The Housing Market

I was asked earlier to give my thoughts on the housing market.

Over ten years ago, I was employed by Wells Fargo which is a regional bank out in California. At the time I left the bank, the housing market was in a steep decline while the stock market was rapidly moving up. The people who I worked with everday were especially of mention. Some of the entry level workers were in their 40s and 50s. In Southern California, in fact, any entry level job at a bank was heavily sought after by all of the left-over real estate agents and small time mortgage bankers that were from the late 80s-early 90s real estate boom.

There was one man in his late 60s who had been a "VP" at a mortgage financing outfit in the early 90s who was now answering phones at the bank as a receptionist. There was yet another man in his late 40s who was resigned to doing other similiar administrative work at a seemingly low rate of pay.

The reason why these overqualified individuals were back in these lowly paying jobs was simple. Real Estate is a highly cyclical industry and many get caught in a trap. There is no money in real estate or mortgage financing unless the industry is on a tear. Otherwise, when its not on a tear, there is simply not the cash or demand for these workers. During the down times, these individuals get caught in a trap. They earned a lot of money during the good times and *SPENT IT*. Now they dont have any cash left and have to take whatever work they can find.

It was funny because a young woman called me yesterday to tell me that she was now going out with a man who is a "physical trainer and real estate agent". I looked up her myspace account and saw the guy there. He had pictures of a boat, a new car and a new motorcycle. I quickly nodded my head and rolled my eyes. This man will become like those guys I saw at Wells Fargo in the 90s right after the real estate bust. He had the thinking that the housing market will roll on forever and that he will always make the kind of money he received the last few years. He will eventually be proven wrong though.

So just how bad can real estate get...There is no doubt in my mind that its going to get a lot worse for all involved. Unlike the stock market, which seems to be more consistent and there is always a bull market in some way, shape or form. Even during the tech crash, there were still quite a few industries where cash could be made or you could have purchased puts on the tech stocks themselves.

Over the summer, I was watching CNBC where a hedge fund manager that was listed in Trader Monthly magazine as a top money maker had sold his house and was now renting. This guy explained in great detail how he thought the housing market had come to an end and now was the best time to rid yourself of a house.

In another segment, I watched how the President of the realtors foundation had his house listed up for over a year and still could not sell it at the asking price. Even an experienced realtor could not sell his own house.

This downturn is going to get slowly worse. The stock market has similiarities and differences to the real estate market. The stock market is similiar to the real estate market in that sentiment can last amongst the two for a while. There are still many people I know who refuse to get back into the stock market because they lost so much in 2000. This will happen in the same with the real estate market. However, when it happens in the real estate market its a lot worse.

If John loses a few hundred thousand in his brokerage account, it happens over the computer without him really experiencing it. When he loses a few hundred thousand on a house he lives in, it becomes a lot more personal and stressful. John doesnt live inside his brokerage account and cant experience it firsthand.

Another key difference is that funds can be liquidated quickly in the brokerage account where as a house cannot be liquidated quite as fast. So with the very personal negative sentiment and the fact that a house cant be liquidated so quickly, a persons house can in fact depreciate very quickly in a few years of time.

The key to winning the battle is to hold properties over 20 years. Some of my properties have been in the family for well over a 100 years. In fact, there is 1 property that is well over a hundred years old and was originally a farm house. Over the years, many things happened such as the Parkway went through it and they built a town around it called Elmwood Park. One hundred years ago, a man would have stepped out of this house to see rolling farm land much like Minnesota for miles. Now he walks out to see a bustling NJ township and the Garden State Parkway.

Some of you might not have that kind of time to wait, however.

I would steer clear from the housing and mortgage related stocks. Bill Gates had sunk some cash into them, but I believe that this might in fact be a dead cat bounce. When an equity falls far enough, people believe it to be a bargain and try to rush into it. However, there will be more negative sentiment to come in relation to housing. There will be many more negative reports. The tech stocks in 2000-2002 had experienced a similiar dead cat bounce where people believed the stocks would go much lower, unfortunately, there was still some more way down to go.

Will the housing stocks go up or down from here? Honestly, I dont know. The P/E ratios do seem compressed and these companies have a lot of cash from the last few years so they might be able to wait out a long downturn over the next few years. I prefer not to get involved with these stocks as the situation is, at best, unpredictable.

Time will tell what happens to housing and I might be wrong with my candid observations. I already have plans for 2010-2011 when I believe sentiment will be at its worse for houses and real estate will again be a buy.

