Real Estate is dying? Investment-wise what is the next Asset Class Du Jour?

Foreclosures soar

Home defaults hit highest level since oil bust days of'88

By John Rebchook, Rocky Mountain News
December 21, 2004

More than 11,000 real estate foreclosures have been filed in the seven-county Denver area through November, about 18 percent more than in all of last year.

And public trustees are estimating that 2004 will end with about 12,290 foreclosures, making it the second-worst year on record.

Only 1988, when there were 17,122 foreclosures, topped this year. Last year, 9,431 foreclosures were filed, which had been the second-worst year.

And there's no sign of a slowdown, even as the economy picks up steam.

"They just keep coming in droves," said Bonny Kovtynovich, deputy public trustee in Adams County.

Mary Wenke, public trustee for Arapahoe County, is seeing the same trend.

"They just keep escalating," she said. "We opened 40 (foreclosures) in one day. They never seem to be leveling off for any period of time. We could probably easily go over 3,200 this year (in Arapahoe County), maybe 3,300."

Economist Tucker Hart Adams said she's not surprised that foreclosures have risen so much. She expects even more foreclosures next year, although the rate of increase may slow.

"It certainly is a matter of concern," Adams said. "I think the worst is not over, because they are a lagging indicator. Colorado and the Denver area have been through a pretty rough patch since 2000, and we're just barely starting to claw our way out in terms of job gains. If you do not have a job, it's pretty hard to make a payment on your house."

Adams said that she thinks that lenders have made it too easy to buy a home and then borrow on it, which is contributing to rising foreclosures.

"People who could never qualify to buy a home before are now moving from apartments," she said. "Rising homeownership rates, now approaching 70 percent, is good news and bad news. It's good for most people, but not if you live in your home for only a year or 18 months before losing it in a foreclosure."

Peter Lansing, president of Universal Lending, one of the largest locally based mortgage bankers in the metro area, said both lenders and consumers are to blame for the increase in foreclosures.

"I believe my industry has some responsibility," he said, noting that almost every day many people receive unsolicited mail telling them they are pre-approved for loans.

"But I also think there is blame from the consumer who asks us for the credit and is using his house like an ATM machine," Lansing said. "Some of that is OK, but some people take it too far."

Also, if overall home values rise by less than 4 percent this year, there will be parts of the metro area where homes are showing no appreciation or are even losing value, he said. That makes it almost impossible to sell homes in those areas if the owner gets divorced, loses a job or becomes too sick to work, he said.

However, the market is not as dire as it was in 1988, when Lansing was chairman of a long-disbanded foreclosure task force.

"I don't see it as an epidemic like we did in the late '80s when the oil industry was leaving Colorado," Lansing said.

If the projections are correct, slightly more than 1 percent of the homes in the metro area will end up in foreclosure this year, compared with an estimated 2.3 percent of the total homes on the market in 1988.

And the rate of foreclosures has slowed dramatically from the beginning of the year, when foreclosure activity was up 67 percent from the first quarter in 2003.

Lansing noted that home sales are still high, and a record $13.6 billion in previously owned homes already have sold.

"It's not the out-of-control snowball rolling down the hill. We're not seeing the crisis we saw in the late 1ate 1980s," he said.

However, he said that also means people aren't seeing the home buys available in the late 1980s, when lenders and the U.S. Department of Housing and Urban Development were offering huge discounts on homes in order to unload them. At one point, HUD was the largest landlord in the Denver area, and in some cases would pay people to take houses off its hands.

And the reason money is so readily available for home loans is because many parts of the country are seeing huge housing appreciation and foreclosures are low. On a national basis, Wall Street packages 100 percent first and second mortgages and sells them as bonds, because the overall risk of default is relatively low, he said.

"If your home is going up 9 percent or in some places 18 percent a year, you will be able to liquidate your home if you lose your job and need to sell it," he said.

