HomeOwnership Doesn’t Make Economic Sense

Time Cover: Rethinking Home Ownership

Time Cover: Rethinking Home Ownership

Time magazine recently had an interesting article, The Case Against Home Ownership which explained why the American dream wasn’t all it was cranked up to be. Mainly, because it just doesn’t make economic sense. It prevented people from being able to migrate to where jobs where, resulted in a 49% higher consumption of energy amongst detached-home owners, and cost the government hundreds of billions in lost tax revenue every year. And the often quoted inverse correlation between teenage pregnancy and home ownership is sketchy and inconclusive (apparently the correlation between car ownership is higher than home ownership!).

The article heavily criticizes the role of the government in its efforts to  keep housing affordable by offering tax incentives and artificially lowering the interest rates on mortgages. The result of these policies is that people over-extend themselves in an effort to get a bigger tax break and the average homeowner saves less than $600 a year on their taxes. The major benefit goes to families making over $250,000 a year and who probably wouldn’t have any problems being able to afford a home anyway. The UK removed the tax deductions on homeownership a decade ago and actually has a higher rate of homeownership than the US (which has hovered around 65% over the past two decades).

Interestingly enough, Switzerland, which is one of the wealthiest nations, has a  low ~35% level of homeownership.

I just had a discussion with a young couple that bought a condo during the peak. They felt somewhat trapped as the husband was unable to move to better opportunities elsewhere because they were underwater on their mortgage. He hadn’t considered doing a short sale on the property, mainly since they both had jobs and didn’t really need to, but they were renting out their spare bedroom to help pay their mortgage (they had obviously over-extended themselves).

As I’ve repeated many times before, your own house is not an investment, it’s where you live. You buy a decent place in a decent neighborhood that you can easily afford. You do not buy a house because you need the tax break or because the bank will lend you more money than you can afford (of course, those days are behind us).  We’re still a couple of years away from a bottom in the real estate market. Until then, renting isn’t a bad option.

How To Avoid Foreclose: Humor

Just read this news article from the Associated Press:

Tue Feb 23, 8:17 am ET

MOSCOW, Ohio – An Ohio man says he bulldozed his $350,000 home to keep a bank from foreclosing on it.

Terry Hoskins says he has struggled with the RiverHills Bank over his home in Moscow for years and had problems with the Internal Revenue Service. He says the IRS placed liens on his carpet store and commercial property and the bank claimed his house as collateral.

Hoskins says he owes $160,000 on the house. He says he spent a lot of money on attorneys and finally had enough. About two weeks ago he bulldozed the home 25 miles southeast of Cincinnati.

Ok, there’s nothing really humorous about this. But I thought it was a great story about getting back at the bank. Banks are notoriously difficult to deal with and after accepting billions in bailout money from the taxpayers aren’t really modifying very many loans. If you think that people who default on their mortgages are scumbags and deserve to lose their homes and that banks are just faultless victims, check this link about a foreclosure attorney who tried to help a couple modify their loan. Actually, regardless of what you think about banks or borrowers  you should still read the article. It’s very interesting.

Real Estate: No Bottom Yet?

John Mauldin is an investment adviser and president of Millennium Wave Investments. He sends out an interesting weekly newsletter, which most recently focusedon the current real estate market.  It seems like the bottom isn’t in sight yet:

Analyst contend that much of the bad news in the subprime-loan and housing market has been written off. And one would have to admit that a lot has been; and with the relaxation of mark-to-market, there may indeed be some truth to that suggestion. But there are still some issues that remain for housing. Take a look at the graph below. (Not sure where it is from, as it was sent to me, but I have seen the same data elsewhere.) Notice that monthly mortgage-rate resets declined markedly in 2009 from 2008, but are expected to rise again in 2010 and 2011. There is still some heartburn in the mortgage market.

Monthly Mortgage Rate Resets

The Shadow Inventory of Homes

And foreclosures keep climbing, though some point to that fact that they seem to be leveling off. However, a strange thing is happening. We are seeing what is being called a “shadow inventory” of foreclosed homes.

