Wall Street Continues to Misunderstand Housing

Wall Street created the U.S. housing bubble and now it’s missing the real estate rebound.

And Andrew Waite understands why.

Waite is the publisher of the Personal Real Estate Investor, a glossy magazine that focuses on investors who buy houses or condos to manage for income or to fix up and sell for a profit. But he’s not some industry cheerleader whose statements are nothing but spin.

He’s a true expert on the U.S. housing sector who goes out of his way to "educate" journalists about the true state of the American housing market, and who criticizes most of the "indicators" in use as useless and irrelevant. Plus, as a onetime Wall Street venture-capitalist who subsequently joined Silicon Valley’s Sand Hill Road private equity crowd, Waite really understands how the Wall Street investment game is played - and, in the case of the U.S. housing market, the missteps Wall Street made and why.

"Wall Street analysts and economists do not understand the housing industry," Waite told Money Morning in a recent interview. "While stocks and bonds are relatively simple to analyze, housing is anything but. Unlike stocks, housing is a non-tradable asset."

But through the creation of mortgage-backed securities, Wall Street tried to transform housing into a tradable asset. That lack of understanding set the stage for the housing bubble. And it’s the same miscalculation that is keeping the big-money crowd from understanding that the housing market may have already bottomed - and may well be on its way back up.

Let’s look at both miscues.

Building a Bubble

Stocks and bonds are "tradable assets." They trade on central exchanges - in a very efficient manner - and play well into the kind of mathematical averaging that paves the way for all sorts of indices (the Standard & Poor’s 500 Index), and sub-indices (the Dow Jones Transportation Index).

That’s not the case with housing, which is very granular in nature - meaning how housing does in one neighborhood differs greatly from how it does in another. Housing is a "non-traded" asset because it is hard to trade - and when it does trade it does so in a highly inefficient market.

As Waite says, housing is referred to as "real" property for a reason: Unlike stocks or bonds, which are paper representations of the underlying asset, housing is the asset itself. People live in houses, and most don’t buy them as investments - they buy them to live in. The typical house is owned for five to seven years, and only about 5% of the U.S. housing stock turns over in a single year. In a "normal" period - by that, I mean a stretch that’s not artificially souped up by the unrealistically loose credit that led up to the subprime-mortgage debacle - prices escalate perhaps 3% to 4% annually. And there aren’t the whipsaw pricing patterns that we see with stocks.

Even so, as part of its mission to transform housing into a tradable asset, Wall Street designed a reporting system that, true to form, was badly flawed, Waite says. The measures applied to the market - sample size, methodology, and statistical presentation - work well for assets that are dynamically traded, as stocks are. But they don’t work for housing:

• Stocks are analyzed by looking at the underlying company’s fundamentals, meaning the conclusions reached are very much tied to the specific earnings power of that firm.
• Housing, by comparison, is analyzed making "illogical" generalizations about the market that fail to reflect reality.
• Stocks are analyzed in a forward-looking fashion, being all about earnings projections and expectations.
• Housing analysis ends up being backward looking (45 days to 180 days), meaning the conclusions that are reached are likely outdated by the time we see them.
• Housing ends up being treated like a commodity, with "five-star" neighborhoods (where sales are brisk and the asking price is now being exceeded as prospective purchasers bid the values up in hopes of landing the house) being "averaged in" with "disastrous" one-star neighborhoods.

Says Waite: "Housing indexes and statistics emanating from Wall Street take a cynical view of housing … and they misrepresent the actual value of housing by ignoring the critically obvious point - most housing purchases are ‘buy, occupy and hold’," and aren’t a speculative play aimed at short-term profits.

By misfiring so badly, Wall Street established an environment in which housing prices were expected to escalate at better-than-their-historical norms, fanning the speculative flames. The easy credit made available by the mortgage-backed debt market only made matters worse. Banks made loans, and Wall Street bundled those loans into an asset-backed security - giving the banks back the cash that they could then use to make their next round of loans. Because the loans were "averaged" out, the resultant securities were given the highest credit ratings by the ratings agencies - which was more than the securities deserved.

It was a recipe for disaster - or, at least, for a bubble.

Wall Street never saw it coming.

Anatomy of a Rebound

Wall Street has also failed to understand the dynamics of a housing market recovery - which is already in the works, Waite says.

And he should know. The portion of the real estate market that Waite’s magazine caters to - the real estate investor - is significant. In fact, a groundbreaking study commissioned by the magazine, and conducted by real-estate researcher REALTrends Inc., in concert with Harris Interactive, found that real estate investors account for 22% to 28% of all home sales (existing and new) each year - a total of 1.5 million to 1.64 million houses each year. That’s a big piece of a $300 billion industry, so it provides a very solid sample.

