Real estate

Top 898. Jan 14, 2006 6:16 PM

» Normxxx - Real Estate Bust, Recession

Real Estate Bust, Upcoming Recession

By Emanuel Balarie | 14 January 2006

Having lived and worked in San Francisco during the Tech and Dotcom bubble, I had a first hand glimpse into the bubble mentality and the irrational exuberance of your average consumer. From Dotcom companies throwing lavish parties (while reporting negative earnings) to college students investing their school money in the stock market, to the creation of "short-lived paper millionaires," I easily recognized that this move up in the stock market was not sustainable. In the midst of this bubble, many people would look at their stock options or 401k plans, classify themselves as millionaires, and spend money in the economy that further propelled the rise up in the stock market and further expanded the bubble. The end result was that most of these stock options expired worthless, investors lost millions of dollars in the stock market, and the "paper millionaires" where no longer millionaires.

Throughout history, you will find notable examples of manias, Ponzi schemes, and bubbles that have ended up in disasters with investors cutting back on their spending and scrambling to atone for their financial mistakes. This scenario did not happen after the Dotcom bubble. Instead, investors shrugged off their losses as they saw the value of their homes skyrocket. Consequently, the rise up in real estate prices allowed them to continue spending and temporarily delayed the US economy from heading into a major recession. I believe that 2006 will be the beginning of the burst of the real estate bubble, and that this burst will have immediate and severe consequences on the US economy as a whole.

Your Mortgage Broker Does Not Know Best

As real estate prices have skyrocketed in the last several years, there have been some people that have argued that the move up in real estate prices is sustainable. Mortgage Brokers, Real Estate Agents, Appraisers, and people who lack an understanding of the markets have argued that rising real estate prices are purely based on supply and demand. They point to the fact that the supply of housing is decreasing, while the demand for these homes are constantly increasing. This argument, however, is flawed. In the last several years, homebuilders have been building homes at a record pace. In fact, there are now more housing starts per person than there was 5 years ago. Although there definitely has been an increase in demand for these homes, it has mainly occurred due to the artificially low interest rates and exotic mortgages that have allowed people to purchase homes that were traditionally out of their means.

"Don't you see the bidding wars?" "If you don't by now, you will never be able to afford it!" The sad reality is that most people who have purchased homes in the last several years could not afford to buy a home via traditional means. By this, I mean, that if you took away the creative mortgage packages (zero percent down, interest only, etc.), and forced these homeowners into a fixed mortgage, they would not be able to afford their monthly payment. Incidentally, when interest rates are at record lows, you want to get a fixed rate mortgage. When interest rates are at their highs, and heading lower, adjustable rate mortgages might make more sense.

This idea that people have been purchasing homes outside of their means is validated by looking at the average median home price versus per capita income. As you can see in the chart below, the valuation of median home price to per capita income is way out of historical proportions.

<img src="http://www.321gold.com/editorials/balari...">
(Source: http://www.piggington.com)

Although, this chart specifically depicts San Diego, you can likely apply these results to your local market. Suffice to say, that the average income has not skyrocketed to the degree that we have seen the real estate market skyrocket. Again, this shows that the average person is living in a home that they can only afford because of the low interest rates and because of the type of loan that they have.

Isaac Newton Knows Best

Newton's 3rd Law of Physics states that "for every action there is an equal and opposite reaction". In a similar manner, I believe that with every bubble, there has to be an equal opposite burst. Our economy is heading towards a recession; and the burst of the real estate bubble will be what finally sends it there. Quite honestly, I did not believe that the real estate bubble would last as long as it has. Nonetheless, I know that the longer a bubble lasts, the more dramatic and severe the burst will be.

Real Estate Prices Decline in 2006

In 2006, we are already seeing signs of a slowdown in the housing market. In recent weeks, home loan applications have fallen to a 3-year low. I believe that most everyone who could take advantage of the low interest rates and exotic mortgages have already done so. The continual rise in interest rates will undoubtedly price new home buyers out of the market. Even with an interest only loan or an adjustable rate mortgage, higher interest rates will most clearly mean higher mortgage payments. Given the fact that your average American consumer has negative savings and that the average income is not rising sharply, I see a sharp decline in the demand for new home sales in 2006.

Coupled with a decline in the demand for new home sales, will be an increase of available homes on the market. This increase in supply will likely come from the following sources:

1. New Homes Still Being Built

Even in the midst of declining home loan applications, there are still new homes being built. Because of the multi year rise in real estate prices, home builders have scrambled to build homes and profit from this irrational real estate demand. As a result, there are still a number of developments in the works and new homes that will soon come on the market.

2. The Speculative Home Buyer

According to the National Associations of Realtors, 36 % of the home sales in 2004 were second home purchases. Although I haven't been able to find out the number for 2005, I can assume that the percentage is even higher. As real estate prices start declining, I believe you will see the speculative home buyers sell their houses and take profits (or cut their losses). Because most of these second home buyers view these homes as an investment, they are more quickly to act in the midst of declining real estate prices.

3. The Over-extended Buyer

As it stands, the average American has negative savings. In addition, because they have adjustable rate mortgages, they will be forced to pay more on their mortgage as interest rates continue to head higher. Most of these home buyers do not have the necessary savings income growth potential to keep up with rise of their mortgage. As a result, the likely scenario is that these homeowners will be forced to default on their mortgages and walk away from their homes.

In the midst of growing inflationary concerns, I believe that the Fed will continue to raise interest rates in 2006. The degree to which they raise interest rates will determine how fast this real estate market will begin to unravel.

