The Housing Crash Isn't Over: Here's How to Profit 26 comments
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The US housing market has not hit bottom and, depending on which view you take, has quite some room to move down further. The truth is that we are still in the middle of a historic crash. However, as with such market dislocations, there are very attractive opportunities to invest and make profits if one has capital, patience, expertise, and a good plan in place.
I’ve pulled together some very compelling data from a myriad of sources including G7 Capital Management, a private equity firm specializing in distressed real estate. It’s using this data that I’ll lay out exactly why I feel the people that are calling for a bottom are the soon-to-be victims of a massive head fake; why the nightmare has a long way to go; and how you might be able to profit from it.
Why Everyone Is Wrong – This Isn’t a Bottom
There are four items in place that are tricking people into calling a bottom, when in fact three of these items are temporary. The result is an artificial restriction of supply and artificial pumping of demand.
1) It’s the seasonally strongest buying season
2) There’s a foreclosure moratorium about to end
3) Federal tax credits offered for 1st time homebuyers
4) Historically low mortgage rates (this may or may not change soon)
Why More Foreclosures Are Coming – A Lot More
Foreclosures will continue to come as long as the job market does not get better. Also, borrowers who have Alt-A loan products will have those coming due in the next couple of years and many of the loans will not qualify for the current values resulting in their homes being foreclosed on. The result is that the market will be flooded with new supply, and without artificially increased demand, prices will continue to drop. Here’s why:
1) We have rising unemployment and a worsening economy.
Click to enlarge
2) Banks hold massive numbers of future foreclosures due to the moratorium. The moratorium will end and those houses will hit the market. In the California market, where G7 is concentrating its purchases, the numbers are devastating.
Click to enlarge
Source: ForeclosureRadar.com and Field Check Group
3) April was highest month for foreclosure since records were kept by Realtytrac.
4) 12% of all homes in the U.S. are now 30 days past due; 24% are underwater on their mortgage. G7 tells me that they believe this number will reach 35-40% by 2010.
Click to enlarge
Sources: Zillow.com Q4-2008 Real Estate Market Report. Moody's Economy.com, First American CoreLogic, T2 Partners Estimates
5) 1/3 of all properties for sale are REOs, or bank-owned real estate.
This last item is key. According to ForeclosureRadar.com and Field Check Group, there are 911,000 Notices of Default [NODs]. These people are living in their houses, for free, waiting for the axe. Of these, 393,000 have been foreclosed. Of the 393,000 foreclosures, 118,000 are unsold REOs. Backing out the 393,000 from the 911,000 total, the remaining 565,000 homes represent potential foreclosures and short sales. That means 683,000 total potential REO and Short Sales coming to market.
What kinds of foreclosures have occurred thus far and will occur going forward? So far, speculators and those with subprime mortgages are the ones who have been taken out. Coming up, G7 expects to see those with Alt A, or Pay Option loans going under, along with Prime and Jumbo loans that are defaulting due to job losses and general price declines. These Jumbo, or non-conforming loans, are a major factor for banks, since they must put that loan on their balance sheet since there is no securitization market. Therefore, banks are being extremely tight in underwriting these loans, making these homes harder to purchase, further increasing supply.
As the more expensive homes begin to default, that will put pricing pressure on that sector, with declines of 20% - 25% expected. As those homes decline in price, the homes in the price tranche just below those will feel the pressure and decline as well. G7 expects declines in the Conforming mortgage pool to decline 7% - 10%, while the median is anticipated to drop 10% - 15% (the median is a tricky statistic though as it may not drop as much if higher priced homes begin to work through the system).
The bottom line here is clear: tons of housing supply coming to market. So how can you profit?
A Generational Low in the Making
The first thing to do is figure out where the worst declines are coming. According to Zillow.com Q4-2008 Real Estate Market Report. Moody's Economy.com, First American CoreLogic, and T2 Partners Estimates, it's the boom areas that are in major trouble: The percentage of mortgages that are underwater is staggering. Here are the top four: Miami (65.1%), San Diego (63.9%), Las Vegas (61.4%), and Los Angeles (56.4%).
