High End Home Market Still Has Further to Fall

| About: Toll Brothers (TOL)

We have been enlightened to a rather public person's Real Estate dilemma; Timothy Geithner.

He, along with his wife, bought a NY house in 2004 for $1.602 million. Currently, they owe $1.25 million in 2 mortgages on that house.

Now that he works in Washington, in February, he put his NY based home up for sale at $1.635 million.

After dropping the price to $1.575 million hoping to attract a buyer, it still did not sell. They now rent the house for $7,500 a month.

At $7,500 a month, they'll get $90,000 in rent revenue. The property taxes are $27,000 a year. Hey, the house is in the "Welfare State."

That leaves $63,000 for interest on the mortgage and any other repair costs to maintain the property they... I mean, the bank owns.

Let's assume the mortgage has an interest rate of 5.25%. Owing $1.25 million at 5.25%, that equals $65,625 in interest to the bank.

The rent does not even cover the interest and property taxes when the mortgage is $1.25 million. ($65,625 + $27,000 = $92,625 - $90,000 in rent = $2,625 loss)

Let's say you bought it for $1.25 million cash and rented it out for $7,500 a month. You would only yield $63,000 after property taxes, which comes out to be about 5%. You still have to pay property insurance, maintenance, etc.

5% yield for an investment that has considerable risk is not prudent. The renter may lose his job and not be able to pay their mortgage anymore like the 1 in 8 current mortgage holders in America not paying their mortgage today.

For me, I would want at least a 12% return on my investment given the risk I'd be taking in today's housing market. If my net cash flow comes out to be $60,000 a year, at 12% rate of return on my capital, I would put the value at $500,000 for Tim and his Wife's house.

This tells us that the high end housing market is still way over valued. I'm currently short Toll Brothers (NYSE:TOL) for clients because their average home is expected to sell for $590,000 to $620,000 per home for 2009 putting them in the camp of high end home market where I expect to see considerably more declines.

Disclosure: Short TOL.