QE2, Bonds and The Fed’s Real Plan

Posted on November 16, 2010 by Tim Freund

For those of you that have been following this blog, you’ll recall a couple of weeks ago I suggested that QE2 would either cause rates to go down or cause them to go up, so in either case, you would want to start your refinance so that you were in line to lock in a low rate.  The storm that has ensued since the Fed’s announcement that they would spend $600B to buy treasuries, makes one wonder what the Fed could be thinking.

The Federal Reserve’s stated goal with QE2 (Quantitative Easing Round 2), was to hold rates down, spur lending and borrowing in an effort ultimately, to jump-start hiring.  Contrary to this design it would appear, the negative market reaction is driving rates up, not down.  Fears of a printing press running day and night in Washington, making dollars cheaper, have flamed the fears of inflation, and thus a controversy is born.

Though not a conspiracy theorist by nature, isn’t it possible that Fed Chairman Bernanke actually anticipated this response?  Consider this: Bond yields rise when the demand is lowered, thus the price has to get cheaper to sell.  This then causes the return on that investment, or yield, to rise.  Said another way, if a bond costs $100 and returns 5%, if no one buys it, it has to be discounted to sell (just like clothing).  For this example, let’s say that magic discounted price is $90.  This means that same 5% return equates to a 5.55% yield at a $90 sales price for the bond.  Yield moves in the opposite direction of price.  Price (demand) goes up, yield goes down; price goes down, yield goes up.

I think it is safe to say, that Ben Bernanke has proven himself to be a shrewd businessman.  His investments of taxpayer monies in General Motors, AIG and the like, have proven to be very, very profitable.  With GM now IPO priced at $32 a share, the tax payer should reap quite a return on their investment. So Bernanke understands that if he is going to cause the Federal Government to invest in bonds, he becomes the largest buyer of U.S. Treasuries.  And what do we know about bonds?  When demand increases, they get more expensive and the yield goes down, so rates drop.  But to do this, the Fed has to pay a premium, because they are not the only buyers of treasuries and thus if rates are to go down, price has to go up.  But isn’t it possible that Bernanke recognizes this and has caused a bond sell off just so he can jump in and buy them at a discount?  If the fed is going to buy $600B in U.S. Bonds, rates are going to go down, that would seem to me to be inevitable, so why not buy them at a discount?  It’s a mind bending concept, but I wouldn’t put such thinking past the Fed.  After all, past Fed Chairman Alan Greenspan dominated the financial world through suggestion and innuendo; moving markets without actually doing anything but hint, suggest and infer.  Perhaps not so unlike his predecessor, this Fed Chief is doing the same, only this time it’s with his eye on profits for the taxpayer.

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Bubble, Bubble, Toil And Trouble

Posted on November 11, 2010 by Tim Freund

I watched the most insightful interview on CNBC today.  It was an interview with Jeremy Grantham, and investment adviser and someone, if you had to look to for crystal ball-like predictions, you would be fairly safe entrusting.  Grantham is very critical of the Fed; not for the reasons most critics are citing, like ballooning budget deficits, but rather because as he puts it, “The Fed is manipulating the stock market”.  His argument in a nut shell is that the Fed is creating bubbles to create a ‘wealth effect’, so that consumers spend.  He argues that this is not effective policy and that it compels markets to become over speculated and thus becomes a bubble.

Grantham advocates investing in emerging markets, undervalued blue chips like Coca-Cola that pay reasonable dividends etc., and he advocates cash.  This is interesting as we consider what inflation does to cash; kills it really.  However what I like, and have been doing myself, is keeping cash available to buy when the market drops.  He called the holding back of cash, “Optionality”.  I love that.

