Monthly Archives: March 2011

Cash Buyers Pour into Distressed Real Estate Markets

“If the current real estate cycle were a baseball game, Las Vegas would be in the fifth or sixth inning, a panel of analysts said Thursday evening at Spanish Trail Country Club.”

Las Vegas Review Journal

Investors purchasing real estate with 100% cash is at a record high.  “According to the National Association of Realtors, buyers paid cash for 23 percent of all homes bought in January, the highest share since NAR started measuring cash versus credit sales in October 2008, when they accounted for 15 percent of the market. The average of all-cash deals was 20 percent in 2009, rising to 28 percent last year.”  Cash sales in Las Vegas alone comprised of 54.5% of sales. (upi.com).

Foreign and out-of-state buyers are accounting for a significant portion of cash buying because of bargain prices and Las Vegas’s warm climate.  Cash transactions get investors better deals and close escrow faster.  This is putting a floor on prices and stabilizing the market.  Prices are generally still dropping but are forming a bottom.

Retail space remains distressed in Las Vegas.  Vacancies are very high with many businesses relocating to find cheaper retail space.  This will keep pressure on low retail rents for the foreseeable future.  Retail businesses will use this to their advantage to re-negotiate their leases with their landlords.  Landlords are likely to give tenants some slack to keep them from leaving.

Investors are Needed to Turn the Market Around

“We can’t expect every one of these homes to be purchased by an owner (occupant) because we don’t have lenders available to make them a mortgage loan,” says Housing analyst Dennis Smith of Home Builders Research. “If they’ve been evicted or left on their own choosing, chances are their credit’s been trashed anyway. We have to have investors. It’s a necessary part of the recovery.” (lvrj.com).

Being able to get financing is difficult for many.  Many residents in the distressed areas have been unemployed, had a foreclosure, bad credit, or don’t have a down payment.  Lending has slowed down considerably and the standards that banks require are higher.

Unemployment is down in Nevada, much of which is due to unemployed people leaving the state.  This will keep prices low in Nevada for awhile.  In February, prices in southern Nevada fell again slightly.  However, Las Vegas will be attractive to investors for at least several years and will provide a rich lifestyle for retirees from regions where the cost of living is very expensive.    

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Why You Should Never Buy a Home for Tax Reasons

Most people generally overweight the value of income tax savings form buying a home.  The amount of savings depends on two factors: the amount of money you borrow and the tax bracket in which you are in.  It is also important to note that only the amount that exceeds your standard deduction ($5,800 if single or $11,600 if married filing joint) will reduce your taxes.  This is why this deduction is more favorable to high income earners if they finance an expensive property.  Beware of tax accountants, real estate agents, and mortgage brokers who advise you to buy a bigger house.  If you decide to purchase a larger home, you should have reasons that are far more important than taxes. 

The Tax Policy Center blog writes, “A new analysis by my Tax Policy Center colleagues Ridathi Chakravarti and Dan Baneman finds that most taxpayers would barely notice the change in their tax bill even if Congress dramatically restructured the subsidy. And with some changes, many of us would end up paying lower taxes than we do today.

In the unlikely event Congress simply repeals the mortgage deduction, the average tax bill would increase by $710. But those who earn between $30,000 and $40,000 would pay an average of about $70 more while those making more than $1 million would pay an additional $4,000.

It is certainly possible that policies regarding real estate related deductions will change in the next few years.  With large budget deficits mounting, mortgage interest deductions could be targeted by Congress to make up for the shortfalls.  If things do not change, definitely take advantage of it.  But, never put yourself in a situation in which you are banking on a tax policy.

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Cutting the Flowers and Watering the Weeds

Individual investors typically perform poorly when managing their own investment portfolios.  This is evident in numerous studies in which individual investors collectively perform far worse than market index benchmarks such as the S & P 500.  Prospect theory plays a huge role in investor psychology and behavioral finance.

The prospect theory value function shows that people are generally risk adverse and that losses hurt far more than gains (generally twice as much).   An example of this from an investment standpoint is that investors hold onto their losses for too long and sell their winners too quickly.  They lock in their gains for a winning stock while hoping for a losing stock to recover.  To make matters worse, individual investors will often buy more of a losing stock by rationalizing that buying more is an even better deal.  These tendencies that individual investors have has been described by Peter Lynch as “cutting the flowers and watering the weeds.”

Investors’ rationale for holding onto losers is that by selling, they will actually become losers.  This implies that investors feel that ‘the game is not over’ until they sell the underlying security.  This makes little logical sense because financial markets are liquid and the current prices reflect what another investor would pay.  This means that if the market price is less than the purchase price, the position is already a loss. 

The price that one pays as an investor should be considered a sunk cost and the price paid should never be used as a reference point.  Instead, you should re-evaluate and judge the security in terms of its value and potential based on the current price.  In most situations, individual investors would be better off if they sell their losses and let the winners run.  

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Skyscrapers as Bubble Indicators

When we think of financial bubbles, we usually think of insane valuations and amateurs entering the market.  Here is a video of how the emergence of skyscrapers as being an indicator.

