How We Got To This Point in the Housing Market
"Every time we've gone into a downturn in the home-building industry, they've always been longer and deeper than we've all imagined. So we're preparing for the worst, and we think this one will be longer and deeper than just the last six months." -Donald Tomnitz, chief executive, D.R. Horton, the nation's largest home builder
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As we wait for Existing Homes Sales data today, and New Home Sales tomorrow, we thought it was an opportune time to review how we got to where we are in the housing market.
Its been exactly one year since we announced in this space that "Real Estate Begins to Cool."
To review what we said last August 2005: Two major themes we have been discussing for quite some time appear to be coming together:
A) Real Estate, though not a bubble, is an extended asset class overdue to retrace;
B) RE has been the dominant sector in the US economy since the recession ended.
It turns out that call was correct; Real Estate has slowly faded, as the rates rose, the Home Affordability Index hit 15 year lows, and a measure of Builder's Sentiment dropped to levels not seen in decades. Indeed, we can even mark the peak in the Housing boom around that same time.
What has been so astonishing about the housing boom is how totally misunderstood its been by people who should have known better, real estate agents, mortgage brokers, developers, and economists. To reiterate our views, half century low interest rates, combined with an investor class burned by the stock market crash, Wall Street scandals and corporate malfeasance on a grand scale saw Housing as a better place to park their dollars.
Mean reversion apparently is not understood by many real-estate professionals. From brokers to lenders to developers and home builders, there was a irrational expectation that the "soaring
property market eventually would glide to a soft landing." It makes little sense to assume that after home prices more than doubled between 2000 and 2005, they would then mean nicely revert to a normalized gain 5%
or 6% a year.
That's the equivalent of stocks reverting to a 10% annual gains after the 1995-2000 run up. In case you forgot, lots of cheerleaders predicted that would happen. Remember, it was a new paradigm, and eyeballs and sticky pages counted much more than revenues and profits.
Of course, the market crashed in 2000, with the Nasdaq -- home to the hottest market sectors of tech, telecom and internet -- getting hit the most. It dropped 78%.
So too, will the hottest sectors of Real Estate get hit the hardest in the slowdown. That means the Coastal Northeast, (NY, Boston). California, South Florida and Las Vegas along with a few other hot areas will feel the burn more than the sleepy parts of the country where home prices ares till relatively reasonable. I don't expect real estate prices to crash 78% in these markets, but a healthy retracement of recent gains is very likely in the cards.
I expect to see a reverse of what occured when rates were slashed. As more and more potential buyers are priced out of the market, many homes will sit for sale longer, and some will have to be discounted aggressively to sell.
Bad news for Housing is good news is for apartment building owners: Marginalized buyers will be come renters. This is a large part of the reason we have seen rents rise lately. The New York Times reports that "in the metropolitan area covering New York, Long Island and Northern New Jersey, annual increases in rent surpassed 5 percent in the second half of last year for the first time since 1990, according to government statistics. And brokers and landlords in the city speak of even sharper rises lately."
They write:
In the early years of this decade, low interest rates and rising home prices prompted more Americans to buy, both because of the lure of a healthy profit and the fear of being left out of the game. As a consequence, demand for rental properties shrank — pushing up vacancy rates and pulling down rents.
By the fourth quarter of 2004, rental vacancy rates had risen to 10.4 percent, the highest level since the government started tracking them in 1960. Overall rent gains slowed to a modest 2.5 percent through early 2004, their slowest since the mid- 1990’s. And in the bigger rental complexes, according to the National Association of Realtors, rents fell nationally in 2002 and 2003 and inched up only marginally in 2004.
We have a combination of falling sales and rising rentals. And sales may be falling even faster than has been recently reported. Today's WSJ observes:
"Nationwide, the median sale price of previously occupied homes in June was 0.9% higher than it was a year earlier, the smallest year-to-year increase since May 1995, according to the National Association of Realtors. Over the next few months, the median price may decline from year-earlier periods, a spokesman for the association says, something that hasn't happened since February 1993.