So why am I talking about equities when I am advocate for real estate?  Further, why would I be advocating holding cash when I see inflation on the horizon?  To quote Grantham: “Optionality”.  To be able to take advantage dramatic declines in values – values of whatever asset you want to buy.  John D. Rockefeller was once quoted as saying, “The way to make money is to buy when blood is running in the streets.”   So this is my argument: real estate values are down 25-30% in our market and a lot more in other markets.  Rates are down 30% over the past 3 years.  With values down 30% and rates down 30%, blood, I argue, is running in the streets; money is cheap and fortune favors the brave.  “Optionality” is the flexibility to buy when the opportunity arises, and now is just such an opportunity in real estate.  I am not saying we are necessarily at the bottom of the housing market; however buying at the bottom is a game of smoke and mirrors.  It’s impossible to get it spot on.  Trying to guess the bottom is a matter of pure luck.  Investors do not rely on luck, but speculators do.  Savvy investors recognize good value, and then act upon it.  Perhaps the investment chosen dips in the short run, but over time, the “Valley of the Bottom”, is not a V-shaped valley at all, but rather a U-shaped one.  In this context, one could argue, as I am, that through the telescope of time, looking backwards, we will not see the “V” of the bottom, but rather the wide valley floor during which time we had ample opportunity to buy; a time when prices of real estate had plummeted and rates were artificially low.  It is through this telescope that we will be boasting to our grandchildren or perhaps leaving the legacy to our grandchildren, of the story about the great real estate opportunity and how smart we were to take advantage of it.

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Playing With Numbers

Posted on November 10, 2010 by Tim Freund

In my real estate office, my manager regularly gives us an excel spreadsheet detailing the numbers of sales year to date as well as the inventory. It’s broken down by month, has data at various price ranges and provides the all important historical framework from which to assess our current market.  Like the stock market or any statistical analysis for that matter, the numbers are subject to interpretation.  For example, remember back to February 2009.  The Dow Jones Industrial Average had dropped to around 6,500.  If you asked yourself, how much of a decline your portfolio had experienced, looking from the recent top of say 13,000, your portfolio had lost approximately 50% in value.  However ask your broker how much your portfolio would have to rise to recoup that money and he would tell you, your portfolio would have to go up 100%.  In other words, 13,000 to 6,500 is 50% but 6,500 to 13,000 is 100%.  Numbers… Bedeviling little buggers aren’t they?  So it is with real estate.

You’ve heard time and time again, and please believe it because it’s true, real estate is a local business.  What is happening in Las Vegas has very little bearing on what is happening in Atlanta, and what’s happening in Phoenix, has little effect on Westlake Village, Ca.  As I troll through the numbers my manager provided for our local market, what jumps out is consistency.  In fact the closed sales number for this week in November are very similar t0 those of the past 6 years – from 2005-2010 this includes those peak years or ’05 and ’06  “No way!” you say; “Way!” says I.  Here they are for the Conejo Valley for the 1st week in November: 2005/30; 2006/36; 2007/25; 2008/36; 2009/53 (an exception due to the expiring tax credit round 1); 2010/27; an average of 34.5 (30.1 if you exclude 2009).

So why lead in with the DJIA figures?  If you, as I’ve suggested, exclude 2009 because of the a fore mentioned tax credit expiration as an anomaly, the spread is between a high of 36 and a low of 25 with this year at 27 closed sales for the 1st week in November.  Put in percentages, 2010 is off 25% from the high, but the high is 33% higher than today; get it?  In other words, do we look at the numbers from then to now or now to then? – it makes a huge difference.  It’s not that the numbers lie; numbers don’t lie, but really about how you read them.  By the way, if we were to exclude 2009 and use the average of 30.1 closed sales in November as compared to this year, we are only 10% lower now than the average; err, or is it that the average is 11.5% higher than we are today?  Either way you play with the numbers, the market looks historically consistent.  And that is a bit of good news.

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The 3 Most Impotant Words In Real Estate

Posted on November 9, 2010 by Tim Freund

I promised some weeks back that I would comment on this age-old adage.  So what are the 3 most important words in real estate?  Answer? …Obvious right? – Location, location, location.  So why waste a moment blogging about it?  Well a new “three most important words” are making their way into first position. Those words are “Price per foot”.

So how important is “Price per foot”?  Personally, I don’t put a lot of weight on it.  It’s a measure of what exactly? – the price of the home as divided by the square footage.  Duh… but is that a relevant statistic?  Buyers today sure think so.  Why?  It’s easy.  It’s Zillow.  It’s Twitter.  It’s BFF, BRB, and LOL.  In our rush to do everything in a split second, we’ve marginalized the most important facts about real estate and swapped them for perhaps the least important data point but one that is fast and easy.

