Chuck Ponzi January 17th, 2006

The voice of San Diego’s Will Carless wrote a little piece about the San Diego real estate market that is sure to bother just about anyone, whether you believe there is a real estate bubble or not.

The piece, Predicting Property Prices, has some true gems that we can glean for future use in viewing the San Diego market. Some of the information we already knew:
1. Stephen Cauley (UCLA Real Estate Ziman Center Director of Research) cautions that Southern California is overvalued and is set for a decline starting mid-2006 that could top 15%
2. Rapheael Bostic (USC Real Estate Analyst) says there will be 5-10% growth in all of Southern California in 2006.

Well, what about the industry, what do they think?

Paul Tryon, CEO of the Building Industry Association of San Diego County said downtown San Diego now represents one-quarter of all the activity in San Diego’s real estate market, making downtown an integral cog in the region’s real estate machine. Tryon said the downtown market is certainly more vulnerable than the rest of the county, primarily because of the amount of speculation that has taken place there. “You’re going to have more challenges in that market than you would find in some of the more traditional markets in San Diego,” he said. That represents a concern, he said, but not a grave concern. And it’s not time for developers to stop building in downtown, as good developments will always be able to find buyers, he said.

OK, so good developments will ALWAYS be able to find buyers. It’s not so much the deterministic nature of the statement that bothers us, it’s the relative description of “good”. So, does that mean that if the development has difficulty finding buyers that it is a bad development? Or, is he also implying that by the very act of finding buyers, it qualifies as a good development? Well, either way, our writer does not delve any deeper so we are left in suspense.

And, what about 25% of the market being in downtown? Anyone else surprised by that?

What about someone else’s opinion?

Craig Gagliardi, a downtown Realtor, agreed with Tryon’s assessment. Nevertheless, Gagliardi said downtown is going to have to pay over the coming months for a market that has not accurately portrayed the demand coming its way. “There’s a fairly large inventory of homes that are sitting on the market,” Gagliardi said. “There are a number of properties that are extremely over-valued.” Those over-valuations, Gagliardi said, are going to have to come into line with the reality of the demand for homes in downtown. That may involve investors taking a hit, he said, but shouldn’t worry those who have bought in downtown with a view to living there long-term.

Wow, that was a mouthful for a Realtor(tm). So, if it represents 25% of the market, and it’s going to decline harshly, one would expect that San Diego County would be hit as well, right?

Although downtown San Diego may present one picture, the county as a whole does
not need to worry, yet, according to predictions being made by other prominent economists. Chris Thornberg, a senior analyst with the UCLA Anderson Forecast, said he is predicting a drop-off in prices, but not for some time. Thornberg foresees prices continuing to increase for the next six months, topping off in the middle of the year, and slowly beginning to drop toward the end of the 2006.

OK, so don’t panic right?

“The question is, is anyone really going to lose 15 percent?” Valone said. To answer his question, Valone used an example: “If I bought my house eight years ago in Rancho Penasquitos for $250,000, and the same house down the street in the same condition sold last July for $800,000. If I sell my house now for $750,000, I didn’t just lose $50,000.”

He may be right if you bought at $250,000, but what if you bought at $800,000? So, my question is, even if he is right, why would anyone buy now? I mean, why not just wait and get a better deal? If you know that the prices of homes are going to come off 8-10% over the next year, why not just wait until then?

It appears they might be, and that is why realtors are worried. You can hear it in their desperation.

Lew Breeze, a Realtor in San Diego’s Little Italy district, said “high-flying” economists have been predicting a housing “bubble” in San Diego for the last five years. He’s been tracking those forecasts since 2002, he said, and they’ve simply played into the hands of Realtors and their clients. “I think it’s kind of good that everybody says that. When people think the stock market’s going to crash and crash and crash, it doesn’t,” he said. “It’s when you don’t think it’s going to crash that it surprises you.”

Well, I’m sure glad that there’s no bubble. The proof? Because experts believe that there is one.

By the same logic, there was no cold war, no war on terrorism, and no oil shortage. Shoot, well, that makes me feel all warm and fuzzy inside. I’m glad to see that Lew is so much smarter than any of those high-falutin’ economestricans.

I guess he says we should all invest in real estate and make a million dollars. Wait, some people believe that, so it can’t happen, right?

We are truly in Bizarro World.

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Chuck Ponzi January 12th, 2006

While this is quite a bit off topic for Southern Californians, we all know that Real Estate has become much more than a place to live, it has become an investment vehicle, and a way to riches and millions in minutes. I would propose that it has become much more than that for a select few, it has become a religion. With prophets like Gary Watts, Carlton Sheets, and David Lereah, it is spreading like wildfire; a creed of greed and avarice.