The Real Estate Burst Effect on the Economy

Without question, the real estate bubble has fueled this US economy in the last several years. I am amazed at the amount of times I have heard about a friend or neighbor who decided to refinance their home, get an adjustable rate mortgage, and take cash out for some type of trivial expenditure. Why not? They would argue. I just made a 200k profit this year. This same irrational exuberance reminds me of the "paper millionaires" in the Dotcom era who pointed to their stock portfolio as a means to justify their spending. Although this spending served to fuel the economy, it also served to further fuel this bubble and send your typical consumer further and further into debt. In the future, those that can afford to pay the additional amount on their higher mortgage will have to "tighten their belt" and not spend as much money in the economy. Consequently, they will hold on to their car a couple of years longer, not frequent their local restaurant as often, and cut back on their overall spending. In turn, this will flow into the economy and we will most likely see a much needed recession as individuals refocus on savings and the re-accumulation of wealth.

The Implications of an Upcoming Recession

Generally speaking, a recession is a prolonged period of time where the economy is contracting. During a recession, you will most likely see consumers spending less money and saving more, a subsequent decline in the stock market, a rise in unemployment, and a decline in real estate prices. The idea is that the economy has to have periods of contraction after years of expansions. From 1991 to today our economy has been constantly growing. Some Economists might argue that we did go through a recession in 2001. I disagree. Although we did have some characteristics that were indicative of a recession, we also had some glaring omissions. How can we have a recession that only lasts one quarter, especially after we just came off a major stock market bubble? Why would real estate prices continue to rise in a time of less spending and more saving? In either case, the recession that is to come will be a multi year recession that will serve to slow down this economy that has been wildly expanding over the last decade and a half.

______________

The contents of this letter/report does not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of this message is not to be construed as constituting market or investment advice. It is intended for educational purposes only. Individuals should consult with their own advisors for specific investment advice.

-- posted by Normxxx

Top 899. Jan 17, 2006 1:47 PM

» Normxxx - Housing Bubble Will Bust

The Housing Bubble Will Bust

This week's letter comes to us from Dr. A. Gary Shilling, president of A. Gary Shilling & Co., Inc. Gary is a long time friend and one of my favorite economic analysts.

In Friday's Thoughts from the Frontline, I mentioned that Gary is less optimistic on the housing market than I am. Gary's January letter looks at 10 nonconsensus investment themes and he spent nearly half the letter on housing and makes a case for why the housing bubble may be headed for trouble. This is a topic that has received a lot of attention over the last couple of years and poses one of the largest threats to the US economy.

This letter may seem longer than most, but that is due to the numerous charts Gary uses to back up his argument. You will find this very interesting food for thought in this week's Outside the Box.

— John Mauldin

The Housing Bubble Will Bust

by A. Gary Shilling

Most observers look for slower but still positive growth in house prices this year. The 20% or greater fall in average median prices on a national basis we foresee is decidedly nonconsensus. And it will have substantial effects at home and abroad. Indeed, even a flattening of house prices will be meaningful. The Fed estimates that through refinancing and home equity loans, homeowners extracted $600 billion from their homes in 2004, up from $439 billion in 2003, and spent half of it on goods and services. That $300 billion accounted for 40% of GDP growth in 2004, and the zeal for home equity borrowing in 2005 (Chart 5) suggested that it was even more important to economic advance last year.

Flat house prices this year would vastly curtail this withdrawal of money to finance consumer spending. It also would make many much less willing to borrow more on credit cards and save less because their house appreciation piggy banks would no longer seem as likely to keep filling themselves. Falling house prices will magnify these effects greatly.

Furthermore, those many who recently bought second homes and homes for investment (Chart 25) will get quite nervous if house prices stop rising. They've flooded the market with rentals, depressing rents (Chart 26), so even with interest only mortgages, many have negative carrying costs with taxes, interest, maintenance and other costs exceeding rental income. Once their confidence in rapid appreciation fades, their zeal to dump their properties onto the market leaps.

The resulting jump in supply will depress prices, probably substantially because of the rapid rise in the number of houses owned by speculators in recent years (Chart 25). And note that many second home purchases are in part spurred by visions of rapid appreciation. Earlier, Alan Greenspan said that a housing bubble wasn't likely because people needed to live somewhere. Selling a house out from under one's family could strain domestic bliss. But widespread multiple homeownership eliminated that restraint, fueled the bubble, and makes a big price break more likely than a flattening of house prices.

Bust or Flat?

Sure, in the past, most housing booms did not result in busts. The FDIC studies data by metropolitan areas and defines a boom as a 30% or greater rise in inflation-adjusted prices in a three-year period, and a bust as at least a 15% decline in nominal prices over five years. From 1978 until the current bubble commenced in 2000, the FDIC identified 50 booms but only 21 busts. Housing bulls hope that, as often in the past, the current booms in many cities will be replaced by more muted appreciation or, at worst, by flatness as the rest of the economy and prices catch up.

But this time, the housing bubble is quite different than in the past, at least since the 1920s. It's national in scope, driven by three national forces. First is low mortgage rates (Chart 27). Second, loose lending practices such as interest-only and option ARMs, high loan-to-value mortgages, heavy use of home equity loans and extensive subprime loans. Note that despite jumping house prices, low end borrowers are already in trouble as shown by the leaping delinquency rates for the usually subprime FHA insured mortgages (Chart 28). Third, after the big stock bear market of 2000-2002, many investors want an alternative to equities.