According to Waite, the housing market bottomed last year. But that bottoming takes place in stages. Housing values continue to decline. But values can’t bottom, solidify, and then head north until sales volumes increase, Waite says.

"First you get volume, and then you get valuations," Waite says.

And it doesn’t get better across the board all at once: Sales will improve in a "predictable sequence" that start with the very best neighborhoods, work their way down to the really good neighborhoods, and finally reach the plain old good developments.

As noted, Waite says the very best neighborhoods are already seeing strongly improved sales, with actual bidding battles taking place as prospective buyers willingly pay more than the asking price in order to land the choicest properties.

As those markets sell out, and the credit spigots open, demand will move from the very best neighborhoods down to the "pretty good" residential properties, Waite says.

Three reports released over the course of three straight days the last week of March seem to support Waite’s view.

Sales of new homes rose 4.7% in February - the first increase in seven months, the U.S. Commerce Department reported March 26. The day before that report came out a government gauge of home prices posted its first gain in almost a year. And the third of that "hat trick" of upbeat reports issued that same week said that sales of previously owned homes - the biggest share of the market - also increased in February.

The plunge in housing prices is also starting to have an effect. In a second report issued March 26, the California Association of Realtors said that existing-home sales in the state were up 83% in February from the previous year. The reason: The median home price was down roughly 40%, which is helping shrink inventories to about a six months’ supply from 15 months in 2008.

If Waite’s theory is correct, as sales of new and existing homes pick up on a month-to-month basis, prices will follow.

But true to form, Wall Street is demanding proof.

The data "have allayed some fears that the housing market would continue to freefall," Omair Sharif, an economist with RBS Greenwich Capital, told The Wall Street Journal. "But it’s way too early to say if we’ve hit bottom."

But Waite fervently believes that bottom has already been hit and that it’s all uphill - over the long haul - from here.

"Wall Street would have you believe that putting money into a house is as sophisticated as putting money in a mattress," he said. "But as it continues to prove, nothing could be further from the truth."

Original post

Comments

[RayD:]

You've got to be kidding me!

Despite Mr. Waite's assertions, there is no denying there is tons of unsold houses, excess inventory, that the market must work through. Plus the household income to home price equation must return to some semblance of normalcy.

Apr 10 02:01 AM

[OptimizedPrime:]

A couple of things.

In my little town (arguably in the "five star" traunch) we have 85 houses on MLS and have had one closed sale THIS YEAR (lots go pending and then mysteriously return to MLS a few months later). Thus 1/4 of a house per month, thus 340 months of inventory. In the surrounding towns the same math gives you years and years of inventory. If anything, the recovery here seems to be going in the exact opposite sequence as the cheap/less desirable neighborhoods are moving and the expensive ones are still frozen.

Second, the Bubble mentality completely reversed (or perversed) the traditional buying pattern. I don't know how many times I heard somebody tell me they were going to "mortgage their life" to squeeze into a house. Why? Closer to work? No. Bigger house? No. Fancier? No. Why then? It's a GREAT INVESTEMENT. It's in an UP AND COMING NEIGHBORHOOD. The house has 6 (4'x6') bedrooms which are useless but a "6 bedroom" will have a GREAT RESELL VALUE.

Why not just rent a bigger, nicer, closer-to-work house at less cost on a monthly basis? Because that would be a BAD INVESTMENT. Not a bad place to live. Not a lack of space for the kids, but a BAD INVESTMENT. This is a speculator talking not somebody that wants comfort. "Screw comfort for now, we'll house-flip our way to riches".

In other words, the Bubble transformed normal people into real estate speculators. En masse. These people, smarting for fresh "losses" from lack of 20% y/y gains they saw from the .bomb years on Wall Street saw housing as the next gravy train.

It's not that Wall Street doesn't get Real Estate, it's that Real Estate people don't get that buyers in the past five years wanted the Wall Street of 1999. For a little while the market gave that to them. Wall Street (and wild speculating) giveth, and it taketh away...

I agree that once prices retreat to pre-bubble prices (viz. 1997 prices? 1990 prices?) then we'll start to see "normal" patterns that are based on things like the state of the economy and interest rates.

Interest rates? Looking good. State of the economy? Not so much.

There's certainly some money on the sidelines that's waiting to move in and grab some bargains, but these rich and lucky people are not going to drive the market as a whole because there aren't enough of them. They'll just put blips on the radar for the occasionall odd month and invite ridiculous articles like this one coming from real estate pimps.

The bottom is nowhere near us. Remember those 1997 prices we need before anything moves? How many people CAN sell a house at that price and walk away with anything to show for it (and to show for a down payment on an upgraded house). I bet it's a very, very small number. As such the houses you see on the market today are not the typical upgrade folks that used to dominate the market (i.e. selling so they can buy something bigger). These are people that know this is a "bad time" and MUST sell NOW. These are DOWNGRADERS not upgraders.

This can't possibly have any effect besides downward pressure on prices and sales...


OP

Apr 10 02:01 AM

[Steven Hansen:]

in some respects, the arguments you make can be defended. i 100% agree with the quote: "First you get volume, and then you get valuations."

i hope no one expected the housing sales volumes to continue to drop forever. at some point (which i would agree is now), volumes will bottom and should start increasing.

but the bottom wall street wants is the values to stop falling. and we ain't close to that point. we need home sellers and buyers to be thinking in the same ballpark.

and one final point. this crisis is not universal. some markets did not drop and have remained relatively strong. to drag out anecdotal evidence of buyers competing for houses is misleading.

Apr 10 04:02 AM

[Jimmy K:]

Andrew Waite is out of his mind... Real Estate as an investment is dead for the next 10 years.

Every person selling a house now- in this climate, is doing so because of economic reasons, not because they want to move up to a bigger, better neighborhood. They are selling now because they are broke, and only weeks away from bankruptcy.

And when they do sell, after paying out 6% to their Realtor, and eating the 40% loss they realized on the short sale, wiping out any equity (down payment) they had... I HAVE to think they'll be renting- not buying their next home.

Apr 10 07:27 AM

[BlueFire:]

"Real Estate as an investment is dead for the next 10 years."

All due respect, but are you out of your mind? Real estate is the easiest money making opportunity on the planet right now. We are able to generate a 30% return in six month's time right now. And the work on the buying side has become easier than ever since we can buy directly from the banks that are now finally bleeding enough to properly price their REOs.

All I can say is that the gloom that you guys keep spreading is awesome for me. Please don't get positive any time soon. The only problem right now is coming up with enough capital fast enough to take advantage. The capital is being scared off by the gloom with private loan investors waiting for things to get better before they buy in. Well, when they get better, you have missed the bottom!

People are buying properly priced houses. With an 8% tax credit from the feds, if you put a property on the market at 10% below current value, it sells. It is a great deal for a non-speculator first time home buyer. Glad to see the speculators too burned to get back in and bid prices up in a crazy fashion.

When you bought it from the bank for 60 cents on the dollar and sell it for 90 cents on the dollar... well it does not sound like waiting 10 years is a good investment plan to me. I'm buying.

Apr 10 11:54 AM

[Charles Lie...:]

These comments are all missing a crucial element in housing. Where does the growth in household formation go? Don't those people have to either buy or rent? And in doing so, doesn't that take units in inventory off the market? Underlying household formation in the U.S. is roughly 1.4 to 1.5 million, compared to new housing starts that adds about 500,000 at an annual rate to the inventory. So, absorption is very strong. It is that growth in households that will absorb the inventory being sold by speculators, banks holding foreclosures, and ordinary sellers. See my analysis www.advisorscenter.com... that goes into this very carefully, adjusting for a wide variety of factors. The bottom line is that the excess housing inventory should be depleted within 2009, most likely leading to a rise in new construction by this summer.

Apr 10 11:55 AM

[HardwoodFlo...:]

Charles Great Points. So to is the point that the Wall Street and the Big Builders don't get. The big builders made a very simple argument to Wall Street:

"We have in house market research and economists. We can do a bettr job that 'mom and pops" at predicting cycles so we won't get caught."

Well we all know how that turned out- and we probably won't forget immediatly. Wall Street and the Big Builders will be out of the game in the near term recovery. It will be a return, first, of the dreaded "mom and pop" contract and sepc homes.

It sounds reasonable doesn't it- local builders building homes for people they know with banks who know their customers. It's a return to the past and thank goodness for that.

Wall Street is just going to have to get left out of this recovery. So Sorry.

Apr 10 04:12 PM

[HardwoodFlo...:]

Charles- I just read your article. Great by the way.

The problem is as you state- every one looks at housing as one big blob. The fact is it is, indeed, regional. But to listen to the pundits you would think that never a new house would need to be built in America.

There are four new houses being built in our neighborhood. All being built by small local builders. First, no banker is going to let a builder build on spec. So there is someone who got the loan and is building the house! Amazing- you would think that with "shadow inventories and prices plumeting" that this could never happen. Well, wake up America it is. Sorry to disappoint CNN and thier new "finacial crisis" set they built for the bald guy- you might have to scrap it before that $5MM set pays off. Sorry to the guys telling us to buy guns, stockpile gold and go get a generator because civil unrest is coming.

