Market Outlook, September 2008

As a buyer’s advocate, with an economics degree, Wall Street experience, serious sounding designations behind my name, and (too) many years in the business… my finger is arguably more squarely placed on the pulse of the market than agent-only professionals (who do not execute loans), loan officers (who do not execute real estate transactions), Wall Street pundits (who read reports but can’t or don’t explain how real estate data are skewed), and talking heads of media (who flip-flop for ratings du jour).

Here is my uncensored commentary on the current housing market… including price valuations, rate trends, and market bottom speculation, as of September 2008.

From what I can see, valuations fall into three categories: under $750k, from $750k-$1.75M, and over $1.75M+.

Along with the credit crunch and sub-prime fallout, the lower-end tier has taken some serious lumps, averaging $35-40% correction in the hardest hit areas. If you look at how much money it costs just to fix up even the most cosmetic portions of a home these days, it begs the question: how much lower can these homes go? Seems to me they may over-correct with market panic for a short time, but fundamentally they are getting pretty close to what it costs to build the actual homes themselves… and not too far away from even cash flow as a rental.

The high-end market ($1.75M+) is made up of folks, who likely have self-sustaining situations, and will be able to withstand all but a nationwide financial collapse. By the same token, these homes are built on the sort of land that begets the expression, “well, they’re just not building any more land”… meaning premium land will likely hold its value, or even appreciate… though maybe not so quickly because wealthy people like leveraging money too and if $500k is hard to come by, try raising $5M these days.

Next is what I call the uppler-middle class segment, the $750k-$1.75m-ish tier. Anyone who said they saw the sub-prime thing coming (which is now amazingly everyone) should also see this next wave coming. Sub-prime was not an “evil people” thing. It was a math thing. Those folks had loans associated with 2-year and 3-year fixed rates. When their rate locks expired, the marginal folks who could not afford the payment shock of the higher rate were forced to refi or sell. But 95% of these borrowers do not qualify with today’s underwriting standards, because 1.) there are no more stated income loans; and 2.) the max loan-to-values allowed have been significantly lowered.

When they couldn’t refi, many tried to sell, but were upside down in value. Next, many turned to lenders to negotiate a loan modification, or a short sale, but all were told negotations do not begin until several missed payments hit the credit report. And with their credit rating destroyed, all incentive to maintain their position was lost. The rest of the story… well, you know.

The rest of the iceberg beneath the surface… oh sorry… I mean, Sub-prime aside, the rest of the loans that were written over the last 5 – 7 years, were extended to Prime and Alt borrowers. These people aren’t evil either. Maybe a little greedy… maybe a little starved for a taste of the good life… but again, the issue here is not character, but math. As all of these loans begin to re-set, 95% of these borrowers will not qualify for a refi under the today’s tougher underwriting standards. Houston we have a problem. Sub-prime all over again, but this time harder, worse, more, and any other adjective you would like to add.

I believe the media and investor attention is being grossly misplaced on our trailing 12-18 months. We should be looking ahead at the upcoming 12-18 months. If Fannie/Freddie (the government backed institutions who insure these loans) requires a government bailout, the figure needed would be roughly $6T. That’s “T” for trillion. That’s another Iraq war $6T. Now, if 10% of the reserves of the FDIC (the body who insures your bank funds up to $100k) were depleted just by IndyMac going belly up… and Fannie/Freddie may require $6T… um… were will the other money come from if future bank failures eat up the remaining 90% of the FDIC’s reserves? Inflation.

Hey, this is a great segue for my other unpopular, but likely prediction: significantly increased interest rates.

Inflation + smart-money buying up cheap homes (rather than lending at low rates) + other countries raising their rates + the printing of more money to support a strained FDIC + a new president to blame = a premium for borrowing money

Whether or not the Fed resists the urge to raise their rates… its the rate at which the guys on Wall Street are willing to lend that counts, people… not the Fed.

So even if you save $100k by waiting a year to buy a “middle tier” home… if the rates at that time are 2% higher, then your monthly payment goes… up.

So to buy? or not to buy? If you’d like some help making sense of how this stuff applies to your own scenario… it just so happens I know a good realtor.

In short, if you’re paying all cash for a home identified above as the “middle tier”, then I might suggest that time is on your side to lower your cost basis. But if you’re buying a home that either costs less than $600k-ish, or more than $1.75M, (or borrowing more than 50% of any price home… even the $750k-$1.75m) then note this: anyone selling right now… really needs to sell… so keep an eye out there for killer buying opportunities.

Bottom line: If you can afford the payment and if you would like to live in a respective house for 10 years, then I believe you simply can’t go wrong. I bet my career that in 10 years we’ll see higher prices than anything we’ve seen yet, due to inflation and demographic explosion.

Finally, stay tuned for a trend I believe we’ll start to see developing, involving niche companies that will spring up to negotiate loan modification terms, on behalf of respective consumers, and on a fee basis. This will apply to any borrower with an existing loan about to re-set, whether its affordable or not. I think this is the key to market stabilization and the housing bottom in general.

Without a fix (pun intended) to this interest rate expiration problem, which is being largely underestimated, we’ll continue to see instability in the financial markets as a whole. But the US financial markets have always been remarkably flexible, and sometimes the darkest hour is the one just before dawn.

Meantime, when you do buy a home, use me as your realtor… I have a new baby to feed, so you’ll know I’ll be motivated to give good service… and oh yeah, I’m good at this stuff.

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