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Take It From Someone Who Called the Housing Crash (and its victims) in 2005, We Are About Midway Through the Downturn, If That Far
Bloomberg reports US Home Prices Fall Again:
Sept. 22 (Bloomberg) — U.S. home prices dropped 3.3 percent in July from a year earlier, the eighth consecutive decline, as foreclosed properties flooded the market.
Prices fell 0.5 percent from June, the
Federal Housing Finance Agency in Washington said in a report today.
Economists had projected prices to fall 0.2 percent from the previous
month, based on the average of 15 estimates in a Bloomberg survey. The
agency revised the previously reported May-to-June decline to 1.2
percent from 0.3 percent.
Foreclosures are boosting the supply of available properties and reducing prices, even as mortgage rates tumble to record lows. The time it would take to clear the market of homes for sale was 12.5 months
in July, the highest in more than a decade of data, according to the
National Association of Realtors. Banks seized a record 95,364
properties from delinquent borrowers in August, according to RealtyTrac
Inc., an Irvine, California-based seller of housing data.
This should be of no surprise to anyone that reads the BoomBust or
follows me regularly. I’ve been warning about the crash for over 5 years
now, and those who feel we are nearing a bottom need to take out their
spreadsheets and plug in some historical numbers.
Paying Subscribers are welcome to download the mortgage and credit
template that was used in the original US (Don’t) Stress (US) tests,
otherwise known as SCAP. We have taken the liberty to update the
template on a periodic basis for the government, since it appears they
are not forcing the banks to do so 
SCAP Assumptions Updated_09082010 Web Version.
This model shows a weakness in the Case Shiller method of following
prices in that the CS doesn’t include investment properties (usually the
first to go into foreclosure), new construction, and REOs. As a matter
of fact, Case Shiller actually looked slightly rosy as of late. The
following graphs were generated from SCAP Assumptions Updated_09082010 Web Version..
Notice how the federal numbers show falls where CS doesn’t. Signs on the street tell me the federal numbers are correct.
As a matter of fact, things are so bad that I believe banks will have
a perverse incentive to actually walk away. Now wouldn’t that be
something??? Next, we take a look into the home builder that makes more
money doing distressed investing than it does building and selling
homes.
Related content of interest:
- I
Told You Housing Was Going to Take a Downturn for the Worse. I’ll Tell
You Something Else, We Are in a Housing Depression! It’ll Get Worse
Until Market Forces Rule Over Government Bubble Blowing! - Anecdotal Evidence That Banks Are Hiding Depressed High End Real Estate
- As I Made Very Clear In March, US Housing Has a Way to Fall
- The Shortlist of the Shortlisted “Stocks to Short for 2010″: What We See as the Most Profitable Bear Postions for 2010
- Commercial
Real Estate Continues to Dropped into Foreclosure as the Landlords of
Said Properties Enjoy Skyrocketing Share Prices? Yep, Makes Plenty of
Sense - Recent Mortgage Loss and Credit Performance Commentary
- Australia: The Land Down Under(water in mortgage debt)
- Australia: The Land Down Under(water in mortgage debt), pt. Deux: Which Banks to Short?
- Aussi Bubble Video to Go With You Aussie Bubble Speculation?
»
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Wow interesting and informative. I thought they banned that on TV.
Reggie, can you please stop bigging yourself up all the time? It turns the stomach.
He should also take some acting classes and get a makeover and breast implants. He's just to sincere and it has to make the other fakers uncomfortable.
Reggie, we have to get you on TV more. Your public demands it! I think that's your best performance on the tube yet. A little nervous maybe right out of the gate but fantastic in the home stretch. Don't be afraid to dive right into technical details - you're talking to us really, not the interviewers. That last bit about CRE spreads to Treasuries was great.
Financial talking head super-stardom awaits...
Reggie, this topic of banks walking away from houses is going to be a hot one.
Chris Whalen has also been talking about it. Apparently one of the big reasons for it is that not only GMAC but a lot of subprime mortgage companies, banks and private ABS pools were negligent or worse with their documentation procedures, and so now all these mortgage owners and servicers face high extra costs to prove the right to foreclose.
