Real Estate: No Bottom Yet?
John Mauldin is an investment adviser and president of Millennium Wave Investments. He sends out an interesting weekly newsletter, which most recently focusedon the current real estate market. It seems like the bottom isn’t in sight yet:
If you found this post helpful, consider donating to my coffee fund!Analyst contend that much of the bad news in the subprime-loan and housing market has been written off. And one would have to admit that a lot has been; and with the relaxation of mark-to-market, there may indeed be some truth to that suggestion. But there are still some issues that remain for housing. Take a look at the graph below. (Not sure where it is from, as it was sent to me, but I have seen the same data elsewhere.) Notice that monthly mortgage-rate resets declined markedly in 2009 from 2008, but are expected to rise again in 2010 and 2011. There is still some heartburn in the mortgage market.
The Shadow Inventory of Homes
And foreclosures keep climbing, though some point to that fact that they seem to be leveling off. However, a strange thing is happening. We are seeing what is being called a “shadow inventory” of foreclosed homes.
“We believe there are in the neighborhood of 600,000 properties nationwide that banks have repossessed but not put on the market,” said Rick Sharga, vice president of RealtyTrac, which compiles nationwide statistics on foreclosures. “California probably represents 80,000 of those homes. It could be disastrous if the banks suddenly flooded the market with those distressed properties. You’d have further depreciation and carnage.” (San Francisco Chronicle)
A Realty Trac survey found that only 30% of foreclosures were listed for sale in real estate listings like the MLS (Multiple Listing Service). Add in homes that people would like to sell but simply can’t find buyers for, and must either hold or rent, and the unsold inventory numbers that are public are likely far below actual available homes.
Might some homes in foreclosure be held off the market because banks eventually want to negotiate with the homeowner? Possibly, but other surveys show that anywhere from 30-40% of homes in the foreclosure process in many areas are actually already vacant. There is no one with whom to negotiate.
Typically a foreclosed home sells within a few weeks, as banks take the first “reasonable” offer. But it normally takes about three months from foreclosure to when the home is put on the market — it takes a few months to get a home ready. But surveys show it is taking a lot longer now, and many homes have not made it onto the market, even as more homes are being foreclosed each month.
The Chronicle suggests several factors may be at work. First, there is the “pig-in-the-python” problem. There are just so many homes that it is hard to get them onto the market and sold. Normally there are about 160,000 homes a year in foreclosure sales. We are now seeing 80,000 a month, or six times normal levels, and rising.
Second, lenders could be deferring sales to put off having to acknowledge the actual extent of their losses. “With banks in the stress they’re in, I don’t think they’re anxious to show losses in assets on their balance sheets,” one observer said.
Finally, banks may not want to flood the market with foreclosures, driving prices down even more. They are simply managing their assets so as to recover the most capital they can.
Given that the graph above says there will be more mortgage misery as large numbers of mortgages reset in the next two years, and given the unknowable nature of the losses, it is somewhat optimistic to think financial profits will rise by 74% in the fourth quarter. But it gets worse.
Commercial Real Estate Starts a Long, Slow Slide
We are now starting to see some real deterioration in traditional bank lending. Delinquencies on home equity loans are rising rapidly. The American Banking Association released a composite index of eight different types of consumer loans, and the delinquency rate on this 35-year-old composite jumped to a record high of 3.22%.
The above reflects 4th-quarter data. As unemployment is up 2% since then and is rising, it is more than reasonable to assume that we will see another record rise in delinquencies this quarter. With unemployment headed to over 10% and maybe 11% from today’s 8.5%, delinquencies are likely to continue to rise for the entire year.
David Rosenberg reports that “The National Federation of Independent Business found in a poll that 28% of small firms said they had a line of credit or credit card limit cut back in the second half of last year; 69% stated they are facing worse terms. A new FICO study found that 11% of US consumers — 22 million people — have had their credit lines cut or accounts closed even though they have been paying their bills on time and retain a solid rating.” This is certainly not good news for those who expect a positive 4th quarter. Cutting credit to small business, the engine of job growth in the US, is hardly a prescription for a growing economy.
