What's Ahead for Real Estate: Doing the Math 12 comments
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More Pains Ahead
Investors, like children in the back seat of a long car trip, keep asking “Are we there yet?” In the case of the investors, the ‘there’ is the bottom of the current down cycle. Unfortunately, the response to the investors is still the same as given to the children: “No, we are not there yet.” With IMF now weighing in on the overall size of the downturn, which it claims will last well into 2009, it would seem that we are still in the middle of the economic maelstrom.
So
what are investors to do? In this article, the Practical Risk Manager
will outline additional signs of the things to come, which astute
investors can use in conjunction with their own due diligence to make
their way through the current market. For my list of previous signs of
things to come, click here.
More Signs Of Things To Come
Residential Real Estate
- With
the arrival of Spring, hopes of home sellers of being able to finally
sell their homes spring eternal. However, their hopes will be dashed.
As more mortgages reset off their initial teaser rates, more
homeowners, who were already treading water, are going to get more
desperate. Their desperation will manifest itself in the following
ways:
- Offers of incentives will increase: more home sellers will offer free add-ons, including vacations and willingness to picking up all of the broker and closing costs.
- Some homeowners will sweeten the incentives further with rent-to-own options. However, this is not the bottom. Once you start seeing more of “take over my mortgage and the house is yours” type of advertisement, then we have hit bottom.
- Real estate advertisement will dry up substantially to a point of being nearly nonexistent. Number of pages of advertisement will go down to a page or even half a page. Not bottom yet. Shortly thereafter, there will be a flood of advertisement all offering one incentive or another, some even begging you to take over their mortgage and house. I would call this a ‘tsunami’ effect. (In a tsunami, the water will first go out to sea, leaving the beach high and dry and then the water will surge back in a torrent of water, sweeping everything in its path.)
Commercial Real Estate
In any economic down cycle, there is a trend of cause and effect. Commercial real estate is no exception. Here are the causes and effects of the economic slowdown on commercial real estate:
- For
smaller commercial properties: news of economic slowdown affects
consumers' sentiment. Their reaction is to slow down on their
purchases. This causes retailers and small businesses to suffer and go
out of business, due to lack of sufficient business. As these small
businesses go out of business, they will vacate their commercial spaces
in strip shopping centers, class-B or class-C office spaces, and
industrial/flex spaces. This will cause a reduction in the net
operation income [NOI] of the commercial property owners. The overall
effects of this cycle are increased delinquency and foreclosure of
commercial properties, especially the ones that cater to marginal
businesses, ‘mom-and-pop’ businesses, and small operations.
- For
large office properties: businesses will trim their workforce in
response to lower profit forecasts. Large corporations will begin to
reduce their middle management and operation support staffers, the
layers that are typically targeted in any downsizing. The effect of the
downsizing is the excess space.
A good rule of thumb for an office space is 200 square feet of space per cubicle dweller and 400 square feet of space for an office dweller. (This accounts for the space needed for aisles, cabinets, pantry, etc.) So, in the case of Citigroup (C), with their layoff of 25,000 people, one can assume 50% office and 50% cubicle for an average of 300 square feet of space. Multiple this by 25,000 staffers will result in 750,000 square feet of space that Citigroup will no longer require, about the space in a major class-A building, as a result of its downsizing. Do the math. Large companies will consolidate their spaces, resulting in higher vacancy rates; leaving some buildings with large blocks of vacant space.
- For shopping centers: in response to economic slowdown, retailers will curtail their expansion plans. As the economic slowdown worsens, retailers will start to close their less profitable stores, leading to increased vacancies at shopping centers, including major malls.
Overall, expect commercial real estate to lose its luster as increasing vacancies lead to falling rents. The above lists are just my views of where I think the real estate markets are headed. Therefore, I strongly encourage you to do your own due diligence.
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This article has 12 comments:
Wrong. Once the vast majority of negatively amortizing Option-ARMs have reached their maximum LTV ceiling (we're still a good year or two away) AND most hybrid/ARM teaser rates have reset (Credit Suisse indicates about 2011), THEN we will be *close* to the market bottom.
We will *know* we are at or very near the bottom when the following is true:
--A median income can buy the median priced house in most neighborhoods with CONVENTIONAL financing.
--Median monthly rents-to-median price ratio is close to the 100:1 historical average.
--Median HH incomes-to-median prices ratio is close to the 3:1 historical average.
--Conventional wisdom --even among the permabull die-hards-- is that housing is the "worst investment ever".
--Real estate investment clubs and seminars ar no longer operating, or are reduced to the few people who bought pre-bubble.
Take over my mortgage doesn't work, we don't have takeover loans anymore, there are due on sale clauses on all loans.
I sell REO's and until those stop or slows down to where inventory is being reduced, we will not see an end to this crisis. When an REO comes on the market it is usually priced lower than the previous one that came on the market in order to get it sold. This is why we are getting the downward spirial and this is why this mess is going beyond the sub-prime and into the alt-A loans and the prime loans. Houses are not worth the mortgage people are paying and they are walking away. This will continue until something is done to stop the foreclosures.
The powers that be don't get it. They are so worried about "moral hazard" the buzz word of the free market and trickle down group...that they can't see the forest for the trees. It is common sense not economic jiberish.
The Foreclosure Prevention Act embraced by Democrats would allow judges to ease the terms of mortgage loans during bankruptcy proceedings.
