Entries Tagged 'real estate' ↓

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So home ownership has fallen to 2002 levels, and at last count there were 2.2 million vacant homes for sale in the U.S.

Lets set aside the critical question of whether a perpetually appreciating housing market should be a goal of economic policy, and assume that home price appreciation is a necessary (but not sufficient) condition for the U.S. economy to improve.

The Bush administration tried to prop up home prices by promoting a higher home ownership rate - with disastrous consequences (to put it mildly).

But there is a direct and self-evidently obvious way of reducing housing inventory, increasing business competitiveness and jump-starting the U.S. consumer base - much more immigration.

The Obama administration needs to look seriously at a completely fresh approach to immigration. To make any new immigration policy both fair and popular, any increases in immigration has to have the following elements:

1. Incentives for financially sound immigrants to move and invest in the U.S. - it is not unthinkable to impose a requirement that immigration seekers within the new system must own a minimum of (say) $250,000 US based property within a year of being granted US residency.
2. Strong disincentives for welfare-seeking immigrants - the last thing the economy needs now is an increase in the number of economically unproductive people.
3. Safeguards to ensure that the system does not evolve into the Dubai model - which places foreigners (and even their Dubai-born children) into a permanently lower class with no hope of citizenship.

The Obama administration should not be afraid of short-sighted union objections to increasing immigration - if it is serious in ending this economic depression, there should be no sacred cows.

It is ironical indeed that in reality, Obama is the ultimate faith-based candidate. Our support of his Presidency is largely based on our faith in his ability, and our much stronger lack of faith in his opponents.

And because our faith is based largely on his oratory, his speeches and words are of much greater importance than those of other Presidents.

Yesterday’s speech was an oratory masterpiece, but it’s now time to get down to business. Obama needs to speak honestly and openly about the following 5 things early on in his presidency:

1. Stimulus spending (the corner stone of Obama’s economic recovery plan) - does not work. The reason for this is stunningly simple. The money that the government spends as part of a stimulus plan does not come out of a huge idle reservoir of money. Stimulus money is either borrowed or taxed. Hence stimulus spending is just transferring wealth from one group to another, and leads to no net gain.
2. Federal bailouts of states are inherently unfair - because these bailouts tax taxpayers who live in states that "lived within their means" and essentially transfers their wealth to irresponsible states who made poor budget decisions.
3. Social security and medicare are by definition ponzi schemes - A smaller workforce cannot support huge benefits for a larger retiring population. Retirees are in for big disappointments no matter what happens next.
4. The housing bubble was caused due to government intervention, not due to the lack of it. The government push for home ownership caused the housing bubble by forcing Freddie/Fannie to lend to unworthy borrowers. This crisis cannot be resolved by lending to even more unworthy borrowers.
5. The era of conspicuous consumption is most likely over. Even alternative energy cannot indefinitely sustain the suburban SUV consumerist lifestyle. Obama needs to sell the idea of a vastly different lifestyle than the ones most Americans are used to.

The Obama campaign was all about what the American people wanted to hear. The Obama Presidency should be about what the American people need to hear.

Like all bubbles the real estate bubble had a kernel of truth - real estate is a tangible asset that you could touch and potentially live in.

Those of us who feared that real estate was a bubble talked about the price-to-rent ratio, which allows us to value real estate in terms of the actual rental income it would bring.

It is possible to value college degrees with similar tools. The value of a degree is the net increase in lifetime income it brings. Every student who decides to spend her parents money (or his own future income) is making a bet that she will profit from this investment.

From John Robb comes this startling fact - the cost of a degree today is approximately equal to the increase in lifetime income - if true, a college degree provides no additional economic benefit after you factor in the cost of acquiring it.

As real estate shows, it is possible to overpay for anything - the tangibility of the asset does not prevent a mania from occurring.

So are we in an education bubble ? The graph certainly looks bubbly.

The real estate market is so awful that buyers are now scooping up homes for as little as $1,000.

There are 18 listings in Flint, Mich., for under $3,000, according to Realtor.com. There are 22 in Indianapolis, 46 in Cleveland and a whopping 709 in Detroit. All of these communities have been hit hard by foreclosures, and most of these homes are being sold by the lenders that repossessed them.

……

These houses are almost always small fixer-uppers. Wiring, plumbing and heating systems have to be replaced, walls and ceilings sheet-rocked, plumbing and light fixtures installed and new kitchen cabinets and counters put in. Few come with working appliances.

Often buyers are legally required to rehab these homes to bring them up to code. In Detroit, buyers are required to sign Affidavits of Compliance Responsibility, which obligates them to make repairs outlined in an inspection report. Only after that can a certificate of occupancy will be issued, which makes the house legal to live in.

But even factoring in these costs, they’re still bargains.

Radical cheap: $1,000 homes - Yahoo! Finance

So whats the catch ? Here’s my prediction - many or most of these homes are in neighborhoods that will never recover. These bargain-hunters will be stuck forever paying for repair work and fending off drug addicts from these properties. The chances of getting renters or buyers for these properties are essentially zero - thats what the $1000 home sellers know that the “bargain hunters” dont.

Predictions are probably the best Rorschach tests for bloggers and investors. Everyone is in the prediction business, because every act of investment (including sitting on cash in the sidelines) is an implicit prediction about the future.

Writing down my predictions for the year has proven itself to be a great tool for me to become explicitly aware of my cognitive biases. Because if there’s one thing I’ve learnt in investing, its this - It’s not what you don’t know that kills you, but instead its what you know that’s wrong. (Can’t seem to find the original source for this quote).

So here’s the top 10 predictions on my mind as of today:

1. Stock market - The Obamarama stock market rally will be mostly over by Obama’s first quarter as President. By late 2009, it will be obvious that all of the government bailout and spending efforts are like holding an umbrella in a hurricane. The nation will finally resign to the reality of a longer term depression. This realization alongwith a few shocking municipal bankruptcies will cause the stock market to finally bottom in early 2010.
2. Bond bubble - The treasury bond bubble will continue to inflate, pushing yields to even lower levels than today. Bond bears will get clobbered in 2009 by being too early and too aggressive. The only thing that can burst the treasury bond bubble is a “growth scare”, which will not occur until 2010.
3. Obama - Barack Obama will not have the courage to give the economy the bitter pill it needs to quickly get rid of the mal-investments and excessive leverage that led to the current crisis. Nor will Obama have the courage to suggest that the government needs to be a referee in the market, rather than the dominant player it has become thanks to Paulson and Bernanke. The high of “Yes we can” will slowly morph into a hangover of “Yes we could have.”
4. Economy - By the end of 2009, almost everyone in the country will continue to believe in the perpetual motion machine that is Keynesian economics and fractional reserve banking. The Keynesians, led by Paul Krugman will still propagate the “free lunch” myth: Deficit spending and huge amounts of bad credit can cure all the problems created by deficit spending and huge amounts of bad credit.
5. Suburbia - 2008 will be seen in 2009 to have been the last year of the techno-triumphalist era. By the end of 2009, it will be apparent that technology (software, finance, green technology) alone cannot indefinitely sustain the now defunct credit-driven consumerist suburban SUV lifestyle. Austerity will be the new black.
6. Real estate - Real estate will overcorrect on the way down, and “fortress areas” like Cupertino in the Bay Area will also experience severe price reductions as IPO/options wealth, jumbo mortgage financing and the hope for a quick recovery dries up. It will be finally realized that encouraging excessive home ownership tends to hurt the economy by making it harder for workers to relocate to where the jobs are.
7. Alternative energy - Alternative energy and OPEC countries will ironically find themselves on the same side, hoping for higher oil prices so that their respective industries and  economies become viable. Oil prices will continue to disappoint them by being stagnant, and this will be a silver lining for the middle-class consumers.
8. Pakistan - The world will again be fashionably outraged for a few days in the Fall of 2009, when it becomes clear that new attacks were being planned against Indian targets even while Pakistan was condemning the recent 26/11 Mumbai attacks. India and Pakistan will again lurch towards war after the next terror attack. The US will once again force India to back down by essentially telling India: “not tonight dear, I have a headache”.
9. Microsoft - Microsoft will realize (if it has not already) that there is no point going after has-been giants like Yahoo, and will instead (correctly) acquire Facebook and/or Twitter at bargain prices. For the first time in its history Google misses out on the obvious due to the “not built here” syndrome.
10. Google - Google revenue will surprise to the upside, but it will be at the cost of cutting down on other expenses, including payroll/bonuses, bandwidth bills for Youtube and possibly even Gmail and other Google apps.

Never intended as investment advice. Read my disclaimer.

Image by Getty Images via Daylife

Today we face the ironic situation of the US government abandoning free market principles to save the free market.

Whether or not the Government will succeed remains to be seen. But in the mean time, there are some fascinating unintended consequences going on (fascinating in a morbid sort of way).

It seems like every generation learns the hard way that central planning does not work, and indeed often worsens the situation that it claims to cure.

So here are just a few examples of how the current US government actions often worsen the situation that they are trying to solve:

1. Lowering interest rates reduces credit to companies

People who invest their money in CDs and money markets are (sometimes unknowingly) lending this money to companies who need the money and are willing to pay interest for short-term loans.

By driving interest rates so low, the Federal Reserve risks a perverse side effect - many money markets will have an expense ratio that’s higher than their interest rate! This means that many money market investors will have a negative return on investment. If this causes investors to withdraw from the money market (and invest into, say treasuries), it lessens the amount of money available for companies to borrow. This is already happening, as evidenced by the huge demand for treasuries (even at near-zero interest rates).