A bubble driven by national forces seems more likely to break and spawn national repercussions than past regional booms that were driven by regional economic cycles. In the 1970s, oil patch real estate leaped with energy prices but then collapsed along with the price of crude in 1986. Similarly, the Cold War aerospace spending surge in the 1980s hyped southern California real estate, which then collapsed with the demise of the Soviet Union in the early 1990s. New tech ups and downs have been reflected in house prices in Silicon Valley and the Route 128 corridor in the Boston area.

Because the bubble this time is driven by national forces, it's national in scope and is found in 55 cities, more than twice the previous peak of 24 in 1988 (Chart 32). True, many of these booming metropolitan areas are on the coasts (Chart 33), but that's where the population and wealth are concentrated.

No CPI Bailout

In addition, in the 1980s when oil patch real estate fell, goods and services inflation, gauged by measure such as the CPI, was still significant. So, rises in those prices cushioned the fall in housing prices as they returned to equilibrium. Even so, median house price busts in 10 oil patch cities averaged 28% declines. Likewise, goods and services inflation in the early 1990s mitigated the house price declines in California, which still averaged 18% in the four bust cities, and in New England, where average prices fell 17% in the five cities that suffered price busts.

In contrast, there is little inflation today, especially outside volatile food and energy areas. So, the likelihood of house prices falling substantially to bring them into proper balance is much greater than earlier. It seems, then, that a 20% decline in house prices nationwide is not a wild forecast, and may be optimistic. Indeed, a 29% fall would be needed to get house prices back in line with rents and 35% to restore balance with the CPI (Chart 35). And remember that markets overshoot on the downside just as they do on the upside.

Sure, house prices may appear to simply go flat— at first— and recently, higher priced houses in tony suburbs around the country are just sitting on the market as buyers retreat to the sidelines. It takes time for house price weakness to sink in because the market prices of people's houses are not available daily. Everyone believes that his house is unique, and there is no price quote flashing by on the TV screen or in the newspaper to force homeowners to realize that their homes have declined in value.

So, they can put their heads in the sand, arguing that any price weakness, even if they are trying to sell their houses quickly, is short-lived. The neighborhood is temporarily out of favor, one will argue, even though the family next door just sold at a big discount. Or, I have a lousy real estate broker but I'll get a good one. Or, it's the wrong season of the year, but spring and stronger prices are coming. Still, the housing bubble appears big enough and the speculative overhand so large that sellers won't be able to wait out the weakness, and a major price drop is likely.

Low Affordability

Price leaps have pushed affordability to the lowest levels since 1991 (Chart 36) despite low mortgage costs. In the third quarter, median house prices rose 12% from a year earlier after a 14% leap in the second quarter. So, many first-time home buyers are frozen out and can't buy the houses of those who want to move up the ladder, ultimately restraining sales all the way to the top McMansions of Reginald van Gleason III.

Mortgage applications recently fell to an 11-week low, with both those for purchases and especially those for refinancings plunging (Chart 37). In 57 of 379 metropolitan areas, houses in the third quarter were so expensive that the family with median income couldn't afford a median priced house with a conventional mortgage. Many have responded, of course, by increasing their financial leverage by 100% financing and interest-only mortgages, which friendly lenders are only too happy to provide.

Some optimists believe that because these financing terms are available, houses are still affordable. Obviously, they aren't concerned with the increased risks and leverage they involve. This is like saying that I have an appointment in a nearby city in one hour and it takes two hours to drive there at a normal average 60 miles per hour. But if I drive at 120, I'll make it on time.

The housing boom is also straining building material suppliers, with resulting price increases that make houses even less affordable. Brass, asphalt, gypsum products, plastic constriction products and concrete have all seen double-digit price rises in the past year, with only lumber and plywood notably lower.

Mounting Evidence

Nevertheless, evidence of the housing bubble's demise is mounting. A recent survey found that 58% of responding real estate agents say inventories of unsold houses are up and 80% believe it takes longer to sell houses. Traffic is down in new home developments, and price cuts and incentives like free carpets and offers to cover closing costs are proliferating.

Due to pressure from regulators, mortgage lenders have slashed option ARMs by 25%, important since they recently accounted for over 30% of jumbo mortgages. These mortgages allow borrowers to make monthly payments that don't even cover interest and, therefore, increase the principal— "negative amortization," as it's called. About 70% of borrowers with option ARMs are making those minimum payments as they strain to own the biggest houses they can manage financially.

The subprime mortgage market, into which many lenders have rushed as they strain for yields, is also showing strains. The rise in delinquencies is actually worse than it appears. Delinquencies for new subprime ARMs in the first nine months of 2005 were 6.2% compared with 3.7% for the same period in 2004. The more recent borrowers have proved to be the worst re-payers. And since many of these ARMs will adjust up in several years, even a flat house price pattern will spike delinquencies since refinancings won't work without price appreciation for many. Note that among 2003 subprime mortgages with ARMs that reset up after two years, delinquencies leaped from 10.2% right before resets to 16.6% six months later. Note also that there were about $220 billion in two-year ARMS in 2003 but $440 billion in 2005.

Investors are not amused. Credit default swaps on subprime ARM pools, in effect insurance policies against defaults, have almost doubled in price from mid-September to December of 2005. Buyers of these derivatives obviously anticipate more trouble. As delinquencies and defaults mount, mortgage lenders will withdraw, much as they abandoned manufactured home lending when that market collapsed in the late 1990s. Lender exits will only add to the plight of desperate, overleveraged homeowners.

Inventories Are Key

As in many markets, the key place to watch for problems in housing is inventories. Suppliers seldom realize they're producing too much until inventories leap as a result of unexpected demand weakness. Furthermore, inventory-sales ratios, a key indicator in most goods-producing businesses, leap as the numerator— inventories— rises while the denominator— sales— falls.

The housing industry calculates inventory-sales ratios as the months' supply for sale, or inventories divided by monthly sales. For new homes, that ratio has been rising for about two years (Chart 38) because rising inventories outran sales increases. It jumped in November as sales fell by 11% from October while inventories rose 3% (Chart 39). Since sales are volatile, it's too early to know whether the sales drop will persist, but if it does and new home builders keep cranking them out, the months' supply will skyrocket until builders slash output. Existing home sales and inventories are showing similar patterns (Charts 40 and 41), with the months' supply climbing to 5.0 in November for single-family homes, and leaping from 5.4 months in October to 5.9 in November for condos.

Publicly-held house builders, of course, assure their stockholders that inventory problems are ancient history, never to be repeated. Many say they build only to firm orders, while others declare they have small and declining numbers of spec houses in their inventories. Public builders also say that shortages of land on the coasts as well as population growth from immigrants and the children of the postwar babies will keep demand and house prices rising rapidly for decades.

Well, our statistical analysis finds no correlation between housing starts and the change in population in their 20s, 30s or 40s, the prime house-buying ages. Also, the percentage of new buyers who walk away before the houses close is rising. And despite public house builders' rosy forecasts, senior managements in those companies have been selling their own shares with gay abandon in the past year.

Fragmented Industry

Furthermore, homebuilding is a fragmented industry. Sure, the top 10 account for 25% of output, up from 10% five years ago. And maybe they do in fact control their inventories tightly. But many of the rest of the 80,000 homebuilders are small operators. Has human nature changed so much that those guys, whose assets consist of a few pick-ups and lists of subcontractors and lenders, aren't building extra spec houses to take advantage of recent leaps in prices?

A substantial fall in house prices will, of course, wipe out many highly leveraged speculators. They are already on the run in some exuberant markets, and their selling is depressing prices. Even where prices are still rising, the gains aren't fast enough to allow speculators to flip properties quickly and still cover brokerage, closing and other costs. The number of investors buying properties in San Diego has been cut in half, by some estimates. In Phoenix, 30% of the properties for sale are investor-owned, so inventories of houses for sale rose from 8,600 in April to 22,340 in October of 2005.

Speculators are only a small part of homeowners, but given their lack of staying power, their dumping will rule the decline in prices. Prices of houses, like most things, are set on the margin by the most zealous sellers and buyers.

Those lower prices in turn will depress the sentiment and spending of many of the 69% of American households that own their abodes (Chart 42). Note that many of the 31% that don't are already strained. They are low-income folks with little income cushion to cover increased energy costs. The weak sales of low-end retailers like Wal-Mart and Family Dollar Stores reveal their plight. Sure, the 61% of homeowners with mortgages won't be forced to sell as long as they have jobs and can meet their monthly mortgage payments. But their convictions that their houses are automatically filling savings accounts will be shattered and their zeal for spending in general will plummet.

The overall effect should be much greater than was caused by the 2000-2002 stock bear market. While 69% of households own their homes, about 50% own stocks or mutual funds. More important, the stock ownership is much more skewed toward higher income people, so the average American is decidedly more influenced by housing than stock market prices.

[Normxxx Here: On the other hand, house prices will fall far more slowly than stock prices, and homeowners will hold onto their homes (as opposed to speculative house purchases) far longer. But it also will be very much more drawn out— figure 5 - 10 years for the bust cycle. ]

Skewed Ownership

Notice (Chart 43) that in 2001, the latest data, the stock holdings of those in the top 10% income bracket were 36 times the $6,800 owned by the lowest 20%. But in ownership of primary residences (Chart 44), the top 10% on average had houses worth only 4.6 times those in the lowest 20% by income.

Because of these different distributions for equities and homes, most American homeowners have made more money in the recent housing boom than they lost in the earlier stock collapse. They are better off even though total individual net worth in relation to disposable personal (after-tax) income remains well below its 2000 peak (Chart 45).

Not surprisingly, research shows that a 10% rise in house prices leads to a 0.62% increase in consumer spending, about twice the rise from a 10% jump in stock prices. So, the $2 trillion rise in house values in the last several years just about offset, in terms of consumer spending effects, the earlier $4 trillion drop in equities. Obviously, this effect will work in reverse as house prices fall.

Beyond the depressing effects of lower house prices on consumer sentiment and spending, the related drying up of housing activity will cause sizable layoffs and income loss. Moody's estimates that 1.1 million of the 2 million net jobs created in the five years ending last October were real estate-sired, including real estate brokers, mortgage bankers and lenders, builders and building material producers. UCLA's Anderson Forecast sees most of those gains disappearing over the next several years with a housing bust— 500,000 jobs lost in construction and 300,000 in financial services.

Investment Opportunities.

A severe housing bust will be detrimental to the earnings and, no doubt, stock prices of homebuilders, building materials producers, mortgage and subprime lenders and related entities like Fannie Mae and Freddie Mac. On the other side, real estate weakness severe enough to convince many that an abode and a great investment are no longer tied up in the same package— a house— will benefit cost-effective housing.

