Housing Bubble Bursting?

[moh malekpour]

As I said several times in my previous posts, there are two different demands for housing: artificial and natural.
Artificial demands are created as the result of monitory stimulus such as lowering the interest rates or easing the financing, their effects are quick, nationwide,temporary and bubble in locations with natural demands because it is a double jeopardy. (getting hit by two demands at the same time)
Natural demands are created as the result of geographical and locational opportunities such as climate, job markets, industries and technologies, universities, schools and other natural attractions. Their effect usually happens gradually and remains for a long time.
There has been a natural demand for housing in Southern California because there is a good climate, several good sea and air ports, several good universities, colleges and schools, several entertainment and sporting events centers, and good job markets and technology centers. These natural demands have been here for many years and have affected the housing market tremendously in the past, present and will do in the future.
The recent low interest rates and easy financing created an artificial demand on the top of its natural demand in Southern California. That is why the growth of real estate market was higher than several other places that didn’t have similar natural demands. With the increase of interest rates, we are going to lose our artificial demands that were created by speculators and non-qualified homebuyers but we are not going to lose our natural demands. Those who are going to buy in the market after that artificial demands were cleaned up are going to be the ones who can afford to pay for a place with above qualities and there are many who can.

 

[JSmith43]

Moh: I'm in favor of abolishing the Fed in favor of private solutions as well. This artificial stuff has got to go

 

[hastalavista]

Moh-

You have an interesting take on "natural" and "artificial". I see nothing artificial about money flowing from one place (the lender's pocket) to another place (real property) if it is efficient to do so (provide a greater return). That seems as "natural" as ca be.

I do agree with you that interest rate changes and the introduction or removal flexible loan programs can have a faster impact on the demand than employment shifts and age trends, but I wouldn't call it artificial; the resulting demand is real, not contrived.

But I don't want to argue economics; I'll leave that to Roger.

 

[moh malekpour]

Moh: I'm in favor of abolishing the Fed in favor of private solutions as well. This artificial stuff has got to go

Roger,
They should be carefully supervised and administered just the same way the dos of morphine is being used in surgical operating rooms of a hospital. Just compare the use of morphine in the operating room and use of heroin in street. Both have the same effect but one is administered by a doctor in an operating room and is controlled, necessary and lifesaver, the other is administered by a drug dealer and is unnecessary out of control and fatal.

 

[JSmith43]

I think the "evolution" of UW standards is just as profound as the apparent paradigm shift to a lower trading zone for long term rates.

I can remember selling real estate when the UWs wouldn't budge off 28/36 & agents and LO's thought FHA's 29/41 debt ratio maximums rocked the World

 

[Mr Rex]

Sorry Roger, my wagon seems to be stuck in the right ditch, but I can't seem to get the old nag to pull me out. FHA was set up to offer the folks on the fringe a way in. Recent market forces have created loss of share for FHA, thus obviously FHA needs to adjust downward. Thats the hernia like "bubble" that appears all over the now bloated mother,Will she make it full term or pass the unborn child? Nobody has ever seen the Greenspan baby. (Pass that quote on to Moe, I think he'll appreacitate it)

 

[JSmith43]

Yes, market forces did in FHA's market share, which, in Moh's terminology, was artificially high anyway:icon_smile:

Automated UW still gets 50% debt ratio FHA deals approved, so they are competitive in that respect. The grand experiment with non home inspection home inspections and other unpredictable stuff has given FHA transactions a relative ranking in the eyes of RE agents and LO's somewhere above VA transactions and below virtually every conventionally underwritten program.

FHA does get someone a shot at a reasonable rate, 2 years out of bankruptcy (with reestablished credit-secured cards, etc), and even a shot after 1 year,depending upon the reasons for the BR, etc. FHA has a few other uses that put it above most b/c programs for buyers that don't fit A or A(-) paper scenarios.

 

[Steve Owen]

Interesting and astute, Moh...

As I said several times in my previous posts, there are two different demands for housing: artificial and natural.
Artificial demands are created as the result of monitory stimulus such as lowering the interest rates or easing the financing, their effects are quick, nationwide,temporary and bubble in locations with natural demands because it is a double jeopardy. (getting hit by two demands at the same time)
Natural demands are created as the result of geographical and locational opportunities such as climate, job markets, industries and technologies, universities, schools and other natural attractions. Their effect usually happens gradually and remains for a long time.
There has been a natural demand for housing in Southern California because there is a good climate, several good sea and air ports, several good universities, colleges and schools, several entertainment and sporting events centers, and good job markets and technology centers. These natural demands have been here for many years and have affected the housing market tremendously in the past, present and will do in the future.
The recent low interest rates and easy financing created an artificial demand on the top of its natural demand in Southern California. That is why the growth of real estate market was higher than several other places that didn’t have similar natural demands. With the increase of interest rates, we are going to lose our artificial demands that were created by speculators and non-qualified homebuyers but we are not going to lose our natural demands. Those who are going to buy in the market after that artificial demands were cleaned up are going to be the ones who can afford to pay for a place with above qualities and there are many who can.

A very good overview... however, you did not consider one type of demand for Southern California that even this Missouri boy is aware of... population increase and access to lots of low-wage labor, created by immigrants, both legal and illegal. (I heard one pundit say that California is addicted to low-wage labor.) Anyway... that one seems to me to fall somewhere on the border (pun intended) between natural and artificial demand.

 

[Randolph Kinney]

A very good overview... however, you did not consider one type of demand for Southern California that even this Missouri boy is aware of... population increase and access to lots of low-wage labor, created by immigrants, both legal and illegal. (I heard one pundit say that California is addicted to low-wage labor.) Anyway... that one seems to me to fall somewhere on the border (pun intended) between natural and artificial demand.

That low wage immigrant / illegal laborer rents a room from an owner of a house. I have seen 2 car garages that have plywood walls put up with 2 people living there. I have seen plywood boxes in the backyard with people living there.

These home owners buy additional houses and rent out by the room. That is driving the demand for low price housing. It is only artificial because you have illegal activity begetting illegal activity. If the laws were ever enforced, that artificial demand would go away.

There would be consequences if the law was enforced; housing demand would drop and foreclosures would increase. Money going to Mexico would slow to a trickle and a recession would ensue there.

 

[Brad Ellis]

Randolph,

The article I read classified that 40% as about 24% investment and 16% second/vacation homes. I believe it was the NAR article. If you have time check that one out because I think these other articles are based upon that survey and it would not be the first time an author misread data- that is if we are not agreeing on the numbers.

So, if I am correct on these numbers I think we may safely assume that the bulk of the invetment properties were purchased for longer term investments and not mere speculation and that the 16% probably also contains some investment income units that the owners are simply calling vacation homes for the survey.

Either way it is a big number but I am not so troubled by it since investors typically do not dump investments when they are getting some sort of return- particularly in illiquid markets.

Moh,

I cannot agree on your premise of artificial and natural components. Real estate is a commodity like any other; it is simply less liquid than say a bond future.

I do not know how old you are but I do remember when mortgage rates (29 year terms back then with almost no exotic products) were below 5%. In 1955 my Dad bought his first house for $19,800 with a 4% VA mortgage (about market back then). Borrowed $1000 from my Mom's Aunt for the down payment. When I bought my first house in the early 70's the rate was 7.9.

We are still not there yet.

But investors always ultimately react to economic realities, en masse. When they have massive disposable income they will do things like buy second homes. When the stock markets dump they look for alternatives. We saw that clearly over the past 5 years in the runup of 2-4 unit properties.

I see nothing that is artificial or unnatural about that.

While what we say here will not amount to a hill of beans as regards market perceptions by participants, it still reminds me of a self-fulfilling prophecy. It is a little bit like me asking where is the stampede, where is the stampede? And then, not seeing one, I start shooting my revolver over and over again until the herd hears it and thinks, maybe I am supposed to run. And so they do; hence the stampede.

I think it was you who suggested that the banks would need to be bailed out. Note that the overwhelming majority of mortgages are owned by investors thru Wall St. Directly, they are about 48-49%. Then add Fannie and Freddie at 24% +/- and FHA/VA insured loans for the balance and those also get securitized like the GSE stuff, so the street owns almost all of it.

They are the ones who have the risk- not the banks.

Let's look at Countrywide with half a trillion in volume. If the loans they now make follow the industry norms and about 2% end up in foreclosure that is
about $100 million. The current national default rate is below 5% and the majority do get cured. A 30% loss on that is $30 million (remember you do recover some of the principal). CW could easily sustain such a loss- even over a few years should that occur.

However, you should also note that actual losses against unpaid balances are really nmore like 10-12% for competent firms- and most of the big ones are competent on this. So that loss is even smaller.

RE value is created by 4 factors - scarcity, purchasing power, utility and demand. Demand is still high, utility has not really changed much, land is still becoming less available. What you are suggesting is that the purchasing power decline due to higher rates will impact everything else. I do not see that.

I see increasing population- CA is still projecting a 40% increae by 2020; many other states are as well. Demand WILL increase. Supply WILL decrease. So, the net impact of lower purchasing power, while it will mitigate price increases as it should, and perhaps even cause declines for a while, it is still only 1 part of the puzzle.

Brad