Housing deflating  

redmustang91 57M  
8744 posts
11/17/2005 8:52 am

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3/5/2006 9:27 pm

Housing deflating

Now is not the time to invest in high priced housing as the market is slowing and the bubble deflating. Toll Brothers announced lower sales and housing stocks fell. Another two years and houses will be cheaper than they are now, I predict! Schwab agrees:

Haunted House? An Update on the Real Estate Market

by Liz Ann Sonders, Chief Investment Strategist, Charles Schwab & Co., Inc.
October 31, 2005

Growing signs of cracks in the foundation of real estate.
Housing Affordability Index plunges to 14-year low.
Hottest metropolitan areas extremely overvalued, with sales declining sharply.
OCC tackling speculative lending practices.
I last wrote about the real estate market about four months ago, and since I’m still regularly asked about it, it’s time for an update.

It continues to be my contention that we don’t have a real estate “bubble” as per the traditional definition (“a period when the price of an asset suddenly soars for irrational reasons and then collapses”. However, there are growing signs of cracks in the foundation of real estate that bear noting and watching:

Although total new homes for sale are at a record, the supply of new homes remains at 4.9 months, which is the highest since 1996, according to the U.S. Department of Commerce. And the median number of months that completed homes remain unsold recently ticked up to 3.9, suggesting that supply is approaching demand for the first time in quite a while. One of the statistics high on our list of what to watch is the Housing Affordability Index, seen below, which recently plunged to a 14-year low, a level last seen during recessionary times.

Housing Affordability Index down sharply

As of September 2005. The National Association of Realtors Housing Affordability Index measures whether or not a typical family could qualify for a mortgage loan on a typical home. A value of 100 means that a family with the median income has exactly enough income to qualify for a mortgage on a median-priced home. An index above 100 signifies that a family earning the median income has more than enough income to qualify for a mortgage loan on a median-priced home, assuming a 20% down payment. Source: FactSet.

Another scary chart below shows the dramatic increase in mortgage interest payments, which are nowhere near matched by the much lower increase in wages. You may recall this paltry performance by wages is why we don’t fear inflation’s bite as much as the consensus right now, but it certainly has implications for consumer health.

Wage growth pales in comparison to mortgage interest payments

As of October 2005. Source: MacroMavens.

Houses no longer acting as ATMs
The support that the appreciation in homes has provided to consumer spending may be a thing of the past, too. Take a look at the extraordinary slowdown in the growth of home equity loans over the past year:

The bloom’s off home equity loans

As of October 2005. Source: FactSet.

Overvalued metropolitan coasts
PMI, a national mortgage insurer, recently put out a study assessing the valuations of the largest real estate markets in the United States. The primary regions of overvaluation are in California, Florida and the Northeast (can you say, “duh!?”. It’s obvious, yes, but it’s more important to point out that these metropolitan areas of greater-than-15% overvaluation represent more than 40% of the market value of the entire nation’s real estate supply. A list of the top 10 and bottom 10 markets, based on valuation, is below:

Area Over or under (-) valuation today
Los Angeles/Long Beach/Glendale, CA 33.7%
Sacramento/Arden/Arcade/Roseville, CA 31.3%
Oakland/Fremont/Hayward, CA 26.5%
San Jose/Sunnyvale/Santa Clara, CA 26.5%
Santa Ana/Anaheim/Irvine, CA 25.5%
Las Vegas/Paradise, NV 25.5%
Tampa-St. Petersburg/Clearwater, FL 23.2%
San Diego/Carlsbad/San Marcos, CA 22.2%
Phoenix/Mesa/Scottsdale, AZ 22.0%
Miami/Miami Beach/Kendall, FL 20.5%
Pittsburgh, PA 0.2%
New Orleans/Metairie/Kenner, LA -0.6%
Charlotte/Gastonia/Concord, NC/SC -1.0%
Nashville/Davidson/Murfreesboro, TN -1.4%
Memphis, TN/MS/AR -1.7%
Indianapolis, IN -1.9%
Cincinnati/Middletown, OH/KY/IN -3.4%
Denver/Aurora, CO -4.2%
Cleveland/Elyria/Mentor, OH -6.9%
Detroit/Livonia/Dearborn, MI -10.3%

So with any significant weakness in some of the larger metropolitan markets, there will be contagious effects at the national level. It’s still our belief that the end of this housing boom (already in play) will be represented by a period (perhaps multi-year) of flattish housing prices in the aggregate.

However, regional declines may be more severe. The biggest lot shortages and the most expensive homes are located in regions currently showing the biggest sales declines: September sales dropped a whopping 29% in the Northeast and 16% in the West, although they were still up 14% in the South.

Speculation in lending
Where we’ve been expressing our greatest concern is on real estate speculation and the concomitant lending practices that have been instituted in order to “fund” the marginal buyer into his/her loftily-priced home. Although mortgage delinquencies continue to fall in the aggregate, they’re much higher for sub-prime mortgages. As I wrote back in June, it’s clear that strain is hitting the marginal buyer as costs begin to exceed incomes, and these dislocations are likely to persist, if not worsen.

Regulators are taking notice. Both the Federal Reserve and the Office of the Comptroller of the Currency have been consistently expressing concern about speculation in the housing market. The OCC charters, regulates and supervises all national banks, and the federal branches and agencies of foreign banks. It’s getting tougher on speculative lending at the national banks and is making efforts to keep the banking system from being overexposed in the event of a more-significant-than-expected price drop.

In the OCC’s sights are some specific lending practices that have grown exponentially in popularity: interest-only loans, option-ARMs and low-documentation loans. The OCC reports that interest-only loans accounted for about 50% of loans last year, while option-ARMs may account for about 50% of this year’s loans. About half of this year’s loans are also reduced documentation loans, and–of the least creditworthy holders of option-ARMs–nearly half have current balances above their original loan amount. You can see the strong biases toward ARMs over the past couple of years:

ARM loans much higher than fixed rate loans

As of October 2005. Source: MacroMavens.

ARMs surprisingly popular given low rates

As of October 2005. Source: MacroMavens.

Exam by exam, the OCC’s toughness is swelling. On its docket are proposals to consider more comprehensive loan approval methods–moving from today’s credit-score methodology to practices that include income parameters and mortgage-rate sensitivity analyses; in other words, more complete consumer disclosure. The consequence is that credit is getting tighter and money supply (M3 in particular) should slow when banks realize that their reasonably safe profitable lending opportunities are relatively few. (Note in the chart below the strong recent surge in real estate loans as a percentage of total bank loans.) These concerns support our still-neutral stance on the financial sector, as we’re wary of those banks and thrifts dependent on growth in lending.

It’s been all about real estate loans

As of October 2005. Source: MacroMavens.

Most telling was a recent comment by John Dugan, the new comptroller of the currency: “Lenders have scrambled to find ways to make expensive houses more affordable–although there’s now a concern that the very availability of this new type of financing has done its share to help drive up house prices, which in turn stimulates demand for even more non-traditional financing.”

Saying it again
I’ll conclude with some of the same thoughts from my June report: If you’re buying a house for purely speculative reasons and/or as a “get-rich-quick” scheme, you’re likely to be very disappointed. Bubble or not, the end of a cycle can still get a little ugly. There are too many investors who speculated too heavily and could get crushed.

saddletrampsk 54F

11/17/2005 9:40 am

Home is still where the heart is..

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