Real Estate

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Straight from NYU finance professor Nouriel Roubini’s blog (the RGE monitor), here is the latest update on the housing sector:

The fourth year of housing recession – and the worst housing recession since the Great Depression – is well on course.

Total housing starts have plunged from the 2.3 million seasonally adjusted annual rate (SAAR) peak of January 2006 all the way to the 466 thousand SAAR of January 2009 (the last data point available), an all time low for the time series that started in January 1959. Single-family starts built for sale are down 81% from their Q1 2006 peak (since seasonally adjusted data is not available, we performed our own seasonal adjustment).

On the demand side, new single-family home sales are down 76% from their July 2005 peak. Both demand and supply of homes are therefore still falling very sharply which does not bode well for inventories. Inventories are the mortal enemy of prices for any goods-producing sector, including housing.

The sharp and unprecedented fall of starts might not have reached a bottom yet. In this economy-wide recession, weakness on the demand side of housing is bound to persist and we believe that supply will have to fall further, given the great wave of foreclosures that is adding to the excess of supply in the market.

We believe that home prices will not bottom out until the middle of 2010. Our target is a 38% peak to trough (so far prices have fallen over 27% from the peak) but given the worsening conditions on the real side of the economy, we see a meaningful chance for over-correction that would bring prices down 44% from the peak reached in the first half of 2006 (Case-Shiller is the reference index for these predictions.)

Thats a pretty dismal outlook! The condo that I was living in last year that went into foreclosure is on the market, listed for close to what it was worth in 2002-end. And there’s a chance prices may fall further still.

Property prices in many cities have reached very attractive valuations. But it doesn’t mean they’ve found a bottom. Prices typically over-correct on the downside and drop until they become ridiculously cheap. Just check out the deals you can buy for under $5,000!.

Gerald Celente runs The Trends Research Institue and has been analysing economic news and data and predicting trends for over 20 years. He advocated buying gold in 2001 when it was under $300/oz and has been accurate in a lot of his predictions.

Right now he’s predicting a revisting of the Great Depression era with huge vacancies in commercial real estate, large amounts of unemployment, a spike in gold prices. He also thinks we’ll see a surge in crime rates and a tax revolution with a revolt against property taxes first followed by school taxes. He thinks Obama’s promise for change is hokum and has no faith in his economic stimulus plans. On the bright side, he doesn’t believe this is the end of the world and says that a new technological revolution similar to the internet in the early 90s will bring us out of it.

Check out this very interesting video:

One person who obviously doesn’t believe him is Elliott Spitzer. He just bought a $180 million office building in Washinton DC, just down the street from the now infamous Mayflower hotel. He paid about $42 million in cash for this acquisition!

Eliott Spitzer is quoted as being optimistic about the real estate market!

According to the Chicago Tribune, Detroit Median Home Sales Price was $7,500! No, I didn’t forget a zero at the end. That’s probably less than what you paid for your car!

So should you rush out and buy a home there?

A house that costs $7500 might make a pretty good investment. Assuming you can rent it out for $250/month, your net return will be in the double digits. But will you really make any money in Detroit?

It’s economy has been slipping for the past 40 years with negative job and population growth. Even the median salary has been dropping for 20 years.  The city’s bond rating is at Junk status.  The city has “only islands of prosperity amid a dismal landscape”.

Right now, it appears that 1,000 people are leaving the city every month. Mayoral candidate Stanley Christmas recently joked about the 14% drop in homicide rates: “I don’t mean to be sarcastic, but there just isn’t anyone left to kill.”

Every year on halloween people roam the city looking for vacant houses and torch them. So if you are unable to rent out a house in  Detroit, there’s a chance it might be used as firewood!

So just beacause real estate is cheap, it doesn’t mean its a good investment! And if you think $7,500 is cheap, check out these real estate deals for under $5,000!

As a member of the school’s Real Estate Club, I got a pretty interesting update on the real estate forecast for 2009. This is just the summary. The whole article was signficantly bigger. A lot of it is obvious, but it’s still a good comprehensive list.

