Investors returning to California's Inland Empire

The rapid decline in prices in the Inland Empire is now starting to draw various investors, who either buy/flip, buy/fix up/flip or buy/rent for cash flow. From an article in the Riverside Press Enterprise:

After retreating in fear from housing's sudden collapse, those who buy homes as an investment are reappearing in Inland Southern California's beaten down marketplace.

Sharply discounted foreclosed properties are luring back the first wave of professional investors and amateurs, both those hoping to "flip" for a quick buck and those wanting to buy and hold for a future rebound...

The process of "flipping" is still risky, many experts warn, since the investor has to take into account that home values continue to fall, which could erode anticipated profits from a resale..

Brokers say most prospective investors, many of whom were burned by waiting too long to sell properties before prices plummeted, still remain timidly on the sidelines.

Mike Novak-Smith, a broker-agent with Re/Max Results in Moreno Valley who specializes in selling repossessed houses, said since the summer he has seen an influx of investors, who he said now account for about 30 percent of his buyers. He said most seem to be novices, while the more seasoned are waiting for prices to fall further.

Investors also must cope with government regulations designed to rein them in. Fannie Mae and Freddie Mac enforce a limit of four homes per borrower, and the Federal Housing Administration requires the seller of a house purchased with an FHA-insured mortgage to have owned it at least 90 days...

The rekindling of investor interest is bad news to some people who blame investors for having fueled the recently burst real estate bubble.

Investors say they are generally targeting the cheapest and most dilapidated houses nobody else wants and turning them into the nicest-looking houses in the neighborhood...

Not everyone agrees that investors perform a public service.

John Marcell, an Upland mortgage broker, said the FHA will lend up to $35,000 to first-time buyers for repairs or improvements. He said he worries that investors will again inflate home prices by flipping.

Marcell also said that investors who buy houses for income and future appreciation will contribute to an oversupply of rentals.

Prudential California Realty agent Marni Jimenez said in competition for houses, investors generally have an edge over first-time buyers. She said that is because investors come with a substantial down payment.

Investors also tend to have conventional financing that lenders prefer over the FHA mortgages that are geared for entry level buyers that take longer to arrange.

Inland economist John Husing said investors who are buying bank-owned houses for rental income further deteriorate neighborhoods and attract crime. "It is a great strategy for the investor but a disastrous strategy for the community," Husing said.

The End of Wall Street

The Wall Street Journal Web site has an interesting three-part video piece entitled "The End of Wall Street."

Chapter One: Why it Happened



Chapter Two: Why it Happened



Chapter Three: What Happens Next

Hispanics a primary victim of mortgage fraud and foreclosures

Having walked through model home complexes during the boom years when sales agents would attempt to explain sub-prime and Option ARM loans to Hispanic buyers who didn't seem to fully understand the ramifications of their signatures, I'm sure the procedure at the lender's office went something like this: "Just sign here. We'll fill out everything for you. Housing always goes up. Have a nice day!"

The problem with such irresponsible lending practices? Foreclosures. Lots of 'em. And it seems that part of the problem was due to other Latinos viewing an untapped demographic and creating their own version of ponzi king Bernard Madoff in order to earn fat commission checks. From a Wall Street Journal story:

For years, immigrants to the U.S. have viewed buying a home as the ultimate benchmark of success. Between 2000 and 2007, as the Hispanic population increased, Hispanic homeownership grew even faster, increasing by 47%, to 6.1 million from 4.1 million, according to the U.S. Census Bureau. Over that same period, homeownership nationally grew by 8%. In 2005 alone, mortgages to Hispanics jumped by 29%, with expensive nonprime mortgages soaring 169%, according to the Federal Financial Institutions Examination Council.

An examination of that borrowing spree by The Wall Street Journal reveals that it wasn't simply the mortgage market at work. It was fueled by a campaign by low-income housing groups, Hispanic lawmakers, a congressional Hispanic housing initiative, mortgage lenders and brokers, who all were pushing to increase homeownership among Latinos...

When the national housing market began unraveling, so did the fortunes of many of the new homeowners. National foreclosure statistics don't break out data by ethnicity or race. But there is evidence that Hispanic borrowers have been hard hit. In part, that's because of large Hispanic populations in areas where the housing bubble was pronounced, such as Southern California, Nevada and Florida.

In U.S. counties where Hispanics account for more than 25% of the population, banks have taken back 6.7 homes per 1,000 residents since Jan. 1, 2006, compared with 4.6 per 1,000 residents in all counties, according to a Journal analysis of U.S. Census and RealtyTrac data...

...a close look at the network of organizations pushing for increased mortgage lending reveals a more complicated picture...Lawmakers and advocacy groups pushed hard for the easy credit that fueled the subprime phenomenon among Latinos. Members of the Congressional Hispanic Caucus, who received donations from the lending industry and saw their constituents moving into new homes, pushed for eased lending standards, which led to problems.

