Saturday, May 14, 2005

No Renters Wanted, They Just Make A Mess

The web site has a report on prices and such. At the bottom, the subject turns to speculators' strategy for owning multiple homes. "The Realtors report issued last week found the median price of detached homes in Carmel Valley closing in on $1 million, up an even $30,000 from March to $985,000 in April."

"'The theory is, hey, you've got two homes, either a vacation home or a primary residence,' Jim Vanderspek said. 'If you don't want to rent a second or vacation home, it makes a lot of sense to move every two years and then be exempt from capital gains every time.'"

"People who are that property-rich, Vanderspek says he knows of one person with six houses, may not think renting out their home is a good idea, he said."

"Leaving the house vacant reduces maintenance costs and potential problems with renters. And if you buy with cash, as some are doing, there's no mortgage to pay off."

"'People are deciding to buy real estate as a straight cash investment. They can just own it and watch it go up in value,' he said."


At 7:57 PM, Anonymous Anonymous said...

"... or *down* in value."

At 8:19 PM, Anonymous Anonymous said...

down in value?

what planet are you on?

At 9:45 PM, Anonymous BKlawyer said...

I'm on about house #15 being given back in the last 30 days of they-can't-afford thier "80/20-stated income (read- falsified)" loan mortgage payment.
But I'm becoming jaded. Here in San Diego, the general feeling is that that interest rates won't/can't rise that fast so IO payments will be manageable for years to come. And as long as values continue to rise, who cares. One side or the other is reading the market wrong.
Ready to sell and rent yet?

At 9:52 PM, Blogger Ben Jones said...

Thanks BKLawyer

At 10:16 PM, Blogger deb said...


"I'm on about house #15 being given back in the last 30 days of they-can't-afford thier "80/20-stated income (read- falsified)" loan mortgage payment."

Is this a change for you?

At 12:28 AM, Anonymous Anonymous said...


I think we'll find that a lot of these speculators will have no choice but to rent out their
"investments" to pay off their
interest only loans....

At 6:39 AM, Anonymous Anonymous said...

Tomorrow I'm signing a 1+1 year lease on a gorgeous waterfront condo that I'd never be able to buy today. The lease payment is less than 1/2 percent of the year-ago purchase price and less than one-third percent of today's asking price for similar units.

This gives me plenty of time to spruce up and sell my owned 80%-equity waterfront condo, with no pressure on me re price. Worst, worst case would be that, after two years and assuming the market collapsed before I sold, I move back into my owned unit. Seems to me to be low risk for potentially high reward.

Anyone know how to find a list of the safest financial institutions in which to park my cash during these two years? I am worried, perhaps irrationally, about putting my money in banks that hold a lot of derivative/hedge stuff.

At 7:09 AM, Blogger deb said...

My RE equity is now parked in a US Treasury only money market fund. Someone commented earlier that by putting our money in short term treasuries instead of a bank CD, we reduce the bank's capital with which to make more rediculous loans. I hadn't even thought of that. I was just doing it for safety, but that thought makes me feel even better about it. Many of the experts say US treasury only MM fund is the safest place (if you want to be in dollars).

At 7:14 AM, Anonymous Anonymous said...

Article from the OC Register. The guy who called the last bust in OC is completely in the dark about this one. No mentiond of lax underwriting standards, GSE risk, Fraud or speculators. As a matter of fact he is a speculator.

Sunday, May 15, 2005

High hopes for housing

The Orange County Register

People in local real-estate circles call economist Gary Watts "Mr. Good & Plenty."

It's a stark contrast to the early 1990s, when he was nicknamed "Dr. Doom and Gloom."

Back then, Watts warned those who cared to listen that a year of falling Orange County home prices was just the start of a long, painful slump. That vision earned him the moniker "Scary Gary."

Fast forward to 2005, and Watts is as bullish about the outlook for the local real-estate market as he once was bearish about it.

This 57-year-old resident of Mission Viejo, who's also a real-estate broker, is now one of the market's biggest cheerleaders.

