Wednesday, January 30, 2008

7 Reasons to Love the Post Housing Bubble

by Osman Parvez
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"It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness..."
- Charles Dickens, A Tale of Two Cities

There's a silver lining to the housing bubble. Sure, it's less sensational than upside down borrowers being tempted to walk away from their mortgages. It's clearly less sensational than what Britney or her sister are up to. But guess what? It's information you can use. Here's 7 reasons you should love the (post) housing bubble.

1. Fewer speculators. Get rich quick schemes are no longer on late night television. Gone are programs that promote "no money" down, fraudulent tactics to purchase properties for "income." Fewer speculators means a healthier market in the long run.

2. Lower rates. As the Fed has already hinted with their unprecedented 3/4 point rate cut, the next 6 to 18 months could represent an opportunity for qualified home owners to lock in more affordable, fixed rate loans. If you own your home with a fairly high interest rate, my advice to you is to start tracking fixed rate loans and get ready to pull the trigger on a low, fixed rate, low cost refinancing. Be sure to use a reputable lender and don't sign unless you understand your loan conditions.

3. Better qualified buyers. Over the last few years, we've noticed our clients have been increasingly able to afford the homes they want. Buyers aren't looking for a quick buck on a flip anymore, they're looking for a place to raise their family. They're more realistic about what they can afford and consequently, more deals get across the finish line. If you're selling a home, this means that you're less likely to be wasting time with a flaky buyer.

4. Realistic sellers. They aren't looking to make a killing anymore. They're not wondering why California saw 15% appreciation last year but Boulder didn't. Sure, they still want maximum value from their home but are more realistic about market conditions and generally more open to negotiation.

5. Fewer real estate agents. Everyone knows a real estate agent, right? The good news it that the flood of agents entering the business is over. Today, more and more people are getting real about real estate. Surprise! This is a tough business, and tossing a home on the MLS isn't enough anymore. The post bubble world is rewarding agents who help their clients with sharp negotiation skills, effective marketing, and a deep understanding of market conditions. In the post bubble world, it's not as easy to sell a house. Value delivered matters. Agents have to step up with better, more valuable services or get out of the business.

6. More affordable housing. In areas where demand was artificially driven by speculation, prices will fall. Foreclosures, reduced buyer demand, and builder discounts will continue to lower house prices in many markets. In our area, Boulder will likely have flat or even slightly lower prices in 2008. I expect prices could drop further this year in other local areas with less demand and more inventory.

7. Better quality lenders. The bubble encouraged all manner of people to enter the business of providing loans to purchase homes. The rewards were great. The risks were low. The regulations were minimal. No longer. Today, lenders are in the cross hairs of regulators and disreputable tactics have been exposed. Home buyers are aware that they should not only shop for better rates, but for a reputable lender. They're also carefully reading their loan documentation and asking questions about loan conditions.

image: guano


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15 comments:

  1. I don't follow the connection between the Fed's recent cuts and the direction of long term interest rates, except that the investment community's expectations of future inflation can be affected by the Fed's gymnastics. IF we are in or heading towards a protracted recession, then I would agree that long-term mortgage interest rates are likely to drop further. However if inflation is exacerbated by the Fed's actions and the recession is just hype, then it's likely that rates will climb in the near term. Of course the above relationship is overly simplified; there are a host of factors interacting in complex ways which determine long term rates, but basically it's the economist's story of finding supply-demand equilibrium, a constantly moving target. Blog readers might want to check out the basic analysis at the following page or search the 'net for "what determines mortage rates":
    http://library.hsh.com/read_article-hsh.asp?row_id=85

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  2. I'm glad you commented David.

    Dallice and I were talking about the relationship between Fed's rate cutting and mortgage rates just yesterday. You're technically correct, when the Fed drops the discount or the Fed Funds rate, there is no *direct* impact to market determined fixed lending rates. The current policy of the Fed is to cut rates when information emerges that points to a recession. Assuming that we are headed to recession, which I think is a fairly common assumption, rates will fall. Inflation acts as an opposing force as lenders seek greater returns to maintain the intrinsic value of their capital. If we have stagflation, where the economy is in recession but prices are rising (as occurred in 1974-1975), it's likely rates will be higher in the long term. But in the short term, before inflation is priced in... there could be an opportunity to lock in a lower fixed rate and pay off your mortgage with cheaper dollars going forward. This is why I suggest that readers start paying attention to fixed rates and get their affairs in order so they can pull the trigger *IF* rates drop dramatically. I think it's quite possible in the short term but the window of opportunity could be small.

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  3. You left out the bit about systemic financial contagion.