“We believe there are in the neighborhood of 600,000 properties nationwide that banks have repossessed but not put on the market,” said Rick Sharga, vice president of RealtyTrac, which compiles nationwide statistics on foreclosures. “California probably represents 80,000 of those homes. It could be disastrous if the banks suddenly flooded the market with those distressed properties. You’d have further depreciation and carnage.” (San Francisco Chronicle)

A Realty Trac survey found that only 30% of foreclosures were listed for sale in real estate listings like the MLS (Multiple Listing Service). Add in homes that people would like to sell but simply can’t find buyers for, and must either hold or rent, and the unsold inventory numbers that are public are likely far below actual available homes.

Might some homes in foreclosure be held off the market because banks eventually want to negotiate with the homeowner? Possibly, but other surveys show that anywhere from 30-40% of homes in the foreclosure process in many areas are actually already vacant. There is no one with whom to negotiate.

Typically a foreclosed home sells within a few weeks, as banks take the first “reasonable” offer. But it normally takes about three months from foreclosure to when the home is put on the market — it takes a few months to get a home ready. But surveys show it is taking a lot longer now, and many homes have not made it onto the market, even as more homes are being foreclosed each month.

The Chronicle suggests several factors may be at work. First, there is the “pig-in-the-python” problem. There are just so many homes that it is hard to get them onto the market and sold. Normally there are about 160,000 homes a year in foreclosure sales. We are now seeing 80,000 a month, or six times normal levels, and rising.

Second, lenders could be deferring sales to put off having to acknowledge the actual extent of their losses. “With banks in the stress they’re in, I don’t think they’re anxious to show losses in assets on their balance sheets,” one observer said.

Finally, banks may not want to flood the market with foreclosures, driving prices down even more. They are simply managing their assets so as to recover the most capital they can.

Given that the graph above says there will be more mortgage misery as large numbers of mortgages reset in the next two years, and given the unknowable nature of the losses, it is somewhat optimistic to think financial profits will rise by 74% in the fourth quarter. But it gets worse.

Commercial Real Estate Starts a Long, Slow Slide

We are now starting to see some real deterioration in traditional bank lending. Delinquencies on home equity loans are rising rapidly. The American Banking Association released a composite index of eight different types of consumer loans, and the delinquency rate on this 35-year-old composite jumped to a record high of 3.22%.

The above reflects 4th-quarter data. As unemployment is up 2% since then and is rising, it is more than reasonable to assume that we will see another record rise in delinquencies this quarter. With unemployment headed to over 10% and maybe 11% from today’s 8.5%, delinquencies are likely to continue to rise for the entire year.

David Rosenberg reports that “The National Federation of Independent Business found in a poll that 28% of small firms said they had a line of credit or credit card limit cut back in the second half of last year; 69% stated they are facing worse terms. A new FICO study found that 11% of US consumers — 22 million people — have had their credit lines cut or accounts closed even though they have been paying their bills on time and retain a solid rating.” This is certainly not good news for those who expect a positive 4th quarter. Cutting credit to small business, the engine of job growth in the US, is hardly a prescription for a growing economy.

Commercial mortgages are in trouble. S&P has warned they may cut ratings on $97 billion in commercial-mortgage asset-backed debt. The country’s 10 biggest banks have $327.6 billion in commercial mortgages, according to regulatory filings. A projected tripling in the default rate would result in losses of about 7% of total unpaid balances, according to estimates from analysts at research firm Reis Inc.

10 Worst Real Estate Markets In 2009

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.

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%

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%

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%


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%

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.

Mortgage Meltdown: The Worst Is Yet To Come!

Check out this 12 minute video from 60 Minutes. There’s another wave of mortgage defaults on the way, this time from Alt-A & Option-Arm (also called Negative-Amortization or Neg-Am) loans. As opposed to the subprime loans which were worth almost $1 Trillion, these two groups make up nearly $1.5 Trillion.  According to Amhurst Capital, they expect a 70% default rate on the Option-Arms based on the current default rate which is occurring at 3% interest rates!

Right now there’s a 3-5 year overhead supply of housing inventory on the market. Along with these coming defaults and the fact that 10% of Americans are behind on their mortgage, you should expect house prices to be depressed for a very long time. I’ll think we’ll have more clarity when home prices actually hit bottom, which might be another 12-24 months from today.

