Chuck Ponzi May 22nd, 2005

Recently, a rash of new stories on real estate bubbles has hit the market. What’s interesting about this, is I remember a time, only 1 year ago, that the mere mention of the word “bubble” by the press would have elicited sneers, snickers, and full belly laughter by many.
In the meantime, Warren Buffet, Alan Greenspan, and even the National Association of Realtors President have outright admitted some housing bubbles exist. In recent months, since my blog began, there are so many articles highlighting the US problem, it is reaching a fairly sizable din. If you haven’t heard about the housing bubble debate, you must be hiding under a rock.
Some observations I made in previous posts deserve a turn, so I will add some additional thoughts:
1. Disinformation:
Alan Greenspan commented on “housing bubbles” on May 20th.
This article comments on the discussion and is titled “Greenspan Sees Bubbles in Housing”
This article comments on the EXACT SAME DISCUSSION, using the EXACT SAME QUOTES, but is titled… you guessed it: “Greenspan sees no housing bubble”
If that isn’t disinformation, I don’t know what is… in fact, even in the latter one that denies the bubble, the following is quoted from Greenspan, “it’s hard not to see … that there are a lot of local bubbles”.
2. Last ones in are the greatest fools: (high volume, even higher inventory)
SANDICOR recently posted their statistics for sales & listings in April 2005. Not surprisingly, sales volume was almost exactly where it was 1 year ago, on top of the world. (See my post on March’s numbers). And… just as I predicted, listing volume is off the charts. I stated in March that we had not had 7K listings in March on Sandicor’s history. Well, the plot thickens; April had over 7K listings as well! Both of these months had never broken 6K before. What this means, with interest rates rising, it will only get worse. The last people who buy, they are the greatest fools.
3. Unsustainable lending, and the coming credit debacle
This article provides the statistical proof of what we knew all along… consumers AND loan brokers are participating in extremely risky behavior with little or no consequence to the broker. The proof: Interest only loans financed nearly 70% of the home purchases in San Francisco, Marin, and San Mateo counties the first 2 months of this year.” This is up from 18% in 2002.
Need I say more?
What does all this mean? We are coming to the final stages of the bubble. We all see the writing on the wall, but what keeps the engine going? The quote says it best, “Humans are driven by 2 things, fear and greed, right now both are working perfectly.”

• Uncategorized
• Comments(6)

Chuck Ponzi May 9th, 2005

While I do not claim to be a professor of finance, it is worthy to note some recent financial reports, as well as reflect on what these mean. I am referring to the recent rash of “condo conversions” happening throughout Southern California.

In May 1998, the American Enterprise Institute for Public Policy research held a conference, and several great thoughts came from the transcripts of these meetings. Here is a summary of this conference. I will point out some thoughts from Lawrence Lindsey at that conference:
1. Prior to 1930, “business cycles” were quite common
2. Expansion would lead to speculation, speculation leads to overcapacity, overcapacity leads to bankruptcies
3. Assets would pass from weak hands to strong ones, and the process would begin again
4. Typically, these cycles lasted about 5 years.
5. We have convinced ourselves that public policy could do away with these “cycles”
6. Bankruptcy is an efficient way for assets to pass from weak hands to strong hands.

One of the most important observations that he makes is that at the bottom of the cycle, assets pass from weak hands to strong hands. To state it another way, through the ensuing upswing, either the entities that hold the assets become weak (not intending to hold the asset), or weak hands acquire the asset (pure speculation). For a definition of weak and strong hands, look here. Therefore, one signal of an asset bubble is that assets could be passing from strong hands to weak hands.

An internet acquaintance, Professor Piggington, did a great job of elaborating some recent reports that an increase in the number of condo conversions has signaled some concern in the real estate investor community. His thoughts are posted here. Basically, the strong hands of well financed real estate investors and well educated rental owners are realizing that the discounted future cash flows of their investments could never support the current valuations of their properties. Therefore, they are “cashing in” their investments and converting them to condominiums. This, in a sense, locks in all of their future profits, and allows them to invest their earnings into lower risk investments with a higher return (such as t-bills).