My opinion of when to get back into housing is this...when everyone feels that you are crazy for buying a house, then thats when you should get back in. As long as people feel that a house is a logical investment, then you shouldnt touch it.

Remember your lesson from the tech crash. In 2003, you would have been thought of as a crazy man for buying Apple, Yahoo and other tech companies. In the same way, when everyone thinks you are crazy for buying a house is the time you should be buying one.

The two guys I described we could all learn from. In the good times, you do not overextend yourself and, in fact, its best to live under your means. The times wont always be this good for any industry or profession.

 

Cool post. Thanks for the history lesson.

A couple of follow up questions:

1. What is your perspective on buying and holding income producing properties right now?

2. When inflation was on a tear in the late 70's, was it generally good, or generally bad to be holding income producing property?


Looking forward to your response...

SM

 

Eagle, well said. I expressed the same sentiment about housing on different threads this entire month. The real estate market's going to get a lot worse before it will get better.

I was heavily into real estate in the 80's and 90's, but in those days, the prices were low enough that you could profitably support your expenses with rental income, even in a flat market. Those days are long gone, and people still bought rental income last few years. I unloaded my last rental property at the very peak of the market in summer of 2005, and I've been gleeful ever since.

On the other hand, I don't agree that the stock market has run it's course and is on it's way down. I still think there's a lot more upside, despite crappy reports, because there's too much liquidity in the world today.

If you're not simply tracking indexes and cherry picking the worthwhile stocks, there's money to be made. However, sentiment shifts in the stock market occur so much faster, you can't afford to not watch it. Guess that proves that there's no such thing as free money... but there's still plenty of money to be made in the market.

 

Think about this. It is very easy to sell a Honda Civic where as it is much harder to sell a Mercedes. A vehicle with a 4 cylinder and 4 doors is easier to sell then one with 2 doors and a V-6. If the Honda Civic has a few dents, it doesnt effect the price much. Where as if the Mercedes has a few dents, then you cant sell it at all.

My point is that properties that house low-income folks will always be needed where as luxury apartments will not be. There is an apartment on the waterfront in Jersey City called The Harborside. While these are in great demand right now and a place that I would definately consider renting if I was in the market for an apartment, I dont believe they will always be in demand. One downturn in the market or the economy and I can imagine a lot of vacancies.

http://www.mack-cali.com/harborside/

If you were going to buy and hold an income producing property, then it will always work out in some of the lower-end neighborhoods. I am always mentioning places like Newark, Irvington and East Orange. Thats because the building codes are relaxed, lots of people who want to rent and since its a "bad area" there is nothing that will impact the property value any further. The people who do rent in these types of neighborhoods will not be especially picky and so you wont have to renovate the apartment everytime someone moves out.

In fact, there are many houses in these lower neighborhoods that, if upgraded, could sell for a premium. There are always those people who want to live near their family or around where they grew up even if it is in a lower neighborhood.

If you buy a property in a middle to upper income neighborhood, there is no assurance that it will stay that way for 20 years. Remember I gave the example of the farmhouse that is now suddenly totally different in look, style and usage some 100 years later.

A bad neighborhood never starts out that way. Its always built with good intentions, but somehow degenerates into an area that is unpleasant.

When I am in the Philippines, I have noticed that there are many buildings and factories that didnt start out in the condition they are now. In fact, that country was amongst the richest in Asia 60 years ago and now it is the poorest.

So my feelings is that it is always good to buy income producing properties in lower end neighborhoods because they have more potential then ones in the higher end.

In fact, there is a man in California that I remember called the "Apartment King". He owned over 150 different complexes. Mainly lower end apartment complexes.

Whatever the economy is like right now or in the future, the lower-end apartments will always be in demand.

I will tell you the secret to managing properties and that is to find someone else to manage it for you. You give them a percentage of the rent as the commission. There are agencies that specialize in this sort of thing, however, you can also find independents to perform this type of thing. You can make an informal under the table cash type arrangement.

I know of a guy who manages properties by himself in this manner. He screens the tenants, cleans the apartments, and does whatever needs to be done for a "take" on the rent.

I like using local policemen to manage properties. They are not paid so much at their department so they are willing to take on such a thing. They are good at collecting rent or taking care of problems at the properties without hassle. In fact, if the building is large enough then it would be much better to have the policeman live in and manage the building. If the tenants know that a policeman lives in the building, the chance of trouble is reduced.

Private investigators also make good building managers. PIs are often involved in debt collecting and deal well with people problems. They often look for sidework and there are many that are interested.

