Friday, August 19, 2005

Bulls Make Money, Bears Make Money, Pigs Get Slaughtered

Pretty good column about the current risks of real estate speculation.


Home sales run about 9 million a year (this includes housing starts of 2 million and existing home sales of 7 million). If over 20 percent of homes purchased are investor properties, it appears that practically all new housing starts in America are accounted for by speculative buying. If second home buyers are added into the equation, speculative and investment buying of real estate (not owning to live in) actually exceeds total housing starts!

There are problems associated with owning second homes and investor properties. Unless these properties are rented out, they yield no cash income and become cash vampires, sucking the owner dry because of escalating taxes, maintenance, the Alternative Minimum Tax, and higher floating-rate mortgage payments.

Let's look at the economics of a "poster property" in San Diego called Park Place. The New York Times reported recently that a one bedroom condo is being offered for $719,000. A prospective buyer would expect to pay about $3,775 a month for a mortgage, plus maintenance fees, taxes and insurance. These additional costs can bring the monthly out-of -pocket total to well over $5,000 a month, or $60,000 a year. However, a renter, who would benefit from the same granite countertops, hardwood floors and fantastic views, can rent a nearly identical unit for only $2,400 a month, or $28,800 a year. At these price levels, the speculator who bought in could run an annual negative cash flow of close to $31,000 if they were forced to rent because no buyers could be found.

Today's inexperienced housing investors may not realize that the hard costs (tax, insurance and maintenance) along with the soft costs (revenue lost due to vacancy, and property management services so you don't have to become the landlord) can easily eat up over 30 percent of rental income before even making the mortgage payment.

In looking at some cities with major price appreciation (New York, Boston, San Diego, Miami, to name a few), in today's world it just doesn't seem possible to buy a house or condo and expect to make an economic return renting it out! Nationwide, there are over 3.8 million vacant units available for rent. In some communities, the over-supply of rental units on the market has pushed the average rent down as much as 20 percent. There remains a surplus of rental units.

First quarter 2005 statistics indicate, nationwide, there are 440,000 new homes for sale and 2,400,000 used homes for sale. By recent historical standards, these numbers account for a 4-month supply and do not look worrisome. However, given what is really going on, this is about as safe as saying "if you see ice on a pond, it must be safe to walk on". The latest HUD statistics show that of the 107,775,000 occupied housing units, 74,488,000 - or over 69 percent - are owned (not rented). This level of home ownership is at an all time record high. In achieving this record home ownership, the following has occurred: Sub-prime buyers now account for more than 10 percent; Another 10 percent can only buy with a "negative amortization mortgage" (very popular in California where 40 percent of mortgages are negative amortization); Up to two-thirds of mortgages are Interest Only ("IO") or Adjustable Rate ("ARM"); Second homes now account for 8 percent of mortgages; and, 38 percent of homes this year have been purchased with less than 5 percent down (if this doesn't reflect scrapping the bottom of the barrel for homeowners, nothing ever would). Yet, household earnings haven't kept up!

If housing speculators stop buying, who's left to buy? The average American with a job has already bought. America has been creating new homes faster than new jobs, and it has been the home speculator, and second home investor, holding up the market for at least the past year.

Well, you know, the Dot-Com thing was so long ago, and people can't be expected to take away lessons from such an ancient event...

No comments: