Sunday, May 01, 2005

Speculator Frenzy A Sign Of A Top

The Seattle Times has an article documenting just how far people are undoing their lives in the hope of a quick buck. "Paul Galasso quit his Costco management job to join his wife, Evelyn, as a full-time real-estate investor. He and his wife have spent more than $20,000 on investor 'boot camps' and seminars to learn how to make deals."

"Galasso said he knows people just like him in Georgia, Texas, California and beyond now investing in residential property. 'I lost a ton of my portfolio in 2001, and that's happened to a lot of people in America,' he said."

"Galasso and his wife fired their financial planner and shifted 75 percent of their retirement resources from regular equities and mutual funds held in a traditional IRA into a 'self-directed' IRA that they can use to fund real-estate deals."

"Michelle Dickerhoof, quit her corporate-affairs job at Starbucks last fall to collaborate full time with her contractor husband to find fixers to invest in. She's just secured a home-equity line of credit on her primary home to pay for the new properties. She expects the two properties she's eyeing could be resold for around $400,000 after they're fixed up."

Jeff Wolfson, a developer said, "I've been in the industry long enough to see how it operates in cycles. I believe the market right now is in a bubble, people are putting 10 percent or 5 percent or zero down, or they're taking adjustable rate mortgages, but then one day their renters can't afford the rent, and the owners aren't prepared for that."

21 Comments:

At 10:05 AM, Blogger John Law said...

I could have done a RE bootcamp for those people...give me $3,000, sell all your properties, rent with the $17.000 leftover.

I rule.

 
At 10:14 AM, Anonymous historybuff said...

This is a pattern that keeps repeating. Stock market tanks, scares people out, they go running to whatever is moving up. We have become a nation addicted to EZ money---whether it's a stock mania, a housing mania, a gambling mania, whatever.

For 20 years, we have come to believe that we are entitled to 20% gains a year---if not with stocks, then with real estate. But if you pull back and look at our economic history, these periods of spectacular gains have been anomolous. Yes, most assets (stocks, real estate, coins) have gone up in value over time. That's called inflation. But there have been long periods for each asset class that have shown no appreciation and often show depreciation.

It's going to take a number of calamitous downdrafts---like the 2000-2002 growth stock plunge---before Americans finally realize there is no free lunch. At some point, investors will begin to focus on capital preservation and not capital speculation. Clearly we're not at that point today.

This Seattle story about people forsaking good careers to jump into a very mature RE cycle reminds me of friends and acquaintances who jumped into the stock market in the late '90s. Stocks had been going up since 1982. But most people didn't get excited in the early '80s. They started paying attention in the late '80s ("greed is good") when the '87 crash hit. That scared out most of the avg Joes who didn't get interested again until the late '90s when the party was essentially over.

As before, so again.

 
At 10:37 AM, Anonymous Anonymous said...

People being afraid of stocks is a recurring theme. I hear it again and again. Don't ever try to tell a house buyer that the return in stocks could be just as good.

Having said that, The DOW is poised for a crash, which should give house buyers even more impetus to stay away from stocks.

The thing is that people plowing all this money into RE is what is causing stocks to crash in the first place ! It is totally stupid.

Every day I wake up and read stories of stupid people making stupid investments in RE.

Either we as a nation have a new paradigm going on, ie lets all be RE speculators or there is going to be one hell of a fallout from all of this.

Seriously, what is a 3 bedroom home that rents for $1200 per month worth ? I say $200K tops. What happens to the guy that just paid $400K or $600K for it ?

People are saying 20 to 40% downside to housing prices. I think it is going to be more like 60 to 80%.

When everything plays out and mortgage rates are 10% with a 20% deposit, why would the house prices fall back to what they were before this whole thing started ? Has there been any huge increase in the demand for housing since 2001 ? Has the population increased that much ?

I seriously think that Greenspan or someone has to step in here and do something before this stupidity takes down our whole financial system. I hope it isn't too late.

 
At 10:47 AM, Anonymous Anonymous said...

Anon 10:37,

Seems like a 40-50% drop is very likely in my area. I'm a Bostonian, and lately I have seen a slew of homes go up for sale. They are not selling since they're price too high...would you pay $350K for a 2br condo that rents for $1200?

A 40-50% would bring that price down to about $200K, just about right for a $1200/mo rent (at the current interest rate), but if rates go up, look out below. You're 60% decline scenario becomes a real possiblity.

All that's left in the buyers pool is speculators and savy bueyrs likey ourselves. The savy buyers will not pay more for a house than what it can rent for.

 
At 11:12 AM, Anonymous Anonymous said...

"I hope it isn't too late"

You can't put the Gennie back in the bottle. I think it is already too late to stop. As soon as interest rates get to 6.5% or we see a moderate slowing of sales, the investors/speculators will rush to put their properties on the market. Then it will intensify once those ARM's start ratcheting up, people will no longer be able to make the payments and since many were no or low downpayments they will lose the property to foreclosure.

 
At 11:13 AM, Blogger Ben Jones said...

(People being afraid of stocks is a recurring theme. I hear it again and again)

I see that in almost all bubble reports these days. What the heck does the stock market have to do with a house?

(I seriously think that Greenspan or someone has to step in here and do something before this stupidity takes down our whole financial system)

That's a point I have tried to press. Just sitting here and watching is ridiculous. Even communist China has more sense than that. And if you believe there is nothing the Fed can do, couldn't they at least pretend to be working?

 
At 11:24 AM, Blogger goleta said...

Can any one recommend some online resources about REIT and other indirect investment that can get into the RE market? I want to make sure none of my 401K funds and other saving gets into RE. As soon as the buyers can no longer get the credit they need to sustain the bubble, the burst will come, and I don't want to lose my retirement saving in the bubble I never benefit from.

 
At 11:37 AM, Anonymous Anonymous said...

You will need to read the prospectus of your investments, that will show you how much of the fund is allocated to what industry and even specific companies.

 
At 12:16 PM, Anonymous Anonymous said...

(What the heck does the stock market have to do with a house?)

Substitute investments. After the bubble crash, some people are going to be 0 for 2 with their investments. Do you think they will then take the time to read a book and learn a bit ? I'll bet some won't and we'll have a 3rd bubble in something else. Oil ? Maybe commodities will be the new thing ! Gold ?

"but if rates go up, look out below. You're 60% decline scenario becomes a real possiblity."

We are at the start of an inflationary cycle because we've run out of commodities and oil. Furthermore, Washington wants to put a trade tarrif on China, which would instantly jack up China products, which is probably about half of what we consume, directly or indirectly. How can the Fed NOT raise interest rates ? I can't think of one scenario other than if we go into recession and deflation sets in, where rates wouldn't rise.

I heard someone say the other day that we can't function with a 4% Fed rate. OMG ! What happened to our country ! 4% is free money compared to 10 years ago. Remember when car loans were 12% ???

"Just sitting here and watching is ridiculous. Even communist China has more sense than that. And if you believe there is nothing the Fed can do, couldn't they at least pretend to be working?"

I can't figure this out either. People keep saying "if" there is a housing bubble. What part of the bubble don't you see !???? Record sales ? Decreasing price to rent ? Massive debt levels ? Skyrocketing prices ? What is left to debate ?

The Fed is using the "if" argument to allow the bubble to run. They know it is there, they just don't want to burst it because the consequences will be grim.

 
At 12:22 PM, Anonymous Anonymous said...

Should be "increasing price to rent"...

 
At 12:42 PM, Anonymous Anonymous said...

As history buff said above...

"At some point, investors will begin to focus on capital preservation and not capital speculation"

Maybe getting burnt twice will be enough.

 
At 1:53 PM, Blogger John Law said...

this is all lunacy.

people buy houses because they lost a bit in stocks. so stocks sort of stay in a range. so then the housing bubble pops, so people sell their stocks to make the mortgage and then sell their house. it's a self-reinforcing nightmare. I bet there will be people who have good finances, but have to sell their second home(even if they own it outright) because their stocks and bonds went down so much because people took money out because they lost so much in the housing bubble.

there are so many bad angles to this.

 
At 4:29 PM, Anonymous Anonymous said...

