Jerry Maguire, Mission Statements and the Great Housing Malaise

I began this missive as a comment to a thoughtful and well-researched Seeking Alpha article by John Lounsbury titled, “Housing: Where Is the Bottom? ” In my Jerry Maguire-like epiphany moment, I inadvertently composed an entire post – a mission statement regarding dealing with the housing / foreclosure crisis. While there is excellent insight and analysis presented in Mr. Lounsbury’s article, the author - and many others who have opined about the housing conundrum on the SA forum – fails to address the critical element of “clearing the market” of the outsized housing supply overhang that exists in the marketplace today: allowing unfettered market forces to act in the wake of new demand fundamentals.

The “fatal flaw” that caused the current national housing foreclosure debacle was the notion that every quasi-responsible (or breathing) adult should have the opportunity to be a homeowner with little or no investment or “skin in the game” through the Fed’s interest rate management program and the alchemy of new-school structured finance. I suspect that many people who critically think about and discuss this topic in 2009 now understand that the “ownership for all” premise was, and continues to be, faulty. There are individuals and families for whom renting is clearly the best near- to mid-term option for shelter. They did not and do not have the savings required to make an “investment” in housing, nor do they fully understand the true costs associated with ongoing home ownership.

There is an argument that many first time buyers during the last cycle / bubble were lured by unscrupulous vendors and the availability of easy credit into making a leveraged bet that housing prices would rise, providing the necessary nest egg to invest in home ownership under “normal circumstances”. Unfortunately when the music stopped, a majority of these buyers learned that their bets had not paid off – that is another discussion altogether.

If we now accept that many of the end users that wanted to be homeowners were not and are not qualified to manage home ownership for a sustainable time, then the next logical question to ask is, “where will the demand for housing units come from now that the once artificially inflated supply has been exposed?”

The answer is simple – but at the same time so difficult for the lenders and the equity investment community to hear and come to terms with: investors. The only way to “clear” the market of foreclosures is to let the market forces work in tandem (e.g. rising interest rate, falling home prices, rental rate adjustments, etc.) allowing prices to gravitate to a level whereby an investor can acquire leverage at a reasonable market level and cost and put equity capital at risk (a goofy concept today, I understand) to generate a return on investment. This is the only formula that will work to clear to the market of the enormous glut that we see today.

Unfortunately, the resulting reset in housing prices would immediately cause a number of banks to become insolvent, upset a multitude of foreign investors in RMBS / CDOs, further exploit the inefficiencies of Fannie and Freddie (pushing their collective heads under water for good) and relegate many “homeowners” hanging by a thread back to “home renters” – a concept that somehow became un-American through this process.

Sophisticated investors in residential properties understand that there are a number of costs associated with managing and maintaining a residential unit (either attached or detached) for the long term. These costs include vacancy rates, operating expenses (all of which may not be borne by the tenant) management expenses and capital expenses (e.g. roofs / HVAC units / Appliances / repainting / etc.). In order to allow the market to clear excess inventory, prices will have to fall to a level whereby an investor can acquire a property from a lender at a price that allows a double-digit annual cash yield/return on his/her equity investment using moderate leverage (60%-65% range) - period.

Rental rates are currently in a state of flux in many major metropolitan areas. A friend recently provided a real-time example where is rent in a Brentwood, CA high rise residential building is decreasing from $1,500 per month to $1,300 per month. Sophisticated investors understand this, and will not risk their equity capital on unrealistic rent growth assumptions. With unemployment trending towards double digits, occupancy in rental housing units of all types is bound to decrease as single apartment dwellers “double up” with a roommate or move back home if that option exists. Empty nesters of America, you have been warned – though I suspect most of you could have written the last line…

In short, the investor segment is best equipped to value the excess housing inventory that exists today since there are not enough qualified “end users” to absorb the supply, making a majority of those housing units rental units in disguise in today’s heavily managed / manipulated market.

I trust that there are a number of investment bankers, mortgage brokers, hedge fund managers and CDO financial engineers who have also had their own Jerry Maguire moment during the past 18 months: “I couldn't escape one simple thought. I hated myself. No..No..No here's what it was...I hated my place in the world.” It is indisputable that the greed and brazen, unadulterated self-interest of a few have truly mortgaged the future of a Nation in a way that has not been seen heretofore. I hope that the private jet-serviced junkets, second homes in the Hamptons and Vail, $500 bottle-service in Vegas and $4,000 / night hotel and spa packages at the St. Regis in Dana Point were well worth it for the few who felt compelled to gamble with the lives and livelihoods of so many. Now we all need to prepare to pay for the excess … with interest at a level that would make Paulson and his Treasury / Federal Reserve cronies blush.