It means yet more mortgage losses for banks and other holders of private ABSs, plus costs and revenue declines for the local governments trying to get property taxes out of houses that both occupier and bank have given up on.
The guys writing about how lucrative it is to buy and rent out homes in today's market should go do it. Good luck to you.
As an investor, I am still looking at rental properties dispite the potential 20-30% drop... the "normal" sales are definitely overpriced when you compare the mortgage against rental income, tax, utilities and maintenance, but there are short sales and bank owned properties that are definitely in the money. There will always be diamonds in the rough.
whats the hurry, why not stash the cash for a few years, then pounce
Cash doesn't pay anything. I plan on keeping these properties indefinitely so I rather invest the money in a positive cash flow property than a measley 1% return.
Its total return that you have to focus on, though. Your properties may through off 8%, but if the property drops 11%, you are underwater, not even taking into consideration the extra risk involved. I wouldn't even look at properties now unless they are well into the double digit cap rate range, for liklihood of further price declines are nealry guaranteed.
Reggie
Tres kewl
Thanks for confirming my suspicions about housing, but wish I understood everything you said !!!
Your brilliance is always appreciated .......
Reggie, the most intelligent discussion I have seen on financial TV in a very long time...nice presentation....you made good points quickly but still with some depth...nice
Righteous, my man!
A class act, our Reggie.
If I may be excused a racially conscious reference, I hold Reggie up, along with Walter Williams and Thomas Sowell, as shining examples whenever the guys in pointy white hoods try to debate me.
conversely, remember to mention the likes of Britney Spears, Lindsay Lohan, Ben Rothlisberger etc. when you want to prove white inferiority and immorality
RM-- thanks for sharing your concise and overview credibly presented. You may have been their easiest and most effective i'view ever.
Wow. Exellent interview with good information Mr. Reggie.
In my opinion of course!
That was a good interview Reggie and as one person put it they didn't even try to talk over you. If you would have been on CNBC, they would have tried to break the flow of the answer and even your thought by either attacking your numbers or belief or interrupting you and asking you another question. Bloomberg actually allowed you to finish your answer to them. Also I'm not to sure also if a bank can actually walk away from a property. Many of these banks are insolvent (just wait for the usual Friday late afternoon/evening after the market closes bank closings). I do have a question for you Reggie, what is your take on the commercial properties? The reason I bring this up is many of the local banks kept commercial properties on their books, and with many towns and cities across america their are strip malls and high rises empty because of the economy and these investors must have defaulted on their 5 10 50 or 200 million dollar loans.
As a commercial real estate appraiser in New York (Mid-Hudson Valley and NYC) I can tell you that commercial real estate is gonna fall hard...er. Unrealistic asking prices (still), unemployed tenants (U-6, anyone?), retail tenants closing due to a lack of business and owners in denial who still think they can get 2008 lease rates in 2010. One anecdotal story: a strip mall owner was asking for $19/SF and getting counter offers of $13/SF. That was 2009. I can only imagine what they're asking for now...and still not getting.
Reggie- You have described zombie houses,...undead rotting carcasses of formely lively homes, undead houses that will be terrorizing our housing market and economic health for years.
I feel like some evil Wall Street scientist brewed up some crazy pharmaceutical and he said it would make our economy thrive without even eating right or exercising, we fell for it and paid the scientist big money for the shots, he got rich on us thinking we were going to get rich...and now we are rotting zombies, reviled and worthless.
The problem with our zombie land is the banks and servicers have too many perverse to just acknowledge their loss and figure the best way to lose the least money. Servicers have complicated entanglements that actually incentivize them to NOT get best deal for owners of mortgages, and banks don't want to lose 10x the supposed book value of the house in lending capacity/reserves. Our only hope would be a piece of legislation called something like Operation Wipe Out that takes all those perverse incentives away. Probably unconstitutional tho....so back to the Zombie horror movie
Bingocat,
Thanks for the "mortgage math".
While I am quite prepared to continue renting into the forseeable future, the calculations you have shown are very informative.
It's ALWAYS a matter of the math (and the optionality you own, but that is part of the math).
