Chuck Ponzi October 31st, 2005

A recent review of articles would and should enrage nearly anyone concerned with the housing bubble, housing affordability, and monetary policy.

I will take some time to address tax policy in a later post, however today’s topic comes from a faux-pas of a man in Orange County, Gary Watts. There are so many stupid things said by this foolish little man, it’s difficult to choose which ones to comment on. The realtorspeak is so ingrained in his vocubulary, you would almost expect a picture of him to include a chearleading skirt and pom-poms.
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Home prices, Watts says, will rise 15 percent to 18 percent in 2006. Interest rates will stay flat, but even if they rise, they won’t hurt real estate appreciation.
“I feel real confident,” Watts told the audience at the Old Ranch Country Club in his third such gathering this month. “One year from now … we’ll be able to look at each other and say, ‘Wow! Another 15 percent.’
…
“I only forecast off the numbers,” Watts said. “It’s all based on pure economics.”
For 90 minutes Friday, Watts rattled off an array of numbers to show that job growth and a shortage of housing were key factors in the 1990s bust and are key factors in the current housing boom.
Supplies are tight and will only get tighter, Watts maintained, noting that population growth, demographics and immigration are creating three waves of homebuyers.
He argued further that others give too much weight to an “affordability index” indicating that just 11 percent of Orange County households can afford a single-family home here.
That index fails to take into account the huge number of homebuyers who have large incomes or already own homes they can use to finance a new purchase, he said.
Watts suggested that real estate agents use a new sign on clients’ lawns. To make the point, he held aloft a placard reading: “For Sale – Rich People Only.”
“The affordability index doesn’t work,” he said.
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The ignorance, childishness, and audacity of this man is absolutely stunning.

First, interest rates should stay stay flat, but even if they rise, they won’t hurt real estate appreciation? Has this man been hiding under a rock? Maybe he is saying these things for shock value, kind of like Howard Stern or Tom Leykis. But, can you really claim to be an economist and be this unaware of economics?

Second, inventories are tight? Sir, you are an idiot. What does the inventory doubling over the past 2 months mean? Obviously you are thinking that all of those midwest millionaires are waiting even longer so they can pay even more for your crummy house with only a view of the neighbor’s stucco wall. The people selling must all be other millionaires trading up to even larger stucco boxes. You must really think that other rich people are as slow and dimwitted as yourself. If the vast majority of people could have already bought, they would have.

Third, population, demographics, immigration? Please. That huge sucking sound you hear when you wake up on Saturday mornings? That’s the sound of families packing up Uhauls and exiting the state in mass droves, taking their real estate winnings with them. The people replacing them? Well, let’s just say that they are finding opportunities in a new country having travelled a difficult journey from a land southward. Those buying now are not millionaires waiting to gleefully spend their every dime on a “hill view” in Aliso Viejo. They are overleveraged middle-income Americans on 100% financing, or just rolling over the down-payment from another house to a larger mortgage and larger nut after buying an H2. Incomes haven’t increased, and when the credit bubble implodes in 2006, our local banks will have more layoffs than you can shake a stick at.

Fourth, in your meteoric rise from pseudo-economist in the early 90’s until now, I am sure you have forgotten that the vast majority of people that buy houses are just normal people. You speak of huge numbers of people with large incomes, all the while blissfully unaware that we as a country are teetering on the precipice of a vast chasm of recession and deflation that 0% interest rates could not solve. I know you think that 0% interest rates would send prices through the roof… OK, Mr. Pseudo-Economist, tell me about Japan’s 4 1/2 year long deflation WITH 0% RATES! You just don’t get it, do you?

Finally, about the 15% appreciation next year and the sign… well, that’s just pure elitism. He is exactly what people hate about Californians. That smug “I’m smarter than you” attitude when he really is just chugging along on luck-fumes. He reminds me of some of the startup 20-somethings during the dot com stock bubble, except that he’s middle-aged. Well, that he’s an idiot and totally underestimating others’ abilities seems to match.