It's like if you never had heard of Y2K would it have existed? Not to be too blithe- there was a finacial melt down mainly do to CDOs and complex derviatives which were then leveraged to take world wide lending north of 50 trillion- but in the real world things are still realtively normal to sucking.

Apr 10 04:24 PM

[HardwoodFlo...:]

Steve- values are going to drop as long as the purchases look like this:

Bottom feeders seeping up floreclosed homes.

So what.

Prices won't go back up until you can off set that with higher priced homes. Well people who don't have to sell aren't going to in a market they percieve as week (unless they can sell a home in a good market and buy a better home cheaper in a percieved lesser market). Higher priced homes are particlarly difficult right now for a number of reasons. One of the biggest reason is that JUMBOs are realively speaking (compared to FHA) expensive. They are also hard to get- becasue the FHA won't back them.

So you have cheap homes being bought on distressed sales. The top end isn't moving. What does that make for cascading prices. So what? does that mean that the whole market has dropped 50-60% with another 30% to go? Of course not.

Read Charles's article and you will see while both the inventory issue and the price issue are being looked at too simplistically.

Apr 10 04:31 PM

[Mad Hedge F...:]

Walking around San Francisco’s financial district the other day, I couldn’t help but notice the colorful, but huge “for lease” and “space available” signs wrapped around whole buildings. The San Francisco Chronicle produced some current market figures for the wasteland that is now the commercial real estate market. Rents have crashed 24% in a year, with Class “A” office space plunging from $50.92 to $38.80, the biggest drop since the dot com bust in 2001. Tenants are downsizing, consolidating, or disappearing altogether. Macy’s and Charles Schwab together are vacating 500,000 square feet this year, with more than half of all Bay Area companies expected to shed staff in the next six months. Purchases of office building have ground to a complete halt because of the absence of financing. Not helping are the city’s notoriously high operating costs, labor rules that would make Bolsheviks blush, and a tax rate that is about to jump from 8.75% to 9.75% to help bail out the state. It’s a lot to pay for a great view. Will the last one leaving please turn out the lights?

Apr 10 04:43 PM

[HardwoodFlo...:]

Mad Hedge Fund Guy. Your doing it again. Posting the same post. It's maddening.

Apr 10 05:35 PM

[Fighting Yoda:]

Housing has not bottomed by any stretch, just because we had an uptick means nothing – it is just noise. Home inventories, and home ownership is still too very high. With job losses and pay cuts – we have falling income, can’t be good for prices. Consumer confidence is very very low- fall in asset values, risk of job loss will deter all buyers.

Housing was a big bubble fueled by speculation – easy and cheap money, poor lending standards. All this is over – we have lending standards – at least 20% down – how many are able to afford that. Lot of home buying was investment properties – this aspect is gone. The credit crunch would of course decrease loan availability – Govt. can only do so much.

The only positive for housing are historic low mortgage rates, but with looming deflation – rates could go lower, and of course home prices could go much lower. IMHO – 20%+ further to go down.

Apr 10 07:02 PM

[thotdoc:]

Let's see...Buy when everyone is fearful...Sell when everyone is greedy.

There are some investments that pay off sooner than others.

Why look at what is happening now if the price of the investment is right?

The best conversation we can have now as investors is assuming things will eventually turn around, which real estate companies are the best to invest in.

G

Apr 11 10:33 AM

[OptimizedPrime:]

This just in: I just read a news story about there being 14M houses vacant in the US.

No massive homeless problem though. No refugee camps to hold the 28M Americans (assuming two per house) that should by all accounts be homeless right now.

Nope, no wide-spread homeless problem beyond what we saw in the pre-bubble days.

So the US can live just fine with 14M less houses. Oh yeah, there's no oversupply. None at all.


OP

Apr 11 12:15 PM

[sssteverrr:]

I just purchased for 620000 the owners are divorcing and have owned the house for 24 years and paid less than 200000. I'm sure they own it and are happy with their return. There are many homes on the market, if their not short and their nor forclosed they are probably profitable.


On Apr 10 07:27 AM Jimmy K wrote:

> Andrew Waite is out of his mind... Real Estate as an investment is
> dead for the next 10 years.
>
> Every person selling a house now- in this climate, is doing so because
> of economic reasons, not because they want to move up to a bigger,
> better neighborhood. They are selling now because they are broke,
> and only weeks away from bankruptcy.
>
> And when they do sell, after paying out 6% to their Realtor, and
> eating the 40% loss they realized on the short sale, wiping out any
> equity (down payment) they had... I HAVE to think they'll be renting-
> not buying their next home.

Apr 12 01:59 AM