Some argue that “Location, location, location” is just a repetitive rule; that PPF provides a real mathematical assessment; it’s quantifiable.  However, I have always looks at “Location, location, location” this way: It’s the City or town; it’s the neighborhood; it’s the specific lot or site within that neighborhood.  When placed in this context, there is a world of value-critical data in those three words.  After all, what’s more important than the city you choose to live in?  Then what’s more important than the neighborhood within that city? – Its proximity to the freeway, to the good school, to the hospital, to your house of worship? – Whatever is important to you, your neighborhood is everything.  Lastly, the specific site – is it a corner; on a cul de sac, does it have a view or exceptional privacy; is it a large enough property to handle a pool or maybe an RV or horses? Is it the condo on top, or in the quietest spot?  “Price per foot” speaks to none of these all important variables nor does it factor in any of those most important characteristics when assessing value – not one!  Further, PPF does not take into account the property’s condition, or floor plan utility, bath count etc. – I could go on and on.  Price per foot only takes the price and divides it by the square footage.  It doesn’t even take into account how many bedrooms there are!  Useless? – pretty much.  So you ask, “It has to be good for something, right?”  I use PPF as a marker; a point from which to start my valuation assessment.  Once I get a general sense of what I am looking at, I have to look deeper and then I forget about PPF; it has about as much relevance after that as the color of the front door.

In life there are certain indisputable facts: the sun rises in the east and sets in the west; the Cubs will probably never win a World Series and “Location, location, location” always has been, and always will be, the three most important words in real estate.

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Pending Home Sales Numbers Interpreted

Posted on November 6, 2010 by Tim Freund

The number I like to watch most closely is the Pending Home sales as reported by the National Association of Realtors (NAR).  This number reflects the homes that have entered contract, rather than those that have closed.  This significant difference is pending reflects real-time – those that just went under contract, whereas sold figures are reporting closings and those homes actually entered contract some months back – think about the typical 30-60 day close of escrow as the time line.

Yesterday’s figures of a 1.8% decline, was below analysts’ expectations which actually anticipated an increase of around 3%.  On the surface the figure looks terrible and further evidence we are a long way from being out of the woods, and that the housing recovery, saddled with mountains of foreclosures, is a long way away.  Diana Olick of CNBC and others point to the recent foreclosure moratorium by a few major lenders as reasons for the slow down.  I do not subscribe to this at all.  Personally I think that’s just an excuse.  Not every market is dominated by distressed properties so not every market’s slowdown can be attributed to a foreclosure moratorium that didn’t even start until mid month, didn’t include all lenders and even for those lenders it did include, didn’t include all states.

I know that I am in the minority here.  In fact if you ask most if my colleagues, they predict a continued decline.  But let me explain why I am neither surprised, nor particularly concerned by this number.  First of all, there is a lot of misinformation that confuses the home buying consumer.  Confusion leads to insecurity, insecurity leads uncertainty (this is best said with a Yoda accent by the way).  This in turn causes many home buyers to sit on the fence rather than jump in feet first on their biggest investment of their life.  Second, whoever said we would hit bottom and immediately go up or for that matter, whoever said the bottom would be smooth?  On the contrary, during the early to mid 1990’s, after that last great real estate correction, we bounced along the bottom from 1994 to 1997.  By 1997 we started seeing consistency in sales and steady improvement in market conditions.  But during those 3.5 years of bouncing along the bottom, we did just that: bounce.  Some months were stronger than others.  My wife Tama tells the story of her great-grandfather who was a gambler.  Some days her grandfather would get dropped off at school in a Rolls Royce with a driver, and other days he had to walk in the Detroit snow.  So goes any real estate recovery.  To expect steady improvement at a time of so much uncertainty, quite simply defies logic.  Rather than economists having expectations of improving numbers, perhaps they should say they are hoping for improved numbers.  Hope leads to a lot less disappointment.  I’ve been hoping for years that my San Francisco Giants would one day win the World Series, but to expect it, would be foolish, and would demonstrate a clear lack of understanding about just how difficult winning the Series is.  So it is in our housing recovery.  We’re hoping things will get better soon and not get worse, but to expect that there won’t be bumps in the road to recovery is foolish, and clearly demonstrate how difficult the recovery will be.