We could go on forever, but it’s just not worth our time. My prediction is that he will be spouting the party-line “Never been a better time to buy” in a year’s time when we see a 3 to 5% correction. When the foreclosures get some steam and adjustables are hitting their maximum cap in 2007, he’ll just plain fade away, and all we will have to remember him by is a funny little memory of the idiot with the crystal ball screaming Hallalujah! Kinda like that one red-faced guy who ran for the democratic ticket in 2004 screaming Yeehah, on to California!

Like the esteemed Cornell Haynes once said “Two is not a winner, and three nobody remembers.”

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Chuck Ponzi October 28th, 2005

Recent events have made us all reflect on the current state of the housing bubble, most recently are a few that I can think of:
1. the Fed’s raise after Katrina
2. Fannie Mae’s rapid unwinding
3. Interest rates are on a scorcher

I recently moved out of the San Diego area into California’s Orange County. So, in a twist of fate, the family has moved to an even more expensive part of California. No worries, my new job prospects allow me to be more flexible with higher rent; it still makes us all wonder how everyone else is making it.

This post’s title is a poke at my new landlord. Frankly, he rented when he should have sold. Successful investors would consider all investment options whenever a major event occurs like a tenant moving out or major life changes. To share the math he must have gone over, I’ll present a few facts that I have uncovered.
1. He originally bought the house in early 2000 for $295,500. It has always been a rental.
2. The realtor who rented it opined that it would sell for $750,000. I would agree with that after looking at similar properties and recent comps.
3. My rent is $2500/month.

I am confident my landlord is cash-flow positive, and would assume that he bought with 20% down, and carries a note of about $235,500. Taxes for the area (including MelloRoos) run 1.9% per year, and add-in about $3500/year for maintenance and upkeep of the home. You would also need to assume insurance of about $1000/year for earthquake and homeowners. Assuming a fixed interest rate of 6.0% that he could have refinanced an investment property to (this is generally not as favorable as personal residences), his monthly total expenses should be about $2,400. His monthly cash-flow is $100 ($1,200/year). Since the mantra of long-term real-estate investments have always been cash-flow counts, not appreciation, and long-term investments do not include a sale of the asset, this is his total return.

One of the reasons that real-estate rental investments tend to be popular is the inflation-adjusting nature of the return; over time, rents increase by a percentage closely resembling inflation. A 2% increase in rent ($50) results in a much larger increase in cash flow (tempered because some costs, like insurance and maintenance also adjust to inflation). Unfortunately for my landlord, time hasn’t been so kind. In 2000, the home originally rented for $2,600/month, for a yearly negative increase in rents, luckily offset by lower interest rates. Still, over the long-term, one would expect that rents increase by about 2%/year and consequently, his return increases about 10%/year.

Our landlord’s return would normally be compared with a risk-free rate of return delivered by US Bonds. On the average, these bonds can return about 6%, but have been closer to 4% more recently. His after-sale equity is estimated at $462,500 (750K-7%-235K) due to transaction fees and payoff of the note. At 4% interest, his cash flow is $18,500. There’s little math that can compare the return of both options.
This, good readers, is the “new mathematics” of real estate investing. Returns are no longer based on cash flows. The asset appreciation is the basis for investment, not the intrinsic discount of the cash flow from the investment.

In my post “Strong hands, weak hands”, I found that economists have noted that during the run-up of an economic cycle, assets pass from strong hands to weak hands. The term strong hands is an investor definition of those intending to hold an asset for a longer period of time, while weak-hands are intending to hold the asset for a short, speculative period of time. Essentially, the return offered under the original method of valuation by strong hands cannot compare with the immediate valuation and profit-taking ensues. Weak hands are not committed to rigorous financial rationalization, so wide price swings occur during these speculative periods. Often, the basis for the asset appreciation is masked in environmental factors, allowing only those speculative bubbles that conform to originating basic economic fundamentals in the onset of the bubble to generate enough groupthink and attention to foster an actual bubble.

Eventually, asset bubbles rise beyond rationality, but prediction of their deflation is nearly impossible until it happens. Asset bubbles can consume every available resource for long periods of time before final deflation; however its fate is always mean-reversion.

When investors have long since thrown rationality out the window, any guess as to its origin and rate of descent is mere, well, speculation.

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