The market may be weaker than the Realtors' widely followed monthly reports suggest. The group's data don't reflect the latest transactions. Its report on July home sales, for instance, due today, will mainly reflect sales that were agreed upon in May or June and closed in July. Moreover, when the market turns down, many home sellers initially let their homes sit instead of cutting prices enough to entice buyers.
The bottom line remains that real estate will no longer drive the economy the way it has over the past 5 years. And nothing else has risen to take its place as a key driver of consumer spending, or creator of jobs.
If that remains the case, its hard to see how a dramatic economic slowdown -- or even a recession -- can be avoided . . .
Source:
Housing Slump Proves Painful For Some Owners and Builders
'Hard Landing' on the Coasts Jolts Those Who Must Sell;
JAMES R. HAGERTY and MICHAEL CORKERY
August 23, 2006; Page A1
http://online.wsj.com/article/SB115630090176442994.html
Rents Are Rising Rapidly After Long Lull
EDUARDO PORTER
NYTimes, August 19, 2006
http://www.nytimes.com/2006/08/19/business/19rents.html
Builders sour on condos, love apartments
Affordablity falls to record low in second quarter
REX NUTTING
MarketWatch, August 22, 2006 3:14 p.m.
http://tinyurl.com/kb9ml
Wednesday, August 23, 2006 | 08:48 AM | Permalink
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Comments
Soft landings are for dimwits and nimrods. The perma bears finally have their day. It's the single one item which has changed my opinion to expect more than a midcycle correction. Consumer credit, mortgage debt, savings rates, blah, blah, blah. It's all about housing.
Posted by: BDG123 | Aug 23, 2006 9:02:48 AM
"The bottom line remains that real estate will no longer drive the economy the way it has over the past 5 years."
I'll beg to differ on that one point, if ever so slightly. Real Estate will drive the economy alright, but instead of up the road will be down.
Posted by: Uncle Jack | Aug 23, 2006 9:05:15 AM
Clearly, low-profile/stodgy areas such as my locale, St. Louis, will experience a lesser pullback/slowdown. However, there has been a clear and steady increase in homes for sale over the last 6 months.
One development on a golf course that I like to play every 2 weeks or so reflect what happens "when worlds collide." The development is 4-5 years old and what I'm seeing is newly finished homes sitting on the market and existing homes for sale (the number of which has tripled in the last 4 months) competing with them.
Lots of rumors about troubles with local builders as well. The 'worst of breed' larger-size builder has also gone belly up during 2006.
If it's this soft in a "zero-growth" metro area like St. Louis, I know it's rough most everywhere else.
Posted by: CDizzle | Aug 23, 2006 9:08:41 AM
"If that remains the case, its hard to see how a dramatic economic slowdown -- or even a recession -- can be avoided . . . "
Wouldn't this also explain the rally in bonds as the ghouls see the same thing coming as you do Barry?
Posted by: doh! | Aug 23, 2006 9:13:52 AM
When it rains it pours. See the KBH news on possible options shenanigans. Would anyone be surprised that there were executive excesses during the heady days of the housing run-up?
Posted by: Craig H | Aug 23, 2006 9:19:53 AM
<>
Real Estate not a bubble?
The "extended overdue asset class" (aka bubble) has been noted frequently since 2003: just not by the major media.
A minor problem will come from layoffs in construction.
The major problem will be going into a downturn with piggy banks (homes) declining in value, financed with mortgage products created to boost the immediate quarterly profits of the mortgage lenders regardless of future problems.
Of course the banks have securitized many of these loans, but when the foreclosures start making the buy backs expensive (or their credit risk too high) liquidity is going to dry up like a grape in the sun.
And that is when realestate and the economy will get ugly.
Posted by: Russell | Aug 23, 2006 9:25:04 AM
With the Wall Street bonuses hitting record highs again this year, I dont think there is much concern around NYC housing market.
The hardest hit areas would be the second-tier, purely speculative markets like Phoenix and Vegas.
Posted by: Bob | Aug 23, 2006 9:37:07 AM
I don't know if landlords should count on rents rising ever higher: Properties that don't sell are likely to become rentals to offset those mortgages...
