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| The Housing
Bubble Revisited |
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| If there
has been any doubt that a housing bubble really exists, recent news should
have changed that. In early July, word got out that trailers in a mobile
home park in Malibu were selling for over $1 million. Well, granted, it’s
not your ordinary trailer park—scenically located at Point Dume and close
enough to the houses of the stars that you can wave Barbra Streisand goodnight.
Whoever can’t afford an eight-digit Malibu mansion moves into a mobile
home; even celebs like Minnie Driver have been reported to own one. |
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| The downside:
what you get for your $1+ million is just the mobile home itself; the
land it sits on doesn’t come with the deal. Which leads to downside number
2—the fact that trailer owners at Point Dume are paying up to $2,500 “space
rent” per month to stay in their domiciles. |
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| Critics may
object that this is one of those typical Tinseltown fads and not representative
for the “real world.” Not true, as a glance to the other coast shows.
In Florida, buy-and-flip real estate investors are outbidding each other
for rickety trailers on postage stamp-sized lots, framed by chicken-wire
fences and often littered with debris from the last hurricane. |
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| Currently
sellers rake in up to $500,000, especially if the property happens
to be located in the Keys. Of course it’s not the trailers but the land
that’s so valuable to investors—in fact, as the Miami Herald reported,
the price of moving the trailers often exceeds their value by so much that
most are being demolished on-site by their proud new owners who no doubt
already envision a nice townhouse or cottage on the premises. |
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| We can
only shake our heads in wonder… and figure that, even though we have
covered the housing bubble in previous issues, the latest developments
warrant an update. In a nutshell: the news is not good. Take housing affordability,
for example. |
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| According
to the National Association of Realtors, in 2002, the median price
for an existing single-family home was $158,100. In June of this year,
that figure stood at $218,600, nearly a 40% increase. That’s pretty heady,
but it might be okay if incomes were keeping pace. They aren’t, not by
a long shot. Over the same period, median family incomes rose from $51,680
to $57,115, a gain of only 10.5%. |
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| What’s
really sobering is the fact that during that same period, the monthly
payment (P&I) required to finance a median-value home jumped from $804
to $1,016, up over 26%. And that despite the fact that average mortgage
interest rates dropped from 6.55% to 5.71%. |
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| Take the NAR’s
Housing Affordability Index, which shows the percentage of American households
that can afford a median home (based on a 25% qualifying ratio of monthly
housing expense/gross monthly income). A year ago, that index stood
at 57. Now it’s 50 and falling. |
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| This
means that only one out of two families in the country can now afford an
average dwelling. In superheated markets, the situation is far worse: a
mere 17% of California families can afford that same house. |
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| The rental
market, in contrast, has remained relatively stable. So what’s happening?
For one thing, folks are spreading themselves exceedingly thin. For another,
those buying houses are increasingly uninterested in a place to live. Soured
on the stock market, they are trying to make their fortunes by speculating
in real estate. |
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| The figures
make this abundantly clear. According to an article in the Wall Street
Journal, in the first four months of 2005 investors accounted for 9.9%
of home mortgages, a better than 60% increase since 2001. In addition,
another 7.2% of mortgages went for second homes, vs. a mere 2.2% in 2001.
(Totals for all of 2004 show 23% investors, 13% second-home buyers.) |
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| These two
groups are largely driving the red-hot market, and they are not stable
home owners. They will sell at the first hint of a price peak. No one
knows, of course, when that will happen, but it will. History teaches that
no asset class continues to appreciate indefinitely. |
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| What goes
up must come down—at some point, the supply will simply exceed buyers’
ability (or desire) to pay. With the affordability index sliding so
dramatically, we believe this tipping point cannot be far off. |
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| Our trailer
story is another indicator, since it is well known that towards the end
of a bubble activity is picking up a frantic pace. |
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| We can hardly
imagine anything more frantic or insane... million-dollar doghouse parcels,
maybe? Compounding the problem has been the ominous rise in the incidence
of non-traditional financing, which Fed Chairman Alan Greenspan commented
on in June, saying that “the apparent froth in housing markets may have
spilled over into mortgage markets.” |
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| There’s
no may have about it. What Greenspan is talking about are such high-risk
propositions as interest-only mortgages—which in their early years require
only interest payments, often leading borrowers to choose a higher-priced
house than they can actually afford; and option ARMs, which are, if possible,
even scarier. Option ARMs have teaser rates as low as 1% and give borrowers
four different choices of how much to pay every month. The minimum-payment
option is so low that it may not even cover all the interest due. Whatever
isn't paid gets added to the principal, a phenomenon called “negative
amortization.” |
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| People who
take on obligations like these are gambling with their places of residence.
When the grace period on monthly payments expires (somewhere between
2 and 10 years out), their monthly payments will jump by a lot—up to
50 percent, or even more if the index for the adjustable rate rises as
well. |
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| What they’re
betting is that housing prices will continue to rise so that, a few years
down the road, they can sell their home for a nice profit before they won’t
be able to afford the (increased) payments anymore. |
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| Even though
that’s the kind of speculation resembling Russian Roulette, buyers are
proceeding to take these big risks, in ever-increasing numbers. Nationally,
for example, a staggering 31% of mortgages were interest-only in 2004,
and in the hottest markets, the ratio was much higher. In California, for
instance, interest-only and negative amortization loans comprised 60% of
all new mortgages (vs. the 2002 figure: 2%). |
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| Taken together,
all these numbers indicate a teetering house of cards. What would cause
it to collapse? A rise in mortgage interest rates, which have not yet
tracked the Fed’s steady raising of prime, would do it. Each 1% increase
translates into an 8.5% decrease in purchasing power for the purchaser.
Thus, should rates rise by 3 points, more than a quarter of all buyers
will be priced out of a given market. Or it could simply happen because
of a supply glut. The graying of America means that the trickle of seniors
downsizing out of large family homes will soon become a flood. |
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| A collapse
means more than just people losing money on housing transactions, too.
It would have a disastrous ripple effect through the whole economy, which
has seen much of its tepid growth result from consumers freeing up capital
gains they’ve accrued on their real estate. In addition, since 2001 over
40% of all new private-sector jobs created have been in housing-related
fields such as construction, real estate, and mortgage brokering. |
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| Is a crash
inevitable? No, but a decline is, and that decline could take a different
form than an outright plunge. Prices could drop in fits and starts, with
any number of fool’s rallies punctuating the trip to the bottom. Or there
could be a long, steady fall, as has happened in Japan, which before the
present U.S. boom boasted the most overpriced market in history. Since
their peak in 1991, Japanese property prices have dropped for 14 consecutive
years, with a cumulative loss of more than 40%. As The Economist points
out, “it is surely no coincidence that Japan and Germany, the two countries
where house prices have fallen for most of the past decade, have had the
weakest growth in consumer spending of all developed economies over that
period.” |
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| Our advice
regarding how to protect yourself and your family in this climate is the
same as it’s been for quite a while now. |
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| Get the lowest
fixed-rate mortgage you can negotiate, and sit on it; avoid gimmicky interest-only
and option ARMs like the plague. Don’t speculate in real estate; you may
miss the top, but you won’t get hurt when the downturn comes. Don’t borrow
against your property’s present value. |
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| What this
all boils down to is merely adopting a more traditional mindset about your
home. It’s the place where you intend to live. |
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