Mortgage lenders appear to have regarded Latinos as a largely untapped demographic. Many were first or second-generation U.S. residents who didn't own homes. Many Hispanic families had multiple wage earners working multiple cash jobs, but had no savings or established credit history to allow them to qualify for traditional loans...

Mortgage brokers became a key portion of the lending pipeline. Phi Nguygn, a former broker, worked at two suburban Washington-area firms that employed hundreds of loan originators, most of them Latino. Countrywide and other subprime lenders sent account representatives to brokerage offices frequently, he says. Countrywide didn't respond to calls requesting comment.

Representatives of subprime lenders passed on "little tricks of the trade" to get borrowers qualified, he says, such as adding a borrower's name to a relative's bank account, an illegal maneuver. Mr. Nguygn says he's now volunteering time to help borrowers facing foreclosure negotiate with banks.

Many loans to Hispanic borrowers were based not on actual income histories but on a borrower's "stated income." These so-called no-doc loans yielded higher commissions and involved less paperwork...

These days, James Scruggs of Northern Virginia Legal Services is swamped with Latino borrowers facing foreclosure. "We see loan applications that are complete fabrications," he says. Typically, he says, everything was marketed to borrowers in Spanish, right up until the closing, which was conducted in English.

Click here for full story.

Diagnosing (economic) depression

With all the rhetoric (and blog posts) about a potential economic depression, The Economist offers a means to diagnose the differences between a recession, a depression and a Great Depression. From the story:

THE word “depression” is popping up more often than at any time in the past 60 years, but what exactly does it mean? The popular rule of thumb for a recession is two consecutive quarters of falling GDP. America’s National Bureau of Economic Research has officially declared a recession based on a more rigorous analysis of a range of economic indicators. But there is no widely accepted definition of depression. So how severe does this current slump have to get before it warrants the “D” word?

A search on the internet suggests two principal criteria for distinguishing a depression from a recession: a decline in real GDP that exceeds 10%, or one that lasts more than three years. America’s Great Depression qualifies on both counts, with GDP falling by around 30% between 1929 and 1933. Output also fell by 13% during 1937 and 1938. The Great Depression was America’s deepest economic slump (excluding those related to wars), but at 43 months it was not the longest: that dubious honour goes to the one in 1873-79, which lasted 65 months...

Before the 1930s all economic downturns were commonly called depressions. The term “recession” was coined later to avoid stirring up nasty memories. Even before the Great Depression, downturns were typically much deeper and longer than they are today (see right-hand chart). One reason why recessions have become milder is higher government spending. In recessions governments, unlike firms, do not slash spending and jobs, so they help to stabilise the economy; and income taxes automatically fall and unemployment benefits rise, helping to support incomes. Another reason is that in the late 19th and early 20th centuries, when countries were on the gold standard, the money supply usually shrank during recessions, exacerbating the downturn. Waves of bank failures also often made things worse.

But a recent analysis by Saul Eslake, chief economist at ANZ bank, concludes that the difference between a recession and a depression is more than simply one of size or duration. The cause of the downturn also matters. A standard recession usually follows a period of tight monetary policy, but a depression is the result of a bursting asset and credit bubble, a contraction in credit, and a decline in the general price level. In the Great Depression average prices in America fell by one-quarter, and nominal GDP ended up shrinking by almost half. America’s worst recessions before the second world war were all associated with financial panics and falling prices: in both 1893-94 and 1907-08 real GDP declined by almost 10%; in 1919-21, it fell by 13%...

Where does that leave us today? America’s GDP may have fallen by an annualised 6% in the fourth quarter of 2008, but most economists dismiss the likelihood of a 1930s-style depression or a repeat of Japan in the 1990s, because policymakers are unlikely to repeat the mistakes of the past. In the Great Depression, the Fed let hundreds of banks fail and the money supply shrink by one-third, while the government tried to balance its budget by cutting spending and raising taxes. America’s monetary and fiscal easing this time has been more aggressive than Japan’s in the 1990s.

However, these reassurances come from many of the same economists who said that a nationwide fall in American house prices was impossible and that financial innovation had made the financial system more resilient. Hopefully, they will be right this time. But this crisis was caused by the largest asset-price and credit bubble in history—even bigger than that in Japan in the late 1980s or America in the late 1920s. Policymakers will not make the same mistakes as in the 1930s, but they may make new ones.

Click here for full story.

10 questions on the housing market

Last month I was asked by the North American Retail Hardware Association to answer 10 questions about the housing market in 2009 for the January issue of the association's magazine, "Hardware Retailing."