    The probable implosion of the GSEs, the destruction of their counterparties i.e. the money center banks, the exposure of the small banks to gse paper, the fact that "safe" money market funds are usually short term gse repos...etc, etc.

    And finally, the $10,000 question, can the fed entice banks to loan money faster than the credit bubble can collapse.

    If not, we heading for a deflationary depression.

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  4. That's quite a dismal view Peter.

    You've based your prediction on the implosion of the GSE's (Fannie Mae, Sally Mae, and Freddy Mac). Personally, I can't think of a likely scenario that would cause this. Not even close. What would do you think would cause their collapse, specifically?

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  5. Fannie and Fredie have been insolvent for years. The Federal government has been hiding this with their bogus BLS statistics and Enron style accounting. People better get out of equities in general, and into foreign bonds and fixed income vehicles to hedge against our continually collapsing dollar.Thanks Bubbles Bernake. Asset deflation, including "homes" is on the horizon.

    Osman, much respect for your fine blog and honest analysis, but people, contrary to what any realtor may tell you, now is not "a great time to buy a home" nor will it be any time soon.

    Regards

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  6. No offense, but you sound a bit like a
    Y2k nut. How do insolvent businesses facilitate originations that measure in the trillions?

    Ah, the mbs market. But through insolvent entities? I don't think so.

    Although credit markets are currently in turmoil, how long do you think it will last with enormous amounts of capital chasing yield? Even if you assume a protracted collapse of the mbs market, do you really think our gov't wouldn't backstop the gse's?

    If so, how are you personally preparing for the apocalypse? Stocking up on bullion and building your weapons arsenal? Ha!

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  7. Osman, point taken, my post does seem a little extreme, however I certainly am not a y2k nut, nor do I prescribe to any permanent gloom and doom philosophy.

    I know you are well informed and follow other credible financial and real estate blogs, like Calculated Risk, RGE Monitor, Mike Shedlock, or even say, Paul Krugman, who forcasts a 10-20% chance of a serious financial meltdown.

    The story of Fannie and Freddie are well documented, and you are exactly right about the government backstoping their losses. With the MBS crisis under way though, there are fewer and fewer ways to hide what is (or should I say off) their balance sheets.

    How do you feel about Merrill Lynch and Goldman Sachs recent forcasts for 25% national housing declines over the next 2 years?

    People are starting to get very tired of all this Federal Reserve manipulation. Credit needs to contract! There has been way too much funny money and speculation going on (as you noted in your post). We need to just let it happen and quit fighting it! Can you imagine if people could actually afford their fixed mortgages, or health insurance, or college for their kids, or even retirement?

    Personally, I sold my house in California in 8/06 and have been renting and patiently waiting to re-enter the market right here in Boulder, and I plan on paying cash, but not overpaying. Per your comment- Boy do I wish I had a safe full of bullion, or getting the same returns in the market as just a few years ago, but unfortunately I am holding on to some dollar devalued CD's and some hedged foreign fixed income. There are very few safe places to go, and all I'm suggesting is wealth preservation vs: chasing returns is where I'm at.

    I don't know how you can possibly think that RE is a good investment right now!I don't even want an investment, I just want a home for my family, but home debt for irrationally inflated prices is not at the top of my list. There are so many problems with the current economy, we are definitely in for a bumpy ride. (I know RE and the economy are local)

    Look, I know you are an RE agent, and from what I gather from your blog, a good one with integrity.(a rare find) So I will keep my financial ideas to my self from now on, as I'm sure you don't want your potential clients reading my negative RE rants. I'm just really concerned with the short term, there are only so many rabbits the the fed can pull out of their rapidly disintegrating hat.

    When prices come back down to earth I'll be there to buy, but not before. I may even ask you to be my agent Osman.

    Regards

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  8. I appreciate your comments. You are most welcome to continue to post your thoughts, even if we don't agree. The only comments I censor are spam and anything disrespectful. Frankly, I enjoy a good discussion.

    By the way, my last response was a little punchy, perhaps. I'm currently a little under the weather with a cold. Sorry about that.

    So.. there are many things in your comments deserving of a response. But I suspect we see more eye to eye than otherwise, so I'll keep it to a few key points.

    First, don't assume I advocate real estate as an investment for everyone. If you are investing a significant amount of capital, residential real estate is probably not the best place to put your money. On the other hand, if you're putting down 20% or less in Boulder, expect to live in the house, and will hold for more than 5 years... even in a relatively flat market, most people are better off buying than renting a primary residence. The tax advantages plus the potential coming inflationary environment will make it easier to pay off the mortgage with cheaper dollars, assuming your passive/active income keeps pace. I encourage you to download my buy vs rent model (available by searching the blog) and test your assumptions. The model even lets you build a curve showing prices falling for the next year or two.