As an aside – from here forward, I personally vote that Congress be required to invest a portion of the funds in the Federal Employees' Retirement System and the Civil Service Retirement System in the same opaque securities and equity capital infusions made in automaker, banks and insurance companies that its members are so eager for the American taxpayer to subsidize. I suspect that if this was the case, there would be a bit more due diligence performed prior to haphazard “investments” being made on behalf of an unwilling and often unwitting populous.

Comments

[Jubilee Year:]

So we have an oversupply problem, which will only get worse as more people are laid off. And we already have, what, 12 months of inventory still on the market? And we are already at 2004 prices, with 20-25% of all homes being upside down right now, with the market still declining.

So, is this even reversable? How exactly does this process end? Is there any way to avoid what you foresee: a mass banking insolvency?

Jan 12 10:45 AM

[mbborak:]

I am convinced that the push for universal homeownership is a scam created by businesses, lobbyists and spineless lawmakers to squeeze every last dime out of the average American's pocket. Most people who own houses are addicted to debt, and have no choice but to borrow to maintain their lifestyle. Think of all the purchases that go along with moving into a house (furnishings, appliances) and all the maintenance/upgrades that drain the pocketbooks of the average homeowner. But remember, this is great because it pumps up consumer spending!

We are told by the powers that be that homeownership is not only "the American Dream" but the greatest and most secure investment you can make. The truth is, most people don't factor in all the costs of maintaining a house, and can't refrain from keeping up with the Joneses by buying a $1,000 washing machine and a $30,000 kitchen upgrade.

The solution is to stop subsidizing homeownership with tax breaks and artificially low mortgage rates and let market forces work. Homeownership is not a natural-born right. It is a privilege that should be gained through working and saving.

Jan 12 12:55 PM

[cadoggy:]

We also need a way to make the housing market more liquid than it is. I find it absurd that a seller is required to pay 10% of a home's value just to sell it.

Realtors are overpaid.
Mortgage brokers are overpaid.
And title companies are extremely overpaid.

Jan 12 02:53 PM

[D. McHattie:]

As mbborak said: "The solution is to stop subsidizing homeownership with tax breaks and artificially low mortgage rates and let market forces work. "

Exactly.

The government needs to get out. Let prices fall so that investors can scoop up bargains and rent them out. The less the investor pays for the rental unit, the less they can rent it out for. Plentiful and cheap rental units will allow renters to save money, rebuild their credit and, if they want, one day become a home owner again.

Falling home prices are a good thing for the prudent.

Jan 12 03:01 PM

[neocon4jesus:]

Greed is Good! Hum, is it really?

Jan 13 06:44 AM

[Guero:]

Unfortunately, many people who think they are "investors" are extremely unsuitable as landlords. I am referring to unresponsiveness and a lack of property maintenance, especially on fully or almost-fully depreciated properties. Some of these property owners are poorly capitalized and cannot afford the maintenance, and some just flat out don't give a squat.

Also, someone made a crack about overpaid realtors/mortgage brokers....you know, there are almost more realtors & mortgage brokers than there are people. That means you can shop around, pick & choose & negotiate what you pay these people. But they aren't going to market your property, or find you a property, or put together a loan for free. Would you work for free?

Jan 13 11:41 AM

[cadoggy:]

I'm not proposing anybody work for free. But a Realtor who makes $30k to sell a $500k house is getting paid too much.

Let's say two agents split the $30k and take home $15k each. Let's also assume that $75k is a reasonable salary for a real estate agent. That means a Realtor would only need to sell 5 homes every year. That's one home every 8 weeks.

The trouble is when a house costs 10% to sell it stifles the liquidity of homes. Our economy is better off when people are free to move about for reasons of love or money.

States should cap real estate commissions to 4% and expect agents to sell at least 1 home per month to earn their $75k.

Jan 13 02:04 PM

[Guero:]

"Salary" is the wrong word. They are independent business people. Entrepreneurs. Think gross income. Then back out of gross income: taxes, broker splits, expenses of all kinds from advertising to office supplies, employees, office space, insurance, fees and maybe you start to get the picture. That 75K turns into 30-40K in a hurry.

Like I said earlier, anyone selling a property can shop around for lower fees. There isn't any reason anyone has to pay 6%, especially on a higher price property.

Jan 13 04:37 PM

[Sully:]

I would never defend the Realtors, in fact, if you've read Freakonomics you know why they disgust me, however, not all of that commission goes in the realtor's pocket. It gets split with the house (brokerage). I'm pretty sure that split can start around 50% and become more favorable as one gains tenure. . . . so your estimate for $75K of 8 sales is understated by as much as 50%. In addition I think the realtors underwrite the advertising, signage and general marketing program for each sale.

Jan 14 07:33 AM