If the government wants more money to be available for lending to companies, it needs to increase interest that people earn on savings. This will provide incentives for people to save, which causes more money to flow into money markets and CDs, and hence increases the pool of money to be lent to companies! Right now the very opposite is happening.

2. Lower interest rates reduces lending to individual borrowers

If you are a bank, here is an easy way for you to get almost free money with virtually no risk:

1. Borrow nearly unlimited amounts of short-term money from the Fed (at the 0.5% “discount rate”)
2. Buy longer term treasuries with this money (earn >2%)
3. Hold to maturity if necessary
4. Repeat

Note that the above does not include having to lend to flaky retail borrowers! So this rate cut actually has an unintended consequence of making retail borrowers even less attractive to banks!

3. Helping defaulting homeowners encourages more to default

If the government provides relief to homeowners who are behind on their payments, it creates incentives for even more homeowners to fall behind, so that they too can get lower interest rates and hopefully even principal reductions!

Surely not what is intended.

4. Guaranteeing deposits causes money to leave good banks

By providing strong guarantees to money deposited in unhealthy banks, it creates an incentive for people to withdraw their funds  from otherwise healthy (but not government-backed) institutions into bad banks that are guaranteed by the government!

5. Lesson learned by bankers - take even bigger risks next time

This is probably the worst of the unintended consequences. An entire generation (and probably more) of bankers and traders have now learned - that if you take risks, make sure you take huge ones. So that if you fail, you are more likely to be bailed out in the long run. The moral hazard being created by this bailout is just staggering.

The financial, mortgage, insurance and auto bailouts almost guarantee that the next bubble will be even bigger and even more disastrous when it bursts.

Image by Qiao-Da-Ye賽門喬大爺 via Flickr

The following could be written about any real estate market over the last decade, but is especially stunning coming out of Dubai:

For the past decade at least, real-estate speculation has been the national sport. The price of houses and apartments, many not yet built, rose by 43 percent in the first quarter of this year alone. Mortgage money was easy to get and speculators commonly flipped properties for substantial profits in a matter of weeks, sometimes even days, before the first monthly payments came due. Everybody wanted in on the game. “Employees didn’t focus on their work anymore,” complains the chairman of a regional transport company. “They all wanted to go buying property for 10 percent down, if that.” As of June, Dubai had 42 million square feet of office space under construction, more than any other city in the world, even Shanghai.

Image via Wikipedia

What was a flat desert 20 years ago is today an urban canyon. Such is the frenzy that the Hard Rock Café, built among vacant lots in 1997, is now surrounded by skyscrapers and plans to tear it down for another high-rise are being debated as if the Hard Rock were a heritage site.

Dubai’s Last Hurrah | Newsweek Project Green | Newsweek.com

What if all that investment had gone towards building world-class universities instead of ultra-luxury condos ?

Image via Wikipedia

A common misconception amongst novice home buyers is - “its a great time to buy - the rates are so low!”

In fact, as Calculated Risk explains, a rational buyer should be doing exactly the opposite:

A rational buyer wouldn’t pay more just because the interest rate is lower - although they might have to pay more because the demand is greater. But the current buyer wouldn’t pay much more, because the rational buyer would realize interest rates will probably not be artificially low when they try to sell, and their future buyer would have a higher interest rate and a lower price.

Calculated Risk: House Prices and Interest Rates

So is it possible to have falling mortgage interest rates and falling real estate prices ? Absolutely, and that is exactly what’s happening now!

One of my most profitable investment tools has been an understanding of why sentiment can often produce counter-intuitive results. Consider this statement by the Indian Finance Minister Chidambaram:

“Hotels must cut tariffs; airlines must cut prices; real estate must cut rates of apartments and homes they sell; car makers and two-wheeler makers must cut prices,” he said, while addressing industrialists at the Indian Economic Summit being organised by the World Economic Forum and the CII in New Delhi.

FM asks realty firms, airlines to cut prices

Of course the Finance Minister wants GDP growth at the cost of profitability, especially in an election year. Every economic transaction adds to the GDP, even if it is loss making for the parties involved. You could boost GDP by paying half of the unemployed workforce to dig a ditch, and the other half to fill it up (yes, India actually has a program along those lines.)

But the deeper question is - why don’t these industries (especially real estate) cut prices to get inventory moving ?

The answer lies in sentiment - real estate is not supposed to go down. Realtors have sold the emerging markets this marketing drivel for too long. A normal market would attract buyers as prices go down. But in today’s sentiment-driven world, reducing prices actually might scare away buyers who see something that “isn’t supposed to happen”. Realtors worry (correctly) that a precedent of lower prices will encourage buyers to wait even longer.

So now we wait for the ongoing credit crunch to force the realtors to sell sell sell, and for the sentiment to turn. And you can bet the market will overreact on the downside too.