Rental apartments are an interesting example of this as younger families no longer see any advantage in jumping into single-family homeownership early on, and instead stay in rentals until their kids are big enough to necessitate separate houses. At a later stage, empty-nesters who hate home maintenance may sell their houses a few years earlier than now and move into rental apartments, not condos. Rental apartments, many owned by REITs, have been recovering in the last 18 months as vacancies have fallen and rents have started to rise, in part due to conversions to condos that reduce supply.

Still, condo speculators, many of whom bought them even before the buildings were started, will probably rent them as condo prices plummet and the resale market dries up. That, as well as the overbuilding of condos, may depress rental rates in future years. Since 2002, the number of existing condos and co-ops has risen 37% and median prices were up 15% in October 2005 from a year earlier. Note that oversupply fears are now inducing lenders to require developers to put more of their own money into condo projects and have cut lending in exuberant markets.

Manufactured and modular homes, which often are much cheaper than site-built housing, should also benefit when houses are no longer seen as great investments. In addition, they will appeal to postwar babies for vacation and retirement homes and are clearly benefiting from hurricane related rebuilding on the Gulf Coast and in Florida. (Note: Dr. Shilling is a Director of Palm Harbor Homes, a publicly-traded factory-built housing company.)

Conclusion

I hope you enjoyed the insights of A. Gary Shilling. You can find out more about his company at http://www.agaryshilling.com.

______________

The contents of this letter/report does not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

-- posted by Normxxx

Top 900. Jan 17, 2006 4:48 PM

» Jas_Jain - FWC: Merrill Lynch Research: “Housing boom is over…”

January 17, 2006

FWC: Merrill Lynch Research: “Housing boom is over…”

ML Research; 01/17/06: “Housing boom is over: more on this in yesterday’s WSJ (page A2 – “Home Builders Brace For a ‘Simmering Down’ of Sales as Few Fear a Serious Decline”)and on the same page we have “Home-Remodeling Boom Cools As Higher Loan Rates Begin to Bite”). This article found that spending on remodeling/renovation slipped 5.6% y/y in November, and this was a message that came across loud and clear in Friday’s retail sales report, with furniture down 0.1% in December and building materials sagging 0.6% m/m. The housing turndown, by the way, is going global: see “Eurozone Sees House Price Rises Slowing” in Monday’s FT (page 2).”
The US Housing Boom has been the biggest source of liquidity, or “money,” for the global economy for the past three years. When this Boom goes to Bust, and the process has already begun, the global recession wouldn’t be far behind.

Jas
-x-x-x-x-x-x-x-x-x-x-x-x-x-x-x-x-

Home Builders Brace For a 'Simmering Down' of Sales As Few Fear a Serious Decline

By JIM CARLTON
Staff Reporter of THE WALL STREET JOURNAL
January 16, 2006; Page A2

ORLANDO, Fla. -- On the surface, business appeared to be better than ever at last week's annual International Builders Show. A record 1,600 exhibitors touted everything from Mr. Steam towel warmers to Synlawn synthetic grass to 10-foot-high Marvin double-hung windows. Attendance also was a record. Just over 105,000 people crowded into this city's Orange County Convention Center. That was up sharply from the 66,000 who attended the show 10 years ago.

But below the surface, there was an air of caution, which stemmed from an industry slowdown that began in the fourth quarter and uncertainty over what it will mean for home construction, as well as the overall economy. Hundreds of builders packed into an auditorium to hear three industry economists predict the first downturn in U.S. housing starts in five years.

David Seiders of the National Association of Home Builders predicted housing starts would fall by between 6% and 7% from last year's torrid pace of about 2.1 million units -- amid high home prices and rising mortgage rates. Although Mr. Seiders, the association's chief economist, characterized the projected drop as only a "simmering down" of the white-hot housing market, his forecast included what he called the remote possibility of "sizable house-price declines" if the investors and short-term-interest borrowers who have helped fuel the boom start rushing for the exits. "The real question," he told the audience, "is where do we go from here."

One pessimist, Ed Sullivan, chief economist of the Portland Cement Association, suggested a recession-like housing spiral isn't so far-fetched. He pointed out that the disparity between incomes and home prices is at its greatest level in at least a quarter century, and that the upward trend in rates could make it harder for adjustable-rate borrowers to keep up on their payments.

But few others in the industry look for a serious decline in housing activity anytime soon, given that mortgage rates remain low by historical standards and demographic trends are still favorable. Rather, the prevailing feeling in Orlando was that 2006 will remain healthy for housing, but that builders and suppliers will have to tighten their belts a notch or two.

The reason: as home sales downshift, builders will find it difficult to raise prices, even though their own costs will continue to grow. Officials of Hovnanian Enterprises Inc. said they expect gross profit margins to decline some in the current fiscal year from 26.4% in the year ended in October. That is chiefly because the Red Bank, N.J., builder won't be able to continue passing along high land-buying costs to buyers, said Larry Sorsby, executive vice president and chief financial officer. Mr. Sorsby added Hovnanian still expects revenue to increase in the low 20% range this year from $5.35 billion in fiscal 2005, which was up 29% from 2004.

Another big builder, WCI Communities Inc., said it has seen price increases erode at its properties in Virginia and Maryland. After raising new-home prices there 15% to 20% in the first half of 2005, WCI officials say they haven't been able to put through much more of an increase since, and that they expect no more than 5% appreciation there this year. However, WCI, based in Bonita Springs, Fla., says it doesn't expect margins to narrow this year, in part because of back orders in its main Florida markets. The question is, what happens in 2007?

