just in from real estate guru of the roundtable
These are the REAL ESTATE related indicators and events I look for in 2009. I will even stick my neck out with some predictions, must be getting daring in my old age.
Summary: In about 30 days, we are going to see the new and improved regime unveil their new and improved rescue plan. Regardless of merits, the market is so desperate that anything would be considered good news. A huge rally will provide an excellent entry for a solid 2009 portfolio. At the moment, I am giving zero probability that any plan would arrest the deteriorating real estate market during 2009. I was far too optimistic with my 2008 outlook. I hope I have lowered the bar enough this time.
Unemployment and Quality of Employment – Undisputed #1 Indicator
The unemployed are not buyers. The underemployed are not buyers. Those in fear of being unemployed are not buyers. Those in government “created” make work are not buyers. The labor market is just now entering a very ugly phase. If job loss accelerates in the next few months, then I opine 2009 can be written off as far as real estate is concerned. No amount of tax credits or interest rate subsidies can stimulate the unable and turn them into able buyers.
2008 Vintage Foreclosure Prevention Programs – “Failure”
Hope for Homeowners, Mod in a Box and other foreclosure prevention programs will all fail for the same reason (not that they have any merits to begin with). These modification plans are all based on some ratio of the borrowers’ ability to pay. They are intended to term of a loan while assuming the borrowers’ financial status is unchanged. None of these modification plans are intended for changes of the borrowers’ financial conditions, such as unemployment. It will be impossible for servicers to sort through the personal finances and employment status of millions of defaulting borrowers.
2009 Vintage Foreclosure Prevention Programs – The Big Unknown
While the details are unclear, it is a foregone conclusion that our political leaders will be working on new plans to reduce “preventable foreclosures”, whatever that means. We know Barney Frank is advocating an early release of TARP funds to “help” homeowners. With only $350b of TARP funds left, it is inconsequential when compared to the over $11 trillion of mortgages outstanding, even if the entire balance is spent on housing. We saw how fast the first $250b of TARP funds disappeared into the black hole. The major accomplishment was “it could have been much worse”.
In the next few months, “preventable foreclosures” are going to progress to “preventable evictions”. Fannie Mae started leaving tenants in their REOs. I think that is the beginning of occupancy subsidy programs.
Looking forward, Bernanke is playing no limit poker on the monetary side. The fiscal side is contemplating a trillion dollar plan with a random job creation target. Pertaining to real estate, it is unclear what these policies will or is intended to accomplish. Worse yet, there can be unintended consequences that exacerbates the problem. For example, stimulating demand may be considered a good objective but if the policy encourages (may even subsidizes) builders to add to the already excessive supply, it will prolong the current supply demand imbalance.
Demand Exhaustion – Very Easy Indicator to Watch
There is an un-quantifiable number of buyers on the sidelines, some home seekers, some investors. We do know this number is pretty small. The pent up demand that the industry is hoping for has already purchased during the toxic era and is now strapped by a loan they can’t afford to service. As the market condition continues to deteriorate, some in the small remaining pool will purchase while others will be removed from the demand pool either due to fear or due to inability such as job loss. The indicator to watch is the reaction to the forthcoming massive stimulus programs using new and existing home sales. I think we are going to see lower sales figures regardless of stimulus.
Housing Supply – Surplus and Shortage
Just like the US auto manufacturers with the giant trucks and SUVs, the homebuilders built what they can sell, hence the McMansions, marble counter tops, media rooms, fountains and features that were unaffordable by the masses but made possible by bubble financing. In addition, communities of thousands of new homes were built miles from the nearest employment centers. In addition, homebuilders are still holding an infinite supply of land. This type of surplus will not only take many years to absorb but may also be the wrong product for the foreseeable future.
In the mean time, the demand for a roof, a kitchen and a bath at affordable rent is expected to increase. Housing demand is not only mismatched in terms of numbers but also type. As a result, I think we are going to see some very inconsistent occupancy statistics in 2009. Why are we not seeing a decline in apartment vacancy rates? What is happening with all those “second homes”?