 

In light of the spirited debate on this thread, I thought this was an interesting piece from People Magazine 22 years ago:

People Magazine, August 30, 1982

LAND SLIDE
After years of soaring prices and huge profits, the Hollywood housing market fizzles

UP FRONT
NEOCOLONIAL ON ACRE IN BEL AIR
3 bedrooms, maid’s quarters, kitchen and 5 baths need work, brook and white wood bridge, was $2,200,000, now only $1,350,000. Oil tycoon Forrest Shumway.

CHARMING HOUSE BEVERLY HILLS VICINITY
2 bedrooms, 2 baths and powder room, 40 ft living room, brick courtyard, pool, media room upholstered for acoustics with video recorder and giant TV screen, 360 degree view of L.A. Behind gates. $1,500,000. Owner, Kristy McNichol.

NEW ENGLISH TUDOR IN BEL AIR
6 bedrooms, 5 ½ baths, maid’s room w/ bath, vaulted ceilings, marble fireplace, brick and copper kitchen, library off master bedroom, Jacuzzi, circular driveway, electric gates w/ intercom. Was $2,300,000, now only $1,550,000. Built 1981, never occupied, for sale by builder.

BEVERLY HILLS ELSIE DEWOLFE DESIGN
2 bedrooms, 2 baths, plus 1 bed sitting room w/ bath, step-down living room, den with sunken bar, 2 maids’ room w/ baths. Pool and outside bar, guest house w/ bedroom, kitchen, bath, gardens. Was $2,900,000, now $2,100,000. Once Rosalind Russell’s home.

BARONIAL HOLMBY HILLS MANOR AND GUEST HOUSE
7 bedrooms, 6 baths, tennis ct, pool, Nautilus room, media room, pinball arcade, library, 1 ½ acres. Guest house w/ bedroom and bath. Behind electric gates. Was $5,500,000, now only $4,500,000. Owner, the late recording czar Neil Bogart.

BEVERLY HILLS MEDITERRANEAN
6 bedrooms, den, family room, bar, large pool, room for tennis court, circular driveway. Was $2,500,000, now only $1,750,000. Owner, talent manager Jack Rael.

BELAIR MODERN
6 bedrooms, guest apt, 3 baths, living room, gourmet kitchen, gardens, solarium, electric gates, on 1 acre. Was $2,500,000, now only $1,575,000. Formerly Sylvester Stallone’s residence.

COZY BELAIR HIDEAWAY
5 bedrooms, 6 baths, swimming pool, .80 acre. Was $2,900,000, now $1,900,000. Owner, Mike Douglas.

Elaine Young looks sadly out at her beleaguered community and sees a once-thriving town ravaged by the vagaries of the depressed US economy. She sees a once-proud people bowed low. “I have friends calling me saying they’re thinking of committing suicide”, she says. “They have no money and their house is their only asset, and no one’s buying. They can’t meet their payments. They have no money. I’m a soft touch and I’ve loaned money to some of them.”

But wait. Don’t bundle old clothes and canned goods into CARE packages just yet. Elaine Young is not talking about unemployed autoworkers in Detroit or impoverished sharecroppers in Mississippi. Young, a Los Angeles real estate agent, is lamenting the slump in the luxury housing market in Beverly Hills. Entertainment superstars who paid millions for mansions in the late ‘70s, Young says, are now finding it difficult to peddle the properties for the traditional astronomical profits. “I have one client who put a house on the market a few months ago for $3.5 million” she laments. “I got an offer of $1.9 million cash, which he turned down. But after the house remained unsold, he called and said he was interested in the offer.”

Five years ago a house in Hollywood was worth its weight in cocaine. Although one-quarter of L.A. real estate deals are done on a cash basis, in the heyday of “creative financing” anybody who could scrape up the typical 25 percent down payment-and Rolls Royces, yachts and diamonds were acceptable-would buy a house, hold it for a few months, then sell at a killing. “People would tie up property for 90 days with a promissory note and no money in the bank and go to the Polo Lounge and try to find an investor,” remembers veteran realtor June Scott. In 1977 Scott bought a house in Beverly Hills for $340,000. In 1981, having remodeled it and added a media room, she sold it to actress Kristy McNichol for $1.3million. “Empty houses were bought, redone and sold for very high prices, “ says Scott, “and people were standing in line for them.”