The numbers could, believe it or not, be even worse. This data does not include the roughly 50% of Alt-A and subprime loans that were cash out refinances that now carry a higher loan balance than original purchase amount. Whoa!
The next issue to look at is timing. Here's a chart from Moody's Economy.com that shows not only how bad the bubble got in terms of homes prices relative to the median price index trendline, but how bad the crash is (and is going to be).
Click to enlarge
So now is the time to be gathering capital and as those foreclosures start to hit, you'll want to judiciously deploy it into those properties.
Now this is all well and good, but given how awful this crash is, how do we know that the market will recover, and when will that happen? I can't predict the future, but there are some extremely compelling trends that tell us this situation is akin to what savvy investors saw with the old Resolution Trust Corporation.
Here's a chart of U.S. Housing Starts from 1959 to the present, provided by Moody's.com (unadjusted for population growth, the highlighted areas are market recessions):
Click to enlarge
Housing starts are at their lowest point in fifty years. It's been said that the "smart money" gets into housing when new starts drop below one million. Meanwhile, because of these price declines, housing affordability is, believe it or not, at unprecedented highs in California.
Click to enlarge
With so few new starts, once this excess inventory comes online and Americans start snapping up the bargains, it's reasonable to assume that housing at the bottom end of the market has limited downside.
And finally, the price-to-rent ratio has reached a point where properties can be rented at rates that not only cover principal, interest, and taxes, but can actually generate cash flow above and beyond those requirements and still have room for future price appreciation. This chart, from Moody's.com, shows MSA fair market value rent for a 3 bedroom unit, divided into the average price for a new home in the market.
Click to enlarge
So How Do You Profit?
There are a few places to fish to take advantage of these trends, depending on how you see things playing out. One school of thought says that all those people being foreclosed on will have to live somewhere, and that may mean that apartment buildings see higher demand. But you'd be barking up the wrong tree. Apartment rental rates are going down. More likely, people who need a house to live in and get foreclosed upon still need a house to live in. So house rental rates will be fine. In this case, apartment REITs in the big housing bubble cities might be one thing to short. Some of these include Avalonbay Communities (AVB), Home Properties (HME), and Equity Residential (EQR).
I think you still want to avoid, or even short, retail REITs. Consumer spending isn't recovering, and when foreclosures slam neighborhoods, businesses in those neighborhoods will be further harmed. General Growth Properties (GGWPQ.PK) just filed for bankruptcy. I'd stay away from Glimcher Realty Trust (GRT), but Getty Realty Corp (GTY) might be fine, as it deals in gas stations and convenience stores. There will still be demand for these, and their latest financials look okay. It pays a 10% yield.
What to do about the homebuilders? Companies like Pulte (PHM), Toll Brothers (TOL), D.R.Horton (DHI), KB Home (KBH), Lennar (LEN), and NVR (NVR) will see their fortunes rise again one day. Sooner or later, all that excess foreclosed inventory is going to be chewed through. About 300,000 homes get demolished each year. I don't quite think we've hit the bottom here yet, but I would start to keep an eye on these players. Choose the ones with the strongest balance sheets and operating in regions that are the least badly hit by foreclosures.
As for those individual homes that are being foreclosed upon, I think those offer the biggest opportunity for capital appreciation. Of course, you really have to know what you're doing, and buying into those wacky do-it-yourself infomercials on how to buy a foreclosed home isn't the best way. You need to know where and when to fish for homes, and it isn’t easy. It goes beyond just grabbing any old foreclosure. You need sophisticated data and analytics. You need plenty of capital to get significant discounts from current values.
The home that needs fixing up is worth more in the long run... and you can’t even get loans for homes that need to be fixed up. The best bet is for accredited investors to seek out private equity funds who have a plan or, for those individuals who want to own a few homes of their own the G-7 Realty has a program where they will help you locate, finance, acquire, rehab and rent the home and later tell you when is the appropriate time to sell.
Full Disclosure: No position in any stocks mentioned.
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This article has 26 comments:
Perhaps we should really solve the probelm...
here is the post:
Problem...Solution...P... the same formula that got us into this mess....
Perhaps we should really solve the probelm...
Perhaps we should really solve the probelm...