 

Id like to add a few more points to this thread which make housing so attractive. You only have to have a few dimes to buy a house with 100% financing, unlike trading stocks, and now I will tell you why.

Loans were originally underwritten by teams at the "investor". Sometimes the loas would be underwritten by the retail brokers themselves in certain situations. An investor is one such as IndyMac or Countrywide. Nowadays, you can get a loan from them directly or through a retail broker that gets loans from them wholesale.

These teams of underwriters would consist of 2 junior underwriters, 2 senior underwriters and a team supervisor. For every 3-4 teams, there would be a higher manager. The highest level would be a senior manager. You can tell from here that it used to be a complex situation to get a loan that did not fit the guidelines. The underwriters would pass it up to the supervisor who would pass it up to the higher manager and finally it might go to the senior manager. Sometimes someone would deny it, lots of hoops.

Now they have computerized underwriting where senior management can just mess with the numbers and make your loan fit automatically without any question. Ahhhh, you see now why companies like IndyMac and Countrywide can be risky investments. There is a huge potential for fraud by senior management with these computerized loan programs. Gone are the teams of underwriters where there was lots of supervision. The only people that supervise the computers is senior management.

Now with these computers, you can get a 100% no downpayment loan. If you know the system, you can buy a few houses without ever paying a downpayment.

Now that I have told you the new system, companies like IndyMac or Countrywide may seem like reasonable shorts, but they are not. I would call them no-mans land at this point in time. If I were going to make that bet on the mortgage companies, however, I would pick NDE as the best short and CFC as the better long.

Countrywide is run by the Mozillos who have been in the mortgage business since the 60s. They have been through several housing turns and economical turns. They know how to run their business. NDE is run by Mike Perry who is a young CEO and hasnt experienced a downturn. He doesnt really know how to operate in a severe downturn. His answer is to raise the dividend and cheerlead.

However, I am not going to touch any of them because the industry is now as unpredictable as the airlines. You can still probably make some cash off of them somehow, but I will not touch them.

 

I bought in 03 with the attitude prices wouldn't hold (in san diego), then traded up from a condo to house in 05 [not willing to risk more $$ by keeping the condo through a downturn I expected]. Now I bought for mostly nonfinancial reasons, but even from 03 I was saying you'd be crazy to buy in this environment. In 05, I was even more gung-ho on this point. But regardless, I locked in on a 15yr 5.125 loan and carried over my equity gains from the 03 purchase, so my attitude was easy come, easy go; this is a long term hold with no profit expectations - just merely a lifestyle choice.

I'll start accumulating real estate when the #s work (ie yields are *historically* appropriate to offset the headaches of renting out to tenants and maintaining positive cashflow), not on the emotional whims of the market.

Regardless, I'd say you are crazy to buy now or even 2 years from now, and like all bear markets, you never go straight down. Right now like you say in the stock sector, people are hunting for low PEs, and are buying indiscriminately. this will correct, I'm sure. The stock market cycles quicker historically than the housing market, though. 1-2 years downturn in the stock market, and 4-5 years downturn in housing.

One thing people don't mention lately is the volatility of the latest housing boom. There is an implication this upcoming downturn will be much deeper than the last, since year over year #s for the past several years were in the 10%+ appreciation range.

On the other hand, this may have merely been an inflationary cue -- think of how commodity prices have caught up with housing apprecation, and home builders' bottom lines are further squeezed. If you have continued base commodity appreciation with dried up liquidity from a slowed economy (note this is another way to say "dollar devaluation"), home builders' future margins will surely turn negative, starting to look more like GM's balance sheet of the last few years.

I'm in southern california, and don't think 30-40% correction in price from current levels is unreasonable. To all of those who want to discredit my aggressive statement saying 'there's a lot of money out there', I say this: the housing market is supported from the bottom up, not the other way around. This is clearly evidenced by the latest boom almost entirely driven by excess liquidity given to historically unqualified (those with under 20% downpayment) buyers given extreme amounts of leverage to bid a market up. From this bottom-up support of the condo and entry level single family home market, the mid-level housing market of tradeup buyers was supported. And on, luxury housing prices were further bouyed. There is nowhere to hide in real estate except where housing has actually depreciated in the last few years (but that exception is largely irrelevant to this discussion). Volatility: easy come, easy go.

There was a lot of big money around even -after- the stock market crash of 1929, just remember that. It was merely redistributed. (yes, all markets are a zero sum game. there is no net gain anywhere, just merely a redistribution of value between commodities, currency, and equity)

One last partly rhetorical question along this same line of thought - what do you think would happen to the US stock market if all margin/leveraged trading were *gradually* eliminated (so as not to immediately crash them)? Or better yet, the commodity markets? [besides liquidity disappearing a bit] How much correction do you think we'd see in valuations?