He backs up his talk with his wallet: He owns four Orange County investment homes.

The current housing upswing is now 8 years old. It has all but tripled the median cost of an Orange County residence, to $565,000.

That winning streak creates plenty of chitchat, among experts and everyday folks alike, about whether the boom will beget another housing bust like that of the early 1990s.

Watts emphatically says no.

"We aren't built that way anymore," he said. "It's a whole different world."

The last boom

A strong economy fueled the last local housing boom, which ran from 1985 to 1989.

That era saw California get a big slice of defense contracts.

President Reagan had embarked on the huge "star wars" missile defense initiative, a boon to a region deep with aerospace companies.

In Orange County, defense work flowed to firms such as Boeing, Grumman, Lockheed and Martin Marietta.

These employers paid sweet salaries, Watts said.

From 1985 to 1989, O.C. job growth rose at an average annual rate of 4.4 percent, according to the Bureau of Labor Statistics.

That influx of workers could get comparatively cheap home financing. Rates hovered around 10 percent for much of this housing boom.

That was a bargain in light of rates that ran up to 17 percent in the early 1980s.

As it does today, psychology played a huge role in that boom's demand.

Buyers thought "home prices can only go up," said real-estate consultant John Burns. "If I don't buy now, I'll never (be able to) buy a home."

The appeal of real estate as an investment was also helped by the 1987 and 1989 stock-market crashes.

And Orange County was evolving, from a bedroom community of Los Angeles County to an economic force on its own, Burns said.

Demand was so hot that there were frequent campouts to buy new homes. Folks slept in cars and tents for several weeks, and others hired stand-ins to keep their spots in line.

Builders ramped up construction to meet the surging need.

Lenient banks lent builders unheard of amounts, including deals for the entire amount of construction costs.

Builders "kept building on the assumption that (demand) would keep going," said real-estate consultant Robert Reicher of Market Profiles.

By May 1989, the O.C. median value had risen 24 percent in a year, to $216,000, DataQuick said.

"We were roaring," Watts said, "but there were problems on the horizon."

'Scary Gary'

In the fall of 1989, Watts told a large group of real-estate folks packed into a Laguna Hills auditorium that O.C. prices would fall.

He expected it to happen within one year and span at least four years.

Watts further shocked the audience when he said values in some neighborhoods could plummet as much as 40 percent over that time.

Dave Knox, who was working in the title business, was at the event.

"I can't say I believed him," he said. "Nobody wants to hear that the party's over."

By September 1990, the median O.C. home value was dropping at a 3 percent annualized rate, DataQuick said.

Desperate sellers lured buyers with perks ranging from free swimming pools to new cars, vacations or college tuition. Big landowners the Irvine Co. and Santa Margarita Co. announced layoffs in 1990.

The following year, Watts said: "You've seen the slowdown, now comes the pain."

That year he was preaching that the housing recession would last another four years. Watts recalls still- optimistic real-estate fans, who hoped the price dip was temporary, crumpling fliers into balls and hurling them at him.

But he was right: The deepest and most prolonged real-estate slump since the Great Depression hit Orange County.

Fallout was ugly.

In 1993, for example, roughly half of Orange County detached homes sold for less than the original purchase price, DataQuick reported.

The median loss in the county that year was $30,000. It was worse in some neighborhoods. Almost half of the home sellers in Corona del Mar lost a median of $187,500.

It wasn't until late 1995 – after five years of falling home prices – that Watts said the bleeding would soon stop. It didn't halt until mid-1997.

In the wake, everybody was hurt.

Folks lost homes to unpaid debts. In 1996, mortgage woes were so prevalent that there was nearly one foreclosure for every five O.C. homes sold, DataQuick statistics show.

It wasn't much better for builders.

William Lyon, one of Orange County's largest and most consistently successful homebuilders for decades, was forced into a smaller operation.

Centex walked away from the huge Talega housing project in San Clemente when real estate became so cheap that the site no longer made financial sense. Santa Margarita Co. barely avoided bankruptcy – a fate the Baldwin Co., developer of Portola Hills, couldn't escape.