Posted by: Patrick (G) | Aug 23, 2006 9:38:35 AM
even in the uk the endgame is near.
they createt the "debt that never dies"
they say that this kind of loan is popular in japan.
what a reference...........
http://immobilienblasen.blogspot.com/2006/08/uk-debt-that-never-dies.html
Posted by: jmf | Aug 23, 2006 9:48:07 AM
NYC will get crushed with a capital K. This is the most aggressive housing build out in over 200 years of this country statistically. Historically, there was always pretty much a 1:1 ratio of new households to new homes. This time it is 2.4 to one. Massive supply is still coming online. Especially in condos.
St. Louis is relatively safe? Maybe. Maybe not. Ohio is one of the worst markets. Do you think if the midwest can be hit hard that it could spread? It's like a ripple in the pond with the industries that could be hit.
Posted by: BDG123 | Aug 23, 2006 9:48:23 AM
Bob,
Unsold Manhattan Apts. at 10 year high.
Posted by: Craig H | Aug 23, 2006 9:48:33 AM
Locally, a Century 21 just shut its doors. It was never a high producing office as it catered to the newbie realtors.
I heard the lease was up. It's interesting to me in that it's only cost is the lease of the office. It pays the realtors nothing unless they can close.
Sign of the times. And it should continue to trickle through the economy.
Posted by: Michael C. | Aug 23, 2006 9:55:23 AM
One of the reasons I said it wasn't a bubble was the intrinsic value of real estate and housing, and the "tether" (for lack of a better word) to a certain percentage of buyers.
This might be a definitional issue, and a 35% haircut is still very significant -- but that is a correction, and not a crash.
Posted by: Barry Ritholtz | Aug 23, 2006 10:06:20 AM
Existing Home sales down 4.1% to 6.33mln rate (6.6 expected). Inventory up to 7.3 months (was 6.8 in June).
Another anecdote, as I was up in Big Bear Lake this past weekend, a fun spot for So Californians. About 60-70% of the properties there had for sale signs. Not an exageration at all, it was quite staggering. Of all the properties for sale I saw maybe 2-3 sold signs. Many were being remodeled, some major remodeling, with the for sale sign outside. This area use to be very cheap and is representative of the "2nd home" or vacation house real estate market, not the primary residence real estate market.
Posted by: Michael C. | Aug 23, 2006 10:11:57 AM
CDizzle, are you referring to Tapawingo? I have also noticed the high-end in St. Louis really getting whacked. One new subdivision, which is pricing homes starting in the high 700's, low 800's (probably 2 - 300 over where they should be) has only sold one house in over a year (75+ home development). They aren't budging on pricing though.
While I see the high end hit hard, the low and middle seems to be doing just fine. Homes in the 200's up to 500's are all selling OK.
I still think folks are making too big a deal about the housing impact. I know in St. Louis most won't go belly up because they can't sell their house at prices they were fetching a year ago. They will just pull the house off the market and wait out the downturn. I am not seeing sellers franctically reduce prices yet, so that tells me we are not yet in a crisis.
Which Luxury/high-end home builder went belly up? Lawless?
Posted by: JDamon | Aug 23, 2006 10:16:54 AM
Existing home sales were down greater than expected. I have seen the economist from the National Association of Realtors on CNBC and he seems more like a marketing rep than an economist. Maybe I am too skeptical but I am not sure that I trust the numbers from the NAR. I have a feeling they are worse than reported.
Posted by: GerryL | Aug 23, 2006 10:17:47 AM
So JD, let me ask you, in 1930 when everyone was worried, would you have been buying into decines? Just in 1929 unemployment was 3%. Profits were raging. Now, we're not in 1929, we're in 1936 but.......... Sentiment is a dangerous tool if all one thinks is it is being a contrarian to consensus.
Posted by: BDG123 | Aug 23, 2006 10:28:33 AM
Wasn't the TOL guy selling million of shares at the exact top: in July 2005 at the head of the housing head & shoulders? lAnd CNBC at the time was sure helping those guys unload their merchandise.
Someone mentioned Ohio. We're already number one in bankruptcies and forclosures. Can't wait until a housing slowdown really hits! (Although, because no sane person would want to live here, houses haven't doubled or anything).