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Jobs, Inflation, Cheap Money and Notes From The Trenches

Posted on November 5, 2010 by Tim Freund

As I wait for the all important Pending Homes sales number from the National Association of Realtors today, the Jobs report has just come out.  The job creation numbers today point to a modest and continuing recovery.  Inflation remains around 1%, the Fed is pumping $6B into the economy and stocks are at the highest levels since 2008, before the Lehman collapse.  This is all good news.

As I have said in the past, it’s all about the jobs.  When we start creating jobs at a strong enough growth rate that not only keeps job loss at net zero (something today’s numbers accomplish), but actually brings down the unemployment rate, then we will truly be on the road to recovery.  People with jobs, spend money, consume, and ultimately buy houses.  This is what we are waiting for… this and a little bit of inflation.

Speaking of inflation, I read an interesting concept this morning in Scott Reckard’s Los Angeles Times article on mortgage rates, when he quoted San Diego State finance professor Dan Seiver as saying he wouldn’t be surprised if over the next 30 years we saw inflation at 3-4%.  Further that if someone bought a home today with an interest rate on a 30 mortgage of 4%, the effective cost to finance that home purchase would be zero.  That’s really an incredible revelation.  What I really like about this is the return to the concept that real estate is a long-term investment.  Seiver is referring to inflation over a 30 year period and paying off a home over that same 30 year period.  For so long we have been looking at housing as a month over month or year over year, number, when in fact traditionally it is a 15-30 year investment.  So on the idea of getting back to long-term thinking about real estate I say, it’s about time.

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QE2 Sets Sail, But Many Are Left On The Dock

Posted on November 4, 2010 by Tim Freund

The Federal Reserve announced yesterday a $600 Billion infusion of capital into the economy.  The intention is to keep interest rates low to stimulate borrowing and spending.  However, the freer money supply doesn’t address the need for freer lending standards.  I’m not talking about 0% down, low FICO score loans, but I sure would like to see easier qualifications for the self-employed.

The need to offer a low documentation loan to non W-2 borrowers cannot be understated.  After all, the backbone of our economy and the largest segment of luxury the home market are the small business owners.  We’re talking about the store owners, the dry cleaners; the mom and pops shops of America.  Currently a small business owner needs to open up their books, trying to add back in all the legitimate tax deductions the IRS allows them, so that they can qualify to buy a home.  No matter how much you try to rebuild the financial picture, it’s just not enough.  Plus, this is not a loan a bank underwriter really wants to sign their name to.  But low doc loans at a small premium have been around since the early 1990’s – until now.  These past few years have eliminated thousands of the best home buyers, the move up buyers, the luxury home buyers, because there is no option for these borrowers to obtain financing.  Property value, like the value of any good or service, is based on supply and demand.  The Fed and every home seller, wants an increase in demand.  Small business owners can help solve that problem, but without a vehicle to finance their home purchase, our most important buyer, is left out of the equation; slowing the housing recovery.  I know the argument that low-income verification is what lead to the mess we are in.  However, that is simply not true.  The crisis was from poor underwriting standards – bad credit; no down, no doc loans to W-2 employees.  That’s not what I’m talking about here. What I’m advocating is a loan that is available without income verification, but requires the borrower to have substantial assets, excellent credit, 25% down payment, have been self-employed for a minimum of 2 years and most importantly, not be a W-2 employee.  Years ago, it cost 1% over market if you were going low doc.  If we had this today, we would quickly infuse the housing market with well qualified buyers and they would be buying expensive homes.  This is the market most desperate.  I remember in 1994 there was a fixer in the flats of Beverly Hills that was on the market for $700,000.  $700K!  If you could buy in the most expensive neighborhood for $700K, then Sherman Oaks had to sell for less; if Sherman Oaks had to sell for less, then Tarzana had to sell for less.  If Tarzana was selling for less, the Woodland Hills had to also and so on.  The downward pressure from the high-end, can crush the value of the middle.  Sure, the low-end will have to push the middle from the bottom up, but that’s only really effective if the high-end doesn’t collapse on top.  Remember, it doesn’t matter how ripe the soil or quality the seed, a tree can’t grow under a stack of bricks.