Now, I know, some will say "gee they took the chance, let them get their lumps......" Two problems with this:
1. If the numbers being bandied about regarding the number of families in financial trouble are correct, letting them be put out on the street will only prolong the impact of this mess.
2. bush and his cronies appear to only support the bailout of big business (aka Bear Stearns). With the white house telling the rank and file gop to push through their attempted legislation that only helps home builders rather than the vox populi , (to whom effectively they say "screw you"), we will only continue to see the markets (housing and financial) to spiral downward.
I sure hope the author is wrong about the drop in print ads... Last year, Sacramento, CA was running almost two full pages. Now it's about two columns! My zipcode was running two columns and now lists about 6 sales.... Ha!
As much as I would like to see support for homeowners, and as much as I dislike Bush on almost all fronts (I have been a registered GOP since I turned 18, but as of the last election, I am a registered Dem...And it would take an act of God to make me go back.) I do see the point of bailing out the financials. We really never want to se a run on the banks! If you think we have problems now, imagine what the landscape would look like with a failed banking system. And, although it is true that the actions to date do not 'seem' to be making any difference, again, I ask you to consider what the landscape would look like without these efforts. Scenes from 'Apocalypse Now' come to mind. The carnage would not be limited to banks and real estate firms, it would cut a swath through our economy that would rival 'Sherman's March through the South'. Paulson and Bernanke are doing what they can.. Be thankful!
Thx jegan ;-)
There are a number of pressure points at work in the residential real estate business, all of which are suffering stress right now.
1. Mortgage lenders have tightened up qualification standards, requiring documented income, documented assets, documented liquidity, and good credit.
2. Home inventory is at an all-time high for modern times, creating a buyers' market. Trouble is, #1 has vastly shrunk the potential pool of buyers.
3. Household incomes nationwide are flat to declining in many areas, preventing people from qualifying for mortgages with the new stricter criteria.
4. In many areas, the median income family cannot afford the median priced home. A sign that prices remain too high to rebalance the market.
5. The securities market for MBSs has shown no signs of revival, making it nearly impossible to package and sell mortgage pools.
Any one of these factors would crimp the housing industry. Wtih all of them at work simultaneously, it's no wonder there's still 'fear and trepidation' in the housing market.
Until all of them are solved, the problems will persist. But it will take many years to work through inadequately capitalized lenders, dropping home prices until middle-income families can afford them, and healing the credit markets.
I’d like to add something:
Neither the Feds, Congress nor Treasury wants to go down as the 21st Century equivalent of Herbert Hoover, so they broken old rules, norms, and traditions regarding Bears Stearns and the investment houses. Expect more of the same as they grapple/fumble for a real fix to the larger credit crisis of which the sub-prime and unfolding Alt-A problems are only a sub-set. The crisis extends to HELOCs, student loans, commercial loans and soon, consumer credit cards. It’s impacting each slightly different.
Fortunately, neither Treasury nor the Feds have claimed victory. I’m in the group that feels all they’ve done is allowed the crisis to unfold more slowly.
Uses of frightening words like “financial system meltdown” are paralyzing some people. Many experience practitioners of modern “high finance” have admitted in other blogs that the global finance system is unwinding (or deleveraging) and it’s so far unstoppable.
Rather than focus on paralyzing words like “meltdown”, I hope the Feds and high finance players are evaluating scenarios that entail recognizing the inevitable: the completion of the de-leveraging process which force massive write-downs of debt and the value of any underlying collateral, be it homes, strip malls, student undergraduate degrees, autos, office complexes or entire municipal infrastructures (e.g. sewage systems).
This seems destined to occur in the midst of a recession. On-going de-leveraging scenarios should include “L”-shaped recessions of significant lengths (think 1973-75). This opens the door for deleveraging to impact careers and occupations that were sustained by excessively leveraged firms and markets (Wall Street, homebuilding, trophy skyscrapers, Hollywood filmmaking, boutique hotels and mega-trendy restaurants, over-priced undergrad education programs, etc.
In all scenarios, the underlying hard assets (defined as anything that if kicked, will cause the kicker some toe pain) will still exists; it simply has a new valuation.
Yes, it will be ugly and psychologically painful, but the assets will still exist…most likely with new owners who paid a lot less for them. There will still be Visa, MasterCard, Toyota, banks, malls, universities, Google, sewers, farms, food and houses and apartments. Some or all with new valuations and new owners.
What’s not guaranteed is that all lessons will be learned and society will be wiser as a whole.
This is described in War Cycles, Peace Cycles.
No complete wipe out. Unless the property was trashed by the original buyer, I guess.
The problem with our usury banking system is that the money supply has to be continually expanding otherwise interest payments would quickly cannabilize and gobble up the money supply and put it in the hands of the lenders. The flow of money would congeal.
No tree grows to the sky, no republic lasts forever, and this current Fed Bank post 1913 artificial money bubble, despite occasional deflations, has kept on growing and growing. But it can't go on for ever. The Fed and the powers behind it are playing God, ignoring the Biblical year of jubilee that is periodically required.
Clearly our culture, especially our media and business reporters and editors, look to The Fed to bestow blessings and favor and growth, and then shriek out in fear when god Fed begins running up interest rates like a vengeful tribal God, as Greenspan and Bernanke did.
But these are only pushy, tribal men. Clearly not gods, much less the deity we dare not speak of.
It is so amazing that in this country we would bail out people that took on loans they knew they could not re-pay. Stunning.