Posted by: Brian | Aug 23, 2006 10:53:56 AM
So, with the new housing data in, how long until a Media Appearence on "Kudlow & Company" comes along? C'mon, Larry's gonna want to go bear hunting now more than ever!
Posted by: Chief Tomahawk | Aug 23, 2006 10:55:15 AM
"This might be a definitional issue, and a 35% haircut is still very significant -- but that is a correction, and not a crash. "
One issue is the drop maybe less than the 78% drop in the NASDAQ, however everyone is levered up in real estate. Most people hadn't levered up their bubbly equity investments.
JV
Posted by: JV | Aug 23, 2006 11:04:27 AM
Recession Risk?
Such contrasts with the views of some other Fed officials who now see growth slowing enough to cause at least a small increase in unemployment, now at 4.8 percent. The slowdown would not be pronounced enough, in their view, to be considered a recession.
The Goldman Sachs economists questioned whether such a forecast was realistic.
``The U.S. economy historically has had an extremely difficult time sustaining below-trend growth without falling into recession,'' they said. ``Every rise in the three-month moving average of the unemployment rate by more than one-third percentage point since 1948 has ended in a recession.''
That sort of history is the principal reason some Fed officials argued very strongly for a pause in raising the lending rate target -- the concern of over-shooting.
Even though Moskow was worried about the inflation outlook, he noted that oil futures contracts currently point to a stabilization of crude prices.
Oil Stability
``Should this occur, once businesses adjust their own prices to cover the higher energy costs, overall inflation should return to its earlier rate,'' Moskow said.
One reason to think the futures markets may be right is the recent behavior of prices.
Even amid the turmoil in the Middle East caused by the war in Iraq, the Israeli invasion of Lebanon and Iran's refusal to abandon its nuclear energy program -- plus sporadic attacks on Nigerian oil facilities and the shutting of a major pipeline in Alaska -- the price of crude oil contracts traded yesterday on the New York Mercantile Exchange was no higher than it was four months ago.
From John M. Berry of Bloomberg News
Posted by: Rick | Aug 23, 2006 11:12:01 AM
When you are talking about leveraged money, a small correction is a big crash.
And I wouldn't bet on rental property. How far does the market have to drop (or rents increase) for an investor to find positive cash flow properties?
It's time to hoard cash and wait.
Posted by: douglas | Aug 23, 2006 11:13:00 AM
Yesss!
I asked the question about two months ago. Does anyone see anything that will replace housing as an economic driver. No one had anything.
If that is true, a recession is unavoidable. I have also made the case that recessions are not all bad. They do build a base for future growth.
Barry. Still would like to hear your definition of a bubble. In my definition of a bubble, housing is a bubble. Bubbles to me are when human emotion overrides logic and experience for the majority. We know that happened in the tech bubble. I certainly see the same happening in the last 2 years in housing.
Posted by: advsys | Aug 23, 2006 11:22:37 AM
Has this really been the most aggressive housing build in 200 years?
Levittown was created in 1947. My guess is that the national building boom that followed to copy Levitt's success in building cookie cutter, mass produced suburbs was probably the most aggressive buildout in 200 years. Just a hunch, don't have the data to support it.
However, I do have data that goes back to 1959.
Using that data, I see there has only been one three- year period in which housing starts exceeded 2 million units each year: 1971, 1972 and 1973.
During the current cycle, there was only one year in which housing starts exceeded 2 million units. That was in 2005 when 2.1 million units were started. And this cycle's peak in 2005 was about 14% less than the 1972 peak of 2.4 million units.
What is unique about this cycle is how long its been since the last "bust" period.
Why do you feel the current cycle is more aggressive than either the 1971 - 1973 period or the period following Levitt's invention of the suburb?
Posted by: S | Aug 23, 2006 11:25:44 AM
20-30% fall will wipe out equity on everyone who bought last 2 or 3 years ...... Buy bonds , stay short the homebuilders until they hit 50% of book
Posted by: ssf | Aug 23, 2006 11:29:24 AM
