The Real Estate Conversation

The Boomerang Generation… heard of it?  They’re the kids that move back with their parents after branching out on their own only to find the costs of independence exceed their income production.  LA Times, writer Don Lee wrote an article today discussing the long term effects on our young twenty-something’s being unemployed or underemployed, moving back with parents and the potential for fundamental cataclysmic changes in their economic behavior as a result.  This is an interesting premise and one that many of us actually witnessed growing up.  For me, being born in 1961, the last year of the Baby Boom Generation, gave me the unique experience of seeing post war prosperity and the lingering effects of the Great Depression.  I recall my grandfather’s conservative nature; his philanthropic generosity, but also his fierce saving for fear of losing everything again.  Lee’s hypothesis suggests that the effects of the Great Recession will be long lasting and will have an impact on our economy, housing and even family creation for years to come.

The argument is like this: young people who can’t find work or can’t find high paying work like previous generations, are “Boomeranging” back to their parent’s home, delaying marriage based on economics and even starting families out of wedlock,  and as a result, creating more families in poverty.  The inference is that, these people are the consumers that we need to lead us out of the recession and they are not spending; that we need them to spend to jump start the economy and even the housing market.  This is where I step in and say, “whoa, now your speaking my language”: housing.

While the impact of this may be slower jumps into home ownership and household creation, this generation is saving more than any since my grandfather’s; 8% of their income reportedly.  This can only help the long term health of the housing industry.   After all, didn’t we just learn the importance of not lending to the “no down, no savings” buyer and the problems of over leveraging?  Further, we cannot, underestimate the power of the aging Baby Boomers.  Here the thinking runs both ways against the middle.  Some argue that as this consuming generation ages, they will reduce their spending, putting us into a deflationary downward spiral.  This would be further complicated if today’s generation is saving and not spending.  However, there is another school of thought, and one in which I find myself firmly a believer in, and that is, as the Boomers age and eventually die off, their vast wealth will be passed on to this younger generation and they in turn will begin spending and spending big time.  This should create a tidal wave of consumption and an ever increasing demand for housing.  One might even argue specifically for luxury housing and secondary homes.

In the end, I suppose the scarring of the Great Recession will be far reaching, but I am optimistic that the lessons learned will propel us, rather than drag us down.  Like the old saying goes, “That which doesn’t kill us, makes us stronger.”

It is said that the stock market has its eye looking forward rather than back.  Obvious right?  After all, we analyze a company’s stock by looking at projected earnings and growth potential.  If you ask most idle watchers of CNBC or listeners to Bloomberg radio, you would find them talking about Apple, and gold, the price of oil and are we Japan poised for negative growth for 20 years or the Weimar Republic, set for incomprehensible inflation?  While I have my opinions on these matters, which I have and will continue to share throughout this blog, I want to point something out that I just saw the paper today; something I don’t understand but can’t help find extremely hopeful and positive… If I asked you what is the highest performing mutual fund sector year to date was, what would you say?  Probably precious metals right?  Gold is well over $1300 an ounce (much to my wife’s personal chagrin), or maybe emerging markets (Brazil, Russia, India, China), and you would be right – almost.  In fact, according to Morning Star, the highest returning mutual fund sector year to date is – ready? – Real estate.  That’s right!  Up nearly 26% year to date and 37% over the past 12 months.  I couldn’t believe it – I still am shocked.  Admittedly, I don’t own any REIT’s and with all the ‘For Rent’ signs I see around town, I can’t imagine commercial real estate is improving.  Yet there it is in black and white, for the whole world to see, from the most respected mutual fund analyzer – Real Estate! – The top gun for the year.  So now I’m asking myself, what does this mean?

If stocks trade based on future and projected growth, and real estate is the highest performing mutual fund sector, doesn’t it stand to reason that someone out there thinks that real estate is going to go up?  Real estate mutual funds are up 37% in the past year?  That’s incredible!  And what does that say about the future for real estate?  That property values and rates have dropped so far that real property is the safest and most likely bet to appreciate as compared to all other investment opportunities for the foreseeable future?  I believe so.  Clearly I’m not alone in this, and I like it!  I like it for my buyers, I like if for my sellers who are moving up or moving out.  I don’t love it for my distressed sellers, but not everyone can win, someone has to lose I guess…  All I know is this: if precious metals are rising, then real property: dirt, bricks and mortar – has got to rise too.  It’s like Will Rogers once said nearly a century ago, “Buy land, because G-d ain’t making anymore”.

This morning I was speaking with a well known local agent about an offer she was bringing me on one of my listings and I mentioned I needed a home with a view for a new client.  She told me to look at a listing of hers that had an incredible view.  I looked it up and said, “that home doesn’t have a view”, and  she said “the view was incredible -it backs right up to the canyon”.  What’s amazing was that she didn’t include any pictures with any kind of view.  I pointed this out to her and she was surprised to learn this and said she would shoot some pictures today and update the listing… it’s been raining off and on today and the home has already been on the market for 196 days.  In fact she just re-listed it 13 days ago with the same pictures.  Is it any wonder most consumers view real estate agents just slightly above used car salesmen?

Today’s headline reads, “Bailout Cost of Fannie, Freddie Rises”.  If you’re like me, you read that and think,  “Like, news flash dude, they hold a boat load of lousy loans…”  And you may also find yourself outraged by this.  If you watch CNBC and listen to Larry Kudlow and the like, you may be thinking, “We should just let them go under.  After all, isn’t that capitalism, the strong survive and the weak do not?  Besides, those are my tax dollars and my money!”  To this, I say, “Let me tell you a story…”

In August 2007 I had by chance, a meeting with Scott Abrams, campaign manager for California Congressman Brad Sherman, to discuss his speaking at a brunch I was putting on.  During our meeting over breakfast, the financial collapse was playing out before our eyes and just being discussed on CNBC.  It was sort of like watching the hole you just dug in the sand, fill up as the wave swept over the top…  It was shocking and scary and very unnerving because it seemed to catch almost everyone off guard.  I told Scott that morning, that it had been unfolding for a few weeks and if something wasn’t done quickly the entire housing market was going to fall off the edge of the earth.  He asked me to explain.  I said, “The banks can’t sell their loans and are running out of money to lend”.  Scott was surprised by this.  Banks run out of money?  From my perspective, I could see that Wall Street had suddenly stopped purchasing packages of mortgages, from the big banks.  As someone selling homes that required mortgages, the only loans my clients could find were from portfolio lenders, usually made up of former thrifts and savings and loans.  (A portfolio lender doesn’t sell the note, but rather keeps it on their shelf; satisfied to earn interest rate return they lent the money at to the borrower. – think Capra’s “It’s a Wonderful Life”, and the Bailey Brothers Building and Loan…) The problem with this I explained, was that the vast majority of lenders did not hold the paper ad infinitum, but rather were satisfied making the 1% loan origination fee and getting the servicing contract (collecting the payment every month from the Wall Street investors who purchased the mortgages).  By selling the loan and getting the money they had just lent back, the lender had a fresh pile of money to lend to someone else.  This allowed them to lend and lend and lend.  But once there were no longer buyers for those loans, the banks, I said, would run out of money and there would be no more transactions.  Banks had to have a marketplace to sell the paper (called the secondary mortgage market), and that marketplace had effectively evaporated over night.  I was particularly concerned about jumbo loans since at that time the conforming loan limit (loans Freddie and Fannie buy) was $417,000, and most of my clients needed to borrow far more money in our “inventory restricted” housing market.  Our breakfast ended with Scott very puzzled and concerned and over the course of several months we exchanged emails as the enormity of the situation became clearer.

So what does this have to do with the Freddie Mac and Fannie Mae bailout costs rising?  Basically, it costs what it costs and we just have to accept that.  “No we don’t”, you might say;  “Uh, yeah you do and you’re going to like it” say I.  You see, without these two, now taxpayer owned behemoths buying mortgages, virtually no one would be able to buy or sell a piece of real estate in America.  Why? Because the banks would have run out of money to lend long ago.  Banks have to keep a certain amount of money in reserve – remember their money is really our deposits and they can’t lend it all in case we want to withdraw it.  Freddie and Fannie are single handedly keeping the housing market going in the U.S.  In places like China, there are a scant few housing loans and even with those, buyers can only borrow at 30-40% of the value, the rest is paid in cash.  In fact most in China still pay 100% in cash for property.  Can you imagine if that were the situation here?  How would you ever be able to buy or sell a house? 

That’s why I’m not worried by the headline and thank G-d that there is a Fannie and Freddie; that they raised their limits to $729,750 and that we continue to bail them out and ensure their solvency, because in doing so, we ensure our own solvency.  Without them we really might be back to selling pencils on the street corner.

If you’ve read my personal history from my website, www.1000OaksRealEstate.com, Facebook, LinkedIn etc., you know that I worked in new home construction, developement and sales for 14 years.  So a gauge I pay particular attention to is the National Home Builders Association Builder Confidence number.  This week’s number showed a 5% increase in positive sentiment.  “So?”, you ask?  To understand this significance, you first have to understand that Home Builders are all about the future.  They have to plan for the future by purchasing land, getting it entitled through the City or County, grading, infrasturcture, design and finally building permits – just to be able to start a home, which then takes months to build before a buyer can move in.  So when the builder’s see their fortunes are looking up, I take notice. 

We have been hearing (or wishing), for months that buyers should be buying because prices are down 30% and rates are down 30% to historic lows.   It’s been going on so long now, the words are almost hollow in meaning.  But here’s the connection to the NAHB confidence number: builder’s senitiment improves when they anticapate an improving market, an improving economy and ultimately a shortage of inventory.  Does any of this sound like our market?  You’re probably thinking, “No, we have millions of distressed properties and sellers and we won’t work through the inventory for years, and prices are still going to go down”.  Yet here are the builders thinking, “I better get ready to ramp up production” – why?

I have been saying for sometime, like so many economists, that I believe employment is the lynch pin for any recovery – duh… right?  But ask yourself this: once employment starts to improve, will people be more interested in buying than they are today?  Of course.  Once employment starts to improve, that means the economy’s improving (employment is a lagging indicator- or in other words, hiring takes place after the economy is getting better), so then, what’s the Fed going to do about interest rates?  Afterall, rates are almost zero and the Fed has been printing money like water to inflate us out of this recession… So they’re going to raise rates to counter inflation (just as China did yesterday to slow their 10% annual growth).  If there is improved employment, and the economy is strengthening, which inturn leads to increased demand for all goods and services including homes, and we have rising interest rates to counter inflation, would you say it’s fair to conclude that the result will be an increase in demand for housing as buyers rush in to buy before rates rise? Naturally, but here’s the rub: I believe when this starts, it will happen quickly, which in turn will absorb any unsold inventory and thus creating a shortage and then an expontential rise in home values.  This is why the NAHB’s builder sentiment number is so significant.  The builders are anticipating this very outcome.  Something else: builders, particularly in Southern California, have been underproducing units for our ever expanding population, many of whom are immigrant entrepeneurs buying the American Dream: a home for the first time.  This has been going on for several years, because demand has been so weak.  The the lack of substantial home production equates to shortages long term.  In our area of the Conejo Valley for example,  I think there are about 10 new homes a year being built – 10!

My conclusion is that when employment starts even a moderate improvement, and consumer confidence inches upward, the speed at which the housing market will correct, is going to be staggering, and I believe the NAHB agrees and is planning for it.

I had intended to devote today’s blog to the 3 most important words in real estate.  However in light of the sales numbers that appeared in the Los Angeles Times today, I’m going to comment on them instead (a blogger’s perogative)…

The headline of Alejandro Lazo’s article today is that sales fell 16%, median price up slightly.  To read that, you’d have to assume the sky is falling again in real estate. This kind of headline sells papers I guess, but given the decline in newspaper sales these days, perhaps a different approach might be warranted.  How about this headline: “Buyers and sellers at a standoff'”.  This is the real story. 

First the numbers:

Sales were off 16% from a year ago, but only down 2.4% from last month.  Notable yes, disasterous? No.  More numbers: Median prices rises 2.6% from August and 7.5% year over year.  Not bad.   So why this apparent contradiction?  Maybe slower sales are the result of the end of the housing credit, maybe tighter lending standards or maybe a simple matter of a difference of opinion.  But why then higher median prices?  The Times suggests a decline in REO property is the cause since foreclosures currently represent only 33.4% of the market today vs. 56.7% a year ago.  While this may be true, I tend to believe more higher end property sales are the root.  So a higher priced home then, is “pulling up” the market rather than fewer lower end homes a selling and “pushing down” the market.

The conclusion?  There is a stand off between sellers and buyers.  Just yestereday I had a convesation with a client who insisted a listing of mine was over priced.  She pointed to a model match sale last spring on a superior location, that sold for a lower price as being eveidence to her point.  I countered with half a dozen more recent sales that suggested it was priced correctly.  The result?  No offer.  My buyer client doesn’t agree and thus won’t open her wallet.  Conversely, my seller client, who has also just listed her property for lease by the way, doesn’t have to agree with the buyer either.  The result?  No sale.  So we are left with a chasm.  For some sellers, selling is the only option so they will lower their price until they find a willing buyer.  Others however, are opting to wait until the spring selling season when demand is stronger and prices firmer.  For buyers like mine, they risk missing historically low rates in the hopes of saving a mythical $10-20,000 from some other seller, yet since no two homes are the same, perhaps missing out on a home she really likes.   When I suggested she pass on this one and look for another, I only annoyed her.  She wants the seller to be realistic and reach the same conclusion she has and reduce the price so she can buy it.  But the seller won’t.  Alas in this scenario, both parties likely lose out.  On that note, I better end now – clearly I’ve got a couple of clients I need to try to talk off the cliff and bring together… wish me luck!