John Law: "this is all lunacy."

Yes it is.

However, before I read your last post, I thought that, in my own mind, I had explored all of the pesimistic extremes.

Thank you

 
At 5:55 PM, Anonymous Anonymous said...

Re: 60% decline in home prices.

Sir John Templeton, the famous British investor who made a fortune shorting Nasdaq at the top, said that real estate will fall 90% in some areas. (!)

 
At 6:32 PM, Anonymous Anonymous said...

Q: Do you think there is a real estate bubble in the U.S.?

John Templeton: "Yes. Real estate is very different from the stock market because it's so local and separate in terms of type. But in many locations and many types of real estate, prices are dangerously high right now. And in real estate it's easier to say what's
dangerously high. You just look at what it costs to rebuild. Right here in the Bahamas, I have recently seen people pay four or five times for a house what it would cost to rebuild."

Well, right here in San Diego, houses that are seliing for upwards of 700K (1000 sq ft) could be rebuilt for about 350 $ per sq ft. That's the number I was hearing after the fires in 2003. Do the math.

 
At 7:35 PM, Anonymous Anonymous said...

...would you pay $350K for a 2br condo that rents for $1200?

A 40-50% would bring that price down to about $200K, just about right for a $1200/mo rent (at the current interest rate), but if rates go up, look out below...


This analysis makes sense to me in a quick and dirty sort of way, but it assumes that rent levels will stay the same as home prices drop.

Everyone seems to think rents are lower than normal right now. Are they artificially low, and prone to rising once overextended home "owners" return to the rental market? Or are they only cheap relative to the cost of buying?

I'm thinking basing the rational house price on the rents we might have to count on somewhat higher rents going forward than we're seeing now. How much higher, anyone?

Also, what effect do the newly vacant foreclosures have on the supply of rental housing? Do banks usually seek to rent out foreclosed housing or only if they can't sell it?

 
At 8:13 PM, Anonymous Anonymous said...

I don't think rents are going up significantly any time soon. I know a yong couple with two houses that they are trying to flip, and now are trying to rent becasue they can't sell. More to come

 
At 8:59 PM, Anonymous Anonymous said...

In the early-mid 90's in the LA area many homes would be put up for lease or sale. Whatever someone offered, that's what they would do. I think we will see more rentals, not less. Also, as people need to sell their homes, but find themselves upside down on their mortgage, they too will rent out their houses to try to ride out the downturn.

 
At 10:07 PM, Anonymous Anonymous said...

"I'm thinking basing the rational house price on the rents we might have to count on somewhat higher rents going forward than we're seeing now. How much higher, anyone?"

Rent can't go up much right now because:

1. Those who are renting refuse to pay more or cannot pay more--unless there are lots of new high-end jobs or serious wage inflation. Inflation will be resisted all around.

2. Houses must be occupied or they rot and lose what value they retain. Ever drive through downtown Detroit? Miles of empty, boarded-up and burned out crack houses.

The marginal properties (in an overbuilt market) will go unused, unowned and unrented. The best will stay occupied and sell when people can afford to buy them.

In a market like coastal California--where there are plenty of rentals but high demand to own because anti-growth laws keep housing substandard--rents are *already* high relative to mortgage payments across the US.

In my area (Monterey/Carmel), rent for a decent 1br 1 ba apartment runs $1,100+. These are generally small and 20-30 years old, if not 50 years old. A nice 2br apartment is closer to $1,500 per month. A condo with a garage or small house edges up to $2,000.

The 0% down ARM buyers are probably paying about the same initial payment to "own" places that start around $500,000 and quickly jump to $800,000. People can't pay any more, for the median household income for the county is $50K-$55K per year.

-Generic

 
At 12:36 AM, Anonymous Anonymous said...

Templeton updated his forecast last summmer to be "20% of homes will be foreclosed"...still pretty bad.

 
At 1:21 PM, Blogger AsgardRagnarok said...

The rents will not increase because as the bubble pops and people rush to sell, they will move into the apartments that we will be vacating in order to buy thier houses. It will maintain an equilibrium. In a perfect world, even I don't belive that will happen.

 

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