 

continued:

In the glory days, Beverly Hills real estate agents were stars, not salespeople. Elaine Young, who was married for five years to the late Gig Young, now dates Frank Sinatra’s sidekick Jilly Rizzo. Super-Realtor Stan Herman, ex of actress Linda Evans, shares his $2.5 million Beverly Hills pad-and his cozy Malibu beach house-with his wife, former actress Denise Vandenburg. But the bubble burst with the rise in interest rates. “The loan market has dried up,” says realtor Mike Silverman. Lack of loans means a lack of buyers, at least for the more “moderate” mansions. “Now nothing under $1 million is selling, and the market for the $500,000 house doesn’t exist,” Herman laments. “Prices are coming down, and there are some real steals available.” He cites Gene Hackman’s Beverly Hills house. The actor moved out a year ago and put the four-bedroom, English country-style house on the market. He had bought it five years before for a little more than $1 million. Having made significant improvements, he was asking $2.5 million, but it wasn’t selling. This month the price was slashed to just about what he paid for it.

One-third of the buyers today are foreigners. Some are French millionaires who fled the socialism of Francois Mitterrand; others are wealthy Arabs or rich Iranians who fled the Khomeini regime. Iranian construction czar Iraj Azadi bought a four-bedroom home from actress Jacqueline Bisset for $2.5 million. “It was a Spanish-Mediterranean-style house on a flat acre in Bel Air-and that’s hard to find,” Azadi says. “The tennis court and the swimming pool and spa below were beautiful. That’s why we purchased it, not because it had been the home of a movie star.” Now that Azadi’s children have moved away, he finds the house “too big” and has put it on the market. The asking price is $3.2 million-just reduced from $4.5 million.

Still, most buyers in Beverly Hills remain entertainment figures; television actors, who can earn up to $40,000 per week, are among the few who can afford even devalued property. But they have proved to be very choosy of late. Real estate agents say that a house’s value no longer goes up simply because a star has lived there; indeed, ostentatious homes can actually decrease in value. “Buyers are looking for stability stripped of sham,” says Scott. “Ten years ago you had people buying houses who never had large amounts of money before. They hired decorators to give them instant lifestyle and a sense of security. The people who are buying today know how they want to live. They prefer less ostentation. They’re more accustomed to the understated elegance of a New York brownstone.”

Of course, understatement is relative in Tinseltown. Buyers still demand as basics a pool, tennis court, bidet, saunas, screening room and, recently, a video game room. But the latest demand is a more practical feature: security, Closed-circuit-TV cameras, menacing dogs and 24-hours guards are common in Beverly Hills. One resident went so far as to create a concrete-and-steel room as a sanctuary against intruders. “When they shut the doors,” says June Scott, “it’s like being encased in a tomb.”

Scott years for the good old days-and, even amid the gloom, there are a few signs that the traditional Hollywood excess is not completely dead. This year San Diego Chargers owner Eugene V. Klein sacrificed his Beverly Hills home for $8 million-$4 million more than the asking price. When Klein bought the six-and-one-half-acre property 12 years ago, he razed the existing English Tudor home and replaced it with a French Regency manse. The buyer and gone Klein one better: Besides adding a third story to the home, this new California seigneur, a transplanted Kuwaiti, is having a gaping pit dug where Klein’s front lawn used to be. In a few months the new owner will be able to look out from his palace on a true Hollywood status symbol-the only lake in Beverly Hills.

DORIS KLEIN BACON and
PETER CARLSON

PEOPLE MAGAZINE, AUGUST 30, 1982

 

Thanks Vulture. History can be very, very educational.

We have a generation of investors, traders, money managers who have never experienced a rising rate environment. Those of us who can do some real research to understand what such an environment is like IN ADVANCE will do all right.

Interesting where interest rates and inflation were in 1982 ...