    About a year ago, we started doing "work sessions" with new clients. Mostly buyers who were just getting started in the process or were mulling over the buy vs rent decision. In about 1/3 of those sessions, after hearing their objectives and getting a sense of their financial condition, my advice was to keep renting for another 12-18 months.

    I know it's uncommon to hear a real estate agent advocating renting. The way I look at it, the people we spend time with appreciate the straight talk. They have and will continue to send us referrals and will likely use our services when they're ready to buy a house.

    Second, your question "How do you feel about Merrill Lynch and Goldman Sachs recent forcasts for 25% national housing declines over the next 2 years?" I think they're being conservative. If you average the fall across the nation on a density basis, I suspect it will be greater than 25% as highly populated overpriced markets on either coast and certain inland areas like Phoenix and Los Vegas implode. These markets were driven by speculation to obscene levels.

    But remember, there is no national real estate market. Here on the front range, prices are likely to dip slightly or be flat for the next 12 to 18 months with the most desirable locations (including Boulder) holding up better than others. The job market is more diverse than in previous recessions so hopefully the broader region will do OK as well. Within Boulder, the low end has very strong demand even now. The mid to high end, somewhat less so. However, if we see strong inflation that will benefit the high end of the market disproportionately. The market dynamic could shift.

    Personally, I wouldn't want to take on debt for irrationally priced assets either. But I don't think Boulder is irrationally priced. At least not to the extent of the former bubble markets. This isn't Phoenix, Miami, or Los Angeles. Compare the average appreciation rates in Boulder over the past few years with the former bubbles for more details. You will find plenty of posts on the subject, with appreciation charts, on this blog.

    Bottom line... if there's a downturn in Boulder real estate lasting more than 18 months, I would be surprised. Any short lull, particularly if rates have a drop, might just be a buying opportunity.

    You might notice I keep talking about inflation. That's because I strongly suspect that the Fed plans to inflate its way out of the largest asset bubble in history, despite lip service to the contrary. If you agree that an inflationary environment lies ahead, you might consider putting a little of your egg down for a low fixed rate mortgage and continue to keep the rest in investments indexed to inflation. You should plan to live in the home for at least 5 years, and the longer the better. Yet another reason to keep an eye on mortgage rates. And if think Boulder is too expensive, consider neighboring communities. For more on how owning a home is a defensive play, may I suggest reading The Coming Generational Storm.

    It seems I've now swung fairly wide of real estate. Given our sue-happy culture, it's time for a disclaimer. Although my comments above may *sound* like investment advice, they are not. Furthermore, my uninformed, biased opinions are subject to change as market conditions evolve. Please consult with your professional advisers before making an investment in real estate, or any other asset class for the matter. And, given the lack of independence and objectivity in the investment community (unless you're shelling out big bucks), be sure to keep thinking for yourself as you're weighing your asset allocation decisions.

    p.s. My number is 303.746.6896, if you need a real estate agent.

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  9. The possibility of a GSE systemic event was detailed by the OFHEO and delivered by the Director Armando Falcon upon his resignation back in 2003.

    http://www.ofheo.gov/Media/Archive/docs/reports/sysrisk.pdf

    Fannie has been incapable of issuing a financial statement for over half a decade. D.C. is going to have a hard time bailing out an entity with more debt than the publicly held Treasury debt.

    And in case you haven't noticed bullion has outperformed nearly every other asset class for the last 7 years.

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  10. If I were in the inflation camp, your advice would be sound, however I feel we have already been experiencing accelerated inflation for the past 6 years or so, and will continue for a short time more, then will turn to DEFLATION in the near future. I think the best model to predict what is to come is what happened in Japan in the early 90's. Bank of Japan lowers interest rates to .5% to spur consumption and capitol expenditures, which was followed by a slow drawn out deflationary cycle lasting 18 years, where RE as well as other asset classes lose a significant amount of value. 1 big difference:The Japanese are savers, and Americans are not. Our savings rate is what, negative .5%. The only place most Americans have any money banked is in their homes, and with mortgage equity withdrawl a thing of the past for most, it could get ugly. I believe most Americans are tapped out.
    It is very difficult to know when or if we turn from inflation to deflation. I tend to think asset inflation is close to being over, while consumables like food and fuel will continue on a little longer.
    In the mean time I will continue to rent and save and keep a close eye on my investments, and when the overburdened banks start accepting 30% off on their vast portfolio of foreclosures, I'll be there!

    Regards

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  11. Pete,
    Again, do you think the government won't do everything remotely possible to backstop the GSE's? If you're banking on their collapse, then you're really banking on the collapse of the United States Gov't and our Financial System. And thus, it's time to build that weapons cache, develop some survival skills, and figure out how to farm.

