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| Coming out of the grain business & pretty much of the opinion I was untouchable, I learned placing hedges & basis trading was a much different horse than trying to eke out a living trading. So, I took that bus over the cliff a few times & those who’ve made that trip may agree it is nice to know, during those moments of anguish, whether are you headed into a pile of rocks, or some other substance not causing quite as much trauma. I learned NEVER to fall in love with a market & to watch the EQUITY in my account maybe even more closely than the overall market. And in regard to assuming a sizeable position, HOMEWORK IS REQUIRED.
I have previously posted some general comments about housing. I think I have looked at this market from a variety of angles. A lot of homework was skipped.
Because of my long friendship with a designer-investor & being exposed to analyzing his market versus the general market, I have watched this thing unfold with considerable curiosity. His market for very high profile individuals rarely involves a mortgage. However, we frequently looked at the market as a whole.
First, we are going to forget the term ‘seasonally adjusted.’
Approximately 42,000 homes were sold in December.
It is estimated there are 400,000 homes + or – in unsold inventory.
Here comes the tricky part.
When you read the small print, the footnotes, and follow a trail in the reports prepared by the US Census Department, there are in fact (estimated for Dec. 31, 2007):
17.771 million Vacant homes in the USA.
3.182 million are vacant rental homes.
2.179 million are vacant homes for sale.
Another 3 million are classified as “other” meaning they are ‘teardowns.”
The balance of these homes are either used as seasonal rentals or residences designed for use, for example, only in the summer time.
33% of these homes were constructed prior to 1959.
The rental vacancy rate at the end of 2007 was 9.6%, at the end of 2002-9.4% & in 2000, prior to this big rush to home ownership, the rate was 7.8%
The vacancy rate for owner-occupied inventory was 2.8% at the end of 2007, 1.6% at the end of 2002 & 1.6% at the end of 2000.
Now, let’s look at collateral. If we are in the cattle business & the market is $100 per cwt. When we walk into the bank, everyone greets us; the banker tells a few jokes & glosses over our financial statement as though it is a formality. This is our third turn in the feedlot, we are sharp cattlemen & the outlook is rosy & know what we are doing & forget hedging, the banker is impressed we have a grasp on this market and agrees ‘it’d be nice for you boys to make the big hit,” (after all he has a blanket mortgage & owns us, lock, stock & barrel).
When the market drops to $85, folks in the front part of the bank are a little quieter, there are no jokes and the banker is wearing bi-focals as he studies every damn line of our financial statement and even has the gall to ask a few sticky questions.
When the fat market plummets to $65 & we walk into the bank, all the help avoids our glance and most are trying to look busy doing something else. The banker is very formal, grim & informs us that he will give us about two weeks to either come up with some additional equity or there is going to be a sale & he might even be brazen enough to mention deficiency judgments. Unless you have some legitimate questions, this meeting usually requires only 10 minutes at the most & there is no accompanying us to the door of his office & feel generally pretty lonely as we walk through the foyer of the bank. The bus just hit the rocks.
The Fed is not going to help us get the equity.
There are several sub-markets in housing.
Folks not requiring mortgages.
Folks requiring mortgages but with high incomes & high net worths.
The vanilla market: homes designed to appeal to a wide cross section of the market, most requiring a mortgage.
The existing home market & can vary from very nice to junk.
The multi-family market.
Mobile Homes.
Modular Homes.
I know pretty much what is costs to build different types of housing, I have the software & can adjust those variables. At the peak of the housing boom, I witnessed pre-1955 two-bedroom homes trade at $200 per square foot. Considerably above replacement cost.
During the boom, builders were stressed to capacity. Their margins escalated. They got fat.
Development land went thru the roof.
From my view point, builders are a crowd with a very short view. Every project package I have been shown this past five years was geared to sell out in a max. of 3 years. I didn’t see any with more realistic 5 or 7 year sell-outs with the appropriate carry interest. In a development scenario, I’d reviewed the discounted cash flows...the appraisers would have numbers to suit…I pretty much have assumed the bankers rarely reviewed the documents, if the appraiser produced the right numbers, the money was most likely available. I have an acid test, none met those criteria.
What about the old junk housing? I know of properties which normally would not bring $35K & require some cosmetic rehab, which were appraised for $100-$125K. Pure junk. I know of one situation, and am sure there were a lot more, where the mortgage broker secured an adjustable rate, 105% financing for an unemployed individual, but he’d made 12-months of rent payments on time & Countrywide bought into the deal.
One of the reasons for this mess was the fee-based lending. At the closing, the typical mortgage broker would receive a fat piece, the attorneys would lick their chops & from what I’ve seen in reviewing documents, the lender presents a list of assorted fees sufficient to choke a horse, but the loan covered it all. If it didn't the seller would take back a 2nd, knowing it was worthless, but the deal was just too good. Countrywide and others encouraged these boys to “bring us more.”
When Bernanke was first appointed, he estimated the housing bust would cost $100B. I think we are now up to $300B & the collateral is falling like a rock. If this were a commodity, in view of the supply, I would expect prices to decline below replacement costs. Just my opinion.
The housing cattle price, in my opinion, based on my example, is $65 and falling.
With collateral shrinking in value, the industry has now decided to return to more established guide lines shrinking the potential market. I now notice sideline economists predicting the Fed action will soon stimulate home building. It will, in some categories, but not the broad market. That is pure nonsense. In my opinion, the housing bus yet has a distance to drop. More Fed action will be required.
"Central bankers... they often don't know where they are, let alone where they are heading; their maps and compasses are unreliable and their steering is wonky. Worst of all their recent policy dilemmas are the equivalent of not knowing whether the earth is round or flat."
The Economist September 28th 2002
I was in search of a one-armed economist so that the guy could never make a statement and then say: “on the other hand."
Harry S. Truman
Edited by SeniorCitizen 1/30/2008 20:12
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The Cliff, the Bus, the Rocks.