You can find .pdf version of the article by clicking here, but I've also republished these 10 questions and answers below:

1. What can and should the Obama administration and Congress do to turn around the stalled housing market?

While I would expect to see a continuation of some solutions that the Federal Reserve, Congress and the White House has been attempting to address a stalled market and rising foreclosures, I think an Obama Administration will begin to take a more active role instead of the all-volunteer ideas espoused so far.

First, both the Hope for Homeowners and FDIC programs will only help buyers behind on their mortgages, so it completely ignores homeowners who are struggling to keep up with payments on credit cards, drawing down savings, or borrowing from relatives. That needs to change.

Secondly, I keep hearing rumors of the FHA working with the same sub-prime lenders that led to the outsized boom in the first place. Since we can ill afford to have FHA fall like another mortgage domino, the Obama Administration needs to appoint a mortgage regulatory czar and provide adequate funding to root out fraud and corruption wherever it exists.

Thirdly, laws will need to be passed to allow mortgage servicers to modify loans so they’re not sued by the multiple investors who own mortgage securities. Currently, servicers are prohibited to make any changes that could materially and adversely impact these bond holders. For example, if servicers could offer a shared-appreciation mortgage in which buyers give up future equity gains in exchange for a more affordable loan, both lenders and borrowers could benefit. As an added bonus, those buyers who can afford to continue to make payments but are under water may think twice before asking for loan modifications.

Fourthly, it looks like the Obama Administration will likely change bankruptcy laws to allow judges to modify mortgage loans at risk of foreclosure, also called a ‘cram down.’ This could include reducing principal, interest rates, or extending the mortgage term. Whatever their solutions, I would not expect to see them continue to be voluntary, because those ideas haven’t worked very well so far. And why should they? No one wants to volunteer to lose money!

2. Are you in favor of first-time home buyer tax credits or providing a government buy-down of mortgage interest rates for home purchases? What other consumer housing incentives should be adopted?

I’m in favor of incentives that work and achieve the goal of re-starting a largely frozen market. The problem with the existing $7,500 tax credit is that it’s more of a loan that has to be paid back as opposed to a genuine credit for taking the risk of buying a home, so it’s done very little to spark the market. Home builders are now floating the idea of a larger tax credit that would never have to be paid back, thereby giving buyers an additional incentive to buy now as opposed to later, and the National Association of Realtors supports keeping the credit at the current level but also removing the requirement that it be paid back.

Similarly, any rate buy-downs would probably need to have some clear termination date – such as mid-2009 – in order to move potential buyers off the fence today. Some other incentives that might work include allowing buyers to immediately use that tax credit money for a down payment, re-instituting down payment assistance programs that are tied to buyers’ credit ratings, and making permanent higher FHA loan limits in high-cost areas that could re-set next year to lower levels. Of course that also assumes that FHA underwriters are closely monitoring buyers’ ability to pay off these pricier mortgages.

3. Will we start to see the housing market turn around during 2009 or will recovery be delayed until 2010?

Since we’re already seeing existing home sales in certain markets starting to rebound due to dramatically lower prices, I think you’ll see a pricing floor sometime towards the end of 2009. However, once that occurs you’ll probably see prices stay flat through 2010 and 2011 and start to rise again by 2012. I guess it really depends on your definition of ‘recovery.’ For the new housing market, I don’t think you’ll see any meaningful increase in starts until 2010.

4. What are the projections for housing starts and existing home sales in 2009 and 2010?

That depends on who you ask. The National Association of Realtors, the trade group for real estate brokers, is projecting a rebound for existing home sales of nearly 5% in 2009 to 5.19 million. Of course this follows two years of declines of over 12% in home sales. By 2010, the NAR is saying that sales will rise by another 7% to 5.55 million as pent-up demand from the past few years begins to be met.

The NAR is also projecting housing starts to continue falling in 2009 by nearly 22% as builders keep the lid on new releases while mopping up inventory, which would total about 731,000 units. They’re saying a rebound for starts won’t occur until 2010, and even then it will be fairly weak, approaching a rise of 6% to 772,000 units.

Not surprisingly, the trade group representing U.S. home builders, or the National Association of Home Builders, is a bit more bullish on the timing and trajectory of an improvement in home building activity. Their chief economist, David Seiders, is projecting annualized housing starts to hit bottom at 740,000 units in the first quarter of 2009 before rising to 835,000 units by the end of the year. But it’s really 2010 that he’s eyeing, projecting 1.1 million housing starts by the end of the year.

I’d say the reality lies somewhere in between the two groups: not as rosy as NAHB would hope, but it’s possible that a rebound will be more pronounced than the NAR is projecting. Nonetheless, builders should not be looking for the types of rebounds they’ve experienced in the past – this recovery will take longer and be much more gradual than in the past.

5. Affordability conditions have long been a driving factor in housing sales. What is the outlook for affordability in 2009?

