Housing Rolling Along 3

Since the other two threads are above 100-replys. Why not make a #3.

The Housing Bubble—Everybody’s Talking
By Fred Dattolo August 2005

Only months ago, more than a few economists ridiculed the notion of a national housing bubble. Now everybody’s talking about it.

Last year, the Trumpet published an article that proved all the signs of a classic bubble were extant in the current housing market (“The Biggest Bubble Ever,” November 2004). We advanced what many considered to be a contrarian view—that when enough regional bubbles start popping so that their impact is felt nationally, no one will question that a genuine national housing bubble exists.

They haven’t started popping yet, but notice what the Wall Street Journal recently disclosed: “[T]he latest data suggest that real-estate values in the nation’s fastest-growing markets are getting so large that the distinction between them and the national market could become meaningless.” Quoting a chief economist at the Federal Deposit Insurance Corp., the article continued: “A slowdown would not only hurt these markets, but the U.S. as a whole” (June 20, emphasis ours).

The newest data further confirm that many homebuyers (aided by accommodating lenders) are stretching more than ever to purchase an otherwise unaffordable home, further inflating the bubble. During the second half of last year, almost two thirds of new mortgages issued were of the risky adjustable-rate (arm) or interest-only variety. So far this year, an estimated 20 percent of new U.S. mortgages are the interest-only kind—an astounding indication that borrowers are stretched to their limits.

In California, interest-only loans accounted for 61 percent of new home mortgages in January and February—compared to less than 2 percent in 2002! A conventional 30-year fixed-rate mortgage for a median-priced home is out of reach for 82 percent of California households, even though interest rates remain very low by historical standards.

“The situation with interest-only arms is just one of several very scary things going on in the mortgage industry,” according to the president of a market-research firm based in New Jersey. “The rise of interest-only loans, combined with other factors … are likely to cause foreclosures to rise … ‘possibly dramatically’” (Wall Street Journal, May 18).

In a bid to keep business booming, lenders and bankers shovel out these loans almost like the free suckers you can pick up at the bank teller window. Business Week makes these claims: Lending standards are looser, especially with adjustable loans whose rates will probably rise; loans are riskier—some loans now allow borrowers to skip payments in some months; and appraisers are pressured to deliver high-end appraisals under veiled threat of otherwise being snubbed. So as it feeds on itself, the bubble gets bigger and bigger.

Speculation

The latest feeding frenzy is accentuated by the rise in speculative activity by buyers who are not interested in purchasing a home to live in but purely as a money-making investment. Prices are climbing so fast that many are now “flipping” their properties—selling them quickly—and making thousands of dollars on a single property in just one month or less. Others are holding them longer hoping for much bigger gains.

Some will buy 10 or 20 homes at a time. A Phoenix homebuilder estimates that as much as 60 percent of local new housing developments are owned by investors. In South Florida, sales to investors are as high as 80 percent in some subdivisions. Many of these buyers don’t care if their rental income is less than the mortgage payment because home prices are climbing much faster than the amount they lose each month.

When the sizzling market finally cools, it will be this flood of speculators who, having the freedom to act (compared to owner-occupiers), will quickly sell their houses to maximize profits. This could easily trigger a downturn in housing-related activity and prompt a downward spiral on home prices. When others (for example, elderly retirees wanting to downsize) seek to jump on the bandwagon and “cash in” on their houses before it’s too late, this roller-coaster ride will have reached its pinnacle and begun to plunge down the other side. The question is: How far will it go?

The Potential Plunge

Since 2001, a whopping 43 percent of all net private sector jobs created have been in housing-related industries! Today, more than 60 percent of bank assets are tied to mortgages. And thanks in large part to inflated housing equity, American households borrowed $1 trillion just in 2004 to buy houses and other goods! Far too many assume they can count on rising home equity to bail themselves out of debt. This has the potential to be a huge disaster. Here’s why.

The Federal Reserve has flooded the economy with new money (doubling bank deposits in just eight years), but much of the excess liquidity found its way into housing rather than business investment, which would have theoretically boosted industrial production and raised wages. Nevertheless, consumer spending continued and has been the engine that has kept the U.S. economy moving. How? The spending has been supported to a great extent by borrowing on inflated home equity, rather than tangible increases in production and wages. In 2004, “household debt increased more than twice as fast as disposable income” (Daily Reckoning, June 20). In other words, it is a debt-fed consumption that continues to sustain the economy. That simply cannot continue.

As we stated in our November article, “The wealth that was created is an illusion—not based on real productive activities” (op. cit.). The Economist agrees: “The housing boom was fun while it lasted, but the biggest increase in wealth in history was largely an illusion” (op. cit.). Rich Americans have already discerned that the handwriting is on the wall. The Wall Street Journal reported that wealthy investors (in general more savvy and informed than the average person) “cut back on their real-estate investments last year, suggesting that the wealthy believe the [housing] market has become overheated …. The drop is a contrast to everyday consumers, who continue to buy up homes and drive up prices” (June 13).

