What happened in real estate?
What happened in real estate?
Here's a quick update on housing, I've been asked a bunch lately, so thought I'd send it widely:
In 2005 Enron and Tyco and corporate bad guys made the federal regulators crazy, so they decided to pick on every public company. This included Fannie Mae and Freddie Mac, two mortgage loan underwriters and bond packagers. This began the market slow-down and also the tightening of standards. In essence Enron made it hard for Fannie Mae to do what they do so well, to create liquidity in the housing money markets.
Early 2006 saw the local near fall down of Harvest Homes, and nationally big builders taking big write-offs. This hurt our local subs and got them thinking about things like margins and service work. Prices continued upward even though the market was stalling. This is called inflation at the macro level and isn't at all good for anyone. Less people could afford to buy a home and therefore specs increased in time to sell and the existing market began to stall.
In late 2006 the housing market went to fully down cycle. But, sadly many builders tried to build specs to keep themselves and the subs afloat. Well when there are too many specs, the title companies get worried. They know that builders have to pay themselves and their staff out of these spec loans, and so they started tightening their rules to make sure that the subs were getting paid first. They also started worrying about loans being given to borrowers that seemed a little less than grade A. Title companies were asked to become the mortgage police, taking a service industry and making it less than helpful.
In early 2007 some regulators and investors began worrying about what is called sub-prime mortgages. These are loans where less than 10% is put down and the buyers may have credit issues. Typically these loans cost a little more, but frankly they were still pretty cheap for the risk. Well as the housing market began to get soft, more foreclosures happened and these sub-prime loans looked like a bigger issue. Maybe the risk in these loans wasn't truly understood? Maybe these loans should have had higher interest rates?
Interest rates continued to rise as the Federal Reserve attempted to further slow inflation in a pretty decent economy except for housing. The housing market even picked up a little in the spring. And then ... sub-prime woes kicked back in 6 weeks ago. Someone found bad news in a bunch of these loans, it spread like wildfire. Investors began selling their mutual funds that included sub-prime loan investments. Well one interesting side note is that sub-prime loans are never packaged all by themselves in a mortgage bond, they are packaged with good loans for good mortgages and good commercial paper. Guess what? The commercial paper and good mortgage market got hurt too. Even though good mortgages have not had major problems, the lenders started feeling pressure across the board from bond holders like hedge funds.
Last week several major mortgage players got phone calls from their investment bankers, guys that had been loaning them billions short term to warehouse their loans while they package them to sell into the bond market, and these bankers said "no more money". Immediately Charter Funding (part of First Magnus) and seven other companies like them had to shut their doors. We had a buyer sitting at the closing table when Charter Funding shut down! Our friend Jim Snyder, mayoral candidate in Portage, told me that he is having to send loan applications to multiple lenders just in case they are gone when he tries to close. But the good news is that lenders still want these higher rate loans, they will just have to price them higher yet for the risk. Jim also said he's getting more lenders wanting loans again already!
All the national news focused on Countrywide, the largest lender in the country, but they got the good fortune of dropping $20 in stock price which kinda attracted some investors. So while 7-10 major players went belly up, Countrywide got about $2 billion in investments and $11 billion in loans to put them back in good standing with shareholders. Hopefully the bond market will be happy as well. The Federal Reserve cut the rate that banks could borrow money at for one night, in an attempt to calm everyone down. They will probably cut interest rates too in September, which means that mortgage rates have come back down closer to 6%. They've shoved about $20 billion in cash into the banking system to keep everyone liquid. In normal times this would be a bad omen, and portend inflation. Right now it did seem to help to calm the banks nerves. I heard that the Chinese hold trillions in mortgage bonds that have sub-prime inside them, the Fed needs to keep the Chinese happy too so they don't dump their investments.
Let's be honest the market will be slow the rest of the year. Floods in the Midwest and drought in the South aren't helping either. Inventory is bad, costing interest and having very little ability to liquidate. Presales with good solid customers will still happen but at a much lower rate, since many of them will have existing homes to sell and of course that market is quite soft. Smart builders will leverage the market slow-down to get better prices from subs and to build pre-sales at solid margins.
Housing will rebound locally, I would guess in late 2008 or early 2009. Vacation markets have been decimated and will probably rebound a bit sooner since the stock market is solid and people will feel like they are making money and buying ahead of the next wave, probably early 2008 the vacation markets will start their climb. I would expect hundreds of subs will fall out of the market this fall, as many of them overcharged and underserviced, and then 30 day pays stretches out to 120 day pay. Job losses in residential construction will be in the thousands this fall.
Opportunities?
Legitimate home buyers who are scared that the sky is falling, and need professional calming to see that this is still a great time to buy a home. 6% is low, you can still get zero down payment loans, you can still qualify with less than perfect credit. Homes are still a great investment.
Cost of construction should continue downward all year, giving capitalized builders a chance to lock in better prices for the next 12 months. Land prices will have stopped rising and may go down a bit. $80,000 for a ¼ acre in Valpo was getting a little crazy.
Commercial construction is still strong, and these lower prices for land and materials may make this a strong niche for the next couple years. Job creation may be more commercial for the next 18 months as residential completes it's down portion of the cycle.
In-fill and Green building will have an even greater appeal to those buying homes. Buyers with money are going to be able to buy "ethical" homes at a decent price.
Politicians will be able to "feel the pain" and get mileage from special bond deals and affordable housing initiatives that no one cared about two years ago.
UPDATE: Sorry for the original lack of formatting, I posted from my blackberry, about a week ago on Active Rain and had a couple local realtors ask that I repost over here.