 

"A Real Estate Market Timer Shares His Secrets

by Blanche Evans

Author Robert Campbell is a market timer. He explains his secret to success - the short memories of housing market ups and downs by others.

"I've always been fascinated by the market," says Campbell, "All of us are emotional creatures driven by fear and greed and that is what drives the market. You develop indicators for supply and demand and you know when they get out of whack. We live in a cyclical world."

Campbell says that real estate cycles last 10 years, but people's memories only last five. "Everyone lives in the present," he says, "and they lose sight that things can change, up or down, and that trend will continue."

Let's talk some more about that cycle thing.

"What has happened in the U.S. since the stock crash of 2000 is the FED has dropped interest rates to 1 percent to combat a struggling economy teetering on deflation," explains Campbell. "Low interest rates fulfilled the goal, but eventually it happened that they have inadvertently fueled, with cheap and easy credit, a housing bubble that we haven't seen in 50 years. Anytime an asset gets above its underling value, a bubble is created. That's what happened. Housing prices have gone up 40 percent in the last eight years, and what has to happen is either real estate prices will come down in-line with incomes and rents or incomes and rents will shoot up to realign themselves with real estate values where they are today."

Campbell says there is no national market, but there are trends. "Since 1968, the median price of homes has never declined and has moved up lockstep with incomes," answers Campbell. "Everything is going up because of inflation. Supply and demand works 85 percent of the time, but what's happened is that normally real estate prices go up with incomes. That isn't close to the case today. What we have instead is cheap and easy credit."

Is this the first time/housing environment that has happened?

"We've had stated income loans before," says Campbell. "Real estate is driven by credit and it has never been easier to get credit. People are up to their eyeballs in debt. People are living off their homes. They are borrowing, using credit cards, refinancing, and they aren't cutting up their cards, they have run their bills up. Never has household debt been higher as a percentage of household income."

What's a reasonable debt load?

"It is 20 percent," says Campbell. "If someone is making $50,000, then $10,000 goes to service debt. The FED is a perpetual wealth machine, as long as they can keep interest rates low, you don't need a job. You can buy your house and a year later you can sell it for a profit.

"Markets turn - not because we don't know what triggers it," says Campbell. "The pure effect is that prices start getting so high that people come to their senses and interest rates come to their senses, and they start backing off. They are under pressure, and they'll start backing away from spending. Upcycles are driven by greed. Down cycles are driven by fear. What matters is at what price is real estate a good investment? If you buy at a peak, debt is the evil enemy, and that is where they get into trouble. That's where the biggest potential risk is - where the reversal of the trend is - and now we are on the downside."

Why is debt such a serious risk, and why are we so comfortable with it?

"If you have too much debt, you won't be around for the long term. You don't have a cushion," reasons Campbell. "People don't save money anymore, and 70 percent of American households live paycheck to paycheck. People are living on the edge. The longer a trend goes on in one direction, the greater the risk and the more complacent people get.

"A 10-year trend has more risk," he continues. "We've had an eight-year housing run. This thing scared me two years ago. I'm not a prophet, but I see these things developing. I know housing prices went up eight percent, incomes were flat, and inflation was one percent. The risk right now is that inflation is building and accelerating and the FED has painted themselves into a corner they don't want to be in. Now they've almost got no choice but to raise interest rates and fast. Debt levels are sky-high and out of alignment with incomes, and homes prices are sky high, and whatever the correction is, even if they can engineer a mild correction, people are still going to get hurt. They are speculating, they are looking at it as a speculation. If those expectations aren't met where they can't refinance, those dreams are dashed and that could spell the turnaround in the market as well."

Campbell continues, "We live in a society that asks not 'what is the price?', but 'what is my monthly payment?' If they can max it out and afford it, and that allows them to buy as big a house as possible, the risk is this - everybody's doing it, and they are maxed out on the debt. It doesn't take much of a rise in interest rates to push people over the limit. They aren't concerned at five percent, but they are looking at seven or eight percent, they can't afford it. They can only offer 75 percent of what the seller paid for the home. If you are qualified for a $220,000 loan, and you add a down payment, you are qualified, but people give themselves no cushion, and when the next set of buyers come in and people can't qualify, then you have to sell for what buyers can qualify for. It is all about payments. It is the 'selling cars' mentality. Easy credit policies, or negative amortization loans."