The Burst

A housing bubble bust could have severe consequences for the heavily entangled banking system, heavily invested mutual funds and pension funds, hundreds of thousands of housing-related jobs, and the typical American consumer who is debt-heavy and savings-light. In the face of a hard reality check, the jolt to the American economy could affect millions of Americans—and the repercussions would be global in scope.

Probably the most significant development to date is that everybody’s talking, because “talk and high prices are the main things that end bubbles. The intensity of talk about the high prices right now is enormous, suggesting an emerging change of public thinking that may signal the end of the bubble” (Wall Street Journal, June 2).

As we pointed out last November, “[T]he U.S. economy has been perking along largely because it’s been propped up by the greatest housing bubble ever known. When it starts to unravel, it will likely lead to the biggest bubble bust in world history, hurtling the U.S. economy into chaos. … The shock waves could lead to a major global recession like we’ve never seen” (op. cit.). As extreme as that sounds, it’s becoming an acknowledged fact of life, even in respected business magazines.

“The global housing boom is the biggest financial bubble in history. The bigger the boom, the bigger the eventual bust” (Economist, op. cit.). The same article said, “[T]he day of reckoning is closer at hand. It is not going to be pretty. How the current housing boom ends could decide the course of the entire world economy over the next few years.”

We proffer the same advice to you now that we did in November. Prepare now to reduce your standard of living.

 

welll, I know that I have taken a profit in one of my properties and will probably do so on another......

all those paper profits are just that until you pull the trigger and complete the trade .....

 

I agree... but seriously when is the last time you'll be able to borrow money at 4.5%... with intrest tax deductible at that too. Taking out equity from the home is one way to reap the benefits without selling. Even if prices were to collapse afterwards.... 4.5% is still awfully cheap to borrow money.

 

I agree ... its quite remarkable that this situtation has occurred. I dont think there will be a collapse ... just a correction and it wont be as much as many people are forcasting ..... still it makes sense to take some profits off the table occasionally ... FYI I am not liquidating all of my real esate because I think the sky is falling ....

 

I believe that if you can still rent a place out for less than the payment, and the payment isn't based on a variable note, then you'll be fine if there is a bubble burst. I honestly believe, that the bubble will deflate slowly, and here's why. For the longest time, the fixed mortgage rates were kept low because they are based on the longer bonds. And as the Fed did their magic and raised short-term rates, the long term rates held steady because the logic was, "The Fed has things under control, so over the long term, rates won't go up". But now, short term rates are up high enough that they are starting to push the long term rates. And with all rates up, renting becomes a more attractive alternative, which cuts the market for home resales.

If you like that bond stuff, you can also look at it another way. Intuitively, our enconomy is not the healthiest, but it isn't sick either. If you didn't have any indicators to guide you other than the neighbors buying new stuff, you'd think that the yield curve should be close to flat, but still positive. Well, since short term rates were artificially low, the yield curve was too steep in the positive direction. As short term rates come up, it has been flattening out. Now, it has the right slope for the economic environment (IMHO). So, if you push short term rates up, the entire curve will have a tendency to move up (long and short term rates). It should do that for a while, until the short term rates are pushed so high that it starts to flatten out more and invert. My point is that we've finally found the sweet spot, and the angle of the yield curve will have some resistance to change.

So, IMHO, to win at the real estate game now, means buying at the low fixed rates while they are still low. But you have to buy into something that cash flows (or almost does). As rates move higher, your landlord competitors who don't get into fixed mortgages won't be able to compete with you and will have to raise rates. When the rates moved down, it was all about buying anything, refinancing, and selling. Now its all about the opposite. Being selective about purchases, locking into a low fixed rate, and holding on for cash flow.

I have a couple of townhouses in one neighborhood that are now renting at a monthly payment that is almost 1/2 of what they should rent for using the old "rent = 1% of value rule". That means, either the rents must go up, or the prices must go down. Since our market isn't overheated, I'm banking on the rents must move up. Rent increases are overdue.

SM

 

housing... ugh

nobody even cares about the cautions anymore.... i didnt even bother reading that article cuz i know exactly what it will say... blahbalbblah bubble..blahb... deaf ears to alarms. lol. everyone and their mother is flipping now. its soooo over.

 

1% of value? Shit, I'm renting at 0.28% of value.
I agree, rents are completely out of whack.

Martin

 

...Well.... the other way to look at this is that the violation of the traditional rent equation is telling you something about conditions ...... That is that rental considerations are no longer the basis of the investment .... Lots of people are taking properties that are underwater and and holding them for apprecitaion, not the rental benefits.

I still basically look at properties as long term holds - which is probably why I am not a billionaire - and I dont enter into them unless they support that philosophy.

 

Correction is much more likely , and acccurate probibility;
even if some are insanely leveraged ,
they could easily lose the property, but its then a good buy for some one else. So even if that is widespread , still not a bubble.

Homebuilders are still strong tek wise;
fundamentalist financial predictions have pretty much the worst track record of all, except Jim Rogers.

 

I find most people who bash housing are the ones who had a chance to buy but has since mised the boat.