In those bearish years, DataQuick found that the countywide median home value slid 17 percent from its peak of $223,000 in June 1991 to a low of $185,000 in January 1997.

Solving the puzzle

All Watts does is connect the dots.

Watts earned a bachelor's in economics from Cal State Sacramento. He is an avid reader of Forbes, The Wall Street Journal, Barron's and local newspapers.

He saw that the 1980s housing boom was fueled by highly paid employees in the defense industry.

But in 1989, the Berlin Wall came down. The Cold War ended. Many defense jobs were soon slashed.

Orange County's employment shrank by an annual average of 1.6 percent from 1991 to 1993, the government said.

Making matters worse was that builders badly overestimated demand and constructed far too many new homes. In March 1991, there were 1,673 new homes for sale in the county– 10 times the level in March 2005, according to Hanley Wood Market Intelligence.

Shrinking demand and fat supply made a recipe for disaster.

"I could see the writing on the wall," Watts said.

Watts' bearish outlook let some folks dodge a horrible financial loss.

Knox heard Watts' 1989 forecast and was originally skeptical. But eventually he learned to trust Watts.

So Knox sold his three-bedroom Tustin home in 1991. He says it went for $93,000 more than what he paid.

Watts took his own advice. In the early 1990s, Watts said, he divorced his second wife and sold her their Mission Viejo home for a profit.

He rented until the mid-1990s.

Mr. Good & Plenty

Watts became re-enamored with the local real-estate market when he saw mortgage rates touch 40-year lows as the supply of available homes for sale dried up.

Prices shot up 24 percent last year, DataQuick said. Watts thinks prices will climb an additional 15 percent this year.

He first made that bold prediction last fall, against the backdrop of a sudden housing slowdown that began last summer. The lull caused many people to fear it was the beginning of another housing collapse.

In October, Watts looked at a housing supply of just 12 weeks in Orange County. By February, he predicted there would be a thin supply of only eight weeks left.

According to Watts' math, that equates to a 15 percent gain in prices. And he doesn't see mortgage rates rising enough to hurt the market.

So far, the prediction is on target. O.C. home values are up an average 17 percent for the first three months of this year, DataQuick said.

"If I thought the market was going down, I wouldn't be putting a significant amount of money into" homes, Watts said.

He bought two condos in 2003. He bought a condo in January2004 and is in the process of selling that to invest in a detached home.

Last summer, he spent $700,000 on a three-bedroom, lake-view Mission Viejo home where he and his third wife now live. He funneled big money into a renovation that adds a koi pond and fire pit in the back yard and mini waterfalls in the front yard.

Those such as Watts, who don't think another real-estate calamity will happen, see today's Orange County as a growing, diversified economy with few houses to buy.

No one industry commands a powerful portion of the local economy, as defense jobs did in the late 1980s.

Ninety-five percent of businesses in Southern California employ fewer than 50 people, Watts says. So the effect of most business failures – if they do occur – should be minimal.

Unlike the early 1990s, the local economy is adding jobs. Consultant Mark Boud of Real Estate Economics predicts county employers will add 31,500 jobs this year.

Plus, builders are stingy about construction. Last year, builders constructed 9,100 O.C. homes, Boud said.

Fifteen years ago, they were building about twice that amount.

And while big projects such as the Irvine Co.'s Northern Sphere in Irvine and Rancho Mission Viejo's plan for south county will produce 26,000- plus homes, sales will be spread over at least two decades.

"Everybody keeps talking about this (price) burst, but economically you can't have a burst unless you've got an oversupply," Watts said. "And we're undersupplied."

A career fluke

Watts got into predicting real estate by chance.

In 1973 he was 25 and had been selling homes for two years as an agent. As part of a public-relations ploy, he sent hundreds of fliers to a Mission Viejo neighborhood, making an informed guess that prices would rise 10 percent in the next year.

Watts said that's what happened.