9 comments:
I agree with you re: green building and also 'legitimate' buyers having great opportunities with still very reasonable interest rates.
Nice post. very pertinent and spot on in my opinion.
I think it will also be good if investors will stop including Jumbos in the 'sub prime' category. In our market, $417k isn't a really big loan as in other areas with average prices at $500k +.
-Zachary
http://www.boulder-buzz.com
Zachary, jumbos are not sub-prime. I would go so far as to suggest that 5% down payment loans are also not sub-prime.
Sub-prime in my estimation is only those loans which require less documentation on income.
Investor loans are not by definition sub-prime then unless they are allowed by underwriters without income documentation.
Maybe part of the problem lies with home builders. When the housing market was booming, too many people thought they could make huge money in home building. Harvest Homes is a prime example. They built pretty homes but lacked quality. If people are going to spend $300-500,000 for a home it better be good, otherwise you won't last for long. Builders end up spending more time and money repairing their homes and images than if they just built them right the first place. I don't blame the banks for tightening their wallets at all. If builders want to complain about banking practices, they can start financing home buyers themselves. I believe there is still a strong housing market right now, it is just for quality, well built homes. Builders need to recognize this. In this natural downturn, quality builders will do fine and inferior builders (Harvest Homes) will be eliminated.
Craig i disagree. On a local level, Harvest Homes didn't run into trouble due to bad quality, they ran into trouble because housing costs too much in Northwest Indiana.
Most of their buyers were people who really really wanted a cheap price for a lot of house. Most of their buyers were trying to get a quickie. I won't get into this beat up on Harvest thing you're trying to do.
The market is slow because the mortgage industry has over-reacted to the sub-prime issue. The market is slow because there havene't been enough jobs created. The market is slow because we crashed the housing industry by raising interest rates and letting the housing business crash to hold down inflation.
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This is less a comment than question, but I just purchased a home in Michigan City with less than 5% down, recieved financing with no problems at all and a 6.625% rate through Wells Fargo. I already feel like the enemy, but here's the cinch- I'm looking for work in the residential construction sector in the Valpo/Chesterton area. Have I just totally barked up the wrong tree? Do I hear myself crawling back to my old job? Any ideas?
Andrew,
First thanks for visiting a couple of my blog-sites. Let me do a version of a history story, my version so I hope it helps.
In 1978 the housing market was destroyed by high taxes, high interest rates, and runaway inflation. There were literally hundreds of thousands of jobs lost. It was my experience (though I was young then) that it took about 6 years to recover some momentum. How? Government finally cut taxes and spending under Reagan and state governments. Inflation finally settled enough that the Fed felt they could cut interest rates. The market began a come-back that culminated in the huge runups that we saw in the late 1990’s and early 2000’s.
During the come-back and especially once we hit 2000, the mortgage industry got very hungry for better returns. 6% interest rates didn’t allow much room for big profits for mortgage bond investors. So the mortgage industry started experimenting with higher rates, higher risk loans. They needed the returns and amazingly there was a huge number of people wanting to buy. You mentioned that you purchased using 5% down … in the late 1990’s and early 2000’s this became very prevalent. In some cases 0% down and shaky credit and even no income verification type loans were created. While the real estate market values kept creeping upward the risk was pretty low.
But … all markets correct. The real estate market had gotten ahead of itself. Investors were flipping properties in Florida and Arizona without really ever checking them out. It was a bit of a Ponzi scheme or pyramid scheme. Well as I suggested earlier, markets correct. First the vacation markets relaxed, then local markets began to relax, made worse by the Fed feeling like they needed to raise rates to slow inflation driven by medical costs and fuel costs.
I know I’m taking the long way around, but it helps me think outloud. What saved the markets in 1980”s? My position is that governments cut taxes and cut spending, which undercut the inflationary pressures. In 2008 I hope we see government leaders begin to talk about real tax cuts and real spending cuts again. Oil looks like it will continue to go up in price toward 100 dollars a barrel. Medical costs are continuing to spiral upward at twice and three times the rate of inflation.
Let me answer your question then finally:
In the short term housing will take about 18 months locally to make a recovery. Most of the home builders have cut staffs and reduced overhead to weather the slowdown locally. Some home builders will cease to exist I’m sure.
In the long term housing will return, and perhaps will return very strong due to the built up and pent up demand. People are scared, because the news tells them to be scared, and they aren’t doing anything even though they need homes.
So, in the short term the jobs market will favor commercial construction, especially in the medical and infrastructure fields. If you want to stay in construction for the short term I would highly suggest commercial estimating or CADD or project management. If you want to look at a trade, I would suggest commercial heating or concrete work.
House flips are tough, I’d sure love to see more of them, but they are very hard to finance. Private money may have to come into the market, private investors willing to front real cash to help people do the elbow grease work of flipping. We need a lot of them, trust me, that’s the best way to turn around bad neighborhoods.
Just a quick comment on Harvest Homes. I own a Harvest Home built Jan-Jun 2005, and I disagree with the general comment about quality. We had a superb Project Manager (Scott A.) and I credit the quality of the home to him and him alone. My personal observation is that issues really started when Dan Steiner left the company, and Steve took over. Now, maybe that coincided with some of the other, larger issues in the market, I don't know for sure. What I do know, is our once beautiful neigborhood is suffering for their actions, dumpsters piled up overfilling, half finished houses, and now according to a Post story, 3 forclosures coming. It's really a shame, and disgracful to see how supposed "men of faith" seem to think they can disregard everything they learn in church when it comes to business. Good thing I believe in karma.
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