On Skyscrapers, Vikram Mansharamani states, “Skyscrapers are a spectacular indicator. They are the manifestation of easy money, overconfidence, and hubris inaction.” The taller the skyscraper, the greater the indicator. The most recent instance of this was Dubai in 2007.

http://cosmos.bcst.yahoo.com/up/fop/embedflv/swf/fop_wrapper.swf?id=24572575&autoStart=0&prepanelEnable=1&infopanelEnable=1&carouselEnable=0

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The Casino Economy

The 21st century has given us one bubble after another: dot.com stocks, real estate, and commodities.

Bubbles are driven by excessive speculation. In a recent article by John Hussman, he states, “we can think of a bubble as an advance in an asset’s price to levels that are “detached from fundamentals” – essentially, the primary motive for investing ceases to be the expectation of future cash flows or consumption, and instead centers on the expectation of further increases in price.”

When an asset has reached bubble status, the investment makes no sense because its high price cannot justify the return on investment from future cash flows.  For example, during the real estate bubble, investors had to “feed” their properties.  That is, they had to take money out of their own pockets to pay the expenses since their cash flows were negative.

Valuation is the Most Important Metric

Valuation when you enter an investment is the biggest determinant of your success. Buying an asset for less than its intrinsic value, as Warren Buffet describes it, is the basic formula for success.  In the S&P 500 (or any other index), long-term bull markets begin at low valuations (usually with an average P/E less than 12) and long-term bear markets start with high valuations (usually with an average P/E of over 20).

The last bull market in the US started in 1982 and ended in 2000. Over that period, people started assuming that the stock market was an easy and guaranteed way to make a return of 10-15% per year.  Currently, we are in a secular bear market that began in 2000. Valuations were at all-time highs and the trend was unsustainable.

Sp500since1982

Where do we stand now?

Currently, valuations are still high with the Case-Shiller adjusted P/E at over 24.  They were reasonable at the bottom of the market crash in 2009 but the rebound has risen to the point in which the next 5-10 year outlook looks to be below average.  The rally that started in April 2009, John Hussman, believes is basically a mild speculative bubble.  A lot of what may be driving the speculation is the anchoring of the stock price peaks we saw in 2000 and 2007. This anchoring gives the illusion that prices are not all that high.

The Case-Shiller adjusted P/E ratio is based on average inflation-adjusted earnings from the previous 10 years. The chart below from multpl.com shows the Case-Shiller index since 1880.  As you can see, the adjusted P/E was around 7 in 1982 and rose to nearly 45 in 2000.  In 2011, we still stand above the long-term trend.  The chart also illustrates how P/E ratios are mean reverting over long periods of time.

Sp500caseshiller

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Banks Slow Foreclosures

“The decrease in foreclosure activity, RealtyTrac says, is likely due to a slowdown in filings because of various lawsuits regarding improper foreclosures by the banking industry. If anything, the legal holdups are probably just dragging out the process and will prolong any real estate resurgence.”

http://cosmos.bcst.yahoo.com/up/fop/embedflv/swf/fop_wrapper.swf?id=24476849&autoStart=0&prepanelEnable=1&infopanelEnable=1&carouselEnable=0

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The End of QE2

Impact on commodity prices and interest rates

Interest rates are likely to rise as QE2 comes to an end.  This also puts pressure against commodity prices including food and oil.  A rebound in the dollar is also a possibility.

It seems there is little political will for another round of QE in the near future (unless the economy stalls again).  QE2 was highly criticized by many in the financial media.  Its impact was mainly felt by consumers buying food and energy.  Higher interest rates resulted which was what QE2 was implemented to prevent. 

Because of the extra liquidity, the excess money ended up in emerging market equities, commodities, and the US stock market.  This policy led to excessive speculation in the financial markets.  Instead of getting more lending into the hands of businesses, investors sought to protect themselves from a weak dollar. 

Too Much Debt

The root of financial problems throughout the world has been too much debt.  We are solving our debt problems by adding more debt.  That is, as consumers pay off their debt, the government is racking up more debt at the same time. 

Why Interest Rates May Rise

The Federal Reserve has been buying treasuries with the intent to keep rates low.  Since prices move inversely to yields, the Fed bids up the price of treasuries.  When QE2 ends, the treasury will have to rely on the free market to buy treasury bonds.  It will then be a matter of what price the market will settle for.  The prices are likely to drop as investors should require higher yields.  Equity markets around the world may also see a correction.

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Rent Zestimates

Zillow Expands Zestimates to Include Rentals

Zillow claims that 70% of movers are renters and few of them do research prior to renting.  Therefore, Zillow has now expanded its estimator data to include rents.

“’Rent Zestimates’, a one-of-a-kind tool that can be used as a starting point for determining a home or apartment’s estimated monthly rent price.  The launch expands on Zillow’s popular Zestimate® home valuations and empowers renters and landlords with estimated rent prices for more than 90 million homes and apartments across the country.

“Rent Zestimates are also a valuable tool for landlords.  Information is especially hard to come by for “accidental landlords,” who represent one-fourth of respondents who are homeowners intending to move in the next three years and who are considering renting out their home…Consumers can find Rent Zestimates on map searches and individual home detail pages on Zillow.com® and all Zillow mobile applications, including iPhone, iPad and Android apps.”

Source: http://zillow.mediaroom.com/index.php?s=159&item=222

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