    With respect to Gold. It's had a 7 year run. It's also now at or above it's historic inflation adjusted high water mark. The last time it hit this point, it declined in value for what...the next 15 years? So the golden question, are you still buying?

    Buy the Farm...

    Japan a good comparison - agreed
    Americans tapped out - agreed
    MEW over - agreed
    Banks to start taking 30% off foreclosure portfolios - agreed, but not in the City of Boulder

    I admit,you present good arguments for the deflation camp. Or rather, inflation turns to deflation. One counter point to consider... Japan has a very different age demographic. Our population has also shifted massively in the last twenty years. Not only do we have another 20 years of Boomers retiring, many of whom are mobile and wealthy, but I heard a recent statistic that 1 in 9 people in America are immigrants to this country. How do these factors play into your deflation scenario?

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  12. Pete makes some great points:

    GSE's : We know they are already leveraged to the teeth.
    We know the the gov. will do anything possible to keep them operating as usual.
    Conclusion: GSE's lending requirements get tighter not looser, as less money is available to lend, thus choking the credit market even more. There are already many people on the inside of OFHEO and Fannie calling for the circus to stop. I do believe there are already 1/4 to 1/2 point spreads being put on conforming loans starting this spring in order to try and reprice risk more appropriately. If the GSE's can't back every loan in America, who is Wall st? and at what cost?

    Bullion: Hmm....I'm not buying for I fear Deflation will effect its price too. Gold baffles me a bit, but I'm pretty sure the Inflation adjusted all time high price is closer to $2000.
    When adjusted for inflation, however, gold remains far short of its all-time high. An ounce of gold at $875 in 1980 would be worth $2,115 to $2,200 today http://www.usatoday.com/money/markets/2008-01-08-gold-prices_N.htm

    Boomer's: I didn't look up anything, but my gut tells me that you are overestimating their savings. If they have conservative investments, (which is age appropriate if nearing retirement), they are probably having trouble keeping up with the real rate of inflation. Their retirement savings,(AKA home equity) isn't doing so hot either, plus most have to sell a house to buy a new one.

    Foreign investors: That is a definite x-factor. My thinking is that global decoupling does not occur. Europe is in big economic troubles as well, and Asia is much more dependent on their exports than your favorite CNBC pundit wants to let on. As our economy goes into recession so does most everyone else, there by stabilizing the already extremely devalued dollar in relation to foreign currencies and inhibiting further inflation.I don't think the dollar will fall that much more. Already Europe is crying about their high currency prices and inability to export profitably. What we are left with is credit destruction, and protracted spending = Deflation.

    Oil producing country money could throw my entire argument out the window?

    It's like a mantra for realtors to always preach "All RE is local", and "There is no national housing market", and I agree on some levels,(especially in Boulder) however credit contractions, recessions, and global finance issues are a lot closer to home now in this technological world we live in. The speed of information also contributes heavily to psychological factors, and how and when people choose to spend their money. Japan, I'll have to debate with you another time.

    Regards

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  13. Pete,
    Again, do you think the government won't do everything remotely possible to backstop the GSE's?

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    Absolutely, in the same manner the USSR did everything possible to keep bread cheap. I have no faith in centralized command economies. Their efforts will fail.

    In fact, it is this moral hazard that is at the very heart of the housing bubble in the first place. By the standards of the NYSE, Fannie should have been delisted years ago if it were not for the presumption of a government bailout.

    If you're banking on their collapse, then you're really banking on the collapse of the United States Gov't and our Financial System.

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    The FedGov using GAAP standards is insolvent.

    And thus, it's time to build that weapons cache,

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    Pick 308 over 223.

    develop some survival skills, and figure out how to farm.
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    Nope, that won't work. You can pretty much define poverty by the % of the population engaged in agriculture.

    With respect to Gold. It's had a 7 year run. It's also now at or above it's historic inflation adjusted high water mark.

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    This is a technical not a fundamental argument.

    The Feds have 70 trillon + in unfunded liabilities. What sort of monetary policy do you think this will result in?

    So the golden question, are you still buying?
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    No but only because appreciation has made commodities a disproportionate part of my portfolio.

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  14. Bullion: Hmm....I'm not buying for I fear Deflation will effect its price too.
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    Gold is a currency, and has been since the days of the Pharohs.

    As deflation demonetizes the dollar and the leveraged credit instruments which have been serving as money, sound currencies such as gold will increase in purchasing power.

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  15. Ok, I checked and you guys are right. Gold is not close to its inflation adjusted high. I stand corrected.

    ReplyDelete