Real Estate: We'll See Blood in the Street Before This Bubble Bursts

In my opinion, the real estate market has a long way to go before bottoming out. Why? Because owning real estate is not like owning stocks. There is no liquidity. In addition, the real estate bubble took several years of froth before it peaked. I remember back in 2002, there was a lot of house flipping going on. People were buying two or three houses in new developments and reselling them before the houses were even built. I kept thinking this can't last much longer, but it did.

Then in 2003, I heard from friends about listing houses for sale and getting multiple offers of $10,000 to $20,000 above asking. I kept thinking this can't last much longer, but it did. In 2004, people were telling me about getting five to ten offers of $50,000 to $100,000 over asking price. I read articles in the newspaper about a couple that bought a two bedroom, one bath fixer in Silicon Valley for $1.2 million. I kept thinking this can't last much longer, but it did.

Finally in 2005, I got cold called about a rental property that I owned, asking if I wanted to sell. I asked how much they thought I should list it for and they said it was worth $440,000. I said that I wanted to list it for $639,000 and they thought I was crazy. I then received a call from my former secretary who said she just got her real estate license. I told her I would give her the listing if she would list it at the price I wanted, and of course she jumped at the chance. That summer, I got two offers over the asking price. If that wasn't the top of the market, then I didn't know what was and nor did I care. As it turned out, it was the top.

Now I see examples such as a house in my neighborhood that was put on the market last year for $1.1 million, later reduced to $939,000, later reduced to $829,000, the listing expired and picked up by another broker who listed it for $799,999, yet it is listed on zillow.com as being worth only $685,000. I'm sure you've seen and heard other stories in your area.

The froth in real estate lasted for several years before the turn; now I think we have to see blood in the street for several years before this is over. Readers of my previous article about shorting the sub-prime lenders, and the followup article about the 26% return in four days, created an interest from readers about other possible shorts, or put purchases. The short party for sub-prime may be almost over but there are other areas of real estate where this drop could reverberate, such as residential construction.

Here are three worth investigating as possible shorts:

Ryland Group Inc. (RYL) is a California based homebuilder and mortgage lender. Quarter revenues dropped by over 11% year over year, and their quarterly earnings sank by 40.4%. The stock is currently at 43.10, way above book value of 35.46. They owe almost a billion dollars in total debt.

Meritage Homes Corp. (MTH) is a single family homebuilder based in Arizona which concentrates primarily in the southwest, with developments in Arizona, California, Nevada, Texas, Colorado, and Florida. [My personal opinion is that Nevada will get hurt the worst in terms of the real estate markets.] Meritagehad a 21% reduction in quarterly revenues and over a 90% drop in revenues. Operating cash flow is a negative $21.9 million.

Brookfield Homes Corp. (BHS) is a luxury and move-up homebuilder that operates in California and the Virginia area. Quarterly revenues dropped 29.8%, quarterly earnings dropped 49.8% and the stock sells for 2.3 times book value.

These stocks can be tracked at stockpickr.com.

Full Disclosure: Author has no position in above-mentioned companies.

Comments

[Tom B]

Housing is overvalued, but I doubt it's overvalued by more than 10-15%, averaging out extreme examples in hot markets. Houses, unlike stocks, have fundamental tangible value. A house is a house; "Pets.com" stock (to take an example from the dot com era) is a piece of paper.

[stocker blog]

Unfortunately, for people who bought houses with nothing down or 10% down, with negative amortization mortgages, and who now can't afford to pay their mortgages [of which there are many thousands throughout the United States], the tangible value of their equity no langer exists.

[ChristopherLaudani]

Most of America has little or no net worth without their house. If they don't sell, they can't get out of debt. This will be a huge mess for years.