 

Eagle, I've seen a lot of people go broke with that precise sentiment. In 'bad' neighborhoods, you have tenants who don't/can't pay rent, and professional rent dodgers who know it takes 60 days for you to file an eviction and get a judgement, assuming you do it yourself immediately and not thru a management company or attorney who don't put a priority on it.
If the professional tenants are good at this, they also know how to hide their assets in their gf/bf/mom/brother's name so you can't lien it when you get your judgement.

In those cases, it can take up to 6 months for eviction, and they can stall you indefinitely by tactics like clogging the toilet/breaking the electrical outlets or simply removing the covers/flooding the apartment, then calling the zoning dept to complain about YOU as the landlord who refuse to fix the 'issues' they themselves caused and they won't pay rent til you fix. Then, they are sufficiently talented to go crying to the nearest legal aid to get donated lawyers to keep them from being put in the street. A talented and experienced rent dodger can move from place to place once every 2 years and pay only security/first month the entire time they are there. Some of these people probably get 20 years of free rent for the price of 10 months.

How do I know this? Because I owned a few small apartment complexes and single family investment homes. It's unbelievable how many of these experienced rental cons are out there.

You are right, good management is best... but you have to find the right person. I've always had managers, and the things they have endured would make your hair stand up. Most don't last long. And if you try tactics like removing their doors or cutting off the utilities YOU pay for (commonly held illegal landlord tactics), they have grounds to run right to legal aid and get YOU served with cease and desist orders, and sue you for specific performance, while they pay you not one penny for rent.

Hiring a cop is a great idea, but in the neighborhoods you're talking about, cops don't want to live there.

Rental income is not for the weak stomached or those without the deep pockets to deal with all the unforseen circumstances they will hit from the moment they own to the moment they sell.

In the 'good old days' when you could buy a property for cheap enough that the rent covers the expenses, with a buffer for bad tenants, property damage and lost utility expense, it was a good idea. At today's market prices, it's not a good idea, even in bad areas.

Those who do it today are taking a hella gamble, and while it may pay off for those who bought 20 years ago, it isn't possible for it to pay off today in most areas of the country now (tho there may be a few, more rural or 'inner city' type areas left).

Investment real estate today is one of the scariest things you can get into, for so many reasons that it would take almost a book to fully cover. I DID make money in it, but that's because I bought when prices were very very low, years ago.

To give you an example of how absurdly low it has to be to cover all extremes, I paid for one 8 unit bldg $110K with rental income that averaged $3500 a month. 3 bedroom single family homes in middle class areas were as cheap as $50,000, and rented for $600 a month back then. I have seen investors lose ALL their money at THOSE prices trying to deal with those types of tenants.

By comparison, a 50% drop in the stock market is a risk that is both smaller and easier to deal with, and you never need worry that an evicted tenant who owed you 6 months of rent will come find you, to kill you in your sleep in a home invasion, to add insult to the injury (since all they have to do to find your home address is to look up the recorded deed for the property at the county courthouse's tax records).

 

Owning investment property is a business and, like in any business, there are always snags. One cant expect to open a business and not put up with some issues. The people who bought investment properties these last few years were not business minded. They believed they could just buy and hold the properties, rent to anyone and make money.

A person needs to have the proper attitude and state of mind when he goes into these types of enterprises. You have to know from the beginning that these problems exist and acknowledge them from the start. By acknowledging the problems from the start and dreaming up the worst case scenarios, then you can go about forming an action plan.

I like to rent to foreigners, non-citizens. A guy that works under the table at a bodyshop, for example. He usually has a family and will always pay the rent. He also has a network of friends that are in a similiar situation who become potential renters and are also good at paying the rent.

It takes time to develop the gut instinct of who would be a good renter. Going to court is a frustrating experience and have been there many times. This is the only way I have learned, through hard depressing experiences.

Many many years ago, I did have a roommate and he ripped me off out of the rent. That was my first experience with renters. . .

People who have never bought investment properties before are like new recruits into the Army. They go in with all the right intentions, but they never thought that the life of a soldier is indeed underpaid thankless manual labor.

The life of an apartment owner is indeed underpaid thankless manual labor. However, it can be profitable with the right state of mind, business acumen and strong heart...

It was tougher back in the 70s-80s renting to people. "The good ole days". Economy was much rougher back then...