After Sub-prime, Is Commercial Property Next?

Based on my own experiences of being allowed to borrow 40 times my annual income to purchase investment property, I knew the real estate party was going to end badly for many borrowers, banks and eventually tax-payers. I had tried  shorting Countrywide, which was the largest lender of mortgages, last year when the stock was trading at around $36. Unfortunately, I was a little early and closing my position at $39 incurring a substantial loss. If I had held on to my position, with Countrywide currently trading in $6-$7 range, I would’ve have been handsomely rewarded.

Hopefully, I’ll have the fortitude to hold onto my positions next time. Right now I think the Commercial real estate is the next bubble to burst.

Easy liquidity and the willingness of investors to settle for low rates of return have squeezed the margins on commercial properties over the past few years. Commercial construction has been on  tear and new malls have sprung up all over the place. There’s also been a contraction in commercial liquidity owing to the sub-prime fiasco. Added to that is the slow-down in consumer spending which will affect the bottom line of retailers and the amount their willing to spend on employees and rent.

I’m currently short Simon Properties (SPG), which gets 25% of its income from retail malls in California and Florida and the Dow Jones Real Estate Index (IYR). Lets see if I can hold on to these positions during the coming few months which will probably be quite volatile.

Forclosure In The Neighborhood

Since I’ve been a homowner, landlord and tenant in my neighborhood for the past 6 years, I follow the real estate market pretty closely. I recently noticed that there was a condo on listed at $264,900.  Since I bought my 2nd condo in 2003 for $270,000, I was curious to find out more info on it.

[Picture of a foreclosed condo for sale in San Diego]

I emailed my friend who’s an agent and she sent me the list details. Apparently its bank-owned. The previous owners bought in 2001 for $170,000 and refinanced it last year for $260,000. The mortgage company has it listed at $265k to break-even on it.

These condos were sold at a peak price of $375,000. I sold both of mine on either sides of the peak at around $350,000 each. A sale price of $265,000 represents a 30% drop from the peak. I’d be amazed if it sold at the asking price.

If I was in a hurry to buy property, I’d be tempted to make a low-ball offer. When I bought my condo in 2001 and again in 2003, there was usually only 1 for sale at a time and usually several buyers. Right now, its the opposite, several for sale and not a single buyer!

Even though the pricing looks good, I expect things to get considerably worse.

Residential Housing To Drop Another 25%

Since 2005, I’ve been saying that San Diego home prices are way overpriced and are due for a 40-45% correction. The homes are so far out-of-whack thats it’s 30-50% cheaper to rent than it is to buy. Of course, the National Association of Realtors (the cheerleaders of the real estate world) will always tell you its always a good time to buy, but anyone who can use a calculator might think otherwise.

Already in most parts of San Diego, home prices are down 20-30%, unsold inventory has sky-rocketed, and real estate is no longer the main topic of cocktail parties.

Someone recently asked me if I though it was a good time to buy in San Diego. Houses in a Cardiff/Solan Beach/Encinitas/Pt. Loma that were $800-900k during the peak were now in the $600-700K range. When would we see the bottom?

I obviously thought it made sense to wait until the prices overshoot fair-value and become undervalued. Real estate has a tendency to keep moving in a trend for a very long period of time. Once its started to go down, it’ll just keep on heading in that direction. The Federal Reserve may try to give the bust a ‘soft landing’ but that won’t have much of an effect. It’ll probably just increase the duration of the downturn, similar to what happened in Japan after their real estate market crashed and was depressed for 15 years.

BusinessWeek finally has an interesting article about the Housing Meltdown: Why home prices could drop 25% more on average before the market finally hits bottom..

Even Mike “Mish” Shedlock thinks that home prices will reach more reasonable levels in 2009. Nice to finally see some corroborative data from an economists point of view.

How many of you think the bottom is in 2008?

Gold Tops Last Year’s High

I’ve been spending the past few days writing and re-writing B-school essays for the Jan 3rd deadline. Wasn’t going to post until the 4th, but with gold breaking previous records, I just had too!

Gold is currently trading for $857/oz, beating the previous high of $850/Oz that was set 28 years ago! (although the intra-day price was nearly $875, it didn’t close at that price). Gold was up a stellar 37% in 2007. How does that compare to other investments?

Dow Jones: 6.4%

S&P 500: 3.5%

NASDAQ: 9.8%

Oil : 57%

Shanghai : 96%

Brazil: 76%

India: 74%

Ireland: -25%

Venezuela: -29%

According to CNNMoney, the best and worst US real estate markets in 2007 were:

Bismark, ND: 15.3%

Salt Lake City: 14.5%

Yakima, WA: 13.6%

Binghamton, NY: 11.4%

Charlotte, NC: 11.0%

Palm Bay, FL: -12.4%

Sacramento, CA: -10.5%

Sarasota, FL : -10%

New Orleans, LA : -8.2%

Hagerstown, MD : – 8.0%

So what lies in store for 2008? Will gold hit $1,000/Oz and oil $125/barrel? Will the average national house price which dropped 3.3% last year drop another 3-4%? I bloody well hope so!

Are 50% Discounts Becoming Common In Florida?

Looks like the housing market is bad in more than just Miami. I just got this email from a real estate agent based in Florida regarding a Short Sale.