What if housing prices don't go up?

"Now people are in trouble," says Campbell. "What do you think is going to happen? The best case is housing values will flatten out and they could drop between 5 and 10 percent, but a leveling out could cause more trouble than anyone anticipates."

What are we not anticipating? "That housing won't keep going up, and that they'll be able to sell it for more than they paid for it with easy credit. They are getting over their heads, overleveraged and overextended, and they are illiquid with no ability to handle the downturn."

Where's the hope?

"The economy is cyclical," says Campbell, "and they will have their way again. Hope is this - if you are not overleveraged and you are prudent, there will be so many bargains that if you don't own a home, buy one and if you don't have a rental, buy one. You can truly develop some equity for yourself. The risk is outweighed by opportunity."

Where is the opportunity now?

"Areas like Dallas, Austin, Denver, Seattle, Atlanta," says Campbell. "These were all hit by tech, airlines, telecommunications - there are also other reasons why they have spiraled down, like Dallas' poor city management. If you were going to buy investment property, buy it when it's down. It will recover and the return on your money is high. Our prices are so sky high like Boston and smart money is selling here (San Diego) and buying in those areas I just mentioned to you."

Campbell often asks himself, what would his guru Warren Buffett do? "If you want to learn to invest, invest like he does," says Campbell. "He's patient, self-disciplined, and he knows the lower you pay for anything, the higher the upside. He's not bad to model after. Real estate is overpriced relative to income, so buy on bad news. This may be over the top, but do the right thing with your money, so you can keep it. It isn't all about money, we're talking about markets. Buy when the blood is in the street. Is Dallas going to turn into a ghost town? Of course not, it will come rebounding back."

"The worse it is, the better it is," says the investor. "High price equals high risk equals low returns. Low price equals low risk equal high returns. When you buy real estate, you have so many more options when prices are high. Things can get bad and you are still OK, if you buy early. It is all about at what price do you acquire that asset?

"Nobody wants a house when its cheap, but everyone wants it when its expensive. When cycles are down, sales activity is low, and when prices double, everybody wants it."

Published: November 30, 2004"

 

The thing is, controlling the economy through the manipulation of the federal funds rate wasn't done properly until they cranked it way up to choke inflation in the early 1980's. As an analogy, up until then, people could only guess at what would make the cars engine slow down, by doing things like removing plug wires. Since then, they've learned how to use the gas pedal and, except for Greenspan getting a little over exuberant at slowing the economy down during the dot com mania, I think they've been doing a pretty decent job. I know, I know, the first rule of investing is to never say, this time its different. However, you have to admit that they are more vigilant these days and they do seem to have a good feel for how to bend the economy to their will through rate changes.

 

More vigilant? All they've done is double down repeatedly.

Trying to keep the good times rolling with an endless flow of easy credit is roughly equivalent to the casino gambler's martingale strategy.

In the long run the martingale strategy doesn't work, because a) the bankroll requirements are ultimately too onerous, and b) the casino imposes real world limits on how big you can bet. Greenspan is the gambler in this situation, the US treasury supplies his bankroll, and the real world limits are imposed by foreign and domestic creditors.

I highly recommend you pick up Victor Sperandeo's "Methods of a Wall Street Master," first or second edition. He does a good job of distilling the core of Austrian economics, which is built on the premise that booms and busts are caused by government attempts to manipulate credit. And that's all Greenspan really does at the end of the day.

Artificial means simply do not work in the long run. Real wealth is created by productivity and innovation, not a printing press, and all that easy credit does is a) prolong the inevitable, and b) make the ultimate bust worse.

