The U.S. Housing Bubble
More Green Stuff e-Letter: Issue # 1
November 21, 2006
The U.S. Housing Bubble: Is It Wrecking Ball Time for the Housing Market?
by Alexander Green
Oxford Club Investment Director
Let me begin by sharing a few thoughts with you on the rapidly cooling housing market. Two months ago, I wrote a report detailing a conversation with my older brother, one of central Flordia’s most successful homebuilders.
He believes that the residential real estate market is wildly inflated in many parts of the country and that the downturn is likely to be protracted. I agree with his view on the U.S. housing bubble and provided a link to a recent chart by the well-known Yale Economist Robert Shiller. It’s called “A History of Home Values.” Take a look at the chart below…
It’s pretty scary. In fact, it bears an uncanny resemblance to a chart of the Nasdaq circa 1994 - 2000.
It clearly shows that while there have been plenty of booms and busts in the housing market, no one alive today has ever seen anything like the mania in housing prices of the past few years. (In the U.S., at least. The Japanese have their own housing bubble stories to tell.)
Of course, when bad news hits the stock market - or an individual stock - the price adjustment is immediate and often severe. Not so in the housing bubble.
A lot of potential buyers have been disappointed that the slowdown in U.S. real estate has not brought values down substantially. In many parts of the country, sellers are hanging on, hoping for pie-in-the-sky prices.
As a result, the inventory of unsold homes is way up and the number of transactions is way down. But be patient…
Why Home Builders Can’t Cut Prices Today
My brother’s take is that the homebuilding industry is “in a freefall” and he would gladly cut his prices 15% or more right now. But he can’t. Not yet, anyway. If he does, many of his existing buyers would walk away from their deposits and buy at the new cheaper prices.
For example:
- if a $400,000 home is going to be cut to $360,000
- It would actually be smarter to forfeit your $20,000 non-refundable deposit and buy the house at $360,000
- You’d come out $20,000 ahead
So he is keeping his prices high, while offering different incentives (like free upgrades and lower-cost financing) to new buyers. But once his existing deals make it through closing, expect to see some serious price adjustments on homes.
This game is playing out right now in many formerly hot real estate markets around the country. In fact, I’ve heard many reports that housing builders are still negotiating prices and financing costs at the closing itself! They don’t want to, of course. But many buyers are using their clout and threatening to walk. No builder wants to be stuck with unsold inventory in an ice cold U.S. market.
Taking Advantage of Falling Prices in today’s U.S. Housing Market
So when will real estate prices bottom in the U.S.? No one can say when the bubble will burst, of course. But as the rates on all those adjustable mortgages out there keep ratcheting up, along with the number of unsold homes, bargains will finally start to materialize.
It’s happening already in some parts of the country. In Miami, for example, vulture funds are swooping down to pick up brand new condo developments that have nothing but the wind whistling through them.
How do you take advantage of the U.S. housing bubble in the stock market?
Well, some intrepid souls are shorting or buying puts on the SPDR Homebuilders Index (NYSE: XHB), betting that things will get worse for homebuilders before they get better. This is a risky bet, of course.
But, if my brother’s instincts are right, it’s a potentially profitable one.
Best Regards,
Alexander Green
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More on the U.S. Housing Bubble:
- Last week the Commerce department reported that new home prices fell by 9.7% in the 12 months since September 2005, the largest amount in 35 years.
- RealtyTrac, a foreclosure tracking service, reported that nationwide home foreclosures rose 24% from July to August this year, and 53% from August 2005.
- Vulture Funds buy securities in distressed investments, in or near default, or equities that are in or near bankruptcy.
- Toll, the largest U.S. luxury house builder said fiscal fourth-quarter orders tumbled 58% this year.
- The U.S. Census Bureau reported the median price for a new home in September was $217,100, a drop of 9.7% from the previous year, the sharpest one-year decline since December 1970.
- The recent AP-AOL Real Estate poll found that 36% of adjustable-rate mortgages owners surveyed worry that they won’t be able to afford mortgage payments if rates increase.
- The Commerce Department reported last week that home construction slowed to the lowest level in six years.
- Also, the number of building permits issued fell for the ninth straight month, reaching its lowest level since 1997 and increasing fear of slower econimc growth.
Wit’s End
“If I were two-faced, would I be wearing this one?”
~ Abraham Lincoln
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- Housing Bubble: The New Real Estate Conspiracy
- 2006 Housing Market Bubble: Today’s Selloff In Real Estate…and How Many Years Before the Next Bull Market
- Housing Market Trends: Attention Bargain Shoppers… Real Estate’s New Buying Season Is Here