Commercial mortgages are in trouble. S&P has warned they may cut ratings on $97 billion in commercial-mortgage asset-backed debt. The country’s 10 biggest banks have $327.6 billion in commercial mortgages, according to regulatory filings. A projected tripling in the default rate would result in losses of about 7% of total unpaid balances, according to estimates from analysts at research firm Reis Inc.
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April 13th, 2009 at 6:04 pm
What is the actionable investment advice coming from this piece? This seems to me to be more scare-mongering, ala Nouriel Roubini and Peter Schiff. What Mauldin posts (the reset schedule for ARM mortgages written from 2004 to 2007) is very old news and not really all that scary any more. It would have been a lot more interesting and actionable in 2006.
The fact that the author doesn’t even know the source of the graph is laughable. Why would anyone publish something he can’t even source? The data may be from 2007 for all we know; someone’s projection of what COULD happen to mortgages if they all reset as they were originally contracted to. But what happens if those homes have already gone into foreclosure, been sold short or have been refinanced? It seems likely to me that the high level of refinancing from the Fed sponsored programs is going to alleviate what the chart shows. This is the entire point of the massively subsidized refi program.
Whether we are at the bottom, or close, it is obvious to me that the Federal government will do whatever it takes to reflate housing. That may be bad for inflation and good for gold, but it will definitely mean a bottom in the housing price slide (gold can’t go up as long as housing keeps going down). Same for other types of real estate. Did this author miss the turn around in Las Vegas property a few weeks ago, most notably the MGM debt renegotiation?
If his action is to sell, sell, sell and stuff money in the mattress, then I hope he keeps preaching that to his clientele. I am long the stock market now and need the proverbial “wall of worry” to make money. And I have made a ton of money the past 30 days, so I hope John Mauldin keeps it up.
April 14th, 2009 at 11:53 am
Excellent article. Thanks for the info. I have considered buying a house, but the downsides still outway the advantages at this point.
April 19th, 2009 at 12:50 pm
[...] Real Estate nowhere near the bottom? [...]
April 20th, 2009 at 10:23 pm
Nice post. I recently wrote one on this topic. It speaks about the price of housing futures currently being traded which call for a near 30% decline in home prices for the 2009 year. Check it out here – http://wrinklydollar.com/?p=31. Nice blog.
April 25th, 2009 at 2:36 pm
I have seen this chart before, it is from Credit Suisse and came out about mid 2007 as I recall. However, I do not believe the chart takes into account the fact that the Option Arm resets do not just reset on the date indicated per the closing documentation.
The option arm was a complicated product and almost always contained a reset based not only on time but also the % above the original loan value. As the borrower deferred interest and it added on to the principle balance they could trigger a reset if the principle reached certain parameters. Lenders set their automatic resets as low as 110% of the original balance. SOOOO…a very important factor was/is the full indexed interest rate (”real interest”) they were paying.
Many people were so focused on the deferred interest payment – they did not realize they were paying extremely high “real interest”. Lenders paid big commissions to brokers in order to provide incentive for them to “sell” the highest rates possible. The net result is that many of these option arms that were set up as 5 year loans ultimately “recast” in about 3 or 4 due to the fact they deferred so much interest that they exceeded the original balance threshold.
That being said – basically my opinion is that this chart is a bit misleading. Many of the option arms ORIGINALLY schedule to reset in 2010 and 2011 are actually resetting now. Meaning – there is no “eye of the storm” but more
April 25th, 2009 at 2:51 pm
I have seen this chart before, it is from Credit Suisse and came out about mid 2007 as I recall. However, I do not believe the chart takes into account the fact that the Option Arm resets do not just reset on the date indicated per the closing documentation.
The option arm was a complicated product and almost always contained a reset based not only on time but also the % above the original loan value. As the borrower deferred interest and it added on to the principle balance they could trigger a reset if the principle reached certain parameters. Lenders set their automatic resets as low as 110% of the original balance. SOOOO…a very important factor was/is the full indexed interest rate (”real interest”) they were paying.