Consider a basic premise from Gavekal: there are good bubbles and bad bubbles. A "good" bubble is one that is financed by investors and leaves productive infrastructure behind when it bursts. Railroads, manufacturing capacity, fiberoptic cables, etc. When a good bubble bursts, a handful of industry winners are left over, useful assets and means of production are laying around waiting to be picked up, and the pain of the bad decisions was largely absorbed by investors.

In contrast, a "bad" bubble is one financed by banks -ultimately the taxpayer- and leaves no productive assets behind when it bursts. By this measure, the housing bubble is the mother of all bad bubbles. When it bursts, we are going to get it coming and going- falling RE + rising rates will hit Joe Sixpack right in the wallet, and we'll probably pay through the nose via tax sponsored bailouts also (remember the savings & loan crisis). And what productive assets will be left behind when the housing bubble bursts? Jack squat. The credit-induced pop in RE valuations is the productivity equivalent of vaporware, like a giant internal ponzi scheme.

If Greenspan hadn't been so gung ho on pain avoidance, we could have taken our licks after the dotcom bubble burst (also credit enhanced by the way) and at least had the benefit of low cost assets left behind with the telecom supernova. Those assets are just now coming into play, and we'll reap long term gains on fiberoptics, technology and internet / technology based productivity improvements over the next decade or two. Things would have been ugly if we took the short term pain, but a lot of the people who were hurting would have transitioned into lower cost jobs -the kind of jobs that are going overseas now- and started saving instead of extending themselves further based on an RE wealth effect. It would have hurt for a while as recessions always do, but we would have replenished our collective savings, companies would have benefited from the expanded local labor pool, and it would have positioned us better for the next upswing by firming up the base.

But no, we couldn't be responsible and take the pain that was due. We had to keep the party going, and so we essentially postponed the pain by transitioning the first bubble into a second one five times bigger than the first, primarily financed by banks (and ultimately taxpayers when it goes bad), and one which will leave zilch behind in terms of productive assets.

Greenspan has a short term mindset like 99% of all other politicians. He is a gambler who is driving us towards the edge of a cliff (while short sighted fans cheer him on). Central banker rock star status will prove to be a temporary phenomenon when his efforts lead us to disaster. And not some new disaster but a classic disaster, the same movie that's been played countless times before.

It really is the same; this time it's not different at all.

 

The player can't go negative on paper and then go BK in the casino. But perhaps a country can?

Lets see....a male lives an average of 73 years...could he perpetuate the cycle long enough to live good...hmmmm....bk every 7 years....hmmmmm......

Would America keep its natural rescources, in the event of a national default? What would the ramifications be on the rest of the world?

Wifey



Trying to keep the good times rolling with an endless flow of easy credit is roughly equivalent to the casino gambler's martingale strategy.

 

Sure we'd keep our natural resources. But the natural resources we buy from the rest of the world -as well as the manufactured stuff- would become prohibitively expensive as the USD became a banana republic currency. Considering our current habit of importing 50% more than we export, that would hurt like hell.

We would, in some form or another, survive the adjustment after a default. But the pain would be enough for politicians to fear public lynchings.

At this point, if the US goes down the crapper, so does the rest of the world. We're still the biggest engine on the wing of the plane, and there's no one to replace us as of yet. The other guys know this. But it won't always be this way. The ball of fire scenario is less likely (though still possible) b/c the world knows their wagon is still hitched to our star. But that doesn't negate the danger of long term erosion as we struggle under the burden of debt liquidation.

Our best hope at this point, as it has been in the past, is innovation. We can't just save our way out of this hole, we have to think our way out. With innovation and intellectual property, we can create enough value to offset the incredible burden of debt we've amassed. But that requires savings for genuine investment in genuinely productive endeavors, not feeling rich b/c property values are hopped up on credit.

If we lose our innovation edge -if it's slowly ground away by bad policy, onerous tax and debt loads + better opportunities elsewhere for innovators and investors- then only the bad habits are left. In the long term, that's the real risk we face. The bigger danger, more so than meltdown risk, is long term erosion.

 

darkhorse,

Your posts are some of the best on ET. Thanks for taking the time to share your thoughts.