A week or so ago, I was listening to NPR and was surprised to hear so much about Iowa farmers being priced out of their land enough to look outside of the country for farmable land. They found it in Brazil. You can listen to some of what I heard in their piece titled U.S. Farmers Turn to Brazilian Land.

For some of you who did not know, Mr. Doe was born and raised in a suburban Iowa neighborhood surrounded by rural farmtowns. He even attended K-12 schools in a semi-rural farmtown outside Des Moines. However, to preserve his anonymity, he won’t disclose which since he has been nearly the only one to move out in 20 years.

So, it comes as some surprise that land is increasing in value. Trust me when I say that there is so much land there that we can grow enough food for the entire world in Iowa.

I recently saw the 20/20 piece entitled “Myths, Lies, and Straight Talk“. At the link, you can read the transcript. But, what’s interesting is that we make 5 times as much food from farmland than we did in the 1920’s. In fact, we have 14 more million acres of forests than we did in 1920 because farmland has been unused and reverted back to forest. Demand for farmland should be decreasing.

However, NPR reported that farmland is surging in prices; that is why farmers are moving to Brazil. In another piece, South Dakota farmland prices increased by 14% in the last year.

John Anderlik, an FDIC regional manager based in Kansas City, Mo., said continued low interest rates, strong farm income, suburban sprawl and recreational use of farmland helped fuel the increase.

So, what do me make of this “demand” for rural America. Is there any other explanation other than a speculative bubble? It does so much more than hearkens back to people buying Florida swampland sight unseen, just to have a piece of dirt.

South Dakota’s FDIC graph shows a spike during the 1970s and 1980s when farmland was overvalued, but its ratio has been relatively flat since 1987.”What that implies is that even though we’ve had a pretty big run-up in farmland values over the past few years, it’s been relatively in line with farm incomes in South Dakota,” Anderlik said. Those high prices, however, are keeping many young farmers from entering the business and boosting rental rates, he added.

The most alarming of the comparison with the Florida Land Rush of 1926 was its relative time to the Great Depression. It was a time of loose monetary policy coupled with a risk-taking sensibility in investments founded on unshakeable faith in the soundness of the American economy. We are most definitely in the swinging 2000’s. How this decade ends could be more like the 1920’s than the 1990’s. And, 50 years from now, historians might equate our contemporaries’ statements of “with a whimper, rather than a bang” with Irving Fischer’s “permanently high plateau”.

This, of course, leads us to our main topic. Has real estate become a religion? There are those who are so unflappable in their belief that the worst that can happen is a return greater than the stock market. Others, bet every cent of their income on it. And, even the average man has been caught up in the exuberence enough to dedicate more than 50% of their income and their entire life savings for a 3+2 in Anaheim; or worse yet, an acreage in rural Iowa.

Therefore, I propose borrowing a statement made from the American Prophet Joseph Smith, and modifying it for use with liquidity and the asset bubbles in the US.

. . . the {currency} of {the US} will go forth boldly, nobly, and independent, till it has penetrated every continent, visited every clime, swept every country and sounded in every {asset}; till the purposes of {the Federal Reserve} shall be accomplished, and the great {Bernanke} shall say “the work is done”.

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Chuck Ponzi January 10th, 2006

While we all new it was only a matter of time before we saw those people whose only asset was appreciating, loot it for all it was worth to turn it into a liquid investment.

A scary story for some, maybe, but not for CNN. You can read about “Cashing in on Real Estate” on their website directly, but here are some surprising suggestions:

Of course, the scenario is all too common here in SoCal. Despite family “wealth” screaming through the stratosphere, our couple, Nelson Handel and Elicia Laport, have not even saved 1 years’ worth of income in their retirement accounts despite being 25 years in the work force, a six-figure income, and having both partners working.

The couple, both 46, have just $100,000 in their retirement accounts, so they need to save and invest aggressively, a prospect Handel finds daunting: “I’m risk-averse when it comes to playing with the stability of our lives.” The couple make $120,000 or more a year depending on Handel’s assignments, and Laport puts 6 percent of her salary into a 401(k) matched dollar for dollar by her employer. They also have one extremely valuable asset: a house in the now trendy Silverlake neighborhood of Los Angeles that’s worth $1 million, nearly four times what they paid in 1995. The equity, Handel says, is “lovely,” but it’s not doing them much good right now.

Ok, so what does the financial advisor tell them to do?