It is a different story on the cost side. Labor costs are rising amid falling unemployment. Labor, along with land acquisition, accounts for the biggest cost of building a home. Amid a scarcity of labor in some fast-growing markets like Florida, construction workers' pay and benefits in September were up 3.5% from a year earlier, compared with an average of 3.1% for all workers, according to the Bureau of Labor Statistics. Construction workers are likely to remain in heavy demand this year, with many dividing their energy between building subdivisions and helping to clear rubble in the Hurricane Katrina zone. "The labor shortages are serious, but they are less serious for the big builders," says Jerry Starkey, president and chief executive of WCI.

Meanwhile, external factors could drive further price increases in building materials like gypsum and cement. Those materials are in strong demand by builders in both the commercial and government sector, which has started coming on strong the past year after a malaise that began in 2001. Officials of Georgia-Pacific, a unit of Koch Industries Inc., said there is no let-up in demand for their gypsum products, even after they imposed four price increases last year totaling about 50%.

Insulation makers like Johns Manville, a Berkshire Hathaway Inc. company, and Owens Corning say they are seeing more demand from people retrofitting their homes to help reduce high energy costs, and thus don't expect any drop-off in sales. National Association of Home Builders economists predict overall building materials and components prices will increase 5% to 6% this year, down slightly from last year's 6.1% rise.

Other suppliers don't have any cushion. Timber giant Weyerhaeuser Co., for instance, sells its building products mainly into the housing market, and officials there say builders may lean on them for price breaks. Still, Weyerhaeuser officials said an industry slowdown wouldn't be all bad. Last year, they said, the Federal Way, Wash., company had to turn away business, and sometimes couldn't meet delivery schedules.

Despite the challenges, most builders remain upbeat. "The mood is generally optimistic," says Samuel Cypert, executive director of the Public Home Builders Council of America. "But they tend to be optimistic anyway."

-x-x-x-x-x-x-x-x-x-x-x-x-
Home-Remodeling Boom Cools As Higher Loan Rates Begin to Bite

By JOI PRECIPHS
Staff Reporter of THE WALL STREET JOURNAL
January 16, 2006; Page A2

The home-renovation boom, spurred by low mortgage rates that made home-equity loans popular and cheap, appears to be cooling off.

The latest government construction-spending data -- for November -- shows spending on home renovations was down 4.1% from the month before, and down 5.6% from November 2004.

And the latest quarterly Remodeling Activity Indicator, a measure crafted by Harvard University's Joint Center for Housing Studies to predict trends before the government releases hard numbers, suggests the pace of home-improvement spending continues to slow. "We are starting to see signs of softening in the remodeling market," said Nicolas P. Retsinas, the center's director. "Rising short-term interest rates and slowing home-price appreciation have tempered homeowner spending on home improvements."

The center's quarterly Remodeling Activity Indicator suggests spending on remodeling rose 4.3% in 2005 after a 20% spurt in 2004. Americans spent nearly $150 billion renovating their homes last year, the center estimates. The Harvard index is based on several factors -- sales by building-supply retailers; average weekly hours worked by residential remodeling firms; sales of existing homes; shipments of electrical appliances and wood products plus construction-service-firm revenues; and a measure of overall residential construction spending.

And the government said Friday that sales at building-materials and garden-supply retailers, which have been growing faster than overall retail sales, slipped by 0.6% in December while overall retail sales rose 0.7%, after adjusting for normal seasonal fluctuations. In all, building-material and garden-supply retail sales in 2005 were $332.6 billion, up 9.7% from 2004, the Commerce Department said.

"I think with the concerns people have in the long term about the economy, they are perhaps becoming a bit smarter with their money," says Josh Baker, owner of Bowa Builders, a construction company in McLean, Va., with about 80 employees. Homeowners, he says, are becoming more "pragmatic" in their remodeling decisions. The shift, he says, leans in favor of targeted investments that allow homeowners to get the most out of their properties with the expectation that they will live there for an extended period.

Although Mr. Baker says his backlog of projects continues to grow in northern Virginia, he is unsure that will continue in the greater Washington area. "I think the backlogs in general for contractors are slowing down," he says.

Housing-industry analysts say that one major generator of renovation spending has been low mortgage rates, which have prompted many homeowners to refinance their mortgages and take out cash for renovations and other spending, as well as aggressive marketing of home-equity lines. But mortgages rates are now rising. Mortgage giant Freddie Mac said last week that rates on 30-year fixed-rate mortgages are averaging 6.15%, up from 5.74% a year ago. Freddie Mac predicts they will hit 6.5% by year-end 2006. And home-equity credit lines are tied to the prime interest rate, which is now 7.25%, up from 5.25% a year ago and 4% in January 2004.

The "refinance boom is over," Frank Nothaft, chief economist at Freddie Mac, said at the National Association of Home Builders' International Builders' Show in Orlando, Fla., last week. Most of the homeowners still refinancing, he said, are those trading adjustable-rate for fixed-rate loans. A slowdown in home-price appreciation may also restrain home renovations, economists say. "You don't invest in things that aren't going to have a high return," said Lehman Brothers economist Drew Matus.

Fewer people are buying houses to renovate and profit from a quick resale, contractors say. The business instead is more concentrated among homeowners looking to "facelift" their properties, says Scott Balentine, an Overland Park, Kan., contractor, especially kitchens and bathrooms. "They want to freshen up the look of the house," says Mr. Balentine, owner of Lifestyles Custom Homes & Remodeling. Such projects generally cost between $10,000 to $40,000, he says.