The above math assumes one is stationary. If one is mobile, or expects to be, it is a far more difficult calculation to make. You actually have to predict the schedule of home price deterioration against the benefit you earn. This isssue is compounded by the question of whether your state is a recourse state or not (non-recourse states are Alaska
Arizona, California, Connecticut, Florida, Idaho, Minnesota, North Carolina, North Dakota, Texas, Utah, Washington) but one has to know the laws (CA is a non-recourse state but only for the initial money mortgage - second mortgages and HELOCs and other loans are recourse loans). If you expect to move house sometimes in the next five years and you live in a recourse state, I am not sure I'd buy...
It is, for lots of people in the US, cheaper to buy than to rent in areas where jumbo loans are not the norm. In places where jumbo loans are the norm, it may actually be "cheaper" to rent than to buy (assuming you want to live in a similar place in either case) because owners of high-end properties are willing to rent them at ridiculously low gross rental return just to get someone in them. Houses deteriorate faster when they are not used.
In my particular tax regime and rental market, it is actually economically advantageous for me to rent rather than buy, until I think housing prices are going up. My tax regime is particular however, and is as far as I know, unique among developed countries.
Some home mortgage math...
If you buy a $300k house with 5% down, at 4% you'll pay $1360 a month for 30yrs. At 5% you'll pay $1530/month. You'll get ~$300 a month back in the beginning if you are in a 25% tax bracket. You'll also be able to claim depreciation of about $570 (assuming house is worth 80% of what the entire property is worth) which in the same 25% tax bracket would effectively return you $140/month. You'd have to pay $200-250/month in property taxes usually, but if you net this out, it is $1160-1320 a month. For the same house, you'd expect that the owner would want 7-8% gross rental return (to be subsequently lowered by taxes and maintenance), so you'd be paying $1700-2000 per month as rent.
You have to calculate what your downpayment would have returned had you not spent it, but with low money down these days and low interest rates, if you have the savings, it is not a bad deal. EVEN IF THE HOUSE GOES TO ZERO.
That's right. If the house goes to zero, your $15k down "grew" in value to be worth the difference between what you paid in maintenance and what you saved in rent. If you save $600 between renting and owning (including property taxes) and average $400/month in maintenance, you are "earning" $200 a month on your $15k, which is 16% a year. Note that this rate will fall over time as the tax benefits of interest payments disappear, but one would not expect the value of a maintained property to fall to zero.
As to banks wanting to walk away from the house completely, it would have to be a case where the backtaxes+maintenance costs would outstrip the result of selling the house at a no-reserve auction. I note that if the bank "just doesn't lay claim to the asset", the county will, and a bank will be forced to pay the taxes anyway, and in many cases, they will be forced to pay for demolishing the unmaintained house too.
For those reasons, I highly doubt that banks will "simply walk away." It would be much better to get into bed with an investment fund for that fund to buy LOTS of houses in a block from a "foreclosure farm", and then rent them out. The bank would generate a better price by selling in bulk, and by making it a condition that the loan to buy them come from the bank. Use the bulk buy premium to lower the house cost and add points to the loan, and raise the cost of the financing, and put terms in which say that the new borrower cannot refinance for a minimum of 12 months. At 12 months and one day, the borrower would buy themselves out of the loan and the bank would be out of it forever.
You cannot depreciate a house you live in. Depreciation deductions are limited to homes you rent to others. So if you are assuming the buyer will live in the house, his monthly cash costs are over $1,000 net interest, $300 in ppt taxes (minimum) plus water and garbage of $75 (things most landlords pay).
If the house value does not rise in five years, the buyer has lost all of his $15k down payment because to sell he needs to pay a 5% commission, exactly his down payment. Now amortize that loss over 5 years and his actual cash costs are another $275, or $1650.
I suspect that such a home in most markets is not likely to cost more than that to rent.
You are, of course, right on the depreciation bit. I was confusing personal use residence and investment residence. I am so used to non-principal residence investing it is second nature to look at depreciation cash-flow. In the end, the depreciation issue is a cash-flow and tax-rate issue anyway.