San Diego-based certified financial planners Christopher Van Slyke and Terry Green recommend an unconventional plan: taking out a new $500,000 ARM. Handel and Laport can pay off their existing mortgage before the rate rises and retire their other debts. They can put the remaining $200,000 into stock and bond funds.

Well, if that isn’t a mouthful. Doesn’t that really seem a bit uncharacteristic of Handel’s profile of “risk averse”? Well, if you aren’t surprised yet, the best is to come.

To be sure, borrowing against a house to put the proceeds into the market rarely makes sense. But in Handel and Laport’s case it does because so much of their net worth is tied up in their home, and the super-hot L.A. real estate market looks primed for a fall.

Ok, so in other words, your house is overvalued, so loot it for all it’s worth and you can pay, and turn it into a forced savings account.

The only problem with this is the riskiness of the venture. See, I don’t think many of us have a problem with balancing our investments, but it seems a bit like we are gambling our life’s accumulation and hoping that the next 10 years will be like the last 20 minus 2001 to today.

Meanwhile, maybe Bernanke has something with his savings glut theory. But, why isn’t it that we have a saving shortage? Is life continually about overconsumption?

Either way, our financial advisors sum it up for us:

They can convert equity that might melt away. And with a $500,000 mortgage, even if the L.A. market drops 30 percent, they would still have substantial equity in the house, which they hope to sell in five to seven years. “This is very aggressive,” says Van Slyke. “For them to catch up, they’ve got to be unconventional. Over time, their investments should grow by more than the interest rate” on their mortgage, which should be under 6 percent.

Cest la vie!

I just hope that these folks aren’t forced to take more gambles with their home. Silverlake, after all, is a lot of hills that have a tendency to slide down when it rains a lot.

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Chuck Ponzi January 3rd, 2006

Think about that for a moment. Remember the Nasdaq 5000? Are we there yet, or are we just about to take off again?

Ok, everyone knows you shouldn’t compare the two, right? Well, what’s wrong with a little comparison?
What’s the same:
1. It’s different this time!
2. Fundamentals don’t matter anymore
3. Newbies infesting the market
4. Leverage, Leverage, Leverage
5. Paper Wealth with loads of Optimism piled on top
6. Historically unprecedented P/E’s
7. Industry-motivated brokers and analysts

What’s different
1. Much higher percentage of GDP
2. Much much higher leverage
3. Utility asset vs. investment asset
4. No way to cash out without significant loss of lifestyle
5. Illiquid market vs. Liquid Market (sticky prices)
6. Relatively weak economy without vs. Relatively strong economy

While we all know that if prices drop 5%, most real estate holders will not dump their holdings, but one thing to keep in mind is that liquidity is not what changes values quickly, it is the relative nature of demand sensitivity to supply sensitivity. Because prices are determined at the margin, their relative sensitivity could have a major impact on future values.

One could argue that the core demand curve is fairly steep, indicating that marginal buyers are not as price sensitive; whatever it costs, they will pay it, but that the quantity consumed is fairly stable. What concerns economists, however, is the “hidden demand” also referred to as “hidden supply (They call it one on the way up, and the other on the way down) represented by speculators. You might remember that the last major housing busts in California and Texas were precipitated by spec built homes based on a price runup that later bankrupted many homebuilders. This would be characterized by a shifted demand curve that would push prices higher during the boom, but push prices lower during the bust. In the past runups, these were largely borne by the builders who supplied spec homes. Many builders have become much more savvy this time around and are only preselling homes.

However, this doesn’t mean speculation is dead, it just shifted to other market participants. Where previously speculation was done by deeper pockets of corporations, today’s mainstream speculator is a private investor with substantial leverage.

Now, one could argue that these speculators will show more restraint than a limited liability company when speculating on property, which I would generally agree with. However, the lack of information they posess about the health of the local economy, and the density of speculation in the market today. (Arguably 25 to 30% of ALL residential home purchases for non-purchaser-consumption), this seems to be a recipe for personal disaster.

When market participants have poor information, markets tend to overreact both on the buy side and the sell side. This leads to over-purchasing of assets on the way up, and over-selling of assets on the way down. Gold would be an excellent example of this during the late 1970’s.

It’s clear that part one of this scenario has already taken place; we have massive overpurchasing of homes; and it is well documented that we have exceeded demand within the US based on demographic information.

When will the next leg of this speculative binge begin? This spring may or may not lead to a partial unwinding. However, don’t expect massive price cuts in the immediate future; belief in an asset class tends to leave many participants clinging on far longer than many believe they will.

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