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Buying Contingent In California: A Case Study

Posted on November 3, 2010 by Tim Freund

In light of the overwhelming election results, and while we wait for QE2, I thought today rather than interpret, analyze and hypothesize about what will happen next, I’d instead talk about selling houses.

A buyer of mine purchases a home subject to selling their current home.  This is called a contingent sale – one sale is contingent upon the sale of another.  Years ago this was a pretty common practice.  But it’s generally a method used in a down market.  When the market was strong, no one believed someone else’s home would sell faster than their own; so contingent sales became far and few between.  However in today’s market, we find the contingent sale is once again an attractive option.  This is especially true when the replacement property or second leg in the chain, is a larger, more expensive home, or perhaps one which for some reason, has been languishing on the market, as was the case for my client.

We found a home that had been on the market for more than 180 days, made an offer, negotiated and opened escrow.  We reduced the price of our home and at the midnight hour – literally the 30th day of a 30 day contingency – received and accepted an offer.  We naturally had to take less than we wanted, but time was running out, and my clients really wanted the home they had purchased.  Now here’s where it gets interesting.  We had purchased originally agreeing to a 45 day closing.  Yet here we were, 30 days in and we have only now sold our home.  We had done an inspection right away, and my client had provided their lender with all the appropriate paperwork, but that was pretty much it.  After all, we hadn’t sold, and despite early price reductions, had no buyer on the horizon.  During a standard sale in California, a purchaser has 17 days with which to conduct investigations, inspections, get an appraisal and obtain their final loan approval.  At the end of the 17 days, the buyer is supposed to sign off and put their “money on the table”.  It’s a contract clearly favoring the buyer since the seller has to take their home of the market for those 17 days and the buyer can cancel should they find something during their investigations they disapprove of or if they can’t qualify for a loan.  Since we were buying with a home sale contingency for 30 days, we let the 17 days pass without completing the process.  The seller subsequently sends a notice to perform, demanding my client sign off on their contingencies – a request that went unheeded.  This response afforded the seller the opportunity to cancel the transaction should they so choose, something the buyer felt entirely reasonable.  The seller elected to let sleeping dogs lie, even though they were frustrated with our lack of response.  Suddenly however, we’ve sold and now we need to extend the original closing date so that the two escrows in the chain can close concurrently – my client gets his money from the sale of his home and subsequently uses that to purchase his new home. Terrific, it takes a little longer but everyone wins, only the seller of home #1 decides he will grant the extension but only if my client compensates him for the costs of the extension.  Those costs being his mortgage taxes and insurance the difference between the original agreed to escrow period and the new closing date that’s tied to the sale of the second leg of the transaction.

Why?

The original contract did not spell out that the contingency of selling home #2 would, by definition, automatically push back the closing of home #1 to coincide with the closing of home #2.  Thus a predicament is born.  Of course logic would suggest this is obvious and further that in this challenging market place a seller would gladly push back to close to accommodate their now incredibly valuable real buyer.  However, logic is not a replacement for a clearly spelled out contract.  Unfortunately, in this story and for reasons difficult to understand, the seller of home #1 is prepared to cancel the transaction if they do not receive their compensation for the extension.  Clearly one would hope the seller’s Realtor would step in and talk their seller “off the cliff”.  Naturally they would explain the obvious: that going back on the market in no way is a benefit to the seller and that the carrying costs of extending are the same as not being in escrow and searching for a new buyer.  In fact as we can easily surmise in this example, given the market we’re in, the costs of canceling will likely eclipse those of extending.  Alas, this is not what is happening.  To the contrary, the seller’s Realtor, in an effort to “represent the seller” is accommodating the seller’s irrational behavior which includes playing attorney and composing amendments to the standard contract.  When driving, this is called “playing Chicken”; in poker it’s called bluffing; in real estate, it’s called suicide.  Can this deal be saved?  Stay tuned and come back next week, for another new episode of, Realtor Wars… Ugh.