Serious dislocation has resulted in the following challenges:
1. A huge capital gap has been created (most debt has vanished, and all the available equity is not enough to fill the hole).
2. No one expects surviving financial institutions to ramp up lending once they finally stop their own mammoth balance sheet bleeding (even with gargantuan government bailouts).
3. Persistent risk aversion and new regulation could limit debt capital flows for the foreseeable future, muting transaction activity.
4. Many owners needing to roll over mortgages in the coming years can expect to face substantial refinancing hurdles, including higher lending rates, more stringent underwriting, increased equity requirements, and recourse terms.
5. The aftershocks of rampant “over-the-top lending” that batter the entire credit system leave property markets substantially overleveraged and vulnerable to significant depreciation.
a. Real estate value losses will average 15 to 20 percent off mid-2007 peaks, and could be more severe for lesser-quality commercial properties in secondary and tertiary locations.
b. For 2009, U.S. commercial real estate faces its worst year since the wrenching 1991–1992 industry depression:
i. Values will drop substantially
ii. Foreclosures and delinquency rates will increase sharply
iii. The limping economy will likely crimp property cash flows
iv. Lower growth going forward
6. In 2009, expected total real estate private equity investment returns will likely register in negative territory for the first time in nearly two decades.
7. In a classic flight to quality, those interviewed continue to favor familiar coastal global pathway cities as investment outlooks grow bleak—ratings uniformly decline for almost all markets.
8. Only apartments show some enduring strength—increasing numbers of young adults and people pushed out of the housing market keep rent rolls relatively healthy.
9. Always favored, industrial properties may weaken in the consumer downturn—fewer goods are shipped and distributed.
10. Businesses stop expanding or downsize, hurting office.
11. Hotels suffer as business and tourist travel is cut back in the recessionary environment.
12. Retail really hits the skids — cash-strapped Americans struggle with credit card debt, the mortgage mess, and gloomy employment environment.
13. Already savaged, homebuilders see little hope for improvement until mortgage markets come back and the job picture brightens—not in 2009.

Current prognostication: Expect financial and property markets to hit bottom in 2009 and flounder well into 2010.

One of the advantages of going to a top-tier MBA program is that you get to meet a lot of succesful, well-known people. Last week, billionaire real estate investor Sam Zell was on campus and gave an hour long speech about his views on the economy.

He made an analogy that the economy was like a bus being run by a monkey who let everyone drink, smoke weed and fornicate like crazy and then crashed it!  There’s no free lunch.  We’re going to have to pay for the past excesses.

sam_zell_equity_properties

Over the past 40 years, there’s only one true metric for real estate – and that’s the replacement cost of a building. Costs cannot stay much higher than that for extended periods of time. During the past few years, real estate was selling at astronomical levels. People were buying long-term with short-term financing, which has always ended in disaster. The value was not based on its intrinsic value, but on how much they could borrow against it. And the people making the loans just sold them off to unsuspecting pension funds and sovereign wealth funds. There was a huge disconnect between the borrower and the actual lender. There was also a disconnect between risk, reward and responsibility.

A lot of the current mess was caused by long held beliefs just being plain wrong. People believed that real estate always goes up, that companies like GM and Merill Lynch were too big too fail.  They also came up with a new belief system that didn’t include paying back loans – instead they just refinanced them! A rolling loan, carries no loss.

Instead of throwing people with bad credit out of homes they couldn’t afford in the first place, the government lamented on the victimization of the borrowers. Zell isn’t impressed with the government’s handling of this situation. In an effort to get the bail-out bill passed, there was a lot of fear-mongering and even a bait-and-switch to get the bill passed.  Apparently a $700 billion bailout got passed with a 3 page memo which no mention of how to spend the money.

He also commented on the recession. He sees consumer consumption going down, but the government will step in replace it. He thinks that government spending will increase from the current 18% of GDP to being more like France, where it is around 50%. This is a structural change caused by the deleveraging effects of and this recession is going to felt around the world.

But this doesn’t mean there won’t be opportunities to make money! Opportunities exist, but for those with access to capital. Capital is as scare as ever and you need to recognizing that capital will be the key to make money in this environment.  Asset pricing has started to become out of whack with reality.  We are starting to see deep discount below the intrinsic value.  We can buy assets below their replacement cost.  This will essentially create a floor at some point, since buyers will step in below the replacement cost.

But right now he see the best opportunities in debt. Right now we can get unlevered returns of 15-20% on performing loans, which is unheard of.   This is a function of liquidity risk, not of default risk!

In the 80s and 90s, Zell was a buyer of the last resort. He’s proud of the fact that everyone calls him the grave dancer, since he buys properties at fire-sale prices and resells them for a profit.He recommends waiting until the equity holders have no equity left in the assets before buying them.  He mentioned the story about a bank who came to him with a property they said was worth $32 million. He offered $16 million. The bank said they’d do the deal at $18 million or else they’d take it to the market. Zell called their bluff and eventually bought it for $9.5 million! Patience is a good thing to have in this market! (Check out this link to see cheap commercial real estate).

