steve12

Why Sub-Prime Doesn't Worry Me

Jason,

You are probably right about the lack of bargains right now in some markets. Brooklyn -- which should present bargains vs. Manhattan -- has only gotten tighter. That lag is often under-appreciated. Real estate tends to turn like an aircraft carrier, not like a PT Boat. But when it does, watch out.

Consider the 87 stock market crash and NY real estate. Many onetime NYers now in their late 40s and early 50s bought their first apartments with great confidence after the stock market crash of 87, in 88 and through 89. They believed that increasing sales prices clearly showed the stock market could not stop the unending upward movement of NY apartment prices (sound familiar?)

These first time buyers soon found a different kind of reality. Three years+ after the crash came tighter credit, decreasing apartment prices, and increased interest rates. Financial services layoffs created a major decline in young investment bankers paying cash. (aka fixed income hedge funders, mortgage and real estate brokers this time). Owners could not sell their expensive studios and one bedrooms, even though many were getting married, having children, and needed the room. Even worse, few could rent because building regulations prohibited it. This became a perfect slow moving black cloud (Taleb would say a black swan).

By 1991 I saw numerous large buildings in Manhattan with over 50 empty studios for sale. But even with drastically reduced prices, few apartments sold. Tough credit and high interest rates combined to keep the next round of first time buyers out of the market, including me.

Want to find some "bargains" today? Check out West Palm Beach. Owners I know there are already in this 1991 NY situation. Many apartments are for sale and there are no buyers. Although as condo owners they can still rent -- that will be for well below cash flow, all BEFORE the massive credit tightening that is happening as you read this. Now throw in the possibility of regulators prohibiting nominal and variable rate mortgages and even an interest rate HIKE. Funny how when the economy goes bad, interest rates seem to go up, creating lots of bargains but nobody able to buy and no banks willing to finance. Cash truly becomes king. If you are able to buy in this scenario, once it becomes apparent, long term you should make money.

But when it goes wrong, it tends to all go wrong at once. We are not be there yet, but it would be naive to think this cannot happen. There were lots worse scenarios in Southern California after the early 80s burst. Take a look at Washington Mutual's year ending balance sheet. Over 30% of its nominal (pay as you like) mortgages were sold in Southern California: New York and Florida were next. Consider the devastating wealth shrinking power of negative amortization loans -- aka interest charged upon interest that will make credit card debt look small. Now add that lovely home equity loan balance that is completely variable.

You may want to keep that powder dry. Those bargains are coming. Or buy my friend's place in West Palm Beach -- it'll be you or the bank. Good luck to you.