Some housing analysts foresee continued strength in home-improvement spending. At the International Builders' Show, NAHB economist David Seiders said he expects "real growth in remodeling activity...because people have amassed a tremendous amount of housing equity."

Indeed, in Milwaukee, contractor Mark Brick remains ebullient. "You're seeing existing homes that are being totally renovated from top to bottom -- and they're adding on rooms on to that." says Mr. Brick, owner of B&E General Contractors Inc.

-- posted by Jas_Jain

Top 901. Jan 18, 2006 3:43 PM

» Jas_Jain - Hidden Collapse Of the Californica Housing Market

January 18, 2006

Hidden Collapse Of the Californica Housing Market

Note: Data for Santa Clara County and Morgan Hill Are from www.mlslistings.com and for our little town from my realtor.

As of 30 minutes ago the ratio of Active Listings to Sales Pending in Santa Clara County, home to Silly.con Valley, was 5.3 and for Morgan Hill (a former rural community not far from Silly.con Valley) it is 11.3. On average, the Sales Pending represent sales over the past 9-10 weeks. This means that SCC has a supply of 11 months and Morgan Hill has a supply of 2 years at the recent rates of Listings and Sales! In our little town, the ratio has gone from 1.1 in the spring of 2005 to 3.6 presently, representing 8 months of supply.

These, folks, are early signs of a dead market. Let me explain what I mean by Hidden Collapse using Morgan Hill as an example. There are sum total of two homes Pending Sale that are were listed below $800K, a price below which there probably is some demand (it is likely that the owners accepted offers well below the listing price). But the homes that would sale at $800K are currently priced close to $1M. If the homes that have been on the market during any time in the past six months and that were not sold were priced to sell within 3 months the prices of homes sold would be 15-20% below the prices of homes that closed escrow in August 2005. There has been a massive expiration of listings and withdrawals as best as I can judge from the data.

Jas

-- posted by Jas_Jain

Top 902. Jan 18, 2006 7:47 PM

» Jas_Jain - “The US Housing Market Only Needs to Flatten…”

January 18, 2006

“The US Housing Market Only Needs to Flatten…”

To harm the US economy. And it is “singularly the largest risk to the Goldilocks scenario.” These were some the comments by Ray Attrill, Global Head of Research at Forecast Australia. He emphasized that “the housing market does not need to collapse for consumers to tighten their belts, it only has to stop going up.”

My friend and fellow deflationist Rick Ackerman thinks that a 3-4% decline in the housing prices will do the job (as in a nosebleed job). I have thought that to be the case, but I have a hard time assuming that in the bubble areas the prices wouldn’t decline more than 10%, YoY, once the decline begins.

At some point the decline will be well in excess of 50% in the coastal bubble areas like California. I am hoping to buy a median-priced home in San Diego for less than $100K, or a fancy home for under $200K, within this decade. People are so ignorant of history that they can’t imagine what has happened several times before.

Soft-landing for the US economy, or the US housing market, is aerodynamically impossible! A pilot is far better trained than a Fed Chairman when it comes to landing!! Modern-day Fed Chairmen are like al Qaeda terrorists who only learned how to take off!!!

Jas

-- posted by Jas_Jain

Top 903. Jan 19, 2006 9:46 AM

» nummnutts - Re: “The US Housing Market Only Needs to Flatten…”

In response to “The US Housing Market Only Needs to Flatten…” posted by Jas_Jain:

Jas,
You sound so exited by the prospect of a collapse in the housing market. Do you cheer car accidents too? By the way, the LA housing market has already declined 10% and I haven't seen panic in the streets. You and Normxxx need to calm down. After all, both of you have been saying the American economy will collapse for years now. Change your id to broken clock.
Phil

-- posted by nummnutts

Top 904. Jan 19, 2006 10:32 AM

» permabear - Re: Re: “The US Housing Market Only Needs to Flatten…”

In response to Re: “The US Housing Market Only Needs to Flatten…” posted by nummnutts:

As is self evident, I am one of those eternal pessimists. It's not a matter of being excited by the prospects of things falling apart, it is the feeling of being the boy who cried wolf and nothing bad happens. After a while no one takes the warnings seriously. I think that's what we are seeing today. While the housing bubble has become a popular mantra in the media these days, no one is really taking the concerns seriously. We still live in the "Goldilocks economy", where all the surface indicators indicate everything is fine, but underneath the surface there are serious problems that the mainstream media, mainstream politicians, and the mainstream public don't take seriously.

I mean how long can the U.S. keep running these massive budget and trade deficits, relying on China to keep purchasing our bonds, before something bad happens? How deep in debt can Americans go as the baby boom generation ages before something bad happens? How long can Americans keep running up their credit cards and home mortgages and equity lines of credit, while saving so little for their retirements before something bad happens?

I don't necessarily share Jas-Jain's faith in the accuracy of long-term cycles, but I do share a belief that history does repeat itself in certain ways. What the United States is now doing is repeating many of the same mistakes we made in the 1920s. We've got an increasing reliance on debt. We have increasing irresponsible fiscal policies. We have increasing disparity in wealth between the rich and everyone else. The policies for Ronald Reagan and George W. Bush in many ways reflect similar approaches and policies to those of Calvin Coolidge and Herbert Hoover. To those of us who are concerned about the foolishness we see around us, of course we are going to point it out, yell it out. But thus far no one is listening. People keep on buying their houses with interest-only loans just as they did in the 1920s.