I’m sure glad I sold my condo in summer 2005! The bank now owns and I’m thinking of putting in a very low-ball offer. An offer so low, it’ll cashflow well and at least break-even if rents drop 50%!
(Check out these cheap real estate deals).

If you’ve been reading the news, you know that at yesterday’s FOMC meeting, Bernanke dropped the interest rates to an unbelivable 0.25% (a cut of 75 basis points). Apparently he thinks that cheap credit will solve the problems facing the US economy right now. Unfortunately, its not the cost of credit but the availability of credit that is the issue. Credit is drying up and making it cheaper isn’t going to make any difference.

Last Monday, the Treasury was able to auction $35 Billion worth of 3 month T-bills at 0%, which means there’s a demand for liquidity and safety. Return of principle is more important than return on principle!

However, the government is using this money (and another few hundred billions) to bail out bankrupt financial firms, insurance companies, and auto manufacturers. It is running printing presses around the clock creating pictures of dead presidents and is inflating the money supply at a 17% annual rate. This is inflationary in the long run and will cause the devaluation of the dollar.

In the long term, Bernanke (or Bernie for short) is more worried about saving the economy than fighting inflation. (He’s not really concerned about the devaluing dollar either). And while the price of everything may increase, he’s hoping that real estate prices will stay flat instead of tanking, and that’s how he’s going to engender “a soft landing for the real estate market”.

Looking at the dollar index over the past few days, the dollar has started showing signs of weakness. Now that the interest rates in the US are even lower than in Japan, maybe people will start using the US Dollar as the new currency of choice for the carry-trade!

You could sell the US Dollar and buy the Australian Dollar or the New Zealand Dollar, both of which have a much higher yield than the US Dollar. (Note: this is not a recommendation, just an example of how to execute the new carry-trade). I bought some Australian Dollar ETF (FXA) yesterday morning in anticipation of a rate cut for my retirement account. The yield on FXA is currently 8%! It’s up nearly 5% since then and I’m happy to say my retirement account is down only 4% for the year – if only all my investments had fared so well this year!

Anyway, with interest rates close to zero I’m reminded of an 80’s song called “Turning Japanese“! Enjoy.

Help! I’m Losing My Home To Foreclosure

The lender has filed a Notice of Default on my condo. I knew this was coming. Ever since I sold the condo in summer 2005 at the peak to an investor who rented it back to me, I suspected I’d be able to buy it back for less than what I paid for it. I found out when the mortgage company sent a letter that said “You Will Lose This House If You Do Not Take Part In the Mortgage Reinstatment Program” which was delivered to me instead of the new owner.

The investor paid $352,000 for the 920 sq ft condo or $382/sqft, (and I paid 3.25% buyers agent commission to her niece – I sold it FSBO or For-Sale-By-Owner, so there was no sellers agent commission). The first lender filed an NOD for $283,000. The seller has been pocking my rent and not paying the mortgage since March 2008. Not applying the rents to the mortgages is called rent skimming, and is only illegal in California during the first year of acquiring a property. Unless the sellers cures the default, the house will be foreclosed upon and the second mortgage of about $35,000 will be wiped out.

Current comparable sales are about $225,000, which represent a 36% drop in prices. I wouldn’t mind buying it myself, but for a few issues.

1. I’m moving to Los Angeles and will be busy with my MBA. Do I want to get involved with yet another investment property.

2. I wouldn’t feel comfortable paying more than $150,000 for it. I think prices may drop another 30% from here, maybe more – who knows.

3. Its taking lenders up to a year to list REO properties that didn’t sell at the auctions. So working with the lender can be painful while I’m in LA.

I called up the mortgage servicing company that sent the letter and the guy on the line said I should stop paying my rent and save my money instead. This is blatantly wrong information. A rental contract is completely separate from a mortgage and there is no correlation between the two. I really doubt my landlord would take me the court, but he has the legal right to do so and an eviction/judgment on my credit history would make it a lot more difficult to find a rental in the future.

So what would you do?

1. Stop paying the rent and continue to live there.

2. Stop paying the rent and move out.

3. Continue to keep paying the rent as if nothing happened.

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 Realtor.com 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?

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!)