Anyone who has a 5yr outlook is going to have a hard time amortizing the down payment out unless the home value rises (thought I'd mentioned short-term horizons could be problematic). My "simple math model" assumed living in the house til maturity of the loan. Anything which requires a trading price is going to introduce other costs (commission, early repayment of loan costs, costs related to sellability, etc). As noted, if we stipulate what all the ownership costs are, and they are higher than rent, then the math dictates the owner has a particular expectation of price rise.
I know of many areas where the loan repayment+maintenance+utilities+prpty taxes would be less than the rent. I know other places where it would not be the case. As noted, if we stipulate that the vast majority of the housing supply is currently priced to be uncompetitive with rent, then it is an easy thing to suggest that prices go down. The problem is that so many people expect house prices to go up that they do not see that they could "make money by owning" even if property prices fall.
If people want a model which allows them to trade their house every five years, housing prices have to go up to pay for the transaction friction AND the rent vs ownership costs spread has to be zero.
One serious issue which we don't look at is the strange case of "mobility" of homeowners. People who are currently "negative equity" have suddenly become immobile. Those who are positive equity have less money to trade up with, but down payments for non-jumbo are so low now, and interest rates are too, that having less post-sale equity than their original downpayment is less of a problem, even when "trading up." Those people are mobile. That will generally mean that the ratio of mobility in a tough economic environment actually favors the "older" rather than the "younger" for the first time in a very long while.
It used to be that if economic opportunity (new job, or company transfer, whatever) beckoned one to a new area, people would sell their house, endure some emotional disappointment for having done so, moaned about having only a short time to sell their house, but they could up stakes, reinvest somewhere else, and get on with their life without structural upheaval. Now one could imagine that in order to take that new job on the other side of the country, one would have to declare personal bankruptcy, take a 7yr hit to one's credit rating, etc, just to take the job elsewhere. That is not going to happen if people can avoid it. This structural lack of potential mobility is going to create its own problems for American recovery.
Yes, you raise a very important and much under-appreciated problem: recent buyers are trapped in their homes and are now faced with defaulting and moving or staying and paying more for shelter than they might otherwise need to pay. I think this is why younger buyers are not jumping at relatively low rates and prices, particularly when employment is no longer a career track for many young people. This is the "vicious cycle" of declining expectations, transactions and income that is the face of de-leveraging.
Your example excludes maintenance and utilities as a homeowner, which drives the cost up.
It also overlooks the fact that what a landlord wants in terms of rental yield is not always what he gets. Many areas have glutted rental markets as a result of glutted sales markets that have turned to rentals to try and save the projects. Areas that are dense in condos and housing developments are prime examples. I can think of areas that were renting at a loss, but that loss was better than the loss that would have been taken waiting for a sellout.
The problem is that as more and more supply comes on market, and more propeties that can't get sold attempts to turn rental, then rental yeilds get pushed even further downward. Each market is specific, but one general premise is that supply materially outstrips demand, and the imbalance is getting worse at a time when other fundamental and macro factors are looing ugly as well.
In order to sell a property at any price, you need a buyer. Properties that are surrounded by many other empty properties degrade each other and make the sale that much more difficult. Take the las vegas story above, or my Baltimore example in my answer above as an example.
Reggie, if you look closely, my "math" does not exclude maintenance. Utilities payment practice (i.e. who pays them) is evolving everywhere but one can amend the formula (and the values) to include utilities. Adding or subtracting payments required does not detract from the argument that owning vs renting can generate a lower monthly payment which may be worth 'harvesting'.
I am sure there are lots of examples of real estate owners who would buy cheap houses now out of foreclosure or short sale and have a worse result than expected. There will be many others who buy, then discover Section 8, and get great results for many years. As to owners not getting rent that they want, I stipulate that's possible. But just to cover that, I now lower the price of the $300k house to $200k and all the payments accordingly (save maintenance and utilities). Maybe that scenario works. If you want to stipulate a house price, and rent for that house, and all the maintenance/utilities/deposit/etc, please do so. If you stipulate a a relationship which makes it so renting is better, renting will be better. I think there are currently vast swaths of American whereby owning is now probably competitive with renting (perhaps not Manhattan, or Silicon Valley, but both places have constant demand from outside).