Most people have recently heard reports in newspapers about self-confessed up-and-coming real estate moguls in their 20’s and 30’s. While this smacks of dot com mania, it is worthy to note that not a single one ever mentions cash flow valuations as a means of testing their investment, but rather state something to the effect of: “I cover my expenses, and my properties keep going up in value”. Honestly, I think it is hard for them to imagine bad paying tenants, frequent evictions, plugged toilets, or negative cash flows in perpetuity, much less all at one time. All realistic and successful investors understand the assets where they put their money, and don’t have rose colored glasses that filter out the negatives… There are always negatives and positives to every investment and there is no such thing as a perfect investment vehicle. The new landlords and multiple property owners are weak hands.

What the conference in 1998 does not specifically state is something that we all know… It is at the top of the market that strong hands pass assets to weak hands. Their understanding of their asset class allows them to see the intrinsic value of the asset, and justify its valuation. Any value above that reasonable valuation prompts them to divest and claim their immediate profits.

A good example would be seeing HIG trading at 15X Earnings. Historically, it has reached that point, but it’s a boring asset, pays cash dividends that are reasonable, and growth only supports multiples in the 9X to 12X range. Cashing out at 15X allows someone to take that money and put it into lower risk investments.

As a final thought, I urge my readers to consider what they are, strong hands or weak hands.

• Uncategorized
• Comments(1)

Chuck Ponzi May 6th, 2005

I just love this guy John Karevoll from Dataquick Information Systems. He gives me so much material, I get better mileage than a Prius. I just wish I could get sound bytes from this, because I would love to listen to it later.

I just saw another article where he was quoted in comments about the affordability in Los Angeles. He says: “It’s an interesting number but for the past two years or so, it hasn’t really meant anything to tell anybody anything … Statistics should either predict something or explain it, and this doesn’t do any of those things.”

I don’t know where to begin with this one. It’s like the holy grail of bubbledom. It reminds me of those during the internet stock bubble that purported that P/E ratios were meaningless in the new economy since there were so many companies that hadn’t provided any earnings or valued somewhere in the over 100 P/E range. I believe what he’s trying to say is that we ought not be concerned that we’re off in uncharted territory, because we’ve been there so long that it doesn’t mean anything any more. Not only does he not understand the basics of what statistics tell us, he fails to recognize a trend staring him in the face.

At first I thought I was reading too much into this comment until I came across this exact thought in an earlier article where he is quoted. I will take the exact 2 quotes that he uses in this article so I don’t bias it in any way, “We are close to uncharted territory for the Los Angeles and Southern California region. We are in uncharted territory in San Diego as far as statistics go…The big question is whether this market will jump off a cliff or come in for a soft landing. By what we’re seeing in San Diego and some subcategories in Los Angeles right now the soft landing scenario is the most likely.” This stuff reads like a comic book. How can we be in uncharted territory, and have a “soft landing”? Wouldn’t the very idea that we are in an unknown position make it such that you wouldn’t be able to comment on the outcome, uh, because, uh, it, uh, is, uh…well… uncharted? Duh.

I have a hard time believing that this guy will ever be able to get a job in the future after this crash. He’s like the many internet stock analysts who called it wrong. His name will go down in history as a puppet for someone else’s gain. He should just call it like it is, and if your boss doesn’t like it, maybe you need to look for another job. You’re not getting rich by making these kinds of idiotic mumblings. John, let me give you some career advice. Don’t go on record any more. Let your boss do the talking before you really get yourself into trouble and you are forced to ‘analyze’ high school toilets for the rest of your life to pay your mortgage.

Soon, Sandicor will be releasing their April statistics, and we can see how much further to that “soft landing” off a cliff will be. We will know that the bubble is almost burst when we see an increase in sales (because of the laggards), but also a much larger increase in inventory. At some point, the inventory will overwhelm the demand, and it’s anyone’s guess how far down we will go. So, go, go, prices go…

• Uncategorized
• Comments(4)