Impressed with his smarts, his employer asked him in 1974 to give a forecast for the following year to its employees. It was the beginning of Watts' annual lectures to real-estate agents, lenders, and title and escrow folks. These forecasts are habitually scheduled around his hobbies: bowling on Tuesdays, golf on Wednesdays and tennis on Saturdays.

John Belles works in the local mortgage industry. He's attended Watts' forecasts the past four years.

"I've been to a lot of seminars, but with his, no one ever gets up to leave," Belles said.

Watts is no tailored-suit consultant. He's been known to wear Bermuda shorts and short-sleeve shirts for some of his talks.

And he's no star among the local real-estate seers. After three decades of forecasting, his popularity is pretty much centered in south O.C.

Esmael Adibi of Chapman University in Orange has been predicting local housing prices for decades. He's not familiar with Watts' work. Neither is Al Gobar – a venerable local real-estate watcher since the 1960s.

Watts knows that no one in his game is correct all the time. For example, his crystal ball didn't reveal the housing slowdown that hit O.C. in the second half of last year.

So how would Watts define the art of housing prediction?

"Educated luck," he said.

At 7:22 AM, Blogger deb said...

How does this guy think that people will continue to pay for these overpriced houses? Does he not look at the affordability?

At 7:51 AM, Anonymous Anonymous said...

simple. affordability will be made possible by 100 year mortgages, like in japan, or by "generational loans" where your children are responsible for your home debt if you default.

and then there's always the likelihood that appraisers will become even more fraudulent, thus helping the bubble to keep churning.

At 8:07 AM, Blogger deb said...

We already have interest only loans (infinite maturity). The payments can't go any lower.

With 6% of homes in OC affordable to the median household income (probably less now- this stat is from Q4 '04), how much higher can prices go?

For perspective, as recently as '99, 50% (yes FIFTY!) of the homes in OC were affordable to the median household. The affordablilty gap has widened to this staggaring level as interest rates have fallen to their lowest levels in decades.

I am sure when the affordability index comes out for Q1 '05, we will see that these numbers have gotten even more insane. How about affordability of 2,3,or 4%?

People should be outraged about these prices, not cheering them.

At 8:29 AM, Anonymous guynoir said...

---affordability will be made possible by 100 year mortgages, like in japan---

I don't think so. Moving the duration out to 100 years doesn't reduce your monthly payment all that month. For example, a conventional 40-yr $500K mortgage at 6% costs $2,751 a month. A conventional 100-yr $500K mortgage at 6% costs $2,506 a month---a 9% savings. So even though you are supposedly amortizing your debt over a period 2.5x as long, you only save 9%.

The 40-year loan results in the payment of $820,513 worth of interest. The 100-year loan results in the payment of $2,507,572 worth of interest.

What a waste of money.

At 8:30 AM, Anonymous Anonymous said...

i'm of the opinion that runaway house price gains are tied directly to the collapse of the US dollar in "real" terms on the world market.

if china unpegs the yuan to the dollar, we are going to see the last bastion of cheap goods disappear.

isnt it funny how home sale prices are excluded from the CPI measure of inflation? they only use a "rental equivalency" price that is estimated based on houses for rent in RURAL, not URBAN areas.

since rents have long ago disconnected from sale prices, this makes perfect sense if you want to fudge the inflation numbers.. if home prices were included, annual inflation would be running close to 20 percent, even higher than the worst days during the carter administration.

At 8:42 AM, Blogger deb said...

"i'm of the opinion that runaway house price gains are tied directly to the collapse of the US dollar in "real" terms on the world market"

But in the mid 90's the dollar index was even lower than it is now, and RE in many areas was collapsing along with it. The dollar then rallied, peaking in 2001. The RE run up was well underway long before 2001. Although we do hear stories about lots of foreign buying, I don't see a correlation if I look at the charts. I think it may have contributed over the last couple years, I don't think it is a major factor.

At 8:42 AM, Anonymous Anonymous said...