Many people were so focused on the deferred interest payment – they did not realize they were paying extremely high “real interest”. Lenders paid big commissions to brokers in order to provide incentive for them to “sell” the highest rates possible. The net result is that many of these option arms that were set up as 5 year loans ultimately “recast” in about 3 or 4 due to the fact they deferred so much interest that they exceeded the original balance threshold.
That being said – basically my opinion is that this chart is a bit misleading. Many of the option arms ORIGINALLY schedule to reset in 2010 and 2011 are actually resetting now. Meaning – there is no “eye of the storm” but more likely we will see an elevated level of foreclosures, similar to what we are currently experiencing, through the first half of 2010. But based on how the option arm works, I expect most of them will be through the system by the end of 2010. At which point there will be a dramatic drop.
So is it safe to buy? Depends on your location – but in my area I believe it is. I just bought a 1630 sq ft house in Gilbert AZ for $119,000. There were four competing bids on it. It is 4 years old in a 3 time award winning master planned community. That is $73/sq ft. How much lower can it go before the sheer cost of materials provides a natural bottom? Obviously I do not think much lower – but that is the question. However – if you think inflation is a possibility down the road – you have to acknowledge that inflation in raw materials will lead to a rise in the cost of housing. If you can’t build it for $73/sq ft – then it will not remain at that price forever.
Just my two cents of course.
April 26th, 2009 at 8:42 am
Charles: Great information in there. You bring up a good point about option ARMs. Most of them will recast at 110%, 115%, or 120%, before the 5 year limit, as you mentioned, and that brings recasts earlier.
I just wanted to mention that the fully indexed rate is another thing to consider, too. The chart was created back in 2007 I believe, when index rates were much higher than today. Many option ARMs are indexed to 12 month MTA. With index rates and fully indexed rates much lower today, that would tend to push recasts outward toward the 5 year limit. It would be interesting to see just how much of that “eye of the storm” has returned with lower rates.
As for real estate prices, they are very localized. While housing futures forecast a roughly 26% decline in prices for 2009, that can vary sharply for costal cities, rural areas, and those most affected by the bubble runup. As an aside, I think “getting back to averages”, as some people argue, will not be enough. Most bubbles tend to overcorrect on the way back down.
April 27th, 2009 at 7:54 am
Wrinkly: Good point on the fact interest rates have fallen. That may indeed help delay the principle balance recast clause.
Indeed, I am sure that adds to the “fog” surrounding anyone’s ability to time an entry into the whole real estate investment sector. In the end though – if you can purchase with a long term perspective, I am one of those who believe we are in the process of over correcting to the downside now. Just as many were wrong to think RE could go up forever, I think there is an overly cautious perspective to the downside. No matter when the last option arm actually resets – if you look at that chart there will be a massive (and fairly abrupt) interruption to the supply side of housing.
Unless the doomsayers are right, it will most likely be timed with an improving economy. Even if we are in an L shaped recovery – there should be some stability at that point. Those still with jobs should no longer be living in daily fear that they will lose them. That, couple with the fact CAP rates are already now attractive to RE investors should lead to increased demand.
I am not advocating one buy blindly – but I do believe for someone willing to do their research and hold long (more than 5 years)- certain markets are beginning to offer attractive opportunity in real estate that may not present itself again (at least in my lifetime).
April 27th, 2009 at 8:54 am
Charles: I suppose only time will tell if today’s real estate levels are cheap or not.
One important thing I neglected to mention concerns lower rates as well. Not only will lower rates tend to push the eye of the storm back out to 5-year recasts, it will also drastically reduce payment shocks. With 12-month MTA around 1.4% today, a borrower could see his mortgage recast to a rate of, say, 5%, as opposed to around 9% when the chart was created. Still an increase over previous payments, but perhaps a tempering of the damage.
In any event:
1. The chart needs updating to paint a better present day picture.
2. Beware option ARMs are a small part of the mortgage and housing market (although a larger part of the “defaulted” market) so basing housing price movements off of OA trends may not paint a relevant picture.