I fully agree that one needs buyers around in order to sell. I also agree that properties surrounded by empty properties may have a lower value than if they were surrounded by well-maintained properties in low-crime neighborhoods with no ownership covenants, lots of weekend barbecues, and a bevy of supermodels living in the neighborhood with a penchant for washing their cars on sunny Saturday afternoons.
Your base case here is that things will go badly for banks because the properties are worth a lot less, perhaps even zero. My argument is that if it has value in the rental pool, it is not worth zero. If you are right and rent is cheaper than owning, then house prices will go down to where it is economic to own and rent out. If you think bank-owned real estate will go to zero because of pre-foreclosure vandalism, and neighborhood issues, and that it will happen on a large scale, thereby bringing down values in all other American homes, you are effectively predicting an American Apocalypse. I am fine with that, but I am not sure it is JUST real estate which causes the apocalypse. It may be that falling real estate prices are symptomatic of the apocalypse.
Your comment about bank foreclosed-upon houses being turned into rentals which then flood the market is only one half of the story. What happened to the family which was living in the house before it was foreclosed upon? With their newly shot-full-of-holes credit score, they are probably renting, which means they reduced the rental supply by the same amount that the foreclosure/REO property for rent increases it. It is extremely difficult to simultaneously have a situation where we have the same number of households, more rental supply, and a substantially higher portion of housing supply which could be up for sale and/or rent which is derelict (i.e. noone wants it and it is worth zero). If lots of it is worth zero, maybe municipalities will bulldoze it like Detroit and Pittsburgh are doing.
"ur comment about bank foreclosed-upon houses being turned into rentals which then flood the market is only one half of the story. What happened to the family which was living in the house before it was foreclosed upon?"
There are many variables to consider. For instance the new construction that never found a family to live in to begin with that gets foreclosed upon, en masse simply adds net supply to the market without displacing any families whatsover. In NYC, arguably the most desirable real estate in the world, there are over 7000 units in that predicament. Many of these untits are adjacent to construction that is STILL ongoing. As you move I to less desirable suburban and rural areas, and other states it gets much worse. I am not preaching apocalypse here, but the situation is already worse than some pundits worse case scenarios.
I agree there is structurally too much supply. I would suggest that a lot of that supply is going to show up in overbuilding of condominiums rather than overbuilding of houses. While there were certainly lots of houses built on spec, and lots of houses bought which were bought too expensively, eventually they find a clearing price (above zero). Once you buy it, it's yours and you pay for the maintenance costs on your house. It is possible, however, with maintenance/etc fees in a condo, that buying a cheap condo is a very expensive proposition. Even if the condo trades for 1 cent, if the large building is largely empty, you end up with significant monthly payments just to make up for the fact that other people are not in the building. I expect that we will see a "condo crisis."
While there is oversupply everywhere (that's what happens in a nationwide bubble), there is substantial oversupply in "nice" places which previously had high local growth rates (Las Vegas, Florida, Arizona, California, NYC).As for NYC having 7000 empty units does not faze me in the least. If it were 10x that number, I might - just might - be concerned. The reason is those 7000 units are not 100 buildings of 15 CPW but are mostly sub $1mm condos. What does start me thinking is how far commercial rents could fall in NYC.
Overall, I think that banks walking away from houses at zero imputed residual value is unlikely. I know any number of people who want to take over banks which fail because they can buy the mortgage debt (potential foreclosure book) from the FDIC at lower prices than market, then resell.
If every bank in the US were willing to sell the mortgage for whatever the "fair market value" of the house is less 15%, any number of distressed funds would buy a pile, then immediately approach home owners to lower their monthly payments down so they were just a little bit in the hole. Most homeowners would jump at that, and it would make everyone feel a lot better. Because so many distressed buyers are willing to perform that function, I highly doubt banks will have to let the houses go for nothing.
Just one month vacant and your rental pro forma is shot to hell since most allow 5% for rent loss. What a joke. Maintenance pro forma costs are also under estimated. Capturing a security deposit helps but many states have stringent requirements in that area. I was in the property management business for 10 years and it is not an easy profession.
With a name like Reginald Middleton, I had you down as a Vivian Richards, Gordon Greenidge or Malcom Marshall type of 'chap'.
Now I'm still not sure. Nice work though.
