Bubbles Bubbles Real Estate Troubles
There‚s an old saying: if it looks like an elephant, walks
like an elephant, and has „I‚m an elephant‰ tattooed to its
rump, the odds are overwhelmingly in favor of its not
being a duck-billed platypus. Judging from recent activity,
it‚s high time the real estate market got itself an „I‚m a
bubble‰ tattoo, despite the desperate assurances of Alan
„I didn‚t know it was a bubble‰ Greenspan,
Real estate is a subject better left to those who know
something about it. In other words, not me. But when
two-thirds of GDP is dependent upon on Mr. and Mrs.
Consumer and this charming yet heavily indebted couple
is three-thirds dependent upon forever-increasing housing
„values‰, I take notice when the market grows especially
bubblicious. Why? Because when everything hinges
upon this bubble, the fall-out of its deflation has the
potential to paint a dark shade of ugly on the financial
world I live in.
In these inflationary times one can‚t necessarily be faulted
for putting some money into the ultimate tangible:
property. But nowadays it appears that many folks aren‚t
simply investing. They‚re speculating, just like they did
during the latter stages of the stock market bubble.
The New York Times reports that in the first eleven
months of 2004, 8.5% of mortgages were taken out by
people who did not intend to live in those homes. That
figure was up 46% from 2000 and other cities are showing
even bigger numbers. In Miami it stood at 11% and 12%
in Phoenix. „It seems that real estate always goes up,‰
said one couple interviewed by the Times.
Sound eerily similar to comments made about the stock
market in the 1990s? Nothing, I repeat NOTHING, always
goes up.
Reportedly some brokers in Miami get their clients into
special VIP sales events before developers offer their
properties to the public. Sound eerily similar to the lust to
get the inside leg on the IPO craze during the late 1990s?
Consider www.getpreconstructionprofits.com which touts
the opportunity to profitably flip properties before they‚re
built, sometimes „...nothing more than a sketch of the final
property‰. Of course, „get rich in real estate‰ schemes are
nothing new. But tell me this doesn‚t have „bubble‰ written
all over it. Flipping sketches of property for profits sounds
an awful lot like buying the worthless paper of profitless
Internet companies in the late 90s, does it not?
Whatever the bubble, be it stocks, tulip bulbs or real
estate, the behaviors and offers tend to be remarkably
similar. The vehicles change, but speculative psychology
doesn‚t.
According to the National Association of Realtors,
investors and second-home buyers made up a full third of
last year‚s market. The NAR‚s chief economist David
Lereah says: „What we‚re seeing is that real estate is...a
viable alternative to stocks and bonds... they‚re placing
money in real estate, which has proven to be a stable and
wealth-building asset.‰
Indeed. But there is NOTHING stable about a market
where 20% a year is considered normal, as in California‚s
LA County, among TOO many others. The New York
Times reports that the 2004 median sales price in
Westchester County rose from $564,000 to $645,000.
Said one real estate agent: „More and more families are
seeing the residential real estate market as the best and
safest place for their money.‰
„More and more families‰: sounds a lot like the „more
and more investors‰ in the latter stages of the stock
bubble. And „more and more families‰ don‚t make money
speculating in the long run. Sure, everybody banks a
temporary profit in a hot market but they give it right back
in the ensuing bear. The dirty little secret of the securities
and futures industries is that 80% or more of investors
lose money. You think the numbers will be better in a
hyper-leveraged real estate bubble? Did investors
suddenly wise up and learn how to speculate profitably
over the past few years? I doubt it.
It‚s always the same story. Times change, investment
vehicles change, but people do the same silly things over
and over again: make a profit in a hot market, leverage it
up repeatedly to make bigger profits until one day they
find themselves at the top of the market holding their
biggest position ever. And buyers are nowhere to be
found.
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Everybody makes temporary profits in a hot market. Like
the old saying goes, in a strong enough wind even pigs
fly. But when that wind dies down, the pigs usually find
themselves lost in a cornfield in the middle of Kansas
without so much as a bus token to get them home.
But bubblicious behavior isn‚t the exclusive domain of Mr.
and Mrs. Consumer. „Fannie Mae‰ is leveraged to the hilt,
holding virtually nothing to get it through a significant real
estate downturn. And as bond underwriter Eric Englund
reports, Fannie Mae‚s debt to equity ratio is a stunning 43
to 1. That‚s 43 times more debt than equity.
It‚s hard to hedge a portfolio the size of Fannie Mae‚s for
obvious reasons. But worse, whoever‚s holding the other
side of the hedge gets killed in a downturn. And it‚s big
enough that the repercussions would sweep through the
credit markets like Rosie O‚Donnell through a cake shop.
It‚s a time-bomb waiting to explode and a dip in the real
estate market could light the fuse.
What‚s being done about it? Nothing. The government
touts the benefits of home ownership while Fannie Mae
rolls out 40-year mortgages under the guise of helping the
wee, poor, disenfranchised folk to participate in the
„ownership society.‰ Who lives in a home for forty years
these days, long enough to pay it down and actually own
it?
Where‚s the ownership in interest-only loans? Ownership
doesn‚t even start until 15 years into the mortgage and by
Fannie Mae‚s own admission, most folks move or
refinance after 5-7 years.
It‚s not about home ownership. It‚s about expanding debt
because in a bankrupt nation the only way to service ever-
expanding debt is by ever-expanding the debt! AND
THAT‚S A BUBBLE. Unfortunately, every credit bubble
always hits a limit and deflates, leaving financial ruin in its
wake.
The danger of this bubble popping, and it will pop, is the
fall-out to the economy as a whole. Folks seem not to
mind too much taking a flyer in the stock market, having
their heads handed to them on a plate, and then moving
on. But when the house drops in value, the psychological
reverse wealth-effect can (and will) take a heavy toll on
our consumer-driven economy.
When the bubble will top out is anyone‚s guess. The
nature of a bubble is such that it tends to run higher and
longer than any rational person might figure. It all hinges
on interest rates. The Fed did a wonderful job of inflating
a new bubble to mitigate the impact of the collapsing stock
market bubble. Unfortunately for them, this bubble is
100% dependent on low interest rates, something which
the Fed can‚t deliver upon forever.
New home sales took a dive in January causing the
inventory to rise by 17% from the previous year, the
highest level since June 1996 and a level which has
historically indicated trouble for the market, according the
Rick Murray of Raymond James & Associates. The
median price fell 13.2%, the first slide in 14 years. Signs
of a top? Perhaps. Or perhaps as they used to say in the
late-1990s stock bubble, „a buying opportunity.‰
Call it what you will, but there comes a point at which most
folks are priced out of the market and buyers become
scarce. Any investor can afford a few shares of Acme
Internet & Bowling Ball at $300 a share during a stock
bubble. Few investors can afford a $600,000 mortgage
on a 2-bedroom shack overlooking a brick wall,
particularly when the assessed value drops to $450,000
after the bubble peaks. A real estate bubble running out
of buyers is a far more dangerous animal than a pricked
stock bubble. Don‚t get stuck holding the bag. Leave it
for the „real estate always goes up‰ crowd.
Mark M. Rostenko
Editor
The Sovereign Strategist |