Deb -- thanks for the tip. Where does one find/buy a US Treasury-only money market fund? Do I need to worry about commissions and fees? And can these be short-term or are you locked in for a year or more? Finally, are these reliably insured for amounts over $100K? That may be a naive question; I just want to be sure this is not a metaphor to gold bullion and gold-mine stocks. My objective is only to preserve my cash, hopefully with enough interest to protect me against hyper-inflation, and available to me fairly readily if I spot a good buy. I'm not an investor -- just selling, and waiting to buy, my principal residence. Thanks.

At 8:50 AM, Blogger deb said...

Gov't guaranteed (T-bills), no limit. Totally liquid. No fees. You can buy through your brokrage or through the fund co. directly. I own the Spartan US Treasury only MM fund.

At 9:01 AM, Anonymous Anonymous said...

Question for the cash hoarders. Arent you running the risk of holding worthless paper if we enter into a hyperinflationary environment. Wouldn't TIPs be a better cash preservation and inflation hedge?

At 9:05 AM, Anonymous Anonymous said...

I think I might see the problem with Mr. Watts' outlook. He has never, in his time as a "seer," passed from a period of rock-bottom interest rates to a period of steadily rising ones, nor from a "no problem" lending environment into an adult one, nor from a period of vast ownership of speculatively-owned property, much of which is idle, to one in which people may be sloughing off properties in a minor panic. It's great that he correctly predicted the OC job market, but I believe the job market is not the boogeyman in the closet this time around. He might even think that Warren Buffet is all wet. Chip

At 9:05 AM, Anonymous Anonymous said...

unfortunately TIPS are only adjusted based upon the CPI's measure of inflation:

and as we know, the CPI does not include the prices of home sales. so if inflation remains limited to housing, energy, and food, then the CPI won't actually go up and you will be just as fucked as if you were holding cash.

the only way the CPI will ever go up is if china starts increasing prices on all the stuff we import from them. because literally, that is all the CPI measures at this point. anything that goes up in price has long since been removed from the CPI.

At 9:07 AM, Anonymous Anonymous said...

9:01 -- What is a TIP?

At 9:13 AM, Anonymous Anonymous said...

TIPs are Treasury Inflation-Protected Securities. They are a special type of marketable Treasury security. When you own TIPS, you receive interest payments every six months and a payment of principal when the security matures. The difference is this: Interest and redemption payments for TIPS are tied to inflation.

At 9:21 AM, Blogger deb said...

Principle is at risk with TIP fund. Could buy Series I bonds, but not as liquid and can only buy $30k/yr. Like you said, it's based on CPI anyway. With Treas only MM, my money is liquid in my brokerage account. If I want to make a change to some other type investment (foreign bond fund, gold stocks, TIPS, whatever) it's just a click away.

At 9:23 AM, Anonymous Anonymous said...

RE is the ultimate inflation hedge. Who needs precious metals when you have RE. No need to worry about strike prices or expiration dates. The leverage is incredible. 5:1 with 20% down, 10:1 with 10% down, 20:1 with 5% down. Best of all you dont have to worry about margin calls.

At 11:43 AM, Anonymous Anonymous said...

(The leverage is incredible. 5:1 with 20% down, 10:1 with 10% down, 20:1 with 5% down.)

Just a reminder, that leverage thing works both ways.

1:10 for instance

You put 10% down and a 10% price drop wipes out 100% of your cash investment. Actually more than that in RE, since selling costs are usually around 8%.

So, you start out 8% under water.

At 11:53 AM, Anonymous gettingreal said...

(So, you start out 8% under water.)

Interesting point. Selling costs are very high with property. With stocks, for example, I can sell $100,000 worth of S&P 500 index funds for $10.99. That price is the same whether I sell 1 share or 10,000 shares. And I can sell it in an instant. With real estate, you pay roughly 8% of the selling price. Obviously, in a boom, this doesn't seem to matter to anyone. But it's a significant cost factor that doesn't come into play with other asset classes.

