Monthly Archives: May 2011

Home Builders Struggle to Compete with Foreclosures and Short Sales

According to the Associated Press:

“Builders are struggling to compete because foreclosures are forcing down prices for previously occupied homes. The median price of a new home was about 34 percent higher in March than the median price for a re-sale. That’s more than twice the markup in healthy housing markets.”

Builders’ outlook for homebuilding was a very low 16 for the month of May which is far below the benchmark of 50.  Any amount below 50 is considered negative.  Also, 118 out of 153 metro area experienced a drop in median prices. 

Consumer sentiment is also low as future homeowners hold out in anticipation of lower prices. This is another phase of a deflationary spiral.

Las Vegas has been ground zero in the housing crisis. In a Bloomberg interview, Las Vegas mayor Oscar Goodman said:

“We’re going to make lemonade out of this ‘crisis’.. by promoting our foreclosures here, and show people who are freezing to death in the middle of the country, and having the worst winter imaginable, that they could come out here [Las Vegas] and buy a home for 1/3 of the cost of 5 years ago and have a wonderful quality of life.”

Currently, we are in the second dip of a double-dip slump in housing. Many houses sit vacant despite the lack of homebuilding going for the reasons stated above. Nationally, housing prices are about at their low since the housing slump started. The rebound created from government stimulus and programs is over which is why the slump has resumed. It will take years for the market to correct because new households need to soak up the excess inventory.

In addition, the problems with bank foreclosures having a process that is too slow still persists. Many mortgages were not handled properly from the beginning which has caused a huge paperwork mess.  Now, the foreclosure process takes even longer as lenders attempt to sort this out.

The housing market is mainly supported through Fannie Mae and Freddie Mack. It will be very interesting to see what the government decides to do with them. These entities alone are propping up the market because they currently consist of almost all the new loans being written.  Without them, financing a new home would be almost impossible.  Banks don’t want to finance residential real estate and hold the loans.

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Middle Class Finding Fewer Opportunities

Unemployment and underemployment will continue for the foreseeable future according to Michael Spense. We have gone through a period of underinvestment and took on too much debt in terms of both individuals and government. The fact that we’ve been complacent will lead to lackluster job growth with no quick fix being possible.

Jobs in the U.S. into two very large sectors: tradable and non-tradable. Tradable jobs are ones that can be done by anyone around the world: manufacturing, back-office operations, pharmaceuticals, engineering, finance, consulting. Non-tradable jobs are those that really can only be done by people in the U.S., such as retail, health care, food service, government, and construction.

Because most of the jobs that have been created since 1990 have been of the non-tradable variety, these jobs should remain as they can’t be offshored easily.

Spence believes that the only long term solution is to invest in education, research, and infrastructure. Currently, there are too many people who don’t have the required skills in which employers are looking for.

Click the link below to watch video

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Real Estate Investing is a Numbers Game

In order to build wealth, you must first understand how money works.  Most people do not.  They prefer a good story and chase whatever is popular. Real estate was popular a few years ago.  Now that prices have fallen to the point where you can actually make money once again, it is become very unpopular. 

Real estate investing, when done the right way, is not such a fun and exciting process.  It involves crunching numbers to see if a potential property makes any investment sense.  When real estate was more popular, people bought houses and had to ‘feed’ that property each and every month.  That makes no financial sense and should have been a red flag that there was something wrong with the market.  Today, you can find properties that will give you over 20% positive cash flow on your investment. 

In one of my favorite books, The Art of Contrary Thinking, Humphrey Neill says that when everybody thinks the same thing, everybody is likely to be wrong.  This has long been a truth that has plagued people with investing.  Psychologically, we are hardwired to be copycats and follow the trends.  This is how we survived in the days before civilization.  In the modern world, we have to be mindful of our heuristics; especially when to avoid using them.  Those who don’t think ahead will continue to buy at the top of the market and sell at the bottom.  

Now, I will get back to my point that real estate is a numbers game.  Where does one start?  I have a Cash Flow Analysis calculator that will get you started.  You simply enter in the expected income, expenses, and loan terms.  The mortgage payments are calculated for you and items that often get overlooked get factored in.  One of these includes deducting a percentage of the rent to factor in vacancy time.  Obviously, a property is not rented 100% of the time.  Therefore, a 5% vacancy rate is included as a default value.  If the average rate is higher in your area, you can change it to a higher amount.  