Chuck Ponzi May 3rd, 2005

Several of my visitors have noticed that I missed a week or 2 in my blog, and perhaps were wondering where I had gotten to? Was I deep in research, trapped under mountains of articles about speculative bubbles? No, sorry, I was just on vacation. While on vacation I got to thinking about the characteristics of speculative bubbles, and I came up with several. I will give them a shot, and compare them to the current state of affairs in our fair southern California.
1. You don’t know that the bubble bursts until after it has happened.
I once heard this phrased as, “You don’t know that you’re in a bubble until afterwards,” but I realized how stupid that sounds. What that means is you’re either causing the speculative bubble or at least, a do-nothing bystander. No, this is more akin to “The Tipping Point“. Much like it is nearly impossible to determine as it is happening, the force of certain events (who knew on 9-11 AM that the country would go into recession for several years?), the minute events that occur every day during a speculative bubble, sometimes feed it, and sometimes pop it. It’s all about momentum. Is it possible that housing prices could continue to go up? Yes. It it possible that the popping could be delayed another year or 2 or 3? Yes. Much like the tulip bulb craze in Holland, nearly worthless items can be pumped by speculators to be worth more than an entire estate. Even government intervention couldn’t keep that bubble from consuming the entire economy. The tipping point comes when more savvy investors begin to crystallize their profits by selling than to offset the number of incoming investors. However, we shouldn’t underestimate the vast mania that has gripped not only our country, but many countries throughout the world. Hyped assets are a self-fulfilling prophecy in the short-run. If information transmits fast enough, and transaction costs are held in check, a simple credit bubble in the US could grip then entire planet. Do I think it will? Only time will tell. Warren Buffet recently said “I have no idea on timing. It’s far easier to tell what will happen than when it will happen.”
2. Bubbles always go on longer than prudent investors believe it can
Some have asked whether I think that prices will come down anytime soon. The answer is simple… it depends. Like I mentioned above, it’s all about investor sympathy. Even though you may be enlightened enough to see that the hovels selling in SD are worth half their value, that doesn’t stop 100 other idiots from buying it well above asking price. No, this will take some time to change people’s perceptions. When do I think prices will bottom out, or when a prudent time would be? Well, I would say that it all depends on general sentiment. When people abhor discussions of real estate, say things like “I will never invest in XXX again”, and when no one wants to buy anymore… That’s the bottom. I would say that unless you want to be like those hapless people with a mortgage greater than the value of your home, you’re going to need to wait for at least 4 to 5 years. That’s right. I know it sounds like a long time, but the last bubble in SoCal took 5 years to unwind (1991 to 1996), and I say AT LEAST because this bubble is so much larger than the last. While the fall will be steep and frightening, with perhaps a few stops along the way, don’t get suckered into these bear rallies, they are just people thinking that prices have to stop falling when they buy in… Like their poop doesn’t stink and they can make no mistakes. No, I am looking to hopefully buy again in 2010 at the earliest. This may sound a bit disheartening, so if you don’t want to wait for the bottom, let me offer a piece of advice. Look for what the home could realistically rent for. If this rent could pay a 30 year mortgage (PITI), then you’ll at least have neutral cash flow (also take into consideration improvements and maintenance). I only say this because… After all, a house is not an investment, it is a place to live.
3. Prudent but not contrarian investors begin to avoid the bubbly asset
Prudent investors know that realistic returns of 6 or 8% above inflation is a great return. They also know what most people do not… Take your profits and walk after a good run up. That is what made them great investors. Perhaps one of the greatest investors of all time, Warren Buffet, has said he is avoiding real estate in his Berkshire Hathaway investor meeting on May 2nd. Warren Buffet is perhaps the 2nd wealthiest man in the world, and unlike most of the people in his wealth category, his wealth came primarily from investing. Many scoffed at his belief of a dot com bubble, only to be shown up by his savvy understanding of financial markets.
Another writer asked me to give my thoughts on Bernanke’s “Glut Theory”. Basically, it says that America’s spending problems are not because our savings rate is too low, but that other countries’ savings rates are too high. We are just doing them a favor by taking that money off their hands to buy ourselves H2 Hummers and plasma screen TV’s. While my blog really only deals with the housing/credit bubble, it is inextricable related to the international currency and national monetary markets, fueled by Greenspan’s attempt to avoid a recession in 2001. However, to Bernanke’s theory, I will quote a more eloquent writer’s feeling on this: “According to this theory an alcoholic is merely helping to alleviate a glut of booze…and a sex fiend is only reacting to a glut of women!” The entire article is located here.
While I can’t really devote enough time to a blog that would address all of the issues with the world financial markets, it will all have an impact locally on our real estate because our housing credit is backed by foreign investors through GSE’s. Fixed or floated Chinese currency, Japanese savings rates, and 3rd world country GDP have a lot to do with our housing bubble. Will we come out unscathed? Absolutely not. Will it be as bad as some doomsday predictors think? Probably not. It will likely be somewhere in between. While I am not your financial advisor, I would offer this thought…Think about where you put your money, and consider that there is always, and I mean ALWAYS risk with investments, but that a house should not be an investment.

• Uncategorized
• Comments(0)