-- posted by permabear

http://www.bankrate.com/brm/news/mortgag...

Top 905. Jan 19, 2006 10:51 AM

» permabear - Interest-only mortgage deja vu

Interest-only mortgage deja vu

Commentary by Jack Guttentag • Bankrate.com

When my mailbox first started to fill with questions about interest-only mortgages a few years ago, I smiled; I knew a flash in the pan when I saw one. Interest-only mortgages were the standard mortgage in the 1920s, but they disappeared during the Great Depression, and for good reason. This sudden renewal of interest would not last -- or so I thought.

An interest-only mortgage is one that allows borrowers to pay only the interest for some specified period. The required monthly mortgage payment includes no repayment of principal, though borrowers can make such payments if they like.

For example, if a 30-year fixed-rate loan of $100,000 has an interest rate of 6 percent, the standard "fully amortizing" monthly payment is $599.56. This payment, if continued with the same interest rate, will pay off the loan at maturity. The interest-only payment, however, is only $500. The interest-only borrower saves $99.56; the borrower with the amortized loan puts that same amount toward repaying principal.

The IOs of the '20s were interest-only for their entire life, usually five to 10 years. This meant that the loan balance was the same at maturity as at the outset. Borrowers who were still in their houses would then refinance.

Foreclosures galore
This worked fine so long as the houses didn't lose value. However, the drop in real estate values during the Depression pushed a large proportion of interest-only loans into foreclosure. Lenders switched entirely to fully amortizing loans, and that has been the standard mortgage loan since.

The new breed of IOs differs from those of the '20s in two ways. First, they are not interest-only for their entire life, only for the first five or (more often) 10 years. At the end of that period, the payment is raised to the fully amortizing level. This appears to make them less risky than the IOs of the '20s, but not so. They are more risky.

Limiting the interest-only period to 10 years means little because few borrowers these days have their mortgages for 10 years. Most will refinance or sell their homes while they are still in the interest-only period.

[Selling quickly for capital gain, and refinancing to "put equity to work," reflects a new mantra: You grow equity through property appreciation, not by paying down your loan balance. The mantra ignores the fact that mortgage amortization is in the homeowner's control while appreciation is not.]

Risky change: now they're adjustable, too
But the big change in the risk of IOs, relative to the '20s version, is their attachment to adjustable-rate mortgages, or ARMs. ARMs are risky in themselves because borrowers are exposed to rising mortgage rates when market rates increase. Adding an interest-only feature heightens the risk. When the ARM rate is adjusted sometime in the future, the new payment is calculated using the original loan amount, as opposed to the smaller balance on a fully amortizing ARM.

Consider, for example, an ARM with an interest-only payment option for 10 years and an initial rate of 4 percent, which resets every six months. In a worst case scenario, the rate would ratchet up by 2 percent every six months and reach a maximum of 10 percent in month 19. The interest-only payment in that month would be 150 percent higher than the initial payment. The fully amortizing payment, in contrast, would be only 82 percent higher.

Gimmickry, misdirection, misperception
The attachment of the interest-only to adjustable-rate mortgages also explains the rapid growth in interest-only popularity. Adding an interest-only period to ARMs opened the door to a variety of merchandising gimmicks based on an ingenious piece of misdirection: IOs are presented as a new type of mortgage, with lower rates than standard fixed-rate mortgages.

Of course, rates on IOs are lower because the IOs being touted are ARMs, not because of the interest-only option. Indeed, because the interest-only option increases default risk, the option added to any given type of mortgage increases its price. Bankrate's surveys, for example, find that the average rate for a 5/1 interest-only ARM is consistently higher than a regular, fully amortizing 5/1 ARM. But most borrowers don't understand this because they don't understand ARMs, so for the most part the misdirection is marvelously effective. I didn't anticipate this, which is why my initial judgment, that IO was a flash in the pan, was so far off the mark. Some large lenders report that IOs account for 40 percent or more of their production.

-- posted by permabear

Top 906. Jan 19, 2006 12:45 PM

» Jas_Jain - Re: Re: “The US Housing Market Only Needs to Flatten…”

In response to Re: “The US Housing Market Only Needs to Flatten…” posted by nummnutts:

--

Phil: "Jas, You sound so exited by the prospect of a collapse in the housing market."

You bet, Phil. I firmly believe in sinners having to pay for their sins, don't you? I know a group of guys who work in the entertainment industry (they are friends of a friend of mine, because he worked with them in the past) who have been using their home equity to take trips to Costa Rica and Cuba for the sole purpose of prostitution with very young gals. I will be very happy to see that come to an end, wouldn't you?

Anyway, people who bought homes in the past two years and those who borrowed money on their homes to spend on frivolous things deserve to get punished when their home values come back to normal levels based on people's incomes.

"Do you cheer car accidents too?"

No, because at least one innocent party is hurt.

"By the way, the LA housing market has already declined 10% and I haven't seen panic in the streets."

You will have to wait for that because that will happen when the decline approaches 50-80% from the peak. But, I already know of few sad cases.

"...you have been saying the American economy will collapse for years now."

It is a good quality to see trouble way ahead of time so that people can prepare for it without rush. It takes people 2-3 years to organize their affairs.

"Change your id to broken clock."

Gladly! That is a complement for a long-term forecaster like myself. My forecast, always early, is good for many many years.

Best of luck to you, Phil.

Jas

-- posted by Jas_Jain