Zell thinks there will be a demand recession. You never want to invest where there is no demand for your product. He recommends buying where demand is still strong. He’s currently building low-income housing in places like Mexico, where there is a strong pent-up demand for that product.

He also spoke about investing in BRIC (thats Brazil, Russia, India and China). He strongly cautions against Russia because there is no law. However, he thinks positively of the other countries since they have embedded demand. If you can service that demand, you will do well. But doing business with honest and ethical people is very important. He recently passed on a proposal to do business with an Indian company because he didn’t think they were ethical. As it turns out, they weren’t and they’re now facing bankrupcy. That company was Satyam, India’s Enron!

He isn’t a fan of investing in Europe. With it’s shrinking population, he sees no demand.

However, if you can find demand in the US, you will do well here too. The US will somehow spend its way to recovery, although he later mentions that this will come at a cost of a severe inflation. But he still likes the US. We’re special. The US is the only place on the planet where you’re allowed a do-over if you mess up. It’s called Chapter 11!

Housing in the US is getting better. While there is a standing inventory of 1 million households, the creation of new households keeps on increasing. Housing will come back, but slowly.

He thinks there will be no instant gratification this time around. The medicine being put into the system will slowly impact the economy. He thinks the economy will start to turn around by the beginning of 2010 but the risk of inflation is very high. He didn’t really elaborate on the inflation or economy part but the only thing I know is that you should buy gold ;-).

The US is a unique society with a lot of opportunity. However, he sees the current government interference hindering the growth that has made us the greatest country on earth. This sounds a bit contradictory to me. First he says the government spending will pull us out of recession but it will also hinder our growth? Again, he didn’t really explain this.

After this he took a few questions:

He doesn’t think the US will lose it’s place as the world’s reserve currency.  There isn’t really any other replacement. In the very long term maybe it might happen, but right now he doesn’t see any alternative. Currently no central bank wants to bet against the dollar.  He also mentioned that the “beggar thy neighbor” mentality of European countries would disappear and interest rates would drop all across the developed rates to match the pathetically low rates of the US.

He also explained how he managed to sell Equity Properties at the very peak of the real estate cycle to Blackstone group. (Speaking of Blackstone, check out this post on How Capitalism Really Works). He does a quarterly valuation of all his holdings. Blackstone made him a $39 Billion offer that was 20% higher than what he thought it was worth, so he sold it.

He also mentioned that he didn’t think the government programs would stem foreclosures. There has been massive fraud going on. He gave the example of an entire subdivision of  homes in Stockton being sold to migrant Mexican workers. People who made $8/hour were somehow approved for $350,000 loans! Only people who can really afford them to get to keep them. He cites the example of Japan. The government/lenders allowed people to stay in the homes rent and mortgage free. Since there was no incentive for people to pay, property prices stayed depressed a lot longer than they should have. So the biggest risk right now is lenders not cleaning up and making poeple pay for there mistakes.

Zell also spoke about his Tribune purchase. He says the newspaper model is broken. It costs more money to have papers home-delivered but you pay less for that service. He explained he would change that model and that would increase the revenues. Let’s see if that’s true.

In all, it was very interesting.  But it was over quickly and the $5  billion man literally ran out the door before anyone could stop him for photographs or autographs.

As I mentioned in a previous post, the real estate market hasn’t hit bottom yet.

According to an Article in Fortune Magazine, 8 of the top 10 worst real estate markets in 2009 are in California. The range of the predicted price decline is between 20 to 25%.

1. Los Angeles

2008 median house price: $375,340

2009 projected change: -24.9%

2010 projected change: -5.1%

The median home price in the L.A.-Long Beach-Glendale metro area is projected to fall nearly 25% in 2009 – the biggest drop in the country.

stockton.jpg
Courtesy: Stockton CVE

2. Stockton, Calif.

2008 median house price: $248,050

2009 projected change: -24.7%

2010 projected change: -4.0%

3. Riverside, Calif.

2008 median house price: $256,540

2009 projected change: -23.3%

2010 projected change: -4.8%

miami_skyline.jpg
AP Photo

4. Miami-Miami Beach

2008 median house price: $293,590

2009 projected change: -22.8%

2010 projected change: -6.4%

Miami will be nursing the hangover from its epic building boom for years to come. After falling 22% in 2008, prices are predicted to plunge another 23% next year.

