just in in-tray
From: Ramsey Su
Sent: Tue, June 7, 2011 1:08:19 AM
Subject: Re-thinking Real Estate
Re-thinking Real Estate (single family residential)
Ramsey Su June 2011
Start over. Let us think about real estate from ground zero.
Where are we today?
We are deep in the hole and still sinking.
Say we have 100 million homes in the US. For every $10 decline in property value, that is a $1 billion loss of wealth in the system. This loss may show up in a higher loss severity for a lender when they foreclose or a reverse wealth effect for the lucky homeowners with plenty of equity.
For every month that the 6 million of so mortgagors who are not paying, some investor is losing interest income that will never to recovered. (Unfortunately, taxpayers are the involuntary loser here.)
The commonly accepted estimate for upside down mortgages is in the 10-15 million range. If we assume 5 million of these would eventually result in a foreclosure or short sale, what is the loss? $50,000 loss per loan equates to $250 billion in losses. $100,000 loss per loan is $500 billion. For the major distressed markets such as Florida, Nevada, Arizona and California, I suspect the average loan loss severity far exceeds $100,000 per loan. This is some serious money that I do not believe the system has adequately reserved for.
There is anecdotal evidence that some ill-advised borrowers are withdrawing from retirement accounts to try to salvage over valued homes. Others who may be in foreclosure and hence receiving free rent are not saving for the day that they have to start paying for housing again.
The hole is now so deep that we must learn how to live in it indefinitely.
Pent up demand.
One of the most common bullish argument today is this thing labeled Pent Up Demand. This blind optimism defies logic. In fact, it is total demand destruction that I rank as the biggest obstacle to any form of real estate recovery.
Look at the youngest group, the recent college grads, the new working class, the under 30 group. These are future first time buyers. The employment picture for this group is dire, compounded by record tuition debt. Demand from this group is likely going to be postponed indefinitely. Employment has to improve in quantity as well as quality before they can be converted to buyers.
The next group is the first time buyers and they are buying. Those who can, are taking advantage of record low interest rates and declining sales price across the country. That is why the entry market is relatively strong. That is why there are multiple offers for each of these entry level listings. Why is the volume not higher? The size of this pool of buyers is very thin. Why are prices not going up? The supply pipeline is full. More important, first time buyers have NO ability to raise offer price. Any increase in price, and/or increase in financing cost would price them right out of the market.
Further up the chain, trade up buyers need equity in their existing homes, not just marginal equity but lots of equity. The minimum amount of equity needed to justify a trade up is at least 10% to cover the selling costs plus 20% of the price of the trade up as downpayment. While there are current studies showing how many mortgages are under water, I have not seen anything lately that analyzes the percentage of homes with, say, >40% equity.
There are still 30% of homeowners with no loans, and some percentage with low LTV mortgages. They are largely responsible for the activity in the higher end but there is very little incentive for lateral moves, not enough to lead the real estate market out of the deep hole.
Finally there are the boomers who are reaching retirement age. Not long ago, these some boomers were expected to retire in style, buying second and third homes so they can golf in the summer and ski in the winter during their golden years. That turned out to be reality for the lucky few who are buying. As for the majority, that is nothing more than a pipe dream. This age group is actually going to create negative demand for the market.
Yes, there are investors, even all cash investors. Unfortunately, they are flippers who are taking advantage of the inefficiencies of the REO/foreclosure disposition system. There are also investors who are accepting negligible returns either because they do not have alternatives or they are betting on real estate appreciation. Regardless, this pool is thin and are not market sustaining forces.
Excess supply.
There is so much excess supply that it is no longer worthy of the effort to estimate. In addition to existing homes, builders are still building new REOs. Banks are sitting on a ton of extend and pretend land loans. Builders are sitting on a never ending supply of raw land.
In summary, the current condition is unprecedented. No time in history had we ever experienced this volume of defaults, foreclosures, diminishing demand, years of supply overhang, broken household balance sheets, waves of failed government intervention, artificially low interest rates and decline in price.
The single family residential real estate market as we knew it is over. It is time to think about what the new market looks like, when we eventually climb out of the hole. |