Contact me at pdlcapital@earthlink.net
On Jul 21 10:59 AM User 438692 wrote:
> How do you get in touch with G-7 Capital Management? I can not seem
> to find them on the web.
and probably going lower
from 2.3 million 3 years ago.
with new starts so low the foreclosures will find buyers and in a year or 2 the market will be going back up again.
especially with trillion dollar deficits at the federal level
I think the situation would deteriorate even further since
* Lack of Job
* Lack of Demand
* Since May, Mortgage Rates Have Gone Up
* Excess Supply
* Option ARM
* Market Psychology
Read More: www.housingnewslive.co...
Notwithstanding I do not see price recovery for a long time - housing as an investment idea is dead. People who need and can afford will be the only ones that would buy, rest will very happily rent.
history isn't wrong most of the time. the only thing that has increased since the holy roman empire (aside from wine production) is the value of real estate. you think george bush and his silly little wars are going to stop that trend?? sorry, you'll be wise to start picking up foreclosed houses, apartments, offices in the next five years. it's all coming back bc why?? human beings like America and freedom and common decency. therefore the american dream is alive and well. (perhaps interrupted occassionally by an inept fool like Bush and Chaney but still the dream is powerful, they aren't so much). where else ya gonna go, Korea, Europe (just got back, gas is 8 bucks, coffee 3 and it's crumbling), so think long term my friend. free country, nice people, great institutions, real estate that withstands earthquakes, floods, hurricanes and even George.
Good luck financing that home, though. You can't get financing to rehab a foreclosed home. Hence the need for private equity.
Meanwhile, go back and look at the rent-to-price ratio chart. The trend of homes cash flowing via rental is going in a positive trajectory, not negative.
On Jul 21 03:16 PM Larry Meyers wrote:
> And these are all the reasons why getting into foreclosed real estate
> is the play going forward. Who needs the stock market with the risk
> it entails?
land is no different than any other asset. if it doesn't generate cash, it's not an asset, it's a liability.
On Jul 23 12:06 PM User 459310 wrote:
> Donnie,
>
> history isn't wrong most of the time. the only thing that has increased
> since the holy roman empire (aside from wine production) is the value
> of real estate. you think george bush and his silly little wars are
> going to stop that trend?? sorry, you'll be wise to start picking
> up foreclosed houses, apartments, offices in the next five years.
> it's all coming back bc why?? human beings like America and freedom
> and common decency. therefore the american dream is alive and well.
> (perhaps interrupted occassionally by an inept fool like Bush and
> Chaney but still the dream is powerful, they aren't so much). where
> else ya gonna go, Korea, Europe (just got back, gas is 8 bucks, coffee
> 3 and it's crumbling), so think long term my friend. free country,
> nice people, great institutions, real estate that withstands earthquakes,
> floods, hurricanes and even George.
Concerning the rent-to-price ratios, that only tells you that the price of homes are fallig quicker than rental rates. However, as the supply of rental homes continues to expand, rental rates will continue to decline. It's somewhat naive to believe that the prices of homes are going to continue to decline but rental rates will not follow suite. At some point even the dumbest person will understand that they can buy for the same monthly payment that they can rent (that's even excluding incentives).
On Jul 25 01:03 AM Larry Meyers wrote:
> It isn't necessary to rent a foreclosed/rehabbed home. Buying it,
> rehabbing it, then flipping it will earn an enormous return.
>
> Good luck financing that home, though. You can't get financing to
> rehab a foreclosed home. Hence the need for private equity.
>
> Meanwhile, go back and look at the rent-to-price ratio chart. The
> trend of homes cash flowing via rental is going in a positive trajectory,
> not negative.
You are correct that financing favors owner-buyers. In the foreclosure market, with houses that need to be rehabbed, you cannot get financing. Hence the reason you need private equity -- they can arrange the financing for you on individual plays (which I believe G7 does), or just buys the house outright with their cash pile.
As to your comment about rentals. As people get foreclosed on they need a place to live. They end up becoming renters and their preference is to rent a house and not an apartment. Also, as house rental rates get closer in line with apartments you will find that apartment renters want to become house renters and then later become home owners. Right now apartment rents are seeing downward pressure while house rental rates are seeing a slight increase. This trend is expected to continue over the next 2 to 3 years.