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Seeking Alpha

Wednesday, July 23, 2008

The Real Estate Bottom is in Place

By Michael Douville
Real Estate Market
,
real estate market bottom price
Things are getting better. Sales are being made. Builder inventory is being cleared. Affordability is returning. A pricing floor has been established at which properties will sell. The bottom is in place. However, let me define the bottom.

The bottom is that price at which an educated, qualified buyer is willing to purchase. Most buyers are educating themselves thoroughly; there is no rush to buy. Although property inventories have stabilized, there has been no drastic drop in homes listed for sale. There is a very large overhang of inventory from which to choose, currently in Phoenix over 50,000 properties. Within that inventory, there are always special situations and distressed properties. At this time, lender owned properties account for 20-30% of the overall inventory and they are aggressively priced.

The overall price drop in Phoenix/Mesa/Scottsdale MSA (Metropolitan Statistical Area), one of the largest new home markets in the nation and one that experienced some of the largest gains, from April 2007 to April 2008, is 18%. The outlying areas have experienced an even greater loss, while more established areas a little less.

Financing is also adding to the price decline. The requirements for lender financing is returning to traditional underwriting standards. Buyers need to be able to qualify for their loan and actually PROVE IT. Although there are still low down mortgages available, particularly with FHA or VA, the underwriting criteria has been more conservative, which has the effect of compressing buyers into lower price ranges.

Also, appraisers are concerned with value and future value resulting in "declining value" appraisals which have a 5% discount deducted. In addition, there are lending caps on these government loans; in traditionally higher priced areas, they offer little relief. Underwriters for the private mortgage insurance companies that insure the portion of conventional loans over 80% are also tightening their requirements. More stringent lender qualifications are removing more buyers from the buy side of the Supply/Demand Equation. In the long run, this is very healthy and contributes to market stability. In the short-run, it adds to lower prices. Construction costs are also lower.

As the new home market contracts, the cost of materials and labor is also dropping. Competitive bidding and softening demand have driven a decline in construction costs of up to 30%. As the price of oil rises and makes the evening news, the price of concrete, lumber, and labor has dropped significantly, and largely goes unnoticed. New prices paid for land have been greatly reduced from prices paid just 2 years ago. The cost of land, development costs, material and labor costs are all combining to reduce new construction costs, thus lowering prices.

Those who rushed to buy during the frenzy and mania of 2004-2006 may be trapped in there homes for the next 24-36 months. The new reality of the real estate market does not care what price the owner paid or how much the loan amount may be. The market does not care, if in the rush to buy, the owner was involved in a bidding war and paid too much... sometimes much too much.

Even though they may want to sell or NEED to sell, the loan amount on many recently purchased properties exceeds the value of the property. In many instances, the reality is that the current owner CANNOT sell. If they remain current, within 36 months, the cycle will have restarted and a recovery in prices should be underway. Until then, the professional asset managers will run off an orderly liquidation of acquired properties... sold at the new price: discounted 20-40% from the bubble top.

The market is stabilizing, but at a much lower price. There will be losses as loans in many cases exceed the value of the properties. However, the demographics of the U.S. market are extremely powerful, and I am confident that within 12-18 months normalcy will return and a new cycle will begin. I expect that those who purchase selectively during this real estate sale will be richly rewarded in 5 years.

Article interests AMEX: DIA, AMEX: SPY, AMEX: DOG, AMEX: SDS, AMEX: QLD, Nasdaq: QQQQ, AMEX: QLD, NYSE: TOL, NYSE: DHI, NYSE: PHM, NYSE: NVR, NYSE: LEN, NYSE: GFA, NYSE: MDC, NYSE: CTX, NYSE: KBH, NYSE: RYL, NYSE: MTH, NYSE: HOV, NYSE: XIN, NYSE: BHS, NYSE: SPF, NYSE: MHO, NYSE: BZH, Nasdaq: AVTR, NYSE: OHB and NYSE: WCI. Please see our disclosure at the Wall Street Greek website.

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2 Comments:

Anonymous Anonymous said...

Very interesting analysis. What is not included are the following facts: 1)Between now and the end of 2009, there is another large batch of resets on variable rate mortgages coming due, loans made at the market top. Very few of these are above water and mostly NINJA (No Income, No Nob or Assets); 2) The inventory is now over 11 months of sales, a level not seen even at the bottom in 1995-96 and 3) The leading edge of the boomers are getting ready to retire. More inventory? As a California Real Estate Broker and Certified Residential Appraiser I would be very hesitant to be calling a bottom much before 2010-2011 and WHEN the bottom is reached I would not be very sanguine as to future appreication. We maybe in for a long period of flat prices. Big fly in the ointment: we may be in for a Weimar hyper-inflationary period and if we are, prices could skyrocket, but it will not mean much.

4:20 PM  
Anonymous Anonymous said...

Well thought out...I agree with you...many of the "NINJA" loans may ultimately be assigned to asset managers...however, the "Mortgage Releif Bill" currently before Congress should provide relief for many true "owner-occupied" properties. The "speculators" who purchased under the guise of "owner-occupied" mortgages may not and in my opinion, should not be helped. I expect the bill will be signed close to it's current form and many homes will be saved from foreclosure. Also, the new limits for conforming loans and the increased limits for FHA/VA will provide greater traditional lending.This will limit the future supply of foreclosures and help with the supply/demand equation eventually clearing all the oversupply

As you have pointed out, selection of an investment property is critcal. I have found properties worth owning...all discounted. When purchasing a target propery that is within my acquisition value, often there are competing offers which indicate the "market" agrees with the valuation. The purchases have been 20-40% below the "bubble top"...sold at a loss to the lender...

As an aside, there are loans within my portfolio that adjust this year..I am anticipating the rates will be lower this year than the adjusted rate last year.

You have touched upon a powerful trend in the US...the demographics of the US are awesome...currently there are over 300 million people living in the US...within 40 years, the population will grow to over 440 million...a good place to live today will probably be a good place 20 years from now..

Thank you for your excellent perceptions...

Michael Douville

3:02 AM  

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