Housing Price Trends – Breaking Point
The optimists opine that we have hit bottom. The pessimists opine that we have 10%, 20% or more to go. The realist (me) opines that the entire housing market is about to change. I do not see any chance that housing has bottom but the price cannot go much lower. As of the September quarter, First American is reporting that almost 30% of San Diego mortgages are under water. About 1/3 of homes in the US are owned free and clear. The average LTV for homes with a mortgage is almost 90% (I forgot the source, only remembered it being an official source). If prices decline another 10-20% from here, would the majority of all mortgages be under water? Could we see a massive abandonment where borrowers are no longer willing to pay and lenders too overwhelmed to foreclose? Who would be the owner of the nation’s housing - the banks, the Feds, the Treasury or Barney Frank?
As prices continue to decline from here, the real estate market as we knew would simply disappear. All transactions would be lender liquidations. As the government becomes more involved in this process, either thru Freddie and Fannie or any new schemes, it will replace the free market system. Once that happens, it is unclear how housing appreciation or depreciation would be measured. Would all appraisals have some type of a base price, then a list of adjustments for various subsidies?
Interest Rate Trends – Very Problematic
Historically, mortgage rate is one of, if not THE most effective tool in stimulating the real estate market. The stimulus comes not in the rate itself but the lowering of rates. Mortgage rates are already at historical lows at the moment and the Feds have already exhausted their arsenal in trying to bring it down. Recent efforts have already dropped a conforming rate down to 5% with very little to show for. Would it take a sub 4% 30 years rate to entice the last few qualified buyers off the sidelines? Any further action is going to require unprecedented strategies and enormous amounts of funds. Plans such as a subsidized interest rate buy down program, probably through the FHA and the government controlled agencies, are likely but very costly.
More problematic is mortgage equity withdrawal (MEW). Traditionally, lower rates trigger refinances, giving the economy an enormous boost. Unfortunately, there is no equity to draw from this time. The only borrowers who will benefit are those with solid qualifications and ample equity. Per MBAA mortgage application data, initial reaction is positive but not by much. We will find out in the next few months when the agencies start reporting MEW percentage for their refinances. I suspect that is going to be minuscule.
Financing Trends – Plenty of Money, Not Enough Qualified Borrowers
Lenders (aside from the government) are not going to bring back the lax underwriting standards of the toxic loan era. The transition back to sensible underwriting is absolutely necessary. What would the government push for? How would the lenders respond? Would 2009 be the end of the agency conforming loans?
Foreclosure Trends – Does it Matter?
Ironically, foreclosures may not be much of an indicator. With so much intervention, it would be impossible to tell what foreclosures represent. At this moment, I think the number of delinquencies reported monthly by Hope Now may be the best and most timely indicator.
Commercial Loans – The Other Shoe
There is no disagreement that C&I loans and AD&C loans are going to be the next wave of problem loans and yet, the market seems to ignoring the inevitable. Working out residential loans is not easy; working out commercial loans is a nightmare. Managing and disposing of commercial REOs are far more complicated than residential REOs. During the RTC era, the lenders were ill-equipped to deal with this problem. The current condition is likely going to be worse. Borrowers, buyers, tenants and all related parties are going to be frustrated by “indecision” even though it is unclear who the decider may be. Confusion is never good for markets, especially a declining market. I believe the market is grossly underestimating the potential losses for these loans. Bankruptcy filings should be a good indicator.
Destabilization – System Overwhelmed
During 2008, the Sheriff of Chicago ( Cook County ) decided to interpret eviction laws, instead of enforcing it. That is just the tip of the iceberg. I believe there will be massive civil disobedience, defined as ignoring real estate law at all levels. Occupants, be it previous owners or renters, will ignore eviction notices in mass, partly due to lack of housing alternatives, partly due to government programs that incentivize them to stay. The court calendar would be jammed with eviction cases. Lock outs (physical eviction after judgment) would take much longer to schedule as law enforcements struggle to keep up with requests. I see 2009 as a year where real estate law is going to be re-written, re-defined or simply ignored.
This will create an atmosphere of uncertainty which discourages investments. It is tough to buy real estate or make a loan when you don’t know what the rules will be.
|