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A Week To Watch

Posted on November 2, 2010 by Tim Freund

There are two big things happening this week.  The election, which looks to bring us back to a divided government and the Fed’s Quantitative Easing II.  The election will have no immediate impact on housing,  but does potentially play into the long-term health of our housing market.  The Republicans espouse less government spending and intervention.  The impact they actually have on policy will likely be minimal.  The Tea Party and the grass-roots movement surrounding them, will be interesting to watch.  Let us not forget that it was the under-regulated and under-enforced policies of the free marketeers that got us into this housing mess in the first place.  Free market greed clearly cannot be left unchecked.  Conversely, over involvement in the “saving of homeowners” is a failed policy too.  Perhaps any shift in this election will bring us a sense of balance; though I hate switching horses mid stream.

As for QE II, I just hope the effect is the desired one in which rates remain low.  I am always concerned with the concept of “already priced in”.  This is where Wall Street investors have already priced in the Fed action and anything below their expectations, end up having the opposite of the desired effect.  Watch the bond markets Wednesday and Thursday for your answers.

With all of that said, it’s hard not to feel a sense of pride on a day like today.  We peacefully vote, we cheer, we groan, but in the end, we are still in the best place on earth to live.

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Under Water Means Under Utilized

Posted on November 1, 2010 by Tim Freund

You have probably heard by now that the consumer has not been participating the way Wall Street or the government would like in the nation’s economic recovery.  Most average Americans remain belt tightened, worried about their jobs, fighting ever increasing health care costs and the rising costs of educating our youth. In Don Lee’s Los Angeles Times article this morning, I read the most compelling argument for government action in forcing the mortgage industry and mortgage lenders to allow refinancing regardless of equity position: spending.  The argument goes like this: 25% of homeowners are upside down on the home’s value, thus unable to refinance and take advantage of the historic rates available today.  In fact many of those homeowners are saddled with interest rates north of 6%.  To contrast that with today’s historically low rates of low 4%, you could say that those homeowners with negative equity, are paying 30% more than they would otherwise, if they could just refinance.  This means they have less discretionary money to spend.

I have long been an advocate of allowing good borrowers be able to refinance despite their equity position, especially on those loans purchased by Fannie Mae and Freddie Mac.  After all, the borrower has title to the property, it’s not like they are a new credit risk; besides they’ve been making the higher payments already.  The only thing reason for a lender to refuse an underwater borrower to refinance is that the bank wants to make the higher return and they know the homeowner is stuck.  It’s almost like loan sharking really.  It’s also called usury.  So OK, the bank took a risk and have a return on that risk and they are entitled to the interest rate that was agreed to.  Certainly the argument goes, if rates rise, the bank doesn’t get to go back to the borrower sand ask them to take a higher rate.  That’s why it’s called a contract; a loan commitment; a fixed rate.  But in Lee’s article he cites New York Federal Reserve president William Dudley as saying, ” ‘Families have not boosted their spending above the levels preceding the severe cuts the made during the recession’ “.  Lee suggests that the quickest, cheapest and easiest way to stimulate the economy is to allow underwater homeowners to reduce their out of pocket expenses by simply making it possible for those homeowners to refinance at current interest rates regardless of equity.  This is absolutely brilliant.

As a Realtor I do not favor delaying foreclosure, or adjusting principle to reflect current market value, if for no other reason than it’s just not fair.  Nor do I endorse a partnership in equity that shares the property’s appreciation with the lender or the government, after a principle reduction.  Free markets have to be allowed to remain free and function independent of outside manipulation.  But this simple yet effective refinancing idea is not only fair, but costs nothing.  The lenders and their investors make less interest on the notes, true, but they save millions by reducing the potential for foreclosure or short sale when the negative equity homeowner just gives up paying at some inflated interest rate.  And don’t forget, the lender also gets to keep the good paying mortgagee, rather than what usually happens when a homeowner refinances: they shop around and more often than not, go to another lender.  So the lender actually benefits themselves, their investors and their shareholders by retaining their low risk borrowers.  Moreover and most importantly, it puts more money in the hands of the consumer to spend, because their monthly mortgage payment goes down by up to a third.  This new found surplus of cash in turn helps everyone in America because it means greater demand for goods and services; greater demand means employers have to hire; when employers hire, people are more confident and the spend even more, and the cycle of economic inaction ceases.  While this may not be the magic bullet penicillin was to world health at the turn of the last century, it certainly would be just what the doctor ordered for our struggling economy, while costing the tax payer zero.   And that ain’t no Castor oil, rather, it’s a spoonful of sugar.

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