The outlook for home affordability in 2009 will be better than it’s been in four years. While no one likes to see the value of their homes decline, in the long run the marked improvements in affordability will provide the best engine for a market rebound. With short-term interest rates at new lows and the government suggesting they’re examining ways to bring rates for 30-year mortgages down to just 4.5%, 2009 could prove to be a great time to buy for those who see housing as a long-term investment.

According to the Housing Opportunity Index produced by the NAHB and Wells Fargo Bank, 56.1% of all new and existing homes sold during the third quarter of 2008 were affordable to families earning the national median income of $61,500. At the peak of the housing boom, that same index stood at just 40.4%, so in just four years national affordability has risen by over 16 percentage points.

Of course these affordability numbers vary greatly by region. In places like Ohio and Michigan, 80% to 90% of families can afford the median-priced home, whereas in certain markets such as New York, San Francisco and Los Angeles, affordability ranges from 10% to 20%. Yet in previous ‘bubble’ places such as California’s San Diego or Ventura County, affordability has skyrocketed to well over 30% as prices have plummeted.

Looking forward to 2009, if median prices continue to fall 10% to 15% as many economists forecast and rates stay low, affordability will only continue to improve, especially for the first-time buyer.

6. With the government taking control of Fannie Mae and Freddie Mac, what impact will that have on the housing industry and the ability of consumers to get a mortgage?

In theory, the government nationalization of these two mortgage giants was necessary to prevent a total melt-down in the mortgage market. After all, once the private mortgage insurers started pulling out of the market, Fannie and Freddie were forced to back up to 80% of the mortgage market, which caused fees to consumers to rise.

With the government now attempting to re-energize the mortgage securitization market and investing $200 billion in the companies, buyers should look for lower rates, reduced fees, more wiggle room for buyers at risk of foreclosure, and some type of stabilization in housing prices versus a complete free-fall. The downside, of course, is to the U.S. taxpayer, who will ultimately pay higher taxes and face cuts in federal services to fund these bailouts. Ultimately, the goal is to prompt private mortgage insurers to re-enter the marketplace, but that won’t happen until the foreclosures have been adequately addressed.

7. Which areas of the country have been impacted the most by the housing crisis? Which areas have been least affected?

The areas most impacted by the housing boom – and bust – have been the sun belt states such as California, Nevada, Arizona and Florida where you saw more over-building and speculative activity. To a certain extent, mini booms – and busts – were also evident in the Washington, D.C. area (which also includes Maryland and Virginia), Boston and some suburbs of New York City. And then of course you’ve got a state such as Michigan, whose housing market has been suffering not due to speculative activity, but because it’s part of the ‘rust belt’ and is directly impacted by troubles in the automobile industry.

One state that was seemingly immune to the housing bust was Texas, although its sales have also been declining recently due to the tighter credit environment. Yet once credit starts to flow more freely, Texas should rebound quickly as well as many parts of the mid-west, much of the northwest and the southeast. Although the housing bust was to a certain extent a national phenomenon, its impact continues to be disproportionately felt in the sun belt states noted earlier.

8. Do you have any insights into when home prices will hit bottom and begin increasing in value again?

The silver lining of rising foreclosures – which now account for 40% of the market nationally – is that they’ve forced prices down faster for existing homes than what’s been experienced in previous downturns. Consequently, many experts believe that home prices in many markets will hit bottom by the end of 2009, whereas other areas won’t hit that trough until 2010. Moreover, whereas many areas will experience another 10% to 15% decline, some regions that are still priced too high relative to incomes or achievable rents may see steeper declines over the next two years. Bear in mind, however, that these estimates are for entire regions – in certain exurbs of major metropolitan areas, the damage has already occurred and you may not see further pricing declines.

As for increasing in value again, this recession is likely to turn into something more ‘u-shaped’ than ‘v-shaped,’ and what that means for housing prices is a lengthy bouncing along the bottom until late 2012. However, in those areas in which foreclosed inventory is quickly mopped up by investors, with builders dramatically cutting down on new supply, prices may firm up and begin to rise – albeit slowly – prior to 2012.

9. As a general rule, when the housing market slumps the home remodeling market picks up, but that has not been the case during the current slowdown. Are there any hopeful signs that remodeling activity will pick up in the near term?

Another big difference with this housing slump versus past ones is that in order to keep their skeleton crews on staff, home builders are increasingly taking on remodeling work. What this means for existing remodelers is an even tougher environment at a time when the value of home owner improvements fell by 4% in 2007. In 2008, according to Harvard’s Joint Center for Housing Studies, this decline is expected to more than double to 9% and rise to 11% during the first quarter of 2009. And, since the remodeling industry grew by 40% in the last cycle, it’s expected to lose about one-third to one-half of that gain in this slump.

Despite these declines, since they’re less than the declines impacting the home building industry – which are off by 65% since the start of 2006 -- builders still see it as a comparatively safe business.