Reggie, as always, great work. You're becoming mainstream .. isn't that a frightening thought? lol.
OK Riddle me this .....
I noticed a foreclosure in my neighborhood so I decided to check it out. I was there early and was talking to the homeowner and then the bank rep. During the conversation with the bank rep she told me she was there to bid on behalf of the bank. Huh? Say What?
Having worked for an auctioneer (OK different country) I know that’s a big no no and told her so. Can someone clarify that for me?
Apparently she does this a lot. First Horizon is the bank. Mass is the state.
The note was for 401K and taxes were probably due as well. approx $5,600 per year.
Bid by the bank who already owned it $370,100.10
Reason they will get a kick back from the taxpayer to cove the losses.
MERS was used to represent the bank in the foreclosure proceedings.
After it was done I knocked on the door and told the homeowner to get a lawyer as MERS has been discredited in many states.
The house is worth 325-350 retail.
Why did the bank buy the house beyond the 20K or so they will receive (after auction fees) ffrom the taxpayer?
Every State handles foreclosures differently but in CA when a bank holds a Trustees Sale, the opening bid is the foreclosed $$ amount (please legal fees and any other fees) and the opening bid is the Banks bid - if someone bids $1 more they are the winning bidder, if no one bids the bank is the winning bidder and get the property back. So the $370k is (probably) the 1st mortgage plus the garbage fees and they were lucky to be only -$20k underwater.
I liked the " you and you have bought treasuries" part.
Pento should say that the next time hes talking with B-cups.
Your the man, I always look forward to your commentary, always the big picture! and in depth analysis.
What is this strange new interview style where the guest is allowed to answer questions without interruption, ridicule, or being incorrectly paraphrased? How the hell did that get past the censors?
I must admit that the crew at Bloomberg are defintely a class act. They were very professional and I have absolutely no compliants.
you' a smart black man who knows his stuff and they can't pull all that cheap shit on you. you have been patronized instead. don't matter reg, you're the man.
With that, you were able to get your thoughts and information across concisely, and you knew your stats to back it up...a pleasure to watch!
And that is why my DRV did over 8%+ today. These shares are the tiniest exposure to credit default swaps I can find. I didn't have the $100 million deposit handy that the ISDA wanted to authorize me to buy my own swaps, so...
Well played, sir.
good interview....
Love ya Reg.
Nice showing reggie!
Reggie .. Reggie!
RM....
Congrats....
The coming bond comp RE devaluation...has to be a given....and couple this with the % of govt. debt being interest....when combined ...this alone spells devaluation/deflation in general....in that less is available to price goods and services....
Future currency comps really are bad vs bad....thus "bad" just like "good" is a constant.....up and down with the tide....
One should think that volatility of prices amongst the "confusion quotient" increasing would be a given....
And the current govt. policy is to make govt. larger...thus making the prices of goods and services even less competitive.....unless of course ...ie the older Italy selling more FIATS when the currency would decline....ie GM sales etc....It is not likely that China will ever position their currency to their disadvantage.....
Third world countries are used to this type of economy....Individuals that have had to survive in the third world...have to be extremely intelligent just to have a very modest life.....
Again...
Congrats....
.............................
Also RM...
2007 = 100 Debt availability + Assets
2010 = 50
2012 = 30
30/100 = Deflation in a big way....
Agree....not agree ?
Just a quick question - How does a bank walk away from a home? They have the title, so do they legally forfeit it? I understand they don't want to pay upkeep and taxes. Wouldn't the cities then have to sue to reclaim taxes?
I am not sure how this would work out.
X
Every State is different, but in CA, the county can hold a tax sale for a property after non-payment of RE taxes after 5 years - the cities here don't tax properties, the counties do. Banks probably aren't going to be paying for maintenance for 5 years without paying the taxes; so it's either pay both or pay none - if the property isn't kept up, the city could attach liens/fines to the title which would carry thru to the tax sale. If a bank is walking away from a home or homes, the bank is probably bust and then the FDIC, HUD, or some other Govt agency would take over the bank assets and then own title to the property. Then when the Govt is responsible for maintenance, the property really goes down hill - at least for now, the banks, are trying to keep REOs in reasonable condition.