Obviously, what you pay for an investment is crucial.  If you don’t buy correctly, you will not have a good return on your investment.  Using Cash Flow Analysis will determine what the investment potential is.  This tool will calculate return on investment for you.  If capital appreciation and tax savings are part of your strategy, our tool can factor that in also.

Building wealth involves saving and investing the right way.  Warren Buffet has a strategy that involves getting a business for less than its intrinsic value.  Using our Cash Flow Analysis calculator, you have one tool to apply to real estate that’s similar to what Buffet uses at Berkshire Hathaway.  By entering the numbers, you will know if the property you’re interested in is undervalued or not.    

There are value traps, however.  You may find that a property seems to look good from a numbers standpoint.  When you go physically inspect the property, it may be run down or it’s in a bad neighborhood.  Therefore, this tool is by no means perfect.  But, it can save you from overpaying and help sort out the financial data associated with a potential investment.

Access the Real Estate Cash Flow Analysis tool

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Filed under Investing, Real Estate

Barry Ritholtz on the Continuing Weakness in Housing

The economic conditions are perfectly normal when comparing this recovery to all other post credit crisis recoveries.  These types of recoveries tend to be very anemic and take a long time to wear off the excesses created from the previous boom.  Corporate balance sheets are in very good shape while consumers continue to improve theirs by paying down debt.  Government, on the other hand, continues to be leveraging up.

With regards to people who bought homes during the boom years who shouldn’t have qualified, only about half of them have been returned to being renters according to Ritholtz.  Therefore, we are only about half way through the correction in housing. 

No doc loans are called “rent with an option to default.”

Housing prices remain (as measured by affordability) about 8 to 10% above the mean for home affordability.  This metric measures median income to median household prices.

Housing will not be a significant part of economic growth for another 5-10 years.  You can watch the full video from Yahoo! Daily Ticker below:

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Filed under Economy, Real Estate

Hernando de Soto on the Lack of Knowledge in Finance

Hernando de Soto argues that in the past, things were much simpler. If you owned property, the information regarding your property was safeguarded locally and it was clear who the owner was and who made the loan  (if the property was fiananced).  Today, things are much more complicated. It is harder to track who owns what. Those who bought paper assets cannot figure out who the actual owner is. Shadow inventory consists of a total asset value of $600 to $700 trillion dollars which is 10 times the size of the world economy!

De Soto believes that the problems with today’s financial industry and banking have not been solved. He outlined the following sectors as trouble areas:

Mortgage Bundling

“Banks that have tried to foreclose on nonperforming mortgages have discovered that in many cases they can’t collect the debts. Why? Because some companies that pooled, packaged, and converted those mortgages into liquid securities had dispensed with the usual procedures to record mortgage owners and passed the property to a shell company called MERS, which pretended to own the mortgages.”

According to Christopher L. Peterson, professor of the University of Utah, “For the first time in the nation’s history, there is no longer an authoritative, public record of who owns land in each county.” Various courts have deemed foreclosures as being improper. Another problem that persists is with areas in which home prices are still declining.  This will increase the already massive pipline of foreclosures.

Default Swaps

Credit default swaps still exist and pose a threat to the financial system. They have been a key part in making securitization possible. Getting rid of these would have reduced leverage in the fiancial system and getting rid of these should have been a no-brainer.

Exemptions

Mark-to-market accounting has been suspended which banks can now overvalue the net worth of their assets. This, however, is a bit of a double edged sword. Mr. Market has often valued assets at prices that were far above or below fair value. This policy added too much volatility to banks’ financial statements and was a poor idea to implement in the first place. When assets prices are rising, the banks are happy because they can report results that are in their favor. The same is true on the downside in which if the market results in a panic sell-off (whether it is truly justified or not), the banks would be forced into taking writedowns.

The other method, which consists of the value being based on a model, also has its problems. When market conditions change, banks can hide the symptoms by not having to take the writedowns until much later or if the borrower defaults. This results in a lack of transparency for investors.

Off-Balance Sheet Accounting

This method “makes companies appear more profitable, despite their debts. By the time Enron closed its doors in 2002, it had created some 3,500 SPEs (special purpose entities).” Another accounting trick being used is to place information in footnotes that are carefully worded.

Rating Agencies

Do we need to explain here? Rating agencies are simply fire alarms that go off after the house burns down.

In the end, record keeping had been an advanced part of Western capitalism. The financial innovations over the last 20 years has put this system in jeopardy.

Source: http://www.businessweek.com/print/magazine/content/11_19/b4227060634112.htm

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Filed under Finance, Real Estate