At 4:54 PM, Anonymous Anonymous said...

I came across this mentality in the DC area. I was helping a friend look for an apartment. We found this place where the owner had just posted a sign on the street. I thought the asking price was high, but found that it was not negotiable. He would rather have it sit empty than rent it for this asking price.

The owner claimed to not really care much if he rented it because "I am making 20% a year". I don't think he was bluffing. The guy was from NC or somewhere deeper south and came across as a wealthy redneck. He stored two of his expensive collector cars in the garage. The unit had layers of dust (had been thoroughly cleaned at some point though) and had obviously been on the "market" for months.

But now I finally saw an ad in the paper....

But this mentality is mind boggling. I looked up the ownership history. He paid $150k in 1994 (new construction) and now I am guessing that it might nominally be worth as much as $400k based on comparable sales. The price he paid in 1994 was high as units were resold for less than that until the prices started escalating in 2000-2001.

What about the opportunity cost of lost cashflow???

p.s. He also told me that prices will go up 10-20% p.a. indefinitely until DC catches up with NYC and California, and this guy really meant it.........

At 5:15 PM, Anonymous Anonymous said...

"p.s. He also told me that prices will go up 10-20% p.a. indefinitely until DC catches up with NYC and California, and this guy really meant it......... "

The people here in D.C. have the attitude that they're bulletproof. I've heard it said over and again that real estate prices never correct inside the beltway. The prices are ridiculous here, and aren't sustainable. The rentals near us stay on the market for months, but people fight over buying the same townhouse.
The government salaries can't support the prices of homes here.

At 10:55 PM, Anonymous Anonymous said...

Someone in another forum suggests that SF Bay Area prices have lots of room to go because they are still a lot lower than those of Tokyo.

BTW, at one point, the imperial palace in Tokyo was "worth" than the entire State of California.

At 6:21 AM, Anonymous Anonymous said...

regarding the article, High Hopes For Housing... Mr. Good & Plenty seems like quite the character... i just looked up orange county (mission viejo) on and it showed nearly 800 homes for sale... that's a pretty large supply...

At 6:36 AM, Anonymous Anonymous said...

9:23 AM Anon,

Sorry... but real estate as a hedge against inflation arguement doesn't work in our current environment... for that to be true, you need wage inflation... and we're nowhere near that...

At 11:54 AM, Blogger Thomas said...

The fact that many "investors" don't even bother to rent out their properties (while waiting for their appreciation to accumulate at 20% per year) suggests that a bursting of the RE bubble would actually have a positive economic effect.

The housing assets that are sitting empty are assets that aren't being used. Effectively, this idling lowers the productivity of the American residential real estate stock. Bringing the cost of ownership more in line with the return from rents would cause more property to be put into productive use, increasing that actual (i.e. sustainable and non-speculative) economic output of housing.

The downside of a housing correction would be severe damage to the mortgage and RE-related industries, and probably a major contraction of credit. However, since such a huge percentage of available credit is already misallocated to driving a speculative real-estate bubble (a non-productive use), a contraction of credit that focused the remaining credit on productive parts of the economy might be a good thing.

One thing that Gary Watts guy is missing: The real estate industry is the new aerospace industry. An end to rampant real-estate speculation would probably have a comparable effect on the Beemer-driving start-up mortgage-broker population as the end of the Cold War had on the California defense contractor employees.

I think I need to start working on a script for a "Falling Down" remake, with a mortgage broker/speculator in Michael Douglas' role.

At 12:35 PM, Anonymous Anonymous said...

mmmm? If this vacant stuff hits the market as rentals then my income from my rental is going where???
We live in interesting times.

At 1:09 PM, Anonymous Anonymous said...

fyi... my wife and i have been looking for an nice, big, modern 2 bd/2 ba. with elevator in the building to rent in hoboken, nj... for the past couple of months, owners have been asking for about $2,000 in rent... we think that's a pretty silly price, considering a ton of speculators have come in here and bought up a ton of stuff... now... the asking price is $1,700... poof!


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