The Aleph Blog » Blog Archive » Eleven Articles on Residential Real Estate

Eleven Articles on Residential Real Estate

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.






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3 Responses to Eleven Articles on Residential Real Estate

  1. 6. I don’t know any serious (experienced) investors that goes to a public auction to buy houses in good times or bad……
    7. You mean you have been negative for 3-5 years? The whole counrty? Every state, county & zip code?
    11. Giving out mortgage advice is a losing proposition.

  2. Paul says:

    Hi David! Great articles. I have a question about how to track credit spreads. Tony Crescenzi mentioned tracking swap spreads in an article on Real Money. How and where would an individual investor go about doing this? Are there particular websites that you look at to monitor credit spreads? Thank you…

  3. Larry, sorry the spam filter caught you initially, but I rescued your post.

    6. True enough

    7. Since mid-2005. That’s when I published my views on RM. I had varying views, feeling that the mid-section would do bad initially, then the coasts.

    11. Fine. Getting a fixed rate loan is almost always a good idea.

    Paul, no there are no good sources of bond spread data on the web. Sorry for the tardy reply. I suppose we could look at some benchmark bonds over at TRACE…

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David Merkel is an investment professional, and like every investment professional, he makes mistakes. David encourages you to do your own independent "due diligence" on any idea that he talks about, because he could be wrong. Nothing written here, at RealMoney, Wall Street All-Stars, or anywhere else David may write is an invitation to buy or sell any particular security; at most, David is handing out educated guesses as to what the markets may do. David is fond of saying, "The markets always find a new way to make a fool out of you," and so he encourages caution in investing. Risk control wins the game in the long run, not bold moves. Even the best strategies of the past fail, sometimes spectacularly, when you least expect it. David is not immune to that, so please understand that any past success of his will be probably be followed by failures.


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