5. Sacramento

2008 median house price: $225,140

2009 projected change: -22.2%

2010 projected change: 2.3%

anaheim.jpg
AP Photo/Joan C. Fahrenthold

6. Santa Ana-Anaheim

2008 median house price: $532,810

2009 projected change: -22.0%

2010 projected change: -3.5%

7. Fresno

2008 median house price: $257,170

2009 projected change: -21.6%

2010 projected change: -3.3%

san_diego_skyline.jpg
BusinessFacilities.com

8. San Diego

2008 median house price: $412,490

2009 projected change: -21.1%

2010 projected change: -2.9%

9. Bakersfield, Calif.

2008 median house price: $227,270

2009 projected change: -20.9%

2010 projected change: -2.5%

wash_dc.jpg
AP Photo/J. Scott Applewhite

10. Washington, D.C.

2008 median house price: $343,160

2009 projected change: -19.9%

2010 projected change: -5.7%

They haven’t really given any reasoning behind the numbers, but if you listen to the video in the previous post you can at least see that there’s some validity to their logic.

"The $1.75 House" In what could possibly be the cheapest house ever sold, a woman decided to forgo her morning cup of Starbucks coffee and used that money to buy a house instead!

SAGINAW, Mich. – With a winning bid of just $1.75, a Chicago woman has won an auction for an abandoned home in Saginaw. Joanne Smith, 30, recently was the top bidder for the home during an auction on eBay, The Saginaw News reported. Her bid was one of eight for the home.

“I am going to try and sell it,” she told the newspaper. “I don’t have any plans to move to Saginaw.”

Smith said she hasn’t seen the property or visited Saginaw, which has been hard-hit by economic troubles in recent years.

There’s a notice on the door of the home saying a foreclosure hearing is pending, the newspaper said. She must pay about $850 in back taxes and yard cleanup costs.

What’s amazing is that 7 people bid less than $1.75! God bless Ebay for bringing home ownership to the masses!

Check out the investment store if you want to find similar great deals on real estate.

According to The American Housing Rescue and Foreclosure Prevention Act of 2008, passed by Congress in July, first time home buyers who purchase homes between April 8th 2008 and July 1st 2009 are eligible for a first time home buyer tax credit. They can get $7,500 tax credit or up to 10% of the value of the home for home purchases under $75,000.

There are certain conditions though. The credit has to be repaid over 15 years, so effectively it’s an interest-free loan from the government. So if you buy a home this year and claim the credit next year, you start paying $500 back in your 2010 taxes which you would file in 2011. So at least you get a few years grace period before you have to start paying it back. Not sure what happens if you sell the home in 2010, though. Maybe you might have to pay back the entire amount in a lump sum.

There are also income exemptions. The credit is phased out for individuals with modified adjusted gross income (AGI) between $75,000 and $95,000. For married couples filing a joint return, the phase out range is $150,000 to $170,000.

But the good news is that if you haven’t owned a primary residence for 3 years by the date of closing, you’re now considered a first time home buyer again!

This is the government’s way to encourage home purchases and prop up housing for as long as possible. This is their “soft landing” approach, where by they try to drag out this mess for as long as possible. Instead of having a quick easy death for banks and mortgage companies, they’re going to keep interfering and prolong the recession.

Regardless of the motives behind it, its out there for home buyers. I’m not jumping to buy at this point since I think there’s probably a little more downside next year followed by several years of stagnation.

Foreclosures have hit record highs and there are seemingly good deals all over the nation. My condo is currently in foreclosure and several of my friends have expressed an interest in buying it as an investment. I’ve told all of them to wait until they can actually cash-flow on investment property. Unlike back in 2005, where it was common to be negative several hundred dollars on an investment property, today you should be able to get 6% or better cash-on-cash return. In fact, in some places you can actually buy properties for under $5,000 and your effective return might easily cross 25% per year.

Before you rush out and start buying any property, I suggest you read the following books:

Another Russian Billionaire just paid $750 million for a house, or palace actually, in the French Mediterranean Cote d’Azur. The purchase price more than doubles the previous record.

Seems just a little too ostentatious for my tastes, but then again, I don’t have nearly a billion dollars to spend on buying a home.

In other news, the New York Post reported that a unnamed SWF (no thats not Single White Female, but rather Sovereign Wealth Fund) has earmarked $29 Billion for “investing” in foreclosed properties in the US. According to the paper, this unidentified fund has been hiring mortgage brokers all over the West Coast and instructing them to start bargin hunting for single and multi-family dwellings. That much money could buy 150,000 average U.S. homes.

Seems like a good way to get rid of your excess dollars and put them into in asset that will match inflation in the long run. And unlike the Japanese who bought up trophy properties at the peak during the 80’s, this SWF at least waited for a correction.

So along with all our gas money, now even our rent checks will end up in the Middle East! 😉

If you want to start your own real estate empire, check out these commercial and residential property listings.