We have several sellers ready to walk away from their property without a penny. We have begun negotiations with the sellers lender who has expressed a desire to sell quickly and accept far less than the loan balance. Now I am looking for the buyer (you) who wants to buy a property at a huge discount.

Here is an example: Seller paid $260,000 last year for a BRAND NEW, 2,300+ Square Feet, 3 Bedroom, 2 Bath, 2 Car Garage, Covered Porch Home in Palm Coast Florida. The best offer we have is $135,000. We are looking for the highest and best. I don’t know how low the bank will go. It is up to you to offer. If you don’t the guy may get it for $135,000.

We have a lot of these and we get more everyday. If you want to Buy or Sell, Call Now

A Short Sale is where an owner is upside down on his house (his mortgage is higher than the house is worth) and the bank is willing to take less than they owe on it. Why would the bank take less? Because the home owner is several months behind on his payments, and has probably tried to sell it for what he owes for a few months with no success. It usually costs the bank around $50,000 to get rid of a house once its been in foreclosure, so in order to speed up the process and avoid going through the hassle, they agree to a short sale.

The seller is benefited since he doesn’t have a foreclosure on his credit. However, the bank usually sends out a 1099 tax statement for the difference. Which means the seller is still stuck with a tax liability. But paying 30% on a $100,000 is much better than paying the $100,000 from your pocket and not getting to deduct it as a tax loss! (To be more specific, homeowners cannot deduct the loss while investors can). So the only person truly benefiting is the buyer of the property. So long as he can afford the payments and doesn’t need to sell it at a loss in another 2 years!

California Properties Overvalued By 40%

According to Andrew Blackman of Bloomberg:

Californian homes are overvalued by as much as 40 percent and stricter lending standards will probably contribute to “material” price declines, according to analysts at Goldman Sachs.

Prices in the state “have proven surprisingly resilient, given the severe curtailment of credit availability and rising unemployment,” the analysts said in a note to investors. “However, we believe that a downturn is imminent.”

In August, the median price for houses in California was $589,000, though economic conditions only support prices of $350,000 to $380,000, the analysts said. The average U.S. home is 13 percent to 14 percent overvalued, the report estimated.

For the past 2 and half years, I’ve been harping on about how over-priced California real estate is and how the National Association of Realtors is completely clueless about real estate cycles, valuations and trends. Here’s a funny video about David Lereah who wrote a book “Are you missing the real estate boom” right at the peak of the cycle in 2005. Lereah is Chief Economist of NAR. (Hey, maybe I should apply for that job!)

San Diego Burning

Most of you have probably heard that San Diego is now in a state of emergency, due to the wildfires spreading through over 150,000 acres. Nearly a million people have been evacuated and nearly 1,000 homes have burnt down.

A similar event happened in 2004, but compared to this time, it was on a much smaller scale. Also different this time, is how the web has made a difference in relaying information and news.

Web 2.0 sites like Google maps and Twitter are being used to help spread news. Google Maps is being used to display where the evacuation zones and evacuation shelters are. Important news items like shut-down freeways and URLs can be embedded onto the map. Twitter is being used for up-to-the-minute breaking news regarding the status of fires and evacuations.

Even though I’m several miles away from the closest fire, there’s a lot of ash swirling around and the air is heavy with the smell of burnt wood. I can’t go outside for more than a few minutes without my eyes starting to burn.

Most businesses have been shut down since yesterday and everyone’s been told to stay indoors. Most hotels are at 100% occupancy so some people are prospering from this situation, although to be fair, its been reported that many hotels are offering significant discounts on their rates.

But the local economy should definitely get a boost from this. Insurance companies will suffer as 1,000 homes need to be rebuilt, but the real estate construction segment of the economy should get a boost. Rentals will be in short-supply over the next 12-24 months as these homes get rebuilt. As local retailers will profit as new homeowners will have to replace all their belongings that were lost/damaged in the fire.

I don’t think this will prop up the prices of homes in the long-run, but maybe this is the soft-landing that the San Diego real estate market was looking for?

Peter Schiff Recommends Bailing On The Dollar

As I’ve been saying for a while, the US Dollar is headed for a slump. Peter Schiff thinks the dollar could lose 50% of its value.

He’s very pessimistic on the state of the economy and the housing market and recommends buying Gold, which he thinks could hit $2,500/Oz.

He also suggests buying foreign dividend-paying stocks, foreign commercial property stocks, foreign government & corporate bonds and investing in commodities.

Check out this short informative video:

Here’s an interesting link on how to profit from dollar devaluation and inflation.

Miami Condos Half-Price

Well I lost money trying to short WCI Communities (WCI) and Countrywide (CFC) by being too early. However, I was right on the money and both stocks are less than 50% from where I tried to short them.

Apparently, even the Miami condo market is down 50% from the peak too. Check out this interesting video.

I’ve heard that water-front lots in Florida that used to sell for $80,000 are now going for only $18,000! When the market turns, land gets marked down significantly more than houses. Thats why the builders are taking significant write-downs on their land inventory and are getting rid of a lot of it, or not exercising their options to purchase land at inflated peak prices.

At some point, Miami condos are going to be selling for much less than the price to build them (replacement value). That’ll be a good time to buy them. What do you think? Would you buy a condo/house if it was 50% off?