In fact, according to the NAHB, half of the builder members are now taking on remodeling jobs, and once they start up these divisions it’s unlikely that they’ll shut them down when the market improves. If anything, they make keep them around to help bolster the bottom line when the market slumps again. For existing remodelers, this might be a good opportunity to reach out to home building companies for joint venture or strategic partnership arrangements, because when the market rebounds, it’s expected to grow at a 4% annual clip.

Looking ahead past the slump, given the increasing age of the country’s existing housing stock and demographic shifts that support remodeling, the value of remodeling jobs is expected to approach $400 billion by 2015, or closing in on the estimated $455 billion in new construction. By 2020, it’s quite possible that the remodeling industry could even eclipse the value of new homes built annually.

10. Builder confidence continues to decline as overall uncertainty about the economy negatively impacts consumer behavior. Will builders experience increased difficulty in securing access to necessary capital or will the credit markets begin to open up soon?

That largely depends on whether a builder is public or private. For private homebuilders, the relationship between them and their lenders has become so strained that over 140 builders throughout the country have teamed up to form the Building Industry Coalition for Economic Recovery. One of their primary goals is to force lenders to allow them to finish up existing projects rather than force them into foreclosure, which they say can mean a huge difference on the value they can extract from the project (i.e., 40 to 60 cents on the dollar versus 20 to 30 cents).

More recently, builders have asked for congressional support for mortgage ‘cram downs,’ in which bankruptcy judges will be allowed to modify loan terms in order to prevent foreclosures. This marks a sharp reversal for home builders, who previously resisted this idea because it would alienate lenders. Yet given the strained relationships with their own construction lenders and President-elect Obama’s support of such an idea, we might see ‘cram down’ legislation enacted in 2009. In addition, an Obama Administration might start attaching strings to bailing out banks, thereby forcing them to open the lending spigots to businesses including home builders instead of hoarding it as cash reserves.

David Lereah's lame mea culpa

Remember the ridiculously bullish David Lereah, Chief Economist for the National Association of Realtors, who penned books urging people to buy homes because nothing bad would ever happen to the real estate market? Money magazine has a brief interview with Lereah, in which he defends his tenure with the NAR by mostly pointing to his need for remaining employed. From a CNNMoney.com story:

Q. Were you wrong to be so bullish?

A. I worked for an association promoting housing, and it was my job to represent their interests. If you look at my actual forecasts, the numbers were right in line with most forecasts. The difference was that I put a positive spin on it. It was easy to do during boom times, harder when times weren't good. I never thought the whole national real estate market would burst.

Q. The NAR's latest forecast calls for a slight increase in home prices next year. Thoughts?

A. My views are quite different now. I'm pretty bearish and have been for the past year and a half. Home prices will continue to drop. I think we'll see a very modest recovery in sales activity in 2009. But we've still got excess inventories, a bad economy and a credit crunch that will push prices down further, another 5% to 10% more. It'll take a long time to get back to the peak prices we saw in many markets.

Q. Any regrets?

A. I would not have done anything different. But I was a public spokesman writing about housing having a good future. I was wrong. I have to take responsibility for that.

Will 2009 be the year of mortgage cram-downs?

The pressure to allow bankruptcy judges to modify loans on principal homes is continuing to grow as voluntary measures by lenders to make existing mortgages more affordable to homeowners in arrears is continuing to build. With the new Obama Administration taking office in just a few weeks, pundits are thinking that allowing judges to make these modifications -- including 'cramming' down the principal and forcing lenders to take the loss -- will be part of the next stimulus plan. From a Wall Street Journal story:

In a cram-down, a judge modifies a loan, often reducing principal so a borrower can afford it. Lenders hate it because they have to absorb the loss. Bankruptcy judges currently have the ability to modify certain personal loans and even mortgages on vacation homes, but they can not cram-down mortgages on primary residences.

Even staunch opponents acknowledge that mortgage cram-downs for primary residences are likely to be as part of Congress's economic-stimulus package in early 2009. The National Association of Home Builders used to reject any bill with a cram-down provision outright. Now it is saying the measure is worth a look...

The latest embattled foreclosure-prevention program is Hope for Homeowners, which was approved by Congress last summer and supposed to help 400,000 homeowners. Only 357 people have signed up so far for the voluntary program. The Department of Housing and Urban Development, which is administering the program, acknowledges that it has been encumbered by high fees and narrow eligibility requirements.

Another government program, FHASecure, was intended to help 80,000 homeowners who had fallen behind on their payments after their adjustable interest rates reset. It has helped only 4,100 delinquent borrowers refinance since September 2007 and will stop taking new loan applications as of Wednesday.

Mortgage lenders also are modifying tens of thousands of loans without government help. But often this hasn't solved the problem. A report last week by the Office of the Comptroller of the Currency and the Office of Thrift Supervision found that nearly 37% of mortgages modified in the first quarter of 2008 were 60 days or more delinquent after six months.

