Those who have read me at RealMoney know that I have been bearish on residential real estate for the last 2-3 years, and on commercial real estate for the last year.  I have found it fascinating to see both markets move to situations where current income is exceeded by what can be earned in Treasury securities, much less mortgage funding costs.  Take it as a rule, when one must depend on rental growth and property appreciation to make a profit, it’s time to sell.  Anyway, here are the articles:

1. I guess I have to start with Bear Stearns’ hedge funds.  An ugly situation where Bear might have to tap $3.2 billion of liquidity to stem the crisis.  Bear can afford the money, but it might bite into their credit rating, and their ability to earn money off of their spare capital.  As I commented on RealMoney yesterday, it is not likely, but possible that this turns into a wider crisis.
2. Though this article is about Collateralized Debt Obligations [CDOs] generally, much of the excess yield that allowed the CDOs to be sold came from subprime CDOs.  Now who holds the risk?  From what I can tell, a bunch of hedge funds, hedge fund-of-funds, and pension plans.  The lure of easy yield beings out the worst in institutional investors stretching to make a certain total return target.  The low-paid managers of public funds are particularly drawn to these investments because of the political pressure to keep taxes low.

   As an aside, the principal-protected versions are a sham; it is the same as investing a small amount in the volatile stuff, and a large amount in Treasuries.  That one can’t lose money on the package is meaningless; look at the two investments separately, and ask if they both make sense.  Lesson: don’t but investments that you don’t fully understand.

3. Little of the current troubles in residential real estate could have gone on without optimistic appraisals.  That’s putting it kindly; before the end of this crisis the appraisers are going to face some degree of additional regulation.  Will it be the right solution?  Probably not, but read the article, and watch a profession in need of tough ethical requirements, or perhaps, means of eliminating shady operators.
4. I’m not sure how one can rent out credit scores.  It would be fraud if done without the consent of the one whose score is borrowed.  With consent, it would be a stupid form of co-signing a loan.  I never recommend co-signing.  You have more protections loaning the person the money yourself, even if you have to take out a loan to do it.
5. I’ve followed this statistic for a while.  With a few conservative assumptions, it means that the average indebted homeowner has only 30% equity in his home.  Not a safe place to be.
6. Buying foreclosures?  Wait a year, okay?  Look, foreclosure, and other forms of distressed investing only work when the ratio of vultures to carrion is low.  It’s not low now.  Let the dumb vultures overspend now; come back when you hear of former vultures having to raise liquidity.
7. Barry Ritholtz and I have long been on the same page on residential real estate investing.  This article has some of the best charts I have seen in some time.
8. Here’s an alternative view of residential real estate pricing.  Rather than listen to the shills at the NAR, this might be a fairer take on the market.  Note that it has been lower and higher than NAR forecasts; I like that, because reality is almost aways more volatile than we would admit.
9. My view of the residential real estate markets is bifurcated.  The Midwest and the South suffered the worst initial foreclosures because housing prices did not rise much there, and refinancing was not an option.

     Tight finances + bad event = default.

   But the pain will shift to the formerly hotter coastal markets, where subprime financing was more prevalent, as the ARM resets hit, and now prices are falling, and interest rates rising.

10. Excess supply is the rule; we have a little less than one year’s supply of housing vacant and ready to sell at present.  That is a record by almost double the long term average.  This will take years to clear up, particularly with the builders still constructing homes.  Perhaps we can solve the problem by selling all the excess homes to wealthy foreigners.  Kill two birds with one stone; fund the current account deficit, and reduce the the housing supply overhang in one fell swoop.
11. Interest rates are the silent killer here.  It would be wise for many people to refinance to prime fixed-rate loans, but with interest rates rising, the bar is getting raised for even creditworthy borrowers.

We are stopping at a butcher’s dozen here.  Not a great time to own residential real estate on leverage.  When I went to work for the hedge funds that employ me, I paid off my mortgage because my earnings would be less certain than what ai earned as a bond manager for an insurance company.  Would that more people were conservative with their finances in the same way.  As it is, I expect the residential real estate price slump to persist into 2009.

This entry was posted on Friday, June 22nd, 2007 at 12:44 am and is filed under Bonds, Macroeconomics, Personal Finance. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.