness to provide loans for qualified borrowers would be even more helpfu!
In 2005-2006, no one believed that housing would fall as much or as quickly as it has. I would caution anyone who has written off housing’s ability to recover soon rather than later to not get too far ahead of themselves in their predictions.
Spring is coming, and we will see some welcome surprises in Housing.
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Mr Green, The real estate market continually gets lumped into an amorphous mass and judgements made on the statistics of the mass. Even your comments are guilty of this; I am an aggressive real estate investor and take a fundamental approach rather than the charting (technical) approach: Yes like many others I got caught with a number of overpriced properties purchased before the crash and yes I’m upside down on a number of properties, but as an investor I cannot afford to walk and must feed them. But right now by keeping a good credit record I am buying houses in a beach community less than one mile from the sea, I’m paying less than 50% of the actual replacement cost, with the lot thrown in for nothing. These cash flow at a minimum, of 12% net up to 18% net. The area after a small population decline is again growing albeit slowly. Hence I consider the bottom in this type of market has been reached, the fundamentals show I am purchasing a property at less than half the replacement cost of the building alone (with the lot free), and even if the prices drop a further 10% who cares we have an investment earning more than most other investments, we have limited downside and the fundamentals underwrite the floor. Over time the values will grow, the population is increasing and people have to live somewhere, our vacancy rates are less than 4%, and at some time the lots, less than 1 mile from the sea, will have value. In this market I don’t really care about trends against historic levels I look at real value in terms of replacement cost and proven cash flow.
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Hello, I really enjoy Alexander’s articles, and get a lot of insight from them. BUT… I have to vehemently disagree with his view of not being able to make profits on real estate in today’s market.I live in So. Cal. and am making 10% net profit on buying properties on the courthouse steps and flipping them. In fact myself & my wife are in Australia vacationing with some of our profits.I can certainly back up my claims on the three(3) properties we have done in less than a year.Thanks Neil
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Alex states that prices will only go down. Where???? Each market is local. Here in Southern California if you were to study the prices from 2008 you would see that prices have gone up 15%. Not the rebound from the falsely inflated market of 2006 but they are not showing signs of decreasing further. We’ve already hit bottom here in Southern California.
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Hello, I really enjoy Alexander’s articles, and get a lot of insight from them. BUT… I have to vehemently disagree with his view of not being able to make profits on real estate in today’s market.
I live in So. Cal. and am making 10% net profit on buying properties on the courthouse steps and flipping them. In fact myself and my wife are in Australia vacationing with some of our profits. I can certainly back up my claims on the three(3) properties we have done in less than a year.
Thanks,
Neil
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Lets see, you are under water in your house value. So what? If you do not need to sell and can make the payments, why cause yourself problems, unless you have a plan to get another house before you default on your existing “under water house”. Because unless you do that before you default, you are likely to be a renter for many years in the future. Your default and foreclosure will be on your credit report for years with all the negative implications that brings. Absent a strongly increasing market value increase of housing prices, which happens, but infrequently, anyone can be under water for awhile after house purchase. It takes time to have sufficent value increase to safely get a house on the market and advantageously sold. It seldom happens immediately. Lets face it, aside from the pride and covenience of home ownership, the return on the buying and maintaining a home is best viewed as a forced savings account. You have to make your home mortgage in order to stay in it, need a place to live, want your own place, and over time it usually works. Where this notion has arisen that a home is a good short term investment, and that if you owe more on the home than its worth you should walk, befuddles me. As a real estate professional for 45 years I have not found it as such. That is flawed thinking. A word of warning to the chap mentioned in the above post who questions still paying on his mortgage because his home value is below his outstanding debt: be sure you plan your default carefully and be certain you are in another home you like and own before you default. Once you go bad on your mortgage, you better like renting otherwise. And, while banks are under the gun to be able to legally pursue every defaulter, bear in mind that at some point they may chase you for a deficiency, or worse, sell your debt to one of the “bad debt scavengers”. Wait till they unleash thir legal tricks on you. The only way to be immune from this stuff is to go bankrupt or be a worthless bum. Are you sure that’s what you want? I know people who have defaulted on their home mortgage, planned well in advance, got out their home which was under water and into one which had already gone on a financial value diet. It worked, but only because they had great credit before their default. After the default, there were and will be issues, legal and otherwise. Careful!!
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I’m shocked at the number of people in disagreement with Mr. Green. It is clearly is a case of wishing for something that is unlikely. Yeah, a increase in values would help me too, but it’s very easy to see another leg down prior to any leveling off, let alone any value increases.
The shadow inventory of repos we all hear about is real. Repos create repos, and there are plenty more to come.
A few friends in the mortgage/real estate/construction and other related businesses have impressed me with an amazing level of optimism. I’m grateful and relieved that a couple have come clean and admitted they’re basically just presenting a positive front, they know that being realisitc won’t help and being positive won’t hurt. But, they confess that they expect more downward movement before any real long term rebound takes hold.
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As has been said here, people who default and go through foreclosure and bankruptcy have to live somewhere. I expect we will see rental prices go up dramatically, as unemployment goes down slowly along with home prices: apartment construction lagged all through the 2000′s.
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