"It is absolutely clear that voluntary modification is just not working," says Rep. Brad Miller, a North Carolina Democrat. "Every plan that Congress has passed, we do it and nothing happens."...

Proponents of bankruptcy reform also note that millions of troubled loans aren't being addressed by current modification programs because they were carved up and sold to investors as securities. Mortgage servicers have been reluctant to aggressively modify these loans because they have been unsure of their legal rights.

The mere threat of mortgage cram-downs could break the standoff between mortgage servicers and mortgage investors, which has slowed aggressive loan modifications. Investors may be more willing to go along with industry-driven modifications when facing the threat that a judge could ultimately order the amounts of loan principals reduced, forcing them to eat bigger losses...

Click here for full story.

New Year's Resolution #1: A Respect for the Truth

Recently, I was talking with a reporter and well-known blogger in Orange County, California who told me a story of an in-house market research analyst for a major home builder whom he met at a local soccer game during the tail end of the housing bubble. “I really envy what you do for a living,” he told the reporter. “You get to tell the truth.”

Having worked not just for various real estate consulting companies but also for a public home builder and a large land developer in my building industry career, I knew exactly what this guy meant. With internal pressures to hit certain targets for prices and absorption, failing to help make a division president’s pet projects see the light of day could otherwise mean the end of an interesting and well-paying job.

When I first started writing market studies in the late 1980s, figuring out the demand for new homes in specific price ranges was a requirement for a full-fledged analysis. But by the late 1990s, as the market began to rebound and public home builders snapped up local companies, the only data many clients wanted to see were the prices and sales velocity of their top competitors. Suddenly, it seemed, the most important factor in determining the potential success of a multi-million dollar development – future demand based on employment and household growth, population influx and incomes -- was rendered irrelevant.

Yet even as an outside consultant with an established company, the constant pressures to bring in revenue often meant a Faustian bargain for colleagues and competitors alike, in which peppering reports with qualifiers such as “if past is prologue” seemed the only practical way to make clients happy while also hitting sales quotas.

Indeed, some companies offering consulting services to developers owe their entire growth strategies to their reputations for providing supposedly objective reports – at least from the unknowing point of view of compliant construction lenders – that would magically hit pre-set targets for prices and sales velocity.

Much like the Wizard of Oz, at first glance these reports – which I’ve been recently updating for clients and having to explain the defective original analysis – would hide objectivity behind expertly formatted exhibits, sunny narratives and professionally bound copies on expensive paper. As a finishing touch, articulate company leaders leading seminars at industry functions could provide a patina of objectivity so few would ever question their methods and ethics. Today, however, one only needs to follow the trail of bankrupt land development deals and mothballed projects to see the true consequence of such financial sleight of hand, in which an entire industry must pay the price.

One company which soared during the boom did so due to its reliance on ‘econometric modeling’ (a fancy word for statistics) and some admittedly impressive but off-the-shelf software that allows clients to alter recommended prices based on changes in interest rates, existing home prices and other factors. By charging several times the typical rate for market studies and declaring all staff members to be in the “Top 5% IQ in the country” (with no apparent proof to back up the claim), the firm would provide clients with Bible-sized reams of data comparing proposed projects against not just direct competitors, but also home sales by zip codes, submarkets and county regions. Recommended prices were ultimately determined not by an experienced consultant who knew why Builder A could command a premium over Builder B, but by simply averaging averages: if this is the average price from this zip code and among these competitors and from this county, then here’s your price. Next!

I know for a fact that I lost a lot of potential business during the end of the boom years because I wasn’t willing to sacrifice my long-term reputation for financial expediency. So when I heard Dr. Christopher Thornberg (then with the UCLA Anderson Forecast) speak in 2005, I introduced myself and thanked him for being courageous and strong enough to point out what he thought was obvious. When he left UCLA and co-founded Beacon Economics, I knew this was a company which shared my values regarding complete and total honesty when conducting economic analysis.

Today, besides being a trusted partner to MetroIntelligence, Beacon has emerged as a primary source to national and local press, trade groups, home builders, developers, Wall Street institutions and municipalities for the unbridled truth on the economy and the fate of the housing market. Rather than warning about the bust to come, they’re now talking about how and when to prepare for the rebound. And finally being able to tell the unvarnished truth to clients willing to listen has never been so important.

Here's hoping 2009 marks a return to a long-term respect for the truth so another housing bust like this doesn't reappear. Happy New Year and good riddance to 2008!

Office market imperiled for 2009

It looks like the next real estate domino to fall (after housing, retail and hotels) will be office space, with every market in the U.S. to suffer rising vacancies and falling rent. From a New York Times story:

Vacancy rates in office buildings exceed 10 percent in virtually every major city in the country and are rising rapidly, a sign of economic distress that could lead to yet another wave of problems for troubled lenders.

With job cuts rampant and businesses retrenching, more empty space is expected from New York to Chicago to Los Angeles in the coming year. Rental income would then decline and property values would slide further. The Urban Land Institute predicts 2009 will be the worst year for the commercial real estate market “since the wrenching 1991-1992 industry depression.”

Banks and other financial companies have not had the problems with commercial properties in this recession that they have had with residential properties. But many building owners, while struggling with more vacancies and less rental income, will need to refinance commercial mortgages this year.

The persistent chill in lending from banks to the credit markets will make that difficult — even for borrowers who are current on their payments — setting the stage for loan defaults.

The prospect bodes ill for banks, along with pension funds, insurance companies, hedge funds and others holding the loans or pieces of them that were packaged and sold as securities...

Click here for full story.

The end of the 'McMansion?'

When my younger brother was recently visiting for the holidays, he was expressing disdain for a well-known film producer with an enormous home measured in the tens of thousands of square feet. In the interests of family peace, I decided not to remind him of his own 4,000-square-foot, 3-level McMansion on a 1/3-acre plot of land near Philadelphia, which he now admits is much more home than he needs for a family of four.

But I think he's onto something -- having experienced the associated costs with owning and maintaining a large home, the housing bust is now having an impact on the very design of homes. Since it stands to reason that builders must innovate if they expect buyers to purchase new homes rather than the perfectly good 3-year-old homes built by the same companies, what might new homes look like over the next few years? A story in the L.A. Times ponders the question:

...History hints that this downturn could change our tastes. Homes built in the 1940s and '50s, for example, were usually smaller and simpler than large, frilly Victorians that had been in style before the Great Depression and World War II. Materials remained scarce for years after the war, and returning veterans, boosted by mortgage assistance provided under the GI Bill of Rights of 1944, bought Levittowns full of simple new houses as quickly as they could be made.

Virginia McAlester, author of the classic "A Field Guide to American Houses," said that after this recession she expects smaller homes built closer together, but with more attention to their positioning on the lot to better preserve privacy and the occupants' access to a little spot of nature...

"We are going to have far more small houses and attached houses," she predicted. The cost of building the roads, sewers and utility lines to serve compact neighborhoods is lower. Soundproofing will become more important when buyers are living closer to their neighbors or to retail and commercial properties...

Some large suburban houses might be turned into multifamily homes, just as many large homes of the late 1880s and early 1900s were converted into duplexes once lifestyles grew more spare.

"There is actually a pattern of building out there that is called manor houses," she said. From the front, they look like traditional houses, with a single entry. But the structure may incorporate two to five homes within, with separate entries tucked away on the sides of the building. "It's been found to be a way of putting affordable housing into an area," McAlester said.

Certainly that would provoke NIMBY wars and probably require changes to some local zoning laws, but breaking up homes into many units could be a way to preserve values if there aren't enough people willing to bear the burden of big-house upkeep by themselves.

Click here for full story.

The real price of printing money for bailouts

I've been reading a lot lately about the impact of these bailouts to the economy, with many pundits predicting future inflation once the current round of deflation eases as inventories of homes, cars and other goods are absorbed and financial deleveraging continues. Eventually, a much higher level of dollars sloshing around the global economy will be chasing fewer goods and places in which to invest. From a New York Times story:

...it may seem perverse that in this new era of reckoning — with consumers finally tapped out, government coffers lean and banks paralyzed by fear — many economists have concluded that the appropriate medicine is a fresh dose of the very course that delivered the disarray: Spend without limit. Print money today, fret about the consequences tomorrow. Otherwise, invite a loss of jobs and business failures that could cripple the nation for years...

But where does all this money come from? And how can a country that got itself in peril by borrowing and spending without limit now borrow and spend its way back to safety?

In the case of the Fed, the money comes from its authority to print dollars from thin air. Since late August, the Fed has expanded its balance sheet from about $900 billion to more than $2.2 trillion, creating $1.3 trillion that did not exist to replace some of the trillions wiped out by falling house prices and vengeful stock markets. The Fed has taken troublesome assets off the hands of banks and simply credited them with having reserves they previously lacked.

In the case of the Treasury, the money comes from the same wellspring that has been financing American debt for decades: Investors in the United States and around the world — not least, the central banks of China, Japan and Saudi Arabia, which have parked national savings in the safety of American government bonds.

Americans have gotten accustomed to treating this well as bottomless, even as anxiety grows that it could one day run dry with potentially devastating consequences...

Since the Great Depression, the conventional prescription for such times is to have the government step in and create demand by cycling its dollars through the economy, generating jobs and business opportunities. That such dollars must be borrowed is hardly ideal, adding to the long-term strains on the nation. But the immediate risks of not spending them could be grave...

The most frequently voiced worry about the bailouts is that the Fed, by sending so much money sloshing through the system, risks generating a bad case of rising prices later on. That puts the onus on the Fed to reverse course and crimp economic activity by lifting interest rates and selling assets back to banks once growth resumes. But finding the appropriate point to act tends to be more art than science. The Fed might move too early and send the economy
back into a tailspin. It might wait too long and let too much money generate inflation...

But that, as most economists see it, is a worry for another day. Some policy makers are focused on staving off the opposite problem — deflation, or falling prices, as demand weakens to the point that goods pile up without buyers, sending prices down and reducing the incentive for businesses to invest. That could shrink demand further and perhaps even deliver the sort of downward spiral that pinned Japan in the weeds of stagnant growth during the 1990s.

Click here for full story.

Barratt American files for bankruptcy

Private home builder Barratt American, based in San Diego County, CA, has finally filed for bankruptcy protection after months of wrangling with its lenders, chiefly Bank of America. From a BigBuilderOnline.com story:

On Christmas Eve, coal filled the stocking of Barratt American Inc., as the company filed for Chapter 11 protection in the U.S. Bankrupcty Court for the Southern District of California.

Mick Pattinson, president of Barratt American, said the company will "continue to build custom homes and fire replacement homes as we sell existing assets and reorganize our company with a view to re-commencing new-home construction in 2010. We do not foresee any recovery in the housing market that would prompt speculative home development in 2009."...

According to Pattinson, the trouble started when, after a 27-year relationship, Bank of America froze the company's credit lines in August 2007. The bank has since foreclosed on 11 of Barratt American's assets, Pattinson added...

In June, Pattinson formed the Building Industry Coalition for Economic Recovery to promote awareness of what he saw as "bad behavior" by banks serving the home building industry. To date, there are 154 coalition members who, according to Pattinson, are "victims of contrived defaults and made to order appraisals as banks disengage themselves from residential lending and instead pursue builders for recovery and fulfillment of personal guarantees."...

Barratt American has been a key Californian home builder for more than 25 years. In 1991, Pattinson became president and CEO of Barratt American, a wholly-owned subsidiary of U.K.-based Barratt Group. In 2004, Pattinson purchased the North American operations of the company for $165 million.

A sad day indeed. Barratt built a nice, high-quality home and was once a regular client of mine. I'm hopeful they'll return better and stronger for the rebound.

Optimistic economists?

Even though we are clearly now in the worst recession since the 1930s, economists surveyed by Blue Chip Economic Indicators -- such as those working for investment banks, trade association and large companies -- are now viewing 2009 with some optimism and declaring the worst to be behind us. From a New York Times story:

If the dominoes fall the right way, the economy should bottom out and start growing again in small steps by July, according to the December survey of 50 professional forecasters by Blue Chip Economic Indicators. Investors seemed to be in a similarly optimistic mood on Friday, bidding up stocks by about 3 percent. But in the absence of that government stimulus, the grim economic headlines of 2008 will probably continue for some time, these forecasters acknowledge...

Even if the economy begins to right itself by this summer, the recession would still be the longest since the 1930s, which was the last time the government engaged in widespread public spending to overcome the persistent inertia in consumer and business spending...

Still, it's important to remember that most of these economic forecasts are based on computer models -- the same kind that completely missed the misery of 2008. That's because although economics is based on numbers -- and therefore lends itself to mathematical formulas -- since it's really a study of human behavior, such models can easily miss swift changes in consumer sentiment and other factors.

Click here for full story.

Good riddance to 2008!

Was 2008 the worst year for most people under age 70? A story at Bloomberg ponders the question:

This wasn’t just a bad year for the economy. By some measures, it was the worst year any American under age 70 has ever seen.

The loss of jobs in the U.S. may be the biggest since the end of World War II. This year’s declines in stock and home prices haven’t been exceeded since the Great Depression. The slump in holiday spending may set a record; foreclosures already have. Credit markets seized, halting the longest expansion in consumer purchases.

Europe and Japan also sank as U.S. demand faltered, marking the first simultaneous recessions since the Second World War ended. High-flying emerging economies, such as China and India, weren’t immune, signaling the world economy is just as interconnected in bad times as in good...

Click here for full story.

"'Twas the Night Before FY"

From HousingCrisis.com, an ode to Fix Housing First definitely worthy of a read for the holidays:

‘Twas the night before FY, we’re now at the bar.
Our guidance is dreadful; we’re no NVR.
And fresh off a WebEx with dame Ivy Z,
We’ve spun metrics, pro formas, even fibbed a degree.

First-time buyers are mirages, our banks are a mess,
And privates are all creaking with signs of distress.
The free-markets free-fall, the jobless claims mount,
FCF